Cartoon Micro page notes

Additions or edits welcome! For information about PPTs for use in class, please email me using your school email address. For more information on this book please visit the Volume One: Cartoon Micro homepage. For more on the companion volume, visit the Volume Two: Cartoon Macro homepage, or go direct to the page notes website for that book.

Chapter 1: Introduction (pages 3-14)

Summary in haiku form

Individuals,
Each doing what’s best for them.
Is that good for all?

Summary in one paragraph

Economics is about the actions and interactions of optimizing individuals. These individuals are simply trying to satisfy their own preferences—they are not just selfish jerks, and economics is not just about money—and the Big Question in economics is about what a world full of optimizing individuals looks like. Sometimes that world looks heavenly: individual self-interest leads to good outcomes for the group as a whole, as expressed in the metaphor of the Invisible Hand. But sometimes individual self-interest leads to bad outcomes for the group as a whole, as in the case of traffic congestion or other instances of the Tragedy of the Commons. We’ll see plenty of examples in the chapters ahead as we build up from individual optimization (decision theory) to strategic interactions between individuals (game theory) and finally to market interactions between many individuals (price theory).

Notes on specific pages

Page 4, “The only reason I don’t sell my children is that I think they’ll be worth more later”: Here’s a compendium of similar “you might be an economist if…” jokes.

Page 4, “The main assumption in economics is that every single person is an optimizing individual”: It’s difficult to overstate the importance of this assumption. If individuals are optimizing, for example, we can abolish Social Security because rational individuals will save for their own retirement. Few people are willing to push the idea of optimizing individuals to this sort of logical extreme: even many “libertarians” want to privatize Social Security, not abolish it; but the alternative to the idea of optimizing individuals (that people are not optimizing individuals and that other people—in the guise of the government—know what’s best for them) is not all that appealing either. This choice between the frying pan and the fire creates one of the central tensions in economics.

Page 9, Macroeconomics versus microeconomics: The “9 out of 5″ line is adapted from Paul Samuelson, who in 1966 wrote that “Wall Street indexes predicted nine out of the last five recessions!” Samuelson won the 1970 Nobel Prize “for the scientific work through which he has developed static and dynamic economic theory and actively contributed to raising the level of analysis in economic science”. The “wrong about specific things” line from PJ O’Rourke is adapted from his book Eat the rich: A treatise on economics (1999).

Page 11, The tragedy of the commons: It’s better to wait on this until we return to the topic in Chapter 8, but “The tragedy of the commons” (easier to read in PDF) refers to a 1968 article in Science by Garrett Hardin.

Page 12, “I, Pencil”:I, Pencil” is a must-read fairy tale by Leonard Read about the miracle of the invisible hand. Originally published in The Freeman in 1958, the work is often mis-attributed to Milton Friedman, who retold the story in Free to Choose and wrote the afterward in this 50th-anniversary PDF of “I, Pencil”. (Friedman won the 1976 Nobel Prize “for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy.”) A good compare-and-contrast article with “I, Pencil” is “Health care that works” by Nicholas Kristof (NYT 9/2/09). Note that they both talk about the postal service!

Page 12, Hot dogs: See interesting articles like “Ovens on Feet Beckon Germans to Bratwurst”, “The Half-Million-Dollar Wiener”, “A Prominent Collection at the Met: Food Carts”, and “Dispute at the Met Escalates as the Police Ticket Seven Food Vendors”.

Page 13, The invisible hand: Adam Smith was a Scottish philosopher and “the father of modern economics”. The metaphor of the “invisible hand” comes from The Wealth of Nations, first published in 1776. (You can still buy it today, and though not always a page-turner it’s remarkably readable.)

Chapter 2: Decision Tree (pages 15-26)

Summary in haiku form

Pick the best option
From among all your choices.
What’s hard about that?

Summary in one paragraph

Optimizing individuals look at all their options and pick the best one. We can learn about individual optimization by using decision trees to see, e.g., that sunk costs—which appear in all the outcome boxes—cannot be the sole basis for a decision. Although companies are actually collections of individuals, each with their own goals, economists often assume that companies act like individuals whose goal is profit-maximization.

