Thursday, October 30, 2014

Blog Post About Bargaining Homework/My Laptop

Here is the link to the post The Diffeq From Hell, which I wrote a couple of years ago.  I think it will be most beneficial to you to explain why you have this homework on Bargaining in the first place, and what economic insights the homework is supposed to provide.  You might also be amused by the history of the construction of the Arbitrator's rule, which is documented in that post.  Math-wise, this was the most difficult homework for me to make.  It is ironic that you found it much easier than the prior homework on Adverse Selection in Insurance markets, which may have been tougher for you but was far easier for me - from the point of view of the underlying math modeling.

* * * * *

For those who were in class today and watch me go into a panic attack as system 8.1 installed on my laptop while I wasn't paying attention, this just to let you know that when I got home it seemed it had actually installed correctly, unlike my two previous attempts where it crashed the computer and wouldn't allow it to reboot. So all is well on that score.

Here is wishing you an early Happy Halloween.  Good luck with the trick or treating, but don't eat too much candy if you are successful on that end.

Excel Homework Due Wed 11/5 at 11 PM

This homework is on the simplest possible version of the principal-agent model.  It is this model that produces pay for performance as a feature.  It is important to understand this base model before we delve into various realistic ways of complicating the model.  (Mostly we will talk about that but I might do some additional modeling in class after going over the basic model.)  There is a video I'd like you to watch first.  I should give you the background you need to do the homework.
The actual homework.

Tuesday, October 28, 2014

Some follow up reading

During the first part of the class where we went over the blog posts and the possible reasons for why one might be charitable to others, I mentioned the book Excellent Sheep, which I'm currently reading. What I've read so far is not particularly uplifting, but you might find it interesting to shed light on your own circumstance.  The focus is on elite college students (think of the Ivy League) and the hoops they must jump through, how that effects them as learners and as human beings.  Outwardly creating the appearance of extraordinary competence, inwardly these students are quite miserable and full of doubt.  To the extent that you are just like the students characterized in this book, it provides an argument that all of you are deserving of empathy, from your peers and your teachers.

During the latter part of the class in discussing intrinsic motivation, I mentioned the concept known as Flow.  The link is to a book by that title.  With little effort, you should also be able to find a TED talk on the subject by the book's author, Mihaly Csikszentmihalyi.  It is my view that if you've learned that on occasion you can find Flow in what you do, and do so while engaged in an activity that brings some joy or value to others, then you're very close to finding your life's work.  And if you learned to do that while in college, then college was a very valuable time for you.

In my own reading, I read Flow after reading Daniel Kahneman's Thinking Fast and Slow.  I did that while teaching our course for the first time, when I only had 8 students and taught it as a seminar (but still there were attendance issues).  You might find this blog post I wrote at the time interesting as it tries to tie the various themes together.  I didn't check all the links in that post but I noticed the particular link to the bat and ball problem was broken, which is why I've provided an alternative here.

Thursday, October 23, 2014

Excel Homework Due Wed 10/29 at 11 PM

The homework is on bargaining.  Note that M&R have a discussion of bargaining in Chapter 5.  You should read that.  The model they go through has both the buyer and seller having two types.  In the Excel homework, the model has a continuum of type on each side of the bargain.  In that sense it is harder but also more elegant.  And, I believe, it should give you a better understanding about the relationship between the private information and the inefficiency  created.

There is a fiction in the model that helps to understand what is going on.  The fiction is that there is a third party - an arbitrator - who provides rules for how the bargaining will happen, when trade will occur, and at what price.  The fiction is necessary because the model is static.  Real world negotiations happen over time and to model that correctly one needs a dynamic model.  There are such models, but they are well beyond the scope of our class.  So we will keep the modeling relatively simple and wave our hands about what happens in real world bargaining.

There is a rather extensive discussion in this homework before you log in.  I encourage you to read that carefully and not gloss over it.  It is about how to bargain well and what happens in real-world procurement, which entails a good deal of such bargaining.  There are practical lessons here that you can carry over to your work life, even if you don't engage in procurement.

Wednesday, October 22, 2014

Homework on Adverse Selection and Tomorrow's Class + Blog Grades Uploaded

Based on last year's class as well as on the observation that nobody has yet to submit a key for the Excel homework due tonight, I would say that conceptually the economic models that are the basis for the homework are more difficult to understand than the prior models that we've done.  So I plan to lecture on those models tomorrow.  I don't have a video on this.  I will cover it only in class, tomorrow.


I have assigned grades for your blog posts during the first half of the course.  There are 5 substantive posts included in this assessment.  I didn't count the bio post you produced about the famous economists who forms the basis of your alias.  Most people are doing a reasonably good job.  There are a few laggards.  I hope we can get everyone to be writing good posts during the second half of the course.

There were a maximum of 125 points allocated here.  In addition to assigning you points, I have also given some comments on your blogging and where I'd liked to see improvement in the second half.

For many students I wrote that you should try to make connections to your own prior posts, class discussion, or ideas from the readings.  You might find this awkward at first, since you are also writing to the prompt.  Now I'm suggesting that you serve two masters and that is harder.  Be that as it may, I encourage you to try it.  You'll get better at doing it with practice.

Also, when you make such connections it is natural to link to the content you're mentioning, using the link tool in the blog editor.  Having your posts with some links in them creates the impression that you've done your homework.  That's a good thing to convey.

From the Econ Department - Internship/Job Possibility - Homecoming Celebration

From: Newell, Melissa Allison
Sent: Wednesday, October 22, 2014 8:08 AM
To: Econ Faculty
Subject: Northrop Grumman Recruiting Event and Homecoming


Please feel free to pass along the information below and promote these upcoming events to your undergraduate Economics students (or those interested in the major).  We hope you are able to attend the Homecoming Celebration on Saturday- it is always a great time and a good way for students to connect to the Department and meet others.


