Economics in Action

Stephen Kinsella has kindly agreed to write a short article for us about his new book Quick Win Economics. This is a great book for those who want to explore economics in the context of daily life.

QUICK WIN ECONOMICS, Oaktree Press, 2011

Link to Book (€14.95)

Link to ebook (€4.95)

by Stephen Kinsella, Lecturer in Economics, University of Limerick.
http://stephenkinsella.net

Q: What is this book about?

Quickwin Economics looks at the 100 most common questions asked in
economics and gives short, commonsense answers, normally with a chart,
graph, or example to back these answers up. The emphasis is on rapid
understanding of the key elements of an idea, with links to further
readings, other important concepts, or real world examples given just
after every entry.

Q: Who is it for?

The book is written to be halfway between a Wikipedia entry and a
textbook. It portrays economics as an unfinished conversation rather
than a canon of knowledge. Economics as it exists today is as full of
contradictions as it is full of promise and insight. Readers will get
a sense of this from the book.

Q: Can you give us a feel for the book?

Sure. Here’s something I wrote for the book about Monetary Policy.
It’s an extra entry, but you’ll get the idea of the book right away.

Q: Can the government manage the economy through monetary policy?

Monetary policy is a set of tools that governments use to control the
levels of spending in an economy. By setting interest rates and
reserve rates on levels of funds that banks must have to meet
withdrawals, by buying and selling government-backed securities, by
deciding how much money to allow into circulation, and by providing
credit to private banks, central banks use the instruments of monetary
policy to try and keep the economy ‘on track’.

So, if the economy is in a slump, central banks can reduce the
interest rates at which they lend money to private banks, allowing
private banks to lend more cheaply, so increasing the amount of credit
in the productive parts of the economy, because banks lend more to
more people, and the economy gets stimulated.

If the economy is going ‘off track’, and inflation is rising as a
result, then the central bank can increase interest rates to private
banks, making loans more expensive, and ensuring the economy stays ‘on
track’, that is, close to its potential output.

If the central bank wants to reduce the money supply, it can start
selling long-dated bonds to the public (usually via private banks and
lending institutions), which buyers pay for by using their deposits of
cash. Banks thus have less money on their books to lend with, and so
the volume of lending drops, followed (in theory) by a drop in
productive activity in the real economy.

Monetary policy is not a science, but rather an art – and does not
always work as intended. In an era of globalised money, the inflows
and outflows of currency make operating a domestic monetary policy
extremely difficult, even for a large country like the United States.
There are many other difficulties besides, including lags between the
setting of monetary policy in a central bank, and its effect on the
real world, and the existence of financial ‘innovation’, where private
banks and lending institutions produce ‘new’ and unregulated financial
products, which make the imposition of credit controls very difficult,
if not impossible.

From assessing entries to the Economics Network Student Challenge 2011, we have found out that economists are very talented people. They create music, write poems and draw cartoons. More importantly, they can use the power of words to address the most worrying problems in the world, such as hunger and poverty. This is what our runner-up Anu Omotunde-Young (Lancaster University) did this year. Below is her poem about her home country Nigeria with explanation of why studying Economics can help solve all problems there.

WHY STUDY ECONOMICS AT UNIVERSITY?

Her wrinkled, tired face turned to me:

No Roads; No Light

Where is the light at the end of the road?

No Income; No Food

Who am I to want food when my family starves from having no income?

No Hospitals; No Safety

When will it be safe enough to survive in our hospitals?

No Water; No Strength

Do I not need strength to lug water home from the town well?

No Education; No Future

What will the future of my offspring be when I leave them with no basic education?

No Leadership; No Inspiration

How can my children be inspired with no one to genuinely lead?

No Home; No Consideration

Why should I consider the consequences of my actions when I was left with no home?

How can you care? What can you do?

You are only one out of a 150 million others.

I can start by caring enough to want change,

I can start by admitting we have a major problem,

I can start by learning the accumulation and maintenance of wealth.

Mother!

For you, I learn about sustainable development.

For you, I learn the difference between money and wealth.

