Wednesday, October 17, 2012

What would Coase think of the Market Design Nobel?

On reflecting on the recent Nobel Prize, I have come to wonder: What would Coase think of market design?  Part of me thinks he would be incredibly sympathetic.  Consider this classic passage from his tremendously-influential article, The Nature of the Firm (published: 1937).
It is convenient if, in searching for a definition of a firm, we first consider the economic system as it is normally treated by the economist. Let us consider the description of the economic system given by Sir Arthur Salter.3“The normal economic system works itself. For its current operation it is under no central control, it needs no central survey. Over the whole range of human activity and human need, supply is adjusted to demand, and production to consumption, by a process that is automatic, elastic and responsive.” An economist thinks of the economic system as being co-ordinated by the price mechanism and society becomes not an organisation but an organism.4 The economic system “works itself.” This does not mean that there is no planning by individuals. These exercise foresight and choose between alternatives. This is necessarily so if there is to be order in the system. But this theory assumes that the direction of resources is dependent directly on the price mechanism. Indeed, it is often considered to be an objection to economic planning that it merely tries to do what is already done by the price mechanism.5 
This last comment is, of course, a reference to Hayek's critique that the price system efficiently uses information. Coase goes on to say: 
Sir Arthur Salter's description, however, gives a very incomplete picture of our economic system. Within a firm, the description does not fit at all. For instance, in economic theory we find that the allocation of factors of production between different uses is determined by the price mechanism. The price of factor A becomes higher in X than in Y. As a result, A moves from Y to Xuntil the difference between the prices in X and Y, except in so far as it compensates for other differential advantages, disappears. Yet in the real world, we find that there are many areas where this does not apply. If a workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do so. Those who object to economic planning on the grounds that the problem is solved by price movements can be answered by pointing out that there is planning within our economic system which is quite different from the individual planning mentioned above and which is akin to what is normally called economic planning. The example given above is typical of a large sphere in our modern economic system. Of course, this fact has not been ignored by economists. Marshall introduces organisation as a fourth factor of production; J. B. Clark gives the co-ordinating function to the entrepreneur; Professor Knight introduces managers who co-ordinate. As D. H. Robertson points out, we find “islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk.”1 But in view of the fact that it is usually argued that co-ordination will be done by the price mechanism, why is such organisation necessary? Why are there these “islands of conscious power”? Outside the firm, price movements direct production, which is co-ordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur-co-ordinator, who directs production.2 It is clear that these are alternative methods of co-ordinating production. Yet, having regard to the fact that if production is regulated by price movements, production could be carried on without any organisation at all, well might we ask, why is there any organisation? 
This question brings me to the crux of this post.  In essence, Coase is saying that there are times when explicitly organizing economic activity makes more sense than trying to coordinate everything through the price system.  Coase pointed out that firms arise when it makes sense to explicitly organize economic activity -- they are islands of command and control in an ocean of free market, so to speak.

Market design receives a similar criticism.  Why not just let the market work?  Ryan wrote about this yesterday, and he makes some important points, citing Roth's contribution to market design.
1) Some transactions are "repugnant" and a price-clearing market simply won't ever be allowed, but we should try to do the best we can anyway (e.g. Roth 2007 "Repugnance as a Constraint on Markets").
2) Market design is an "engineering approach" to solving economic problems; that is, it's "practical." When Roth is called in to "fix" a market, the solution needs to be arrived at quickly, and context of the market and politics surrounding the market matter (e.g. Roth 2002 "The Economist as Engineer"). Introducing prices, transfers, and perfectly competitive markets where they've never existed before might be too much to ask.
Fundamentally, these points are specific reasons why coordinating a "market design problem" using the price system may cost more than using the tools of market design.  In other words, an effective argument for market design research is Coasean -- problems suitable to market design are situations where transaction and coordination costs are high.  Given these costs (repugnance, unfamiliarity), there is room to improve on the status quo.

A final comment on Coase and Market Design.  Coase likely doesn't love the market design approach because it is incredibly mathematical.  Coase is famous for economics that can be developed through logic and clear prose.  As evidence, here is a quote from just this spring about Coase:
“Ronald belongs to an era before economics was taken over by mathematicians,” says Douglas Baird, the Harry A. Bigelow Distinguished Service Professor of Law. “He thinks about economics in intuitive terms. He does not think that there are any important terms in economics that you cannot understand using words, descriptions, and arithmetic. 
“Some people say that shows he is from a much earlier era. The better view is that there is something fundamentally healthy about his work that is too often lost on modern economists, who are sometimes so enchanted by mathematical models that they lose touch with planet Earth.”
To sum up, Coase probably doesn't think much of the market design prize, but his doppelgänger who loves math would be thrilled.

Monday, October 15, 2012

In Honor of the 2012 Economics Nobel

This is a reprisal of a post I wrote over two years ago entitled What is Math?  Shapley has had a number of other important contributions that have influenced the ways economists think (this one comes to mind), but as I mention in this post, the original paper outlining the Gale-Shapley algorithm is a masterpiece in clarity.