Notes on specific pages

Page 21, Marginal analysis: “Marginal” means thinking about one more or one less, so the “marginal benefit” from a few more minutes of fishing is the extra benefit from those few additional minutes; the “marginal utility” of one more dollar’s worth of apples is the extra utility (i.e., pleasure) from spending $13 on apples instead of $12; and the “value of the marginal product of labor” is the extra amount of revenue a firm can get from hiring one more unit of labor (e.g., one more hour’s worth of labor).

Page 22, Pirate economics: The expert on pirate economics is Peter Leeson, author of The Invisible Hook: The Hidden Economics of Pirates (2009) as well as papers such as “”Pirational choice: The economics of infamous pirate practices” and this interview he argues that pirates were (and are) “economic actors, businessmen really” and that this explains why real pirates didn’t make people walk the plank (!).

Page 22, Principal-agent theory: Principal-agent theory looks at the incentives involved when an employer (the principal) is dealing with an employee (the agent), or similarly when stockholders are dealing with company managers. Since the incentives of the agent may not match those of the principal, the challenge is for the principal to design an incentive structure that gives the agent appropriate incentives to act in accordance with the principal’s goals. (For example, an employer could pay an employee on commission.)

Page 24, On drug companies: See “Questcor Finds Profits, at $28,000 a Vial” (NY Times, Dec 29 2012). Also “Drug Firms Face Billions in Losses in ’11 as Patents End” (NY Times, March 6 2011).

Page 26, “Higher prices don’t always lead to higher profits”: In 2009 tech columnist David Pogue wrote about the Apple “App Store Effect“, claiming that “if you cut a software program’s price in half, you sell far more than twice as many copies. If you cut it to one-tenth, you sell far more than 10 times as many. And so on.”

Chapter 3: Time (pages 27-38)

Summary in haiku form

A tricky question,
Today versus tomorrow.
Use present value.

Summary in one paragraph

Optimizing individuals often have to make choices over time, e.g., between money today and money tomorrow. These cannot be directly compared because of inflation and also because most individuals have a preference for sooner rather than later. In order to compare money today and money tomorrow we can use the interest rate at the bank to convert everything into a common unit: present value, the amount of money you’d need to put in the bank today in order to finance one or more payments in the future. We can use the concept of present value to find a “money today” equivalent for future payments received as lump sums, annuities, or perpetuities, with the surprising conclusion that a perpetuity—a perpetual stream of annual payments, e.g., $100 a year forever—is not worth an infinite amount of money.

Notes on specific pages

Page 32, “Present value is the value today of one or more future payments”: Fine examples of present value can be found in the 2009 Social Security Trustees Report or the 2009 Medicare Trustees Report. These are giant documents, so just search for the phrase “present value” until you find the sections about how the present value of the 75-year deficits (i.e., the amount required to keep these programs solvent for the next 75 year) are $5.3 trillion for Social Security, $13.4 trillion for Medicare HI (hospital care), $23.2 trillion for Medicare Part B (out-patient) and $9.4 trillion for Medicare Part D (prescriptions drugs). (If you think these are big numbers, consider the “infinite-horizon” deficits, which are $15.1 trillion for Social Security, $36.4 trillion for Medicare HI, $50.1 trillion for Medicare Part B, and $20.3 trillion for Medicare Part D.) For a summary of the status of Social Security and Medicare, scroll down to Charts B and C in this summary from the Social Security and Medicare Boards of Trustees. You can also look in the glossary at the end of these reports to get their definition: “Present value. The present value of a future stream of payments is the lump-sum amount that, if invested today, together with interest earnings would be just enough to meet each of the payments as it fell due. At the time of the last payment, the invested fund would be exactly zero.” Note that they’re assuming investments in U.S. government bonds, which as the safest investment in the world also have the lowest interest rate.

Page 30, “Inflation, a general increase in prices over time”: The U.S. Bureau of Labor Statistics has an inflation calculator that you can use to look at the Consumer Price Index (one measure of inflation), and there’s an optional chapter in the textbook on inflation, but remember that even without inflation there is still a positive interest rate because people have a preference for sooner rather than later!