For you, I learn how I can generate income and growth using our very own resources.

For you, I learn the components needed for a free market,

For you, I learn about Public Goods and can tell you that you deserve access to healthcare, education, water and shelter.

For you, I stay up all night reading and applying the mechanisms that help boost Investment and Savings.

With this, I propose economic growth that will take you a step further towards that essential job you want.

For us, I do a degree that gives me the skill and passion to make our motherland prosperous.

For us, I work towards being the change we need

In a country filled with abundant natural, human, physical and mental resources such as Nigeria, extreme poverty still outweighs the abundance of wealth. Poverty as mentioned does not occur mainly from the lack of resources but from the unequal share of wealth amongst citizens of a proud nation like Nigeria. The wrinkled, tired woman mentioned in the poem represents the average mother in Nigeria who has no choice but to be strong and extremely hardworking to put food on the table and keep a roof over her family’s heads. Nigeria is the 5^th largest oil-producing country in the world and yet over 50% of its inhabitants lack basic water supply, affordable and efficient health services, roads, education and many other basic goods. Nigeria’s economic failure to develop is primarily attributed to its domestic market imperfections, economic inefficiencies, and social rigidities. Political corruption, a parasite social and bureaucratic structure, and the failure to make appropriate Investment in education, agriculture and other prerequisites for economic development restrain the nation.

As a Nigerian student lucky to be born in an averagely comfortable home, I was only made aware of the seriousness of Nigeria’s economic imperfections when as a teen my Father took me to a less developed area in the business capital city of Lagos [areas normally termed the Ghetto] called Ajegunle, and was shocked at the living conditions imposed on the less privileged. This made me aware that life was not all rosy and thus from that moment on, I made a pledge to myself and my fellow countrymen- to do my bit as a citizen of the country to help fully develop the country to a favourable standard. At this time, I was just about to enrol into the upper Secondary School level where I had made plans to take subjects that were intended for a career in creative writing or journalism, however after that experience, I started to read on politics and economics and thus found I had a higher interest in these topics; this made me take these subjects at school and ever since it has been my focus of study till now, and will definitely be for the next few years. The first half of the poem in literary terms depicts the thoughts and fears experienced by the average Nigerian parent on the future of their offspring; the second part is a form of revelation that shows that change can come from the littlest of things, meaning change happens not by thoughts alone but by actions; the third part of the poem substantiates this and shows how in my own way, I am working towards making that change.

Here is the winning rap from Joevas Asare (University of Surrey).

Economics Network Student Challenge 2011 Winning Entry

Following my last post, I have been given a great article by Peter Sozou and Robert Seymour (titled “Costly but worthless gifts facilitate courtship“) about the application of game theory in relationship issues. This unconventional article on game theory shows the great power economists have to solve social problems. It is free and worth reading if you are keen on studying game theory.

And apparently, intrinsically worthless gifts (e.g. an engagement ring?) are great signals.

So, one week of micro basic game theory revision can drive you to the edge of insanity… Talking to certain people about their love problems has definitely pushed me over that edge. Here is my analysis of love as a dynamic game of imperfect information. Enjoy!

THE SETUP:

I will base my analysis on a simple two-players model, which can be extended to create love triangles, quadrangles, etc… We have players A and B, who have concave utility functions, and hence are both risk-averse (i.e. they prefer certainty over an uncertain prospect). People are risk-averse to different degrees, and this will affect the payoffs each player faces, and as a result, the way the game is played. In this game, I will assume that both players are very risk-averse (which is true in most cases). Both players are trying to maximise their payoffs.

Firstly nature chooses whether player A will like player B (we have an information set). The subjective probabilities (something B may believe in) that A likes B and A does not like B are p and (1-p) respectively. This probability will affect the final equilibrium as shown later. Player B really fancies player A, but does not know whether player A will reciprocate. Player B has two strategies: profess and not profess his/her love. Player A’s action is to reciprocate or not reciprocate. However, player A will only reciprocate if nature has made him/her like B and vice versa, i.e. A cannot determine whether he/she will reciprocate. Each player’s payoff will depend on where player B is in the game, and what he/she chooses to do. The potential payoffs are as follows:

1) Player A reciprocates and player B professes: A gets 20 and B gets 20 (both players end up happily together, yay!!!).

