Monthly Archive: April 2016

Economics is often called the dismal science.  The conventional reasoning for this nickname is that economics often tells us that we can't do something.  It is about finding the optimal way to use scarce resources, about how to make the hard choices that a society must contend with in order to decide what should should be produced and how much of it, who should produce and who should consume.  And, I suppose, there is a great deal of truth to this.

But I can't help wondering if there isn't another, equally compelling reason.

It seems to me that economists spend a lot of time proving common sense notions through methods that are sometimes scientific, sometimes mathematical, and sometimes far less rigorous than reading tea leaves.  Certainly there is value in providing a rigorous underpinning to old saws, honored adages, and accepted truisms, but much of that value is blunted by some of the most dense nomenclature that can be found in any science.

Take the familiar saying 'Too much of a good thing'.  The written attribution of this phrase falls to Shakespeare's As You Like It from around 1600.  It elegantly captures the basic idea that had long been known from antiquity and which formed a central concept in Aristotle's definition of virtue - moderation.  To almost all of Western civilization, it was manifestly obvious that too little or too much of anything, even a 'good thing', was unbalanced and harmful.

With the advent of modern economic theory, many old notions were placed in a structured framework and equipped with mathematical rigor that made their study more of a science and less of a ethical philosophy.  But it is important to note that in these cases no new content was added.  So why then did economists go out of their way to name things obscurely?  Perhaps it was because they wished to add a gravitas that reflected the rigor or perhaps it was that they just simply wanted to sound smart.  Whatever might be the reason, their 'arcane' terms have done a lot to make their discipline seem even more dismal that it really is.

In the case of 'too much of a good thing', economists use the terms total utility and marginal utility.  These clunky terms are meant to convey just what Aristotle argued - that there is a virtue in every activity where there is neither too little or too much.  In the case of utility, the thing of interest is usually a good or a service. I'll use good to mean both.

The total utility is an absolute measure of the usefulness of a good.  A consumer will not trade for or even consider a good if that consumer doesn't think that he will gain something out of such an acquisition.  This something is what is meant by utility.  The total utility of a good is difficult to define let alone measure since the worth of a good is really only understood in comparison with other goods.  Nonetheless, it is a convenient fiction for introducing a related but much more useful concept:  marginal utility.

Marginal utility is the relative gain in utility as the quantity of the acquired good increases.  It is the derivative of the total utility curve with respect to the quantity demanded/consumed.  This observation explains why it isn't terribly important to be able to assign an absolute number to the total utility.  Each total utility curve with the same marginal utility differs from the other members by a constant of integration which shifts its relative importance.  Its relative importance and rate of its change are what matters; absolute ranking being totally irrelevant.

The total utility must be positive for at least the first quantity of the good acquired since the consumer has a desire to consume it.  What happens to the total utility after that depends on the good but generally the initial rise in total utility is followed by slower growth.  Eventually, a stagnation point is reached where the total utility reaches a maximum value.  Consuming/acquiring more of the good beyond this point causes the total utility to fall as the cost of dealing with unwanted goods overwhelms the intrinsic value of the good itself.  This drop in utility reflects the added costs associated with storage of the good or with the fact that acquisition of a surplus of one good squeezes out other goods due to lack of time, money, or space.  In this regime, the consumer can be said to be having too much of a good thing.  And in this fashion, economist have re-expressed in a far less artful way what the great Bard put to paper over 150 years before Adam Smith penned The Wealth of Nations.

Often, it is believed that the marginal utility falls steadily as new goods are acquired but this need not be the case.  The following table shows the values for total and marginal utility as a function of the quantity of goods consumed for a case study in chapter 4 of Microeconomic Theory, 3rd edition by Salvatore.

Note that in practice, the marginal utility is computed from the forward first difference in the total utility - the difference between the total utility in a given row (for a given quantity) and the prior row.  This is due to the fact that quantity is often only expressed as a discrete number (would you buy a seventh of a toaster?)..  As a result, the value for the marginal utility is blank in the first row.

What is happening is easier to see graphically than in tabular form. The initial rise in total utility is a modest value of 4 as the first good is consumed.  The total utility increases more rapidly as the second and third goods are consumed and the marginal utility rises as a result.  Eventually, the total utility reaches a maximum where the marginal utility reaches zero,  Beyond that, the consumer is getting too much of a good thing.

A natural question may be springing to the reader's mind.  What kind of a good is it where getting two is much better than getting one?  There are many possible answers, but the best one is a shareable good where the value for two is far increased over the value for one because two people get to enjoy the good at the same time - say a pair of tickets to the theater to see As You Like It.