Originally Posted: 10 February 2010
Here is a quote from an article I read last week.
Most mathematicians at one time or another have probably found themselves in the position of trying to refute the notion that they are people with "a head for figures," or that they "know a lot of formulas." At such times it may be convenient to have an illustration at hand to show that mathematics need not be concerned with figures, either numerical or geometrical. For this purpose we recommend the statement and proof of our Theorem 1. The argument is carried out not in mathematical symbols but in ordinary English; there are no obscure or technical terms. Knowledge of calculus is not presupposed. In fact, one hardly needs to know how to count. Yet any mathematician will immediately recognize the argument as mathematical, while people without mathematical training will probably find difficulty in following the argument., though not because of unfamiliarity with the subject matter.

What, then, to raise the old question once more, is mathematics? The answer, it appears, is that any argument which is carried out with sufficient precision is mathematical, and the reason your friends and ours cannot understand mathematics is not because they have no head for figures, but because they are unable to achieve the degree of concentration required to follow a moderately involved sequences of inferences. This observation will hardly be news to those engaged in teaching mathematics, but it may not be so readily accepted by people outside of the profession. For them the foregoing may serve as a useful illustration.
The article is a classic in economics by Gale and Shapley. The title? College Admissions and the Stability of Marriage. If you "have a head for inferences," I suggest you read it [here]. It is an interesting and influential paper, and it is only 7 pages long.

Friday, October 12, 2012

A Plea to Amazon

Eli Dourado has an interesting plea to Amazon.  His proposal: Amazon should strike a deal with UPS to offer a used-book-to-Kindle recycling program.
This is a win-win-win-win proposition.
I win because I have fewer physical books cluttering up my house, while retaining access to my library.
Amazon wins because more consumers will have large Kindle libraries. This will create an incentive to make future purchases in the Kindle ecosystem.
Book publishers win because when used books are recycled, the market for used books shrinks. Physical books are durable and resalable; converting to Kindle books solves the durable goods problem and makes publisher profits higher because they would sell more copies.
UPS wins because they get a small fee-per-book that comes out of the gains to the other parties.
When I talk about this idea, I find that the main objection I get is an emotional one: “Isn’t it wasteful to destroy used books?” people ask. And the answer is not really. No information is destroyed by recycling the book, because Kindle books are a pretty good substitute. And if the book were not destroyed, then the publishers would never go for the deal, and we would be stuck in a more wasteful situation, one in which a significant fraction of real estate goes toward book storage.
This gives some interesting food for thought, and I think it is especially compelling from the standpoint of Amazon.  If Amazon can do the equivalent of ripping your physical library to a digital library  -- that's a CD reference to those of you from the iTunes generation -- they could make the Kindle your main hub for reading.  Even if the dead-tree-to-electron program costs something, it seems like it would pay for itself (at least from the standpoint of Amazon).

Now, what to do about those stubborn customers who cultivate libraries of impressive sounding books for signalling value?

Thursday, October 11, 2012

Number 48

Starting today, you'll notice this cool logo on my sidebar.

  Top Economics Site

Today, I was informed that This Young Economist has been named one of the Top 100 Sites for Enlightened Economists -- right alongside my favorite econ blog, and some others you might have read.

Here's what they say about the blog.
This Young Economist presents the (generally left-leaning) economic insights of grad student of economics. In addition to his microeconomic analysis, he presents an incredibly useful list of educational videos on a wide variety on economic topics.
I much appreciate the reference to my YouTube video collection, but I didn't realize that I generally lean left.   This is a little ironic, given that the post that they chose to highlight is one in which I favorably quote John Cochrane.  At any rate, it is nice to know people are reading.


In the interest of balance, if you came to my blog from the Top 100 Sites for Enlightened Economists, check out my friend Ryan's blog.  He's not on the list, but he has interesting stuff.  I think he is generally right-leaning, but you can be the judge.

Sunday, October 7, 2012

A Note on Econometrics Notes

In case you are interested, I have made available (by self-publishing at Lulu) my course notes from my honors econometrics class.   I priced the notes at UChicago's cost of printing them on university printers (10 cents per page x 125 pages = $12.50), but because my self-publishing company can capitalize on economies of scale, there is a small margin in there for higher-quality printing and a nice binding.   You can purchase a copy here.  Who is the book's audience?  This is the description I wrote about my notes:
This set of notes follows an introductory econometrics course that assumes familiarity with probability and mathematical statistics at the multivariate calculus level. These notes cover topics that are appropriate for a 10-week course for advanced undergraduates at an honors level. The material presented in these notes is a preview/ bridge to the study of econometrics at the graduate level as well as an advanced introduction to econometrics. For this reason, advanced undergraduates and first-year graduate students in economics (master's students and Ph.D. students looking for a succinct econometrics review) are the appropriate target audience for this text.
To get an idea of the level of material in my notes, here's a playlist of math review videos that I recorded for the class (these roughly cover some missing details in Chapter 1 of 4).  Hopefully, someone finds these useful.

Tuesday, October 2, 2012

More Competition

Apparently Jeff Ely is getting into the business of providing free online education.  Here's a short video on Welfare Economics.

As an economics guy, I find the example -- judges voting in the 2012 Olympics -- to be a compelling introduction to the idea of Pareto Optimality.  It looks like Ely has the help of the IT department in making these videos, and the production quality shows.

In case you're interested, here is what a less well known and younger economist does on a lower videography budget.

Pareto Efficiency

Something Related, More Basic, and Easier

For my taste, these two approaches are complements rather than substitutes.  I'm happy to see the competition because I think short, clear videos like this are underutilized.