Page 35, “You can still blow it all today even if you take the annuity”: Google “sell annuity” and you’ll find dozens of firms eager to pay cash upfront in exchange for annuities or other “structured payments”.

Chapter 4: Risk (pages 39-52)

Summary in haiku form

Should I risk a fine?
Or feed the parking meter?
Expected value.

Summary in one paragraph

Optimizing individuals also have to makes choices about uncertainty, e.g., whether to buy insurance or whether to go gambling. An important concept is expected value, which can be thought of as the average outcome of a risky situation. If you want to get formal about it, the Law of Large Numbers says that repeating a bet a large number of times is likely to produce an average outcome close to the expected value; this explains why casinos and insurance companies are not necessarily risky businesses. Expected value calculations also demonstrate the problem of adverse selection: when buyers and sellers don’t both have the same information—for example, consumers who know more about their health than insurance companies—the resulting information asymmetry can lead to an outcome where individual optimization does not lead to good outcomes for the group as a whole.

Notes on specific pages

Page 40, “Optimizing individuals can have one of three different attitudes about risk”: We’ll return to the topic in Chapter 16, but Daniel Kahneman shared the 2002 Nobel Prize (with Vernon Smith) “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.” (Basically, Kahneman and co-author Amos Tversky—who would almost have shared the prize had he lived long enough—showed that people don’t really act like optimizing individuals, e.g., they treat small losses as “more important” than small gains.)

Page 41, “Why is he winning so much? He owns the casino!” A fun read here is “Casinos have great night” (The Onion, May 28, 2003).

Page 47, James Tobin and the theory of optimal investments: Jim Tobin won the 1981 Nobel Prize “for his analysis of financial markets and their relations to expenditure decisions, employment, production and prices.” The jokes about “Congratulations, you win the Nobel Prize” started with a true story recounted as follows in his 2002 NY Times obituary: After he won the Nobel Prize, reporters asked him to explain the portfolio theory. When he tried to do so, one journalist interrupted, ”Oh, no, please explain it in lay language.” So he described the theory of diversification by saying: ”You know, don’t put your eggs in one basket.” Headline writers around the world the next day created some version of ”Economist Wins Nobel for Saying, ‘Don’t Put Eggs in One Basket.’ ”

Page 49, George Akerlof and adverse selection: George Akerlof shared the 2001 Nobel Prize (with Michael Spence and Joseph Stiglitz) “for their analyses of markets with asymmetric information.” Akerlof’s Nobel-prize-winning ideas about adverse selection were rejected by three journals before finally being published in the Quarterly Journal of Economics. Read more about this and other terrific rejection stories in “How are the mighty fallen: Rejected classic articles by leading economists” (Joshua S. Gans and George B. Shepherd, Journal of Economic Perspectives 8:165-179, 1994).

Page 52, “It does help explain why economists spend so much time debating health care policy”: Some interesting articles on health care policy include this short-and-sweet article on the “public option” by Victor Fuchs, often called the father of health economics, and a longer article, “Rethinking Social Insurance”, which is actually Martin Feldstein’s presidential address to the American Economic Association in January 2005. (Feldstein was thought to be one of the three top candidates to take over leadership of the Federal Reserve when Alan Greenspan retired. Ben Bernanke was the lucky winner; Felstein was arguably an even luckier loser, and so was Glenn Hubbard, whose students at CBS—Columbia Business School—made this terrific consolation-prize video.) There are of course a million other articles you can find by economists and others.

Chapter 5: From One to Some (pages 53-64)

Summary in haiku form

An econ surprise:
Comparative advantage.
Just let people trade!

Summary in one paragraph

Moving from a world with just a single individual to a world with multiple individuals allows us to study the benefits of trade. The example of comparative advantage—called the only surprising example in economics—shows that trade between two people can provide mutual benefits even when one person is better than the other at everything. This shows that it can sometimes be difficult to see potential benefits from trade, but the Coase Theorem says that optimizing individuals have an incentive to keep trading until they exhaust all possible gains from trade. This suggests that a world full of optimizing individuals will be orderly rather than chaotic, and in fact we see this order in phenomena like the law of one price, which predicts that goods that are easy to trade will be sold at approximately the same price all over the world.