It is odd to say that I stumbled onto this topic by simply waking up one morning but that is the actual way it began.  More precisely, it began with a half-awake, half-witted attempt to listen to the morning show that my wife and I favor.  The topics include a smattering of current national politics interspersed with interesting local stories, human interest tales, and other items meant to amuse or outrage or otherwise energize the listener to a brand new day.

This particular day, only about a week ago, one of the hosts was reveling in the scientific study that concluded that paper towels in public restrooms were the best choice for hygiene.  The show was flooded with numerous callers all clearly falling into one of two camps: those for paper towels and those for hand dryers.  There seemed to be no middle ground.  Suddenly I was aware of a great and terrible debate that had been raging all around me to which I was hideous oblivious – the paper towel wars.

It seems that the argument over which method was best is so pervasive that all one needs to do is to start typing

to get a Bing's or Google's autocomplete to immediately come back with

And judging by the articles that turn up, this debate has stewed for some time and it is typically very polarizing with most people pitching their loyalty with one side (hand dyers) or the other (paper towels).  Sharp are the lines between these two camps and strong are the passionate claims that each makes about the advantages it has over the other.

Consider the pro paper towel camp.  Washington Post contributor Alexandra Petri minces no words (The paper towel-hand dryer wars are over) when it comes to the paper towel side.  She likens the clash between the two camps to the old feud between the Hatfields and the McCoys and claims that, at least in this case, the “correct team has won.”  Citing the 2012 Mayo Clinic study entitled The Hygienic Efficacy of Different Hand-Drying Methods: A Review of the Evidence, Petri gleefully brings ‘science’ in to support the conclusion that paper towels are the correct choice.  In her reading, hand dryers are ineffective and unhygienic and near the close of her article, she presents this gem of a paragraph

To bolster the pro-paper case even more, News Max reported a follow-on story in June of 2015 entitled Paper Towels vs Air Dryer: Which Gets Rid of More Hand Germs? Citing Dr. Philip Teirno, a professor of microbiology and pathology at the New York School of Medicine, the article concluded that paper towels offer a better alternative to hand dryers since the direct contact friction is an essential ingredient in eliminating germs from the hands after washing.

But the pro hand drying camp is not without its scientific studies, which conclude, oddly enough, that hand dryers are the correct choice.  RestroomDirect, a company specializing in the distribution of hand dryers and commercial restroom cleaning supplies asks Which is better in a commercial restroom?  Hand dryers or paper towels?  They present a strong, and no less scientific, argument that hand dryers are far more energy and resource efficient thus making them better for the environment.  Hand dryers are also far less expensive to operate meaning that businesses can put additional resources towards more important things.  To add fuel to the fire, there is also a scientific study from the University of Buffalo (Paper towels fold in study versus hand dryers 6/14/14) that concludes that paper towel dispensers are actually far more unhygienic than hand dryers.

To make matters even more confusing there is even a YouTube video that attempts to scientifically weigh in with the pros and cons of both approaches

Pros and cons.  Competing and contradictory scientific studies.  So what is a consumer to do?

This situation is representative of the classic conundrum that occurs in the market place.  The correct economic choice may be apparent if perfect knowledge were present, but consumers almost always have to make choices based on information that is far from perfect.

This lack of knowledge drives many of the hedges and securities mechanisms that decorate our day-to-day market interactions.  Uncertainty and doubt set premiums on life, car, and homeowners insurance.  Hedge funds sell guards against market downturns, sudden jumps in stock prices, and other forms of volatility.  Interest on loans are a way of protecting against future inflation and rewarding delayed gratification.

Much in our economic lives is shaped by uncertainty as to what the future holds and how to make the best choice with limited information.  We see it every day but it is rare to see it as cleanly laid out as it is in the paper towel wars.

There is no doubt about it, Elon Musk knows how to generate excitement and how to sell product.  Tesla motors recently announced plans for the relatively affordable Model 3, a much less expensive version of their famous electric car (although some beg to disagree).

One of the selling points that Musk accentuates is the notion that buying a Tesla helps save the planet.  Driving an electric car contributes to the environmental changes so desperately needed for the big blue marble.  This very claim about lifestyle is just ludicrous.

Don’t get me wrong.  I like the idea of competition in the market place and a greater number of choices available for the consumer.  And I like the idea of electric cars in general and the Tesla in particular.  What I don’t like is some of the shoddy economic thinking that drives certain people to think that the Tesla Model 3 will be the revolutionary next word in environmental stewardship.