2) Player A reciprocates and player B does not profess (sad times hah?): A gets 0 (he/she will never find out that he/she could have been a lot happier, but this can not be treated as a loss either) and B gets -10 for being an idiot (a rational fool) and not professing.

3) Player A does not reciprocate and player B professes (the worst thing ever right?): A gets -10 because suddenly he/she is facing an incredibly awkward situation, which clearly causes a lot of distress (like you need to be nice to that other person, explain why you will not reciprocate blah blah blah), B gets -100 for taking the risk whilst being so risk-averse (in other words for being an irrational fool). This is the most embarrassing scenario for both players.

4) Player A does not reciprocate and player B does not professes (a really boring scenario): A gets 0 again for very similar reasons (the lack of knowledge means he/she will never find out that he/she could have been a lot more stressed), B gets -5 for being a rational fool again (he/she will forever question whether A would have reciprocated).

It is probably easier to see the payoffs if you just draw the normal and extensive forms of the game.

POSSIBLE EQUILIBRIA:

Note that there is no strictly dominant strategy in this version of the game due to player B being very risk-averse.

We now look at best responses. It is pointless trying to look for A’s best responses because whether he/she reciprocates is decided by nature. Thus, we look for B’s best responses:

Best response for B given A reciprocates = profess.

Best response for B given A does not reciprocate = not profess.

Thus, we have two equilibria: (reciprocate, profess) = (20,20), (not reciprocate, not profess) = (0,-5). These are not strictly Nash’s equilibria as A’s action is predetermined by nature. Clearly though, the first equilibrium brings more utility to both players.

THE EASIER SOLUTION (i.e. under perfect information):

If we have a third party to provide (signal) player B information about his/her position in the game, then the game is pretty straight forward. Player B, knowing at which node he/she is, will be able to make the best decision for himself/herself. There will be two Nash equilibria. If player B knows that player A will reciprocate, then he/she will profess, making both players happy. On the other hand, if player B knows for sure that player A will not reciprocate, he/she will not profess and avoid the potential embarrassment. This happens sometimes (as I have seen recently), but most of the time people are in the dark about whether the other person like him/her or not.

THE SOLUTION UNDER IMPERFECT INFORMATION:

There are no mixed strategies in this game as player B can profess only once. However, it is probably possible to have mixed strategies if signalling is introduced. Since B knows nothing about A’s feeling, he/she will have to form expected utility from professing and not professing:

E [U(B)/B professes] = 20p – 100(1-p) = 120p – 100

E [U(B)/B does not profess] = -10p – 5(1-p) = -5p – 5

In order for B to profess, the first equality must be greater than the second. Basic calculations give that p must be greater than 0.76. However, remember what I said in the beginning about p being a subjective value and B being very risk-averse, most people will not say that the probability that someone likes them is that high (unless they have better knowledge after interacting).

SIGNALLING?

Signalling in this game can be slightly more complicated as after player B sends a signal, player A will likely send a signal back, and both players will have to form beliefs functions. Sending a signal can incur costs (say buying flowers and presents or trying to look more physically attractive) or no costs (just showing affection). The signal also may or may not increase the probability that player A will reciprocate player B’s feeling. This is probably too difficult for me to analyse right now, so I will leave this for another note in the near (indefinite) future.

MORE PLAYERS?

We have never done anything like this in the lectures, and my brain is melting… so I will go and write a blues on my piano! But I hope that everyone has seen that love is a really complicated game because people are just rational fools!

Have you ever wondered what studying Economics at university will be like? If yes, then we have some exciting answers for you. Furthermore, it is not in writing. You probably can read a lot about studying Economics in university guides, but we reckon there is no better way to find out than listen to what students themselves have to say.

We have asked Eoghan, an undergraduate at the University of Bristol, to interview students about their experiences since coming to the university to study Economics. The videos he produced give great insights into the lives of typical Economics undergraduates. Hopefully, they will help you the final decision to apply for Economics at university.