Notes on specific pages

Page 58, Comparative advantage: The theory of comparative advantage comes from David Ricardo (1772-1823).

Page 60, Ronald Coase and the Coase Theorem: Ronald Coase won the 1991 Nobel Prize “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.” The essence of the Coase Theorem was captured in a quote attributed to musician B.B. King: “Smart people always get together and work it out.”

Page 63, Efficient market hypothesis: A great deal of ink has been spilled over the EMH and what exactly it means, but for our purposes it’s enough to note that most actively managed investment funds fail to outperform “passive” funds that simply buy a little bit of everything.

Chapter 6: Cake Cutting (pages 67-78)

Summary in haiku form

I know that you know
That I know game theory.
Think strategically!

Summary in one paragraph

Game theory, the study of strategic interactions between optimizing individuals, has applications as diverse as warfare and business and biology and, yes, games like poker. One application of game theory is to fair division problems such as the “I cut, you choose” solution to the cake-cutting problem, where we can see the importance of information: sometimes you want to be the cutter and sometimes you want to be the chooser.

Notes on specific pages

Page 69, John Nash: John Nash shared the 1994 Nobel Prize (with John Harsanyi and Reinhard Selten) “for their pioneering analysis of equilibria in the theory of non-cooperative games.” His life was the topic of Sylvia Nasar’s 1998 book A Beautiful Mind, which in 2001 was made into an Academy-Award-winning film of the same name starring Russell Crowe. For a more true-to-life video, check out PBS’s A Beautiful Madness (buy it here, teacher’s guide here), which includes interviews with Nash.

Page 69, Rock Paper Scissors: Test your Rock Paper Scissors skills against a computer (backed by artificial intelligence)! You can also enter various RPS Championships, like the one mentioned in “A Winning Hand, and a Zen Master’s Heart” (NY Times, November 26, 2006), but they mostly seem to be excuses for people to go to bars. See also “Rock, Paper, Payoff: Child’s Play Wins Auction House an Art Sale”, NY Times, April 29, 2005, and an evolutionary game similar to RPS that features the Side-Blotched Lizard.

Page 69, Warfare: The classic book on warfare is The Strategy of Conflict (1960) by Thomas Schelling (1921 – ), who shared the 2005 Nobel Prize “for having enhanced our understanding of conflict and cooperation through game-theory analysis.” In academic and policy circles, he is best known for his work on nuclear weapons and arms control; in popular culture, his most lasting contribution was introducing director Stanley Kubrik to the novels and ideas that led to the 1964 movie Dr. Strangelove, or: How I Learned to Stop Worrying and Love the Bomb.

Page 69, Hotelling’s Law: Named after Harold Hotelling (1895-1973), this idea also helps explain why political parties (especially in America’s 2-party system) may try to race for the middle ground to appeal to swing voters.

Page 69, Biology: The logic behind the 1:1 sex ratio is credited to biologist Ronald Fisher (hence “Fisher’s Principle”, called “probably the most celebrated argument in evolutionary biology”) but some of the ideas go back to Darwin; see Martin Osborne’s “Darwin, Fisher, and a theory of the evolution of the sex ratio” (1996). Also, you can read about an evolutionary game similar to Rock Paper Scissors that features the Side-Blotched Lizard.

Page 70, Auctions: More on auctions in Chapter 9.

Page 72, “Government policy… tradable fishing permits”: ITQs (Individual Transferable Quotas) are a major policy tool in fishing regulations, and “cap-and-trade” systems for CO2 are based on a similar idea of determining a total amount (of fish to be caught or CO2 emissions to be allowed); dividing that total (by auctioning, grandfathering, etc.) into a fixed number of permits, each of which allows the bearer to catch one ton of fish or emit one ton of CO2; and then allowing the permits to be traded. More on CO2 cap-and-trade in Chapter 15, “The Big Picture”.