The simple reason for this is the enduring and unassailable law of economics – everything has a cost.  This is what is known in common parlance as ‘there’s no such thing as a free lunch’.   But surely, goes the common wisdom, driving an electric car is much friendlier to the environment; it has zero emissions.

Well Frederic Bastiat would be quick to point out that such a conception is based on thinking that is only looking at what is seen.  The so-called hidden costs remain just that, hidden.  What are this hidden costs?  The generation of the electricity still comes from almost exclusively from fossil fuels.  This fact leads to two complications that may actually be serious enough to turn the notion that electric cars are contributing to the solution on its head.

The first and most benign complication is something about which I’ve written before.  The tax structures and incentives that are currently in place encourage the electric car owner to be a free rider; to use public goods without contributing his fair share.  Since the maintenance of the public roads depends on revenue almost exclusively arising from gasoline taxes, the electric car owner gets to use the roads without directly paying for the maintenance.  It is entirely possible that law makers will then have to keep gasoline prices low enough to encourage more of the conventional drivers to buy enough fuel to offset the loss.  This additional consumption has the opposite effect on the environment that what was originally intended.

The second and much more serious complication is that fossil fuels are the primary source of electrical energy in this country.  So as more electric cars find their way on the road, the use of fossils fuels will recede from the public view and become hidden behind the long lines of copper that remove us from the power plants where the chemical energy is converted into electrical.  There may even be a thermodynamic argument that shows that it is more inefficient to generate the needed energy and transmit it to the electric car than it is to simply burn gasoline in an internal combustion engine.  I don’t know one way or another – I simply know that very few talk about this hidden face.

Of course, the typical zealot who thinks only about the upside to the electric car will point out that the great and powerful Musk has a solar panel business as well and that we can all simply move to renewable energy powered by the Sun.  Unfortunately, that doesn’t work.

The table below has a modest estimate of the cost required to outfit the country with solar panels that exclusively provide the energy needs of the USA.  The amount of available solar energy is over estimated in several spots (6 hours/day is about 30% too large; 40% of total power captured is 10-20% too large).  The efficiency of the solar panels is put in the middle range of what is currently achievable and the cost is brought down by at least two orders of magnitude.  The estimate for total energy used in the US is taken as the lowest value found (about 10% low).

So even if the country were of a mind to do nothing but make solar panels, it would take over 5 years just to outfit our national needs (that means no growing crops, to manufacturing food or housing or anything else, no health care, no fun).

There would also be serious environmental effects with so much solar panel manufacturing.  The chemicals and materials are far from safe (many are downright toxic) and the industrial process requires energy itself.  Clearly solar power isn’t the answer.

The energy densities needed to transform the national use from fossil fuels to clean energy are really only found in nuclear power but even that approach is not without cost and risk; even if the cost and risk were appropriately mitigated there still remains the political opposition to this energy source; an opposition that is firmly rooted in an irrational fear of a nuclear holocaust that ever far less dangerous than global warming; and this fear is, itself, deeply rooted in the same muddled thinking that leads these same people to cling to the notion that solar is the answer.

So at the end of the day, I’m all for the consumer buying a Tesla just so long as he understands that he while he may be saving money he isn’t saving the environment; that he has yet to find a way to get a free lunch.

A peculiar thing happened a few weeks ago.  On March 22^nd, thousands of JavaScript developers were faced with broken builds and failed installations due to a missing piece of code, 11 lines in length.  Much like the events in the Day the Earth Stood Still, a single superior force brought the much larger but far more primitive press of humanity to a grinding stop.   But unlike that iconic movie, the motive in the internet crisis wasn’t moral but rather economic (although there is certainly a moral aspect to this story as well – as there is in all things economic).

The timeline of events is disclosed in detail elsewhere.  The key features for the sake of this argument are simply these.   There exists a common JavaScript code repository called NPM which dubs itself as the place to “Build amazing things” and describes itself as:

One such developer, by the name of Azer Koçulu, had provided to all of humanity, 250 JavaScript Modules.  Of these, the reader must focus on only two of them.  The first was named kik, which is also the common short form name of Kik Messenger, a messaging app for smartphones.  The second, called left-pad, was the 11-line piece of code that brought much of the internet to its knees and opened lots of new horizons in the ownership of intellectual property.

As might be predicted by the common name, a clash developed between Azer and Kik’s corporate office.  The latter requested that Koçulu surrender the name of the module since they legally owned the trademark.  When he refused their less than polite request, they went to NPM to force the issue and, when NPM management complied, Koçulu unpublished all his modules.  The resulting elimination of “left-pad” broke the systems that depended on it, precipitated NPM’s unprecedented step of restoring “left-pad” (so-called un-unpublising), and launched a controversy that is likely to become a watershed event discussed for decades to come.