Videos

Warwick Economics Summit is an annual event organised entirely by students from Warwick University. The three-day event sees students from across the world come together to exchange ideas and listen to some of the most prominent modern economists talking about current economic problems in the world. This year’s summit has been attended by students from as far as USA, Brazil and Slovenia.

On behalf of the Economics Network, I attended the event on the second day to promote our Student Challenge as well as the two websites I am working on. Needless to say, I was very impressed with the quality of the student team that organised the event (despite some initial hiccups with booking tickets). Everyone was very friendly and helpful, and I instantly felt welcomed. It was clear that everyone put in lots of effort to make the summit a success.

I decided to go to few talks myself. Perhaps, the most interesting for me was the talk given by Nick Leeson – a former derivatives broker who went to prison for his fraudulent activities (his autobiography was made into a film starring Ewan McGregor). After that I went to one of the many seminars, which I easily signed up for using the form on their website.

Unfortunately, being a busy student meant I could not attend all other exciting events organised by the summit team, which included several networking sessions with sponsors and the amazing Masquerade Ball. Nevertheless, the summit left a big impression on me.

Finance and Stability talk by Andy Haldane

This is a very interesting article on education in America from the NY Times. It questions whether access to higher education can be solved on a meritocratic basis. Perhaps, we could draw analogies with what is happening in the UK.

http://economix.blogs.nytimes.com/2011/02/18/why-does-college-cost-so-much/

This post is essentially an extension to my continuing flirtation with game theory and its real-life application.

As our society advances, we have to deal with the consequences of our previous actions. Environmental problems that resulted from unsustainable usage of limited resources on Earth is a prime example of this. Governments and international bodies now put a lot of effort into addressing this issue. The focus has been placed on raising awareness, and it has certainly become somewhat of a social trend (think about the movie Avatar). The question is whether giving people information alone will be enough. Will the knowledge motivate us to act?

It probably will in most cases… assuming everyone has the same moral standard (or can be succumbed to peer pressure). Supposedly moral individuals will act to protect the environment (at the cost of their present material benefits) because they care about the future generations, self-preservation and anything that is morally right. From the game theory perspective, their payoffs from protecting the environment is higher than from not protecting. However, people are different, and we cannot just assume that everyone will behave in a moral for us way. In the end, a person does not have to care about the future if he thinks he has no stakes in it. He will rather use the most of what he can access now and get a higher payoff from polluting. We can call him a selfish moral monster and humanity might become extinct because of his behaviour, but he will be dead by then anyway and does not care. This possibility is very difficult to accept.

Nevertheless, game theory allows this to happen. Game theorists are not concerned with the motives behind each individual action, they care only about the fact it has been chosen (hence must have given a higher payoff). Perhaps, this makes it easier for them to predict all possibilities and incorporate all types of behaviour. Given this, what can we do to protect our environment? In academic circles, the Tragedy of the Commons has been used for a long time to illustrate what will happen if we use resources unsustainably. However, not many focus on the actual solution to the problem, they clearly thought that showing people the problem is enough. We need to rely on something more than people’s morality. Mechanism Design is a branch of game theory that deals with this. It tries to change the conditions of the game in such a way that polluting will directly affect everyone negatively at present. This will in turn prompts each individual, no matter how moral he or she is, to act in the desired way for us.

John Lennon’s famous song Imagine is about the perfect utopian society, which in many sense is a communist society. It is the society most of us dream about. The idea of sharing resources responsibly is so great, but at the same time so unobtainable. However, game theory might just give us a clue on how to solve existing social problems and make little steps towards that imaginary perfect society.

John Lennon – Imagine

My colleague Martin sent me a rather interesting link to EDGE World Question Centre 2011. I found two particular articles on Positive-Sum Games and The Law of Comparative Advantage interesting. Below are the links to them:

http://www.edge.org/q2011/q11_2.html#pinker

http://www.edge.org/q2011/q11_2.html#evans

Hope you all enjoy reading this