Page 72, Cake-cutting: There actually are a number of books on cake-cutting and other fair division problems, including two by a pair of scholars who apply their patented “adjusted winner algorithm” to celebrity divorces and the Middle East. For more see Brams and Taylor’s Fair Division: From Cake-Cutting to Dispute Resolution (1996), Brams and Taylor’s The Win-Win Solution: Guaranteeing Fair Shares to Everybody (2000), and Robertson and Webb’s Cake-Cutting Algorithms: Be Fair if You Can (1998). (This last book is by a pair of mathematicians and gets very difficult very quickly.)

Page 73, Moving knife procedure: More here.

Chapter 7: Pareto Efficiency (pages 79-88)

Summary in haiku form

Is that outcome good?
Pareto efficiency
Is only one part.

Summary in one paragraph

It’s probably impossible for everyone to agree on the definition of a “good outcome”, but economists pay lots of attention to one part of “good”: Pareto efficiency, which occurs when an outcome is so good that it’s not possible to make one person better off without making someone else worse off (in other words, when there are no Pareto improvements over it). Pareto efficient outcomes may not be good—for example, it’s Pareto efficient to cut the cake so that one child gets the whole cake—but Pareto inefficient outcomes are in a meaningful sense bad: if it’s possible to make someone better off without making anyone worse off, why not do it? One way to promote Pareto efficiency is to provide opportunities to trade, e.g., with tradable fishing permits or tradable pollution permits. The Coase theorem says that people have an incentive to trade until they have exhausted all possible gains from trade, and if that happens then we have reached a Pareto efficient outcome!

Notes on specific pages

Page 81, Vilfredo Pareto: More here.

Chapter 8: Simultaneous-Move Games (pages 89-102)

Summary in haiku form

Don’t get caught up in
The prisoners’ dilemma.
It’s a tragedy!

Summary in one paragraph

All games—most obviously games like rock-paper-scissors—can be described using a payoff matrix that lists the players’ strategies and the outcomes of the different strategy combinations. An important game is the prisoners’ dilemma, which is a two-player game in which players have dominant strategies that lead to a Pareto inefficient outcome. Generalizing the prisoners’ dilemma to more than two players produces the Tragedy of the Commons, a game that describes overfishing and overpollution and traffic congestion and many other problems. These situations are classic instances in which individual optimization does not lead to good outcomes for the group as a whole. There is, however, a glimmer of hope: competition between two sellers is a prisoners’ dilemma situation for the sellers, but it drivers sellers to provide consumers with good-quality products and low prices!

Notes on specific pages

Page 90, Rock Paper Scissors: See the notes up above on Rock Paper Scissors.

Page 90, Prisoners’ Dilemma: Often called “Prisoner’s Dilemma”, but we call it “Prisoners’ Dilemma” because each individual prisoner has no dilemma. Somewhat related is the non-fiction book Prisoner’s Dilemma (1993) by William Poundstone.

Page 98, Tragedy of the Commons: “The tragedy of the commons” (easier to read in PDF) refers to a 1968 article in Science by Garrett Hardin.

Page 99, Climate change: More in Chapter 15, “The Big Picture”.

Chapter 9: Auctions (pages 103-116)

Summary in haiku form

If you learn about
Auction equivalences
You’ll save time online.

Summary in one paragraph

Auctions are used in many important situations (and in less important situations like eBay) because they can help reveal how much something is worth, because they can help prevent collusion, and because they can help sell perishable items fast. There are many different kinds of auctions, but it turns out that there is a strategic equivalence between ascending auctions and second-price sealed-bid auctions: in both cases bidding your true value—your maximum willingess to pay—is a dominant strategy. There is also a strategic equivalences between descending auctions and first-price sealed-bid auctions—in both cases you want to shade your bid below your true value—and a deeper result called the Revenue Equivalence Theorem proves that in many situations all four types of auctions will yield the same expected revenue for the seller.

Notes on specific pages

Page 104 and 106, Aalsmeer flower auction: The Aalsmeer flower auction takes place in one of the largest buildings in the world and (together with a nearby site) accounts for 120,000 transactions a day and about 60% of the worldwide export market in flowers; you can visit the auction if you’re in the Netherlands. Video of the auction and the Dutch auction clocks starts at about 2:56 in “Flower Auction FloraHolland. Where beauty meets business”. These are descending auctions, which are sometimes called Dutch auctions.