Now I’m not going to weigh in on the various legal points that have been raised, such as did Kik have the right to the name, did NPM have the right to give it away or to un-unpublish the “left-pad”, or did Koçulu have the right to unpublish the code in the first place.  As interesting as these questions are there is a much more interesting question.  Was “left-pad” a public good?

To appreciate this question one must first understand how economists place goods into the four categories of private, club, common-pool resources, and public.  Each good is judged in terms of two attributes:  excludability and rivalry.

A good is termed excludable if a person or entity possesses legal rights that enable them to prevent others from using it.  A good is non-excludable if no one either possess such a right or if the right is effectively non-enforceable.  The term open is synonymous with non-excludable in what follows.

A good is rivalrous if the use of the good by one entity precludes its use by all others.  A good is non-rivalrous if it can be used by many entities without harm being done to any of them.  The term shareable is synonymous with non-rivalrous in what follows.  Note that only intangible things likes ideas and concepts can be truly shareable but that in many cases some goods are so much closer to shareable than not that the idealization is useful.

The four possible combinations of excludable/open with rivalrous/shareable give the four categories of goods:

• Private good - excludable and rivalrous
• Club good – excludable and shareable
• Common-pool resource – open and rivalrous
• Public good – open and shareable

These definitions are abstract and difficult to think about so a common tool is to construct a 2x2 table with instances of each type.  Common tangible goods can be placed in such a table and on such version is

The next step is to create an analogous table for digital goods and then, using the resulting categorization, conclude in which of these cells the innocuous but vital “left-pad” module should live.

Adapting the 2x2 table to cyberspace is a bit more challenging than tangible goods precisely because of the blurred lines that exist in the digital world between ownership and right-to-use.  For example, when one buys a videogame, one is really buying the right-to-use the game on a game console and not the game itself. Unlike Monopoly, where the owner really owns the matter/hardware that goes into the game and can transform it as he sees fit, the owner of Halo really owns the ability to interact with that particular copy of the game he purchased.  The situation is further complicated by the fact that there is a fundamental difference between the embodiment of the game (the pit and blanks on the DVD, the DVD itself, the game console, etc.) and the code that makes up the game.

Nonetheless, after some thought, it is possible to come up with good examples in three of the four categories; the common-pool resource being the only one that seems to lack a digital analog.  One such instance is

The only step that remains is to determine where in this table “left-pad” finds a home.  The natural first reaction is that “left-pad” is a public good; an opinion mostly endorsed by Nadia Eghbal.  But this question isn’t really well-defined enough to answer.

Certainly, the code concept itself, taken as an abstract entity, is a public good.  Koçulu neither claimed copy-right nor did he regulate (exclude) use.  But the embodiment that he maintained on NPM was more like a club good, where for much of its life the club was everyone.  Then after the debacle with Kik, Koçulu simply redefined the club to be no one. The delicate point here being between the particular copy or instance of the code and the ownership of the code itself.

As time progresses and society, in general, and economists, in particular, have a chance to analyze the fallout from this event and others like it, I suspect that whole new modes of thought will have to be developed about who owns what in digital realm.

Klaatu barada nikto!

So, once again, I decided to learn a little more about how economists see the world.  The basic ingredients of their studies center on two pieces: goods and services; and the transactions and behaviors whereby they are produced, traded, and consumed.  Many of my past blogs have dealt with the behavioral aspect so it seemed reasonable to ponder a bit more at just what the term ‘goods’ means (obviously expanded to include tangible items like cars and intangible items like tax preparation services).

And so off I went on a rambling intellectual walk-about through a variety of sources, both written ones, collecting dust in my home library, and virtual ones, collecting cyber-dust somewhere in the great digital repository that we all casually call the net.

I held one goal close enough to my heart that its achievement would fill me with satisfaction for a time, but far enough away that its failure would not disappoint.  I greatly want to understand how the classical economist ever embraced the clearly flawed idealization of a rational consumer/actor.  People rarely act rationally if, by rationally, we mean the narrow concept that they seek material gain as the primary, or perhaps even only, aim.  The Ultimatum Game being one of the surest refutations of that position.  Certainly I am mindful that all disciplines need approximations and idealizations to progress but at what point did the idealization cease being a model and started to become gospel was the question.  Perhaps the answer lay in how economists look at the goods people produce, trade, and consume.

