Friday, 21 July 2017

Health economics and the economics of education in introductory economics

Sometimes it's good to receive some affirmation that what you're teaching is also taught in a similar way, and at a similar level, at top international universities. In the latest issue of the Journal of Economics Education, two of the articles have demonstrated to me that the material I teach in the health economics and economics of education topics in ECON110 is current best practice.

In the first paper (sorry I don't see an ungated version), David Cutler (Harvard) writes about health economics:
Health care is one of the biggest industries in the economy, so it is natural that the health care industry should play some role in the teaching of introductory economics... The class that I teach is an hour long...
In his hour-long class, Cutler covers medical care systems, the financing of medical care, and the demand and supply of medical care. In ECON110, I have a whole topic (three hours of lectures, and two hours of tutorials) devoted to health economics, and we cover the peculiarities of health care as a service (peculiar due to derived demand, positive externalities, information asymmetries, and uncertainty), cost-minimisation/cost-effectiveness/cost-utility analysis (including consideration of expected values to deal with uncertainty), the value of statistical life and cost-benefit analysis, and health systems. Obviously I can cover more ground because I have more time available, but it's good to see that the things that Cutler covers at Harvard are part of my topic.

Similarly in the second paper (also no ungated version), Cecilia Elena Rouse (Princeton) writes about the economics of education:
There are many aspects of the “economics of education” that would make excellent examples for introductory economics students... I chose two related topics that are central to the economics of education and to human capital theory: the economic benefit (or “returns”) to schooling and educational attainment as an investment.
Again, those sub-topics that Rouse identifies are part of the ECON110 topic on the economics of education. In that topic, we cover human capital theory and the private education decision (including introducing the concept of discounting future cash flows), the public education decision (including consideration of the optimal subsidy for education, and dealing with credit constraints). Recently, I've also been discussing the economics of MOOCs (Massive Open Online Courses).

Both papers gave me a few small points to follow up on, but overall it looks like the fact that Harvard and Princeton teach similar topics in a similar way is a good sign of the ongoing quality of the ECON110 paper.

Wednesday, 19 July 2017

Why fire protection is (or was) a club good

Goods and services can be categorised on two dimensions: (1) whether they are rival, or non-rival; and (2) whether they are excludable, or non-excludable. Goods and services are rival if one person’s use of the good diminishes the amount of the good that is available for other peoples' use. Most goods and services that we purchase are rival. In contrast, non-rival goods are those where one person using them doesn’t reduce the amount of the good that is available for everyone else. Listening to the radio is a non-rival good, since if one person listens, that doesn't reduce the number of other people who can also listen.

Goods and services are excludable if a person can be prevented from using or benefiting from them. In other words, there is some way to exclude people from using the good. Often (but not always), the exclusion mechanism is a price - to use the good or service you must pay the price. In contrast, non-excludable goods are available to everyone if they are available to anyone - there isn't a way of excluding people from using or benefiting from the good or service. A fireworks display is non-excludable. If you let off fireworks, you can't easily prevent other people from seeing them.

Based on those two dimensions, there are four types of goods as laid out in the table below.

I want to focus this post on club goods - goods (or services) that are non-rival and excludable. With club goods, often the exclusion mechanism is a price - you have to pay the price in order to be a part of the club (and receive the benefits of club membership).

Some goods or services that are categorised as club goods may be contentious. For instance, according to the table fire protection is a club good - it is non-rival and excludable. Provided there aren't large numbers of fires, if the fire service attends one fire, that doesn't reduce the fire protection available to everyone else [*]. So, fire protection is non-rival. Is fire protection excludable? In theory, yes. People can be prevented from benefiting from fire protection. Say there was some sort of fire service levy, and the fire service decided to only respond to fires at homes or businesses that were fully paid up. For the same reason, tertiary education is also in many cases a club good. [**]

I always thought that fire protection as a club good was purely a theoretical case, but this recent Mac Mckenna article notes:
Since 1906 the Fire Service has been universally available to all New Zealanders. Prior to then, the Fire Service was run by insurance companies to mitigate loss. Firefighters would only respond to save houses which had a red rock outside showing the owners had fire insurance cover.
I was a bit surprised by this piece of history, and I haven't been able to confirm it from another source. But it does demonstrate how fire protection at one point was excludable in more than just the theoretical sense, and therefore it was at that time a genuine club good.

However, in practice the government chooses not to exclude any home or business from fire protection, making it non-excludable, and therefore a public good. Of course, non-excludability comes with problems such as free riding (where a person benefits from the good or service without paying for it). As Mckenna notes, by funding the Fire Service by levying only those who take out insurance, the insured will be subsidising the free-riders who choose not to take out insurance.


[*] Of course, in a large-scale disaster, or in summer when there are large forest or bush fires burning, this may not be true.

[**] Tertiary education is a club good provided it is non-rival. For most university and polytechnic courses, this is the case. However, some courses have limited spaces and in the case of those courses tertiary education is a private good (rival and excludable).

Tuesday, 18 July 2017

Caramilk arbitrage and the endowment effect

As 1974 Nobel Prize winner Friedrich Hayek noted, markets allocate goods to the buyers who value them the most, since those are the buyers who are willing to pay the most for them. So, consumers who purchase the good at a low price, may be willing to give up their purchase in exchange for more money from those who value the good more.

Having said that though, the endowment effect doesn't make Hayek's observation automatic. Quasi-rational decision makers are loss averse - we value losses much more than otherwise-equivalent gains. That makes us are unwilling to give up something that we already have, or in other words we require more in compensation to give it up than what we would have been willing to pay to obtain it in the first place. So if we buy something for $10 that we were willing to pay $20 for, we may choose not to re-sell it even if someone offers us $30 for it.