Page 108, William Vickrey: William Vickrey (1914-1996) shared the 1996 Nobel Prize (with James Mirrlees) “for their fundamental contributions to the economic theory of incentives under asymmetric information.” Vickrey died three days after the prize announcement.

Page 112, eBay: Read about eBay’s automatic bidding feature.

Page 116, Revenue equivalence theorem: More here.

Chapter 10: From Some to Many (pages 117-126)

Summary in haiku form

Economists dream
Of grains of sand on the beach…
Buyers and sellers.

Summary in one paragraph

The strategic complications of game theory disappear when we move to a world of competitive markets in which buyers and sellers are small relative to the market as a whole. This means that buyers and sellers are all price-takers: individually they are too small to affect the market as a whole, so strategic behavior is pointless. The result is a straightforward analysis that applies to many kinds of markets and leads to an optimistic conclusion: competitive markets lead to Pareto efficient outcomes, which is an important part of good!

Notes on specific pages

Page 121, Tolstoy: The reference is to the opening line of Tolstoy’s Anna Karenina: “Happy families are all alike; every unhappy family is unhappy in its own way.”

Chapter 11: Supply and Demand (pages 129-142)

Summary in haiku form

One short phrase explains
The mystery of prices:
Supply and demand.

Summary in one paragraph

In competitive markets buyers and sellers are all price-takers, i.e., they all take the market price as given; but then where do market prices come from? Economists spend many years debating whether market prices were determined by supply (i.e., cost of production) or by demand (i.e., willingness to pay) until finally Alfred Marshall convinced everyone that arguing whether it’s supply or demand is like arguing “whether it is the upper or the under blade of a pair of scissors that cuts the paper.” Prices are determined by supply and demand: the market equilibrium price is the only price at which the amount that buyers want to buy at that price equals the amount that sellers want to sell at that price. (At any other price, individual incentives will push prices towards the equilibrium.) It follows that any change in the market price is caused by underlying changes in supply and demand, e.g., increased cost of fertilizer will reduce supply, pushing the supply curve to the left, leading to a higher market equilibrium price.

Notes on specific pages

Page 131, “Where market prices came from”: See the Diamond-Water Paradox.

Page 131, Alfred Marshall: Alfred Marshall (1842-1924) was one of the founders of modern economics (called neo-classical economics). He introduced supply and demand curves in his book Principles of Economics, first published in 1890. His book contains the quote about which blade of the scissors cuts the paper (see section V.III.27); it also put price on the y-axis and quantity on the x-axis, perhaps because of a typographical error, perhaps because of a desire to emphasize marginal costs and benefits.

Chapter 12: Taxes (pages 143-154)

Summary in haiku form

Tax equivalence:
Where does the tax burden fall?
Don’t ask a lawyer.

Summary in one paragraph

Lawyers determine the legal incidence of taxes—i.e., who formally pays the taxes—but the forces of supply and demand determine the economic incidence of taxes, i.e., who ultimately bears the burden. In fact, the tax equivalence result says that a tax on the sellers produces the same economic outcome as an equivalent tax on the buyers, meaning that the Social Security tax—which is legally divided between employees and employers—would have the same economic outcome even if it were placed entirely on one side or the other. As we’ll see in Chapter 14, in many markets the long-run economic burden of taxes falls entirely on the buyers.

Notes on specific pages

Page 145, “The art of taxation”: The quote is attributed to Jean-Baptiste Colbert (1619-1683), a minster of King Louis XIV of France.

Page 154, Social Security: Social Security (OASDI) taxes are 6.2% on employees and 6.2% on employers, for a total of 12.4% on the first $110,000 or so of labor income. In 2011 and 2012 the employee portion was reduced to 4.2%. See also the quote attributed to FDR: “We put those pay roll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.” See also Social Security links above from Chapter 3.

Chapter 13: Margins (pages 155-168)

Summary in haiku form

True optimizers
Don’t want one more or one less.
Think at the margin.