I wasn’t really expecting an answer but I would have liked to have even a hint.  Alas, even a hint was too much to ask but I did learn some interesting things about goods that is worth at least a few more paragraphs.  In short, there are three categories that, with apologies to Sergio Leone, I call good, bad, and ugly goods.  Economists, of course, don’t call them that, but their categories match mine quite closely so I’ll not be shy in using my lingo interchangeably with theirs.

Good goods are what are generally termed ordinary goods by economists.  An ordinary good possesses a negatively sloped demand curve.  As the price of the good rises, there is less consumption of it as consumers seek out substitutes and alternatives.  A substitute is a good that serves the same function but costs less.  Switching out Bombay Sapphire for Beefeater is the kind of switch that economists mean by the term ‘substitution’ although they, no doubt, would never stoop so low as to buy a lesser gin.  In contrast, giving up gin and tonics permanently in favor of tea-totaling falls under the heading of ‘alternative’.  In either case, the consumer generally responds to an increase in price by changing their behavior so that they consume less when the vendor asks more.

Good goods further sub-divide into three categories called: inferior, normal (or necessary), and luxury.  This sub-categorization reflects the natural evolution in most consumers that, as their income grows, they themselves grow accustomed to better styles of living.  I borrowed this latter terminology from the divorce court lawyers who argue that their client is entitled to alimony that supports the client in the style to which the client has become accustomed.  Levity aside, each category reflects the income elasticity of demand of a good found within its bounds.  Economists define income elasticity of demand (eM) as the ratio between the percentage change in the quantity demanded to the percentage change in the household income.

As a person’s income grows his fractional change in income is positive.  If he decides that he no longer needs to eat ramen noodles every night because he now has enough money to go out for a burger from time to time, then the fractional change in ramen demand is negative.  The ratio between the two is also negative and the good is inferior.  More simply put, as a person’s income grows his need to settle for a good he would otherwise not buy diminishes.  Thus ramen is an inferior good.

Normal and luxury goods have positive elasticity, meaning that the quantity demanded typically grows as income grows.  The difference between these types of goods lies the magnitude of the elasticity.  An elasticity less than one means that changes in income do little to change the quantity of the good demanded whereas an elasticity greater than one means that a small change in income (or in a related fashion price) makes a big change in the amount demanded.  Normal goods fall into the former category (as a result they are sometimes called necessities) and luxury goods fall into the latter.  Food is typically a normal good and the consumer will buy his staples, say a gallon of milk, each week for the most part regardless of the change in price or his income.  Fine gin is regarded by many as a luxury item (although it shouldn’t be); to be bought when the price is right or the take home pay is sufficient to allow an indulgence.

In deference to any actual economists who may read this, I do want to be clear that in the last paragraph I played fast and loose and blurred the distinction between income elasticity of demand and price elasticity of demand.  They are distinct but highly-interrelated concepts, ultimately connected in a much broader definition of elasticity in personal value.  Here I am imagining something like elasticity defined as the ratio of percentage change in demand to percentage change in the percent of the household expenditure associated with buying the good.  A professional can either work that concept out in detail or prove/argue why it can’t work – it won’t change the fact that each of us weighs the demand for a good by more than the change in price or in income with all other things held constant.

Bad goods are what economists call Giffin goods. These goods defy the law of demand in that their demand curve is upward sloped.  As the price increases so too does the demand.  The big brains claim a Giffen good is typically

• an inferior good
• does not have easily available substitutes
• purchase of it must be a substantial fraction of the total household expenditure meaning that the good is purchased only due to the limited income of the household.

The oft-cited, Giffin-good, example is a staple food depended upon by the poor.  As its price rises, additional income used to buy other goods becomes slimmer and the household is forced to buy more of the cheaper but price-rising good just to be able to eat.  In the example above, if ramen increases in price, our hypothetical burger-muncher may have visit Five Guys less often because he has to sink more of his income into ramen just to have something to eat each day.  Sir Robert Giffen claims to have seen this behavior in Victorian England but certain economists assert that there is no such thing.

The ugly good is synonymous with what economists call a Veblen good.  Like the Giffen good, demand for a Veblen good rises as its price rises.  However, the rise in the demand reflects the good as a status symbol showing that the purchaser is truly a king among men in that he can afford more of what others can’t afford at all.  Conspicuous consumption, which is another name for the kind of behavior that supports a Veblen good, is featured prominently in the rather amusing first part of Chesterton’s The Queer Feet and the reader is directed here for a nice quote.

So there you have it.  A concise, if not precise, summary of how economists categorize goods and their corresponding elasticities.   It would be an interesting follow-up to see if their analysis, papers, and books, which are goods in and of themselves, are good, bad, or ugly.