Price System: some assumptions

This randomly came up today and I got to thinking about when the price system is the best way to distribute things, I should mention that this is off the top of my head so it might not be a textbook complete answer. This is related to my other post about price gouging.

So the assumptions i’m going to talk about are going to be in order of ascending rarity: unequal utility; limited resources; limited wealth inequality; and rational people.

Unequal utility, this assumption is the easiest to meet, its hard to even think of a situation where utility is the same. This is because not everybody values things in the same way, even if its their life you are talking about, some people may be suicidal, whilst others might be willing to kill a hundred babies to live. The trick here is an element of perception of utility, one might perceive a higher or lower utility than the actual one he will get and that might distort things, but this is probably more relevant in the rational people section.

Limited resources, this is also fairly easy to assume, there’s never an infinite amount of resources. If you have an infinite amount of television sets available to people then they will maybe use the first 3 to watch 3 channels at once, maybe more if they handle more than that, then, the next couple will be for backup, then maybe you would like to use the next couple as chairs around the house, then the couple maybe for releasing stress by dropping them off the 7th floor. The point is that there is diminishing marginal utility from these televisions but since they are free you have no reason to stop getting them. Of course what matters is not whether or not the resource is infinite, but whether your access to it is infinite.

Limited wealth inequality is touched on in my last post but its also an important assumption. Relatively more money allows for relatively more leisure, if there is a heart for sale and someone only has 10 dollars and is willing to use it all to purchase this heard because his is about to expire. But someone else who is in fine shape whose heart is only 0.1% likely to fail him in the next decade but who has a trillion dollars, would maybe be willing to pay 1000 dollars to buy the heart and freeze it somewhere as insurance. Here excessive inequality has led to the item in question not being used to its highest utility.

I should mention that the wealth doesn’t have to be a liquid asset, even a house or future promises to achieve something, maybe even offering yourself up to be a sex slave, in this case even gender creates inequality, since if the vendor is a straight man, then females will have an extra option to exchange for the heart.

Rational people is in my mind the most far reaching assumption. This is because you might have people who use morals, religion, or have some other irrational mechanism with which they make decisions. There are many cases of people not adapting to their environment to offer up the service or product required to achieve their end means because of morals. You might be desperate for food and find someone selling a loaf of bread for 1000 dollars and think that he is ripping you off and so you decide to wait for someone cheaper to come along, without knowing if this cheaper vendor even exists.

Worse yet, even if there is perfect equality, and a given person x has a higher utility than everyone else and there is only a single unit of the product that will save him, and he knows that there is only one unit and only one chance to buy it(heck it could even be free), he might still decide to forego it due to religious reasons.

We must also assume rationality from the vendor’s side, although its perfectly rational to accept only cash if you don’t trust the people around you. If he does trust everyone to a good degree then he should be able to accept illiquid forms of cash as long as the time value of money is taken into account in the form of interest. It is also true that for the vendor to perfectly utilize the price system he must be able to analyze and calculate the perfect price for his product at any given time in order to make sure that he sells it at the highest price where it is going to be sold out. Even if you sell a bottle of water for 100 dollars, you would have been better off selling two for anything over 50, so its important to be able to price things as optimally as possible.

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Should feminists be suffering from existentialism?

Usually I don’t like him because he takes every chance he gets to jump on the “hate government bandwagon” but lets start with Thomas Sowell’s recent column anyway. He tell us what Ceteris Parabis is:

“The old — and repeatedly discredited — game of citing women’s incomes as some percentage of men’s incomes is being played once again, as part of the “war on women” theme.

Since women average fewer hours of work per year, and fewer years of consecutive full-time employment than men, among other differences, comparisons of male and female annual earnings are comparisons of apples and oranges, as various female economists have pointed out.

When you compare women and men in the same occupations with the same skills, education, hours of work, and many other factors that go into determining pay, the differences in incomes shrink to the vanishing point — and, in some cases, the women earn more than comparable men.”

Then lets move to this first paper here:

In 2003, a new law required that 40% of Norwegian firms’ directors be women—at the time only 9% of directors were women. We use the prequota cross-sectional variation in female board representation to instrument for exogenous changes to corporate boards following the quota. We find that the constraint imposed by the quota caused a significant drop in the stock price at the announcement of the law and a large decline in Tobin’s Q over the following years, consistent with the idea that firms choose boards to maximize value. The quota led to younger and less experienced boards, increases in leverage and acquisitions, and deterioration in operating performance.

Now on the the Bureau of labor statistics. On average women work less hours than men, men work 40 and women work 35 hours per week. So that’s another explanation of the mythical “gender wage gap”, you could try to argue that the dependent variable in the model should just be the earnings per hour, but it would not work because its natural that people who work more hours get the promotion. This study here also supports the BLS:

In our data, the median male physician with 10 years of experience works 11 hours per week more than the median female physician in our sample with 10 years of experience. Simply put, the majority of women physicians do not appear to work enough hours earning the physician-wage premium to amortize that profession’s higher upfront investments.

This is also backed by this study:

This paper documents and studies the gender gap in performance among associate lawyers in the United States. Unlike most high-skilled professions, the legal profession has widely-used objective methods to measure and reward lawyers’ productivity: the number of hours billed to clients and the amount of new-client revenue generated. We find clear evidence of a gender gap in annual performance with respect to both measures. Male lawyers bill ten-percent more hours and bring in more than double the new-client revenue. We show that the differential impact across genders in the presence of young children and the differences in aspirations to become a law-firm partner account for a large part of the difference in performance. These performance gaps have important consequences for gender gaps in earnings. While individual and firm characteristics explain up to 50 percent of earnings gap, the inclusion of performance measures explains most of the remainder.