Summary in one paragraph

Supply curves tell us how much sellers want to sell at certain market prices, but they can be reinterpreted as marginal cost curves, which tell us the additional cost of producing one more unit of output. And demand curves, which tell us how much buyers want to buy at certain market prices, can be reinterpreted as marginal benefit curves that tell us the additional willingness-to-pay for consuming one more unit of output. Every story about supply and demand therefore has a parallel story about marginal costs and benefits, e.g., a tax on sellers that reduces supply—thereby shifting the supply curve to the left—can also be seen as a tax that increases the sellers’ marginal costs of production, thereby shifting the marginal cost curve up.

Notes on specific pages

Page 155, “…at the margin!” This joke relates to the Americanism of adding “in bed” to whatever is on your fortune cookie. More here, including that fortune cookies are not part of Chinese food in China.

Page 157, “I think I’ll buy an orange”: This quote also appears in my comedy video “Principles of economics, translated”.

Page 157, “Just as we can learn about pool sharks by studying physics”: The analogy of the pool player comes from Milton Friedman, who won the 1976 Nobel Prize “for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy.”

Page 158, “Some pictures can be seen in two entirely different ways”: See also the Young Girl-Old Woman Illusion and more examples on wikipedia.

Page 162, John Hicks and the relationship between demand curves and marginal benefit curves: John Hicks shared the 1972 Nobel Prize (with Kenneth Arrow) “for their pioneering contributions to general economic equilibrium theory and welfare theory.”

Chapter 14: Elasticity (pages 169-180)

Summary in haiku form

Elasticity:
Responsiveness to changes.
How much do you stretch?

Summary in one paragraph

Elasticities measure responsiveness, e.g., the price elasticity of demand measures the percentage change in quantity demanded produced by a 1% increase in price. (More generally, the X elasticity of Y measures the percentage change in Y produced by a 1% increase in X.) Like a rubber band, more elasticity corresponds to greater responsiveness.

Notes on specific pages

Page 170, Wealth elasticity of consumption: This is also called the wealth effect.

Page 170, “Before we had to eat potatoes 5 days a week… now we have to eat potatoes 6 days a week”: The reference here is to the Irish Potato Famine that killed about 1 million people in the late 1840s. Some economists argue that potatoes were such an important and relatively cheap way to get calories at the time that when the price of potatoes went up people bought more of them, in other words the demand curve sloped upward. Such an event is so rare that economists argue about whether such Giffen goods have ever existed in real life—the case for the Irish Potato Famine is shaky—but there’s no doubt that this is a theoretical possibility. Study more economics and you’ll learn that the “Law of Demand”—which says that demand curves always slope downward, i.e., that as the price goes up people want to buy less—refers to Hicksian demand curves and not to Marshallian demand curves. The difference is that Hicksian demand curves assume away the income effect, which is measured by the income elasticity of demand.

Page 170, Elasticities: Another application of elasticities is the Laffer curve, which concerns the tax rate elasticity of tax revenue, i.e., how a change in the tax rate affects tax revenue. If income taxes rates (for example) go up and up (40%, 60%, 80%…) then at some point the disincentive to work will be so strong that tax revenue will go down. Beyond that point, increasing tax rates will reduce tax revenue and reducing tax rates will increase tax revenue. Some proponents of supply-side economics use this logic to argue that tax cuts will “pay for themselves”, but the evidence suggests that current tax rates are not high enough for this to be true. However, it is true that changes in tax rates will affect behavior and tax revenue; “dynamic scoring” models try to account for this.

Chapter 15: The Big Picture (pages 181-192)

Summary in haiku form

Competition needs
Lots of tender loving care
Plus a carbon tax.

Summary in one paragraph

Need to add this…

Notes on specific pages

Page 183, “In a perfect world, competitive markets will lead to a Pareto efficient outcome”: The graphic here is of the Edgeworth Box. The quote above relates to the Fundamental Theorems of Welfare Economics, known informally as the “Invisible Hand Theorems”. (The quote is actually the First Welfare Theorem; the Second Welfare Theorem says that any Pareto efficient outcome can be obtained with complete and competitive markets plus an initial redistribution of income.) These Welfare Theorems were proved by Ken Arrow and Gerard Debreu; see their Nobel prize gag on page 198.