We've seen a graphic example of both of these effects (goods flowing to the buyers who value them the most, and endowment effects) this week, as Newshub reports:
Ever since Cadbury relaunched its iconic Caramilk chocolate in New Zealand last month, our Aussie neighbours have been desperate to get in on the action.  
The chocolate, a solid bar which is a blend of caramelised white chocolate, was a '90s classic, and appeared back on supermarket shelves around New Zealand at the end of June. The limited edition product is a New Zealand-only release and isn't available in Australia.
Now some clever Kiwis have cottoned on to the demand across the ditch and are putting Caramilk blocks on Ebay Australia for Aussies to buy.
And it turns out they're willing to pay quite a bit.
One auction, which closed early on Monday afternoon (NZ time), saw 19 bids for one $3 block, which eventually sold for AU$40 (NZ$42.64). release and isn't available in Australia.
Savvy New Zealand chocolate buyers have been snapping up Caramilk chocolate for a low price in New Zealand, and promptly on-selling the bars to Australians for a higher price (this practice of buying in a low price market and re-selling in a high price market is known as arbitrage). However, in order to overcome the endowment effect, the price must be high enough to induce them to sell and overcome the endowment effect. But NZ$42 can buy a lot of alternative chocolate!

Eventually though, greater quantities of Caramilk being offered to Australians will leave only those Australians with lower willingness-to-pay for it unsatisfied, and the auction prices will fall. Once the buyers who are willing to pay $42 have their chocolate, that only leaves buyers willing to pay $40, and once they've got their chocolate that only leaves buyers willing to pay $38, and so on. So if you're thinking of trying to take advantage of this arbitrage opportunity, you'd better get in fast.

[HT: Memphis from my ECON100 class]

Monday, 17 July 2017

The optimising behaviour of Italian bank robbers

One of 1992 Nobel Prize winner Gary Becker's many contributions to economics was the development of an economic theory of crime (see the first chapter in this pdf). Becker argued that criminals, like other rational decision-makers, weigh up the costs and benefits of their actions, and will take the action that offers the greatest net benefits. That assumes we are talking about a discrete decision (a yes or no decision) based on incremental benefits and incremental costs. The benefits of crime include the monetary gains, and any 'rush' associated with committing the crime. The costs include any punishment that might be received, conditional on the probability of being caught (and convicted).

However, not all criminal decisions are yes/no type decisions. That is, not all decisions are made on the extensive margin. Some decisions are instead made on the intensive margin, such as how long to spend inside a bank while committing a robbery. The trade-off here is that the longer a criminal spends in the bank, the greater their haul of loot, but also the greater the risk of the police arriving and the criminal being caught. When a question is about the optimal amount of something (e.g. the optimal amount of time for the bank robber to spend in the bank), a rational decision-maker will optimise at the quantity where marginal benefit is equal to marginal cost. In this case, that will be whatever time in the bank where the last minute spent there equates the additional loot collected with the disutility (the negative utility) of being caught and punished.

In a recent discussion paper, Giovanni Mastrobuoni (University of Essex) and David Rivers (University of Western Ontario) exploit this equality using data on nearly 5,000 bank robberies in Italy, to estimate the disutility of imprisonment. Their dataset is quite rich and, while it doesn't include data on the robbers, it includes a lot of data about the robbery including, crucially, the exact duration of the robbery (which is often able to be confirmed using CCTV camera footage). They find that:
...the most successful robbers in terms of hauls use weapons, wear masks, and rob banks with fewer security devices and no guards. Those who work in groups, wear masks, target banks around closing time, and target banks with no security guards and few employees, achieve lower rates of apprehension. Offenders who use a mask and target banks without security guards have higher disutilities of prison. Robber ability is also found to be a strong driver of larger hauls, lower probabilities of arrest, and larger disutilities of prison. The latter finding is consistent with higher ability offenders having a larger opportunity cost of prison.
That latter finding is most interesting. Higher ability offenders tend to earn more from crime (and possibly have better earning opportunities outside of crime as well). So, the foregone earnings (from crime or otherwise) are higher for these offenders if they are imprisoned, which explains their higher opportunity cost of prison and their higher disutility of prison. The other results are mostly unsurprising. Mastrobuoni and Rivers also find that:
...heterogeneity in robber ability generates a positive correlation between criminal harmfulness and disutility. An importance consequence of this is that policies designed to affect those with higher disutilities of prison (for example simply raising overall sentences) have the added benefit of disproportionately targeting the more harmful (higher ability) offenders.
What that means is that the offenders who create the most harm (by being least likely to be caught, and generating the greatest hauls of loot) are also those with the greatest disutility of punishment. So, increasing the punishment for bank robbery would disproportionately deter the highest ability criminals, and have a large effect on reducing bank robberies. Whether the benefits to the state of greater punishment (less bank robbery) exceed the costs (more prisoners who cost money to house and feed) is not considered in the paper. However, for Italy it may well be the case, since:
Each year there are more bank robberies in Italy (approximately 3,000) than in the rest of Europe combined, with a 10 percent chance of victimization on average (there are about 30,000 bank branches).
Over the period 2000-2006, on average 8.7 percent of Italian banks were robbed each year. That compares with 2.2 percent in New Zealand (and a surprising 14.1 percent in Canada!). So, even if the benefits of greater prison terms for bank robberies exceed costs in the case of Italy, they may not do so for New Zealand.

[HT: Marginal Revolution]