Even though the equal pay act has existed since 1963, pressure from feminist groups continue to attempt to destroy equality. It was normal that women take a few decades to get close to men’s wages since even when you first passed the bill that didn’t suddenly bring women’s skills up to men’s standards, it had to take awhile. Yet this movement persists, earlier this year they tried to pass the “Paycheck fairness act” but thankfully the senate didn’t go for it.

If after all this time feminists have been masquerading equal pay under the veil of equal opportunity then I have a better approach for equal wages. Mandate women’s work hours to mirror mens hours! We also could try force the other sex to change, force men to work less hours!

Moving further up on the ridiculous scale: Women take some days off after giving birth, and even if parental leave is also a thing, the reality is women take more leave than men. So we could fix the wage gap by mandating all women to have abortions every time! Or biologically change men so that they can also have babies!

So there is no problem, meritocracy is at work, is it really a problem that women don’t prioritize wealth as much as men do?  I don’t think so. The market isn’t perfect but I have not seen conclusive aggregate evidence of market failure in this domain.

edit: here’s an interesting speech by Larry Summers on the topic http://www.harvard.edu/president/speeches/summers_2005/nber.php

Does Basel III make sense?

In the past couple of decades the sung mantra for deregulation has been overwhelmingly dominant yet today light touch regulation is shown to increase volatility in growth. With a new era of regulation taking place, perhaps the single most globally important measure is BASEL.  Although BASEL II was never fully fulfilled in the US, BASEL III is now in line to be implemented it’s important to understand the risk management mechanics of this series of regulatory implementations. BASEL aims to recommend to banks how to be solvent by creating a system that evaluates risk based on leverage and the rating of assets. The innovations of  BASEL III is that it introduces a buffer conservation which restricts shareholder compensation if the equity level is too low and a counter cyclical buffer which is an attempt at creating a more dynamic capital requirement which increases if the credit to GDP ratio rises. This is a great step in making BASEL more dynamic but as long as arbitrary static figures exist within it it’s likely to not be efficient.

It’s a romanticised notion that this is actually a policy which would reduce risk by limiting the amount of exposure allowed. However this can also be seen as a transfer of liquidity risk. From a retail banks point of view, the liquidity risk is passed to the citizen as he can now borrow less. The static figures of capital requirements also assume an excessive amount of knowledge as to how many good investments are really available, relying excessively on a top down approach measuring style of how much banks should lend. Additionally limiting leverage based on risk weight actually reduces diversification because it encourages investment in low risk assets as the number of low risk assets has not increased, this reduction in diversification could increase risk in the long run. This system also allows for an excessive amount of leverage if too many low risk assets are used. In the worst case scenario fruitful investment will not be undertaken and in the best case scenario predatory lending will decrease, having imperfect knowledge means at least one of these will occur.

However having risk weights also encourages banks to want to pass on the risks to other bearers who might not be optimal holders. For example holding mortgage-backed securities today on a balance sheet is a very expensive endeavour which encourages the passing of this risk. BASEL could have been the culprit behind the reckless behavior that caused the financial crisis since it indirectly encouraged securitization because of its ability to skip over capital requirements. This goes contrary to an optimal framework because to reduce risk on securitized assets the optimal practice is to keep them with bearers who have the most information about them, and the longer the chain of risk selling, the more fragmented and scarce on information on the product becomes. A more thought out policy would take measures to ensure that the holders of the risk were not too far from the entity whose risk they are holding. A more bottom up approach such as giving regulators guidelines on systemic risk is a much more potent way of controlling it. To boost regulatory performance, there should be incentives such as bonuses based on low systemic risk measurements to ensure there are parties actively pursuing the interest of taxpayers.

Economics vs Politics. Is free trade any good?

Economics experts fight over numerous of things, it’s the shame of the profession. The fact is that anything can be proven if you use the right econometric techniques, the right time-period and the right data set. So coherent theories are in fact in many ways more important than empirical evidence. Regardless of the dichotomy in economic debate there is at least one thing that would be in the economic bible and that is Free trade.

Free trade just means allowing products in and out of the country without imposing tariffs. The rationale for tariffs is that you want people to buy products that are made inside the country so that money stays in the country and develops the domestic industry. However from the consumer’s point of view, why should he/she care where the product is made? Since if even if the Japanese car industry thrives, they will export their great cars to your country and raise his/her standard of living. Whilst putting tariffs on their cars would either mean the consumer has to either accept a lower quality domestic car or accept to buy the Japanese car anyway at a higher cost, which either way reduces your standard of living because you either have an inferior product or because you have less dispensable income.

The part the Economics profession usually forgets is the politics aspect of tariffs. The reason you might not want to have free trade is if you believe instabilities between two countries will occur. You don’t want Japan to be providing all your cars for you because if they decide they no longer like you and want to go War with you, they can block all their products from coming into your country and helping you. Depending on how good the environment in the country is for setting up businesses, it is likely that either another country will provide the products or domestic industry will emerge, however if the Japanese industry was dominant chances are that your new supplier will not be as proficient, and depending on the product it could have devastating effects on the economy, such as if the product was food, that domestic workers tried to replace without enough expertise and end up selling toxic food.

So tariff’s are rationalized as a bargaining chip between governments, if you believe that relations with two countries are not likely to fall then then free trade is without doubt the route to go. This would probably be the US and Israel or Cyprus and Greece. So China making everything nowadays is not likely to be problematic, unless one believes that they might one day use it against other countries.