Page 185, “we should just give [poor people] money”: This is the idea behind the Earned Income Tax Credit, one of the largest anti-poverty programs in the USA. (Find out if you qualify here.) The same idea was behind the negative income tax proposal of Milton Friedman; see more here.

Page 185, Amartya Sen: Amartya Sen won the 1996 Nobel Prize “for his contributions to welfare economics.”

Page 187, antitrust policies: The classic example was the Standard Oil trust controlled by John D Rockefeller in the late 1800s. To read about current antitrust issues, visit the U.S. Department of Justice Antitrust Division and/or the Federal Trade Commission’s Bureau of Competition.

Page 189, “Now that’s an idea worthy of a Nobel Prize!” Marty Weitzman is on my short list to win the Nobel Prize any day now for his work on environmental economics, including his pioneering “Prices versus quantities” paper comparing pollution taxes and cap-and-trade.

Chapter 16: Conclusion (pages 193-204)

Summary in haiku form

Is the big question
Still unanswered in your mind?
Study more econ.

Summary in one paragraph

Need to add this…

Notes on specific pages

Page 197, “You might think that a decentralized economy…”: The quote is inspired by Ken Arrow (see page 198) and his co-author Robert Hahn, who write in General Competitive Analysis (1971) that:

There is by now a long and fairly imposing line of economists from Adam Smith to the present who have sought to show that a decentralized economy motivated by self-interest and guided by price signals would be compatible with a coherent disposition of economic re¬sources that could be regarded, in a well-defined sense, as superior to a large class of possible alternative dispositions. Moreover, the price signals would operate in a way to establish this degree of coherence. It is important to understand how surprising this claim must be to any¬one not exposed to the tradition. The immediate “common sense” answer to the question “What will an economy motivated by individual greed and controlled by a very large number of different agents look like?” is probably: There will be chaos. That quite a different answer has long been claimed true and has indeed permeated the economic thinking of a large number of people who are in no way economists is itself sufficient ground for investigating it seriously. The proposition having been put forward and very seriously entertained, it is important to know not only whether it is true, but whether it could be true. A good deal of what follows is concerned with this last question, which seems to us to have considerable claims on the attention of economists.

Page 198, Ken Arrow, Gerard Debreu, and the “Invisible Hand Theorems”: Ken Arrow shared the 1972 Nobel Prize (with John Hicks) “for their pioneering contributions to general economic equilibrium theory and welfare theory.” Gerard Debreu won the 1983 Nobel Prize “for having incorporated new analytical methods into economic theory and for his rigorous reformulation of the theory of general equilibrium.”

Page 198, “Nash’s poker model”: See “A Simple Three-Person Poker Game” by Nash and Shapley.

Page 199, Joseph Stiglitz: Joseph Stiglitz shared the 2001 Nobel Prize (with George “adverse selection” Akerlof and Michael Spence) “for their analyses of markets with asymmetric information.”

Page 200, Daniel Kahneman and behavioral economics: Daniel Kahneman shared the 2002 Nobel Prize (with Vernon Smith) “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.” His colleague and co-author Amos Tversky would almost have shared the prize had he lived long enough.

Page 200, “Save More Later”: The idea comes from the book Nudge by Thaler and Sunstein. More about Save More Later here. More about Nudge about nudges.org. Another fascinating idea (developed by Yale economist Dean Karlan) is Stickk, which has the tag line “Take out a contract… on yourself!”

Page 201, Pirates: See the work on pirate economics of Peter Leeson, author of The Invisible Hook: The Hidden Economics of Pirates.

Page 201, Gary Becker and the economics of crime: Gary Becker won the 1992 Nobel Prize “for having extended the domain of microeconomic analysis to a wide range of human behaviour and interaction, including nonmarket behaviour.”

Page 203, “Does anyone know where I can find a one-handed economist?” This quote is popularly attributed to President Harry Truman, but it’s doubtful that he actually said it.

Page 204, “Macroeconomics… That’s what our next book is going to be about”: It’s true… Volume Two: Macroeconomics came out in Jan 2012!

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