Northrop Grumman Info Event
Thursday, October 23
114 DKH
Business Casual Attire
Dinner Provided
Internships and Full-Time Positions!
An Executive from Northrop Grumman (and UI Alumnus) will be presenting on the company and providing information on internships and full-time opportunities!  Even if you are not looking for an internship or full-time job yet, this is a great opportunity to hear about a company who recruits Econ students.
We have Econ alumni working for Northrop Grumman (positions such as Financial Analyst), and they recruit on campus, and are looking for Economics Students.  This is a great opportunity to hear more about the company, ask questions, and network.
Northrop Grumman is a leading global security company providing innovative systems, products and solutions in unmanned systems, cyber, C4ISR, and logistics and modernization to government and commercial customers worldwide.

Economics Homecoming Celebration
Today is the last day to register to attend our Homecoming Celebration:
Saturday, October 25
Tent on the David Kinley Hall Quad
(DKH Quad is East of the building)
 Attire: Informal - ILLINI ORANGE & BLUE
 Meet other students, alumni, faculty, and staff, and it's free!  Win prizes, enjoy great food, and celebrate an Illini and Economics tradition!

Saturday, October 18, 2014

Airbnb and "Helping Industries"

I'm only about halfway with reading the blog posts for this week but I thought this piece tied in nicely to the posts as I've not yet read one that talks about somebody wanting to start their own business after they graduate.  Why is that?  Let's raise that question in class on Tuesday.

Thursday, October 16, 2014

Excel Homework Due Wednesday 10/22 at 11 PM

This one is on insurance under private information.  A person could be a low risk (low probability of loss) or a high risk (high probability of loss) but there are no distinguishing features that lets the insurance company know which type an individual is.  The individuals know which type they are, but if low risk types get better rates than the both types have incentive to claim they are low risk.  The market must somehow address this incentive problem.

I didn't have a chance to talk about this today, but we will make some simplifying assumptions on the supply side to make the equilibrium analysis easier.  In actual insurance, there are costs - writing policies, determining whether claims are legitimate or not, etc.  And sometimes insurance companies will not pay on a claim.  For example, in a car accident where both parties have their own insurance and where the accident was clearly the fault of one driver only, sometimes the goal of the insurance company for the driver who was not at fault is to collect from the other insurance company and there can be disputes about that.  We abstract entirely from all this reality in our models.  Our focus is to understand how the market addresses the incentive problem, not to understand all other aspects of insurance.

Tuesday, October 14, 2014

Extra Credit Projects

This is an experiment for me and perhaps something of interest for those in the class who are eager for getting deeper into the subject matter or are looking to self-insure on their grades.

The experiment part is for me to see whether projects of this sort should become a regular part of the course, the next time it is taught.  Here is what I have in mind:

1.  You indicate an interest in doing a project by sending an email to me indicating that.  This must be done within the next two weeks.  Before you do this, note that the project will entail real work on your part.  If the end product shows little to no evidence of such work, you will not receive any credit for it.

2.  Once I've received the email from I will suggest a paper for you on which your project is based.  Alternatively, in your email you can suggest a paper that interests you either from those I've mentioned previously in class or in the online presentations.  As an alternative to a paper, you can review a Nobel prize lecture, such as the one by Herbert Simon or the one by Oliver Williamson.

3.  Your first draft will be a review of the paper you read.  I will give more specific instructions on what needs to be in this review and how you should set it up.

4.  I will provide comments on the first draft and based on those you will produce a second draft/final submission, but the form of this will be like the PowerPoint presentations I've provided at the beginning of the semester.  The paper part will be in the notes area.  Each slide will have a title and an image to illustrate the ideas.  A link back to the image source will be included in the slide.

I will then grade the submission via points.  The maximum possible is 50 points.

References for Post Midterm Reflection

Post to class last year:
Figuring It Out/Demonstrating Personal Commitment to the Class

Campus Strategic Plan:
Goal 2 - Provide Transformative Learning Experiences

From the Tomorrow's Professor eNewsletter - MindsetsToward Learning
Book - Mindset by Carol Dweck - Glenn Loury and William Deresiewicz
Book - Excellent Sheep by William Deresiewicz

Quote from Fahrenheit 451 by Ray Bradbury:
We need not to be let alone. We need to be really bothered once in a while. How long is it since you were really bothered? About something important, about something real?

Monday, October 13, 2014

The Exams Are Graded

They will be returned in class tomorrow and we will spend some of the class time going over the test.  I will update the Moodle grade book only after the class session.  I hope you will attend tomorrow.  I believe the session will be quite beneficial to you.

Tirole Wins Nobel Prize in Economics

Here is a snip about the announcement from the NY Times.

And here is a photo of me holding the textbook by Tirole and his frequent co-author Laffont on Procurement and Regulation.  In the early 1990s, I taught out of that book in a graduate course on Regulation.

Thursday, October 9, 2014

My Prediction for the Nobel in Economics

The announcement should be next Monday.  I've been predicting William Baumol as the winner for the last 10 years or so.  He hasn't won it yet, but I've got no reason to change my prediction.

Excel Homework Due Wednesday 10/15 at 11 PM

This is the homework on the Math of Risk and Risk Preference.   While you might be able to grind through it without viewing the content in the previous post, my expectation is that you will have done so.  It will greatly increase your understanding of what is going on.

Also, if you are an eager beaver in the crowd and do the homework before class next Tuesday (I applaud the eager beavers in the class) note that when you get to line 86 of the spreadsheet it says we have covered these ideas in class already.  We should get to those ideas on Tuesday, if only briefly.

Preliminaries on Probability and the Economics of Risk

Each of these should be reviewed before doing the next Excel homework, which assumes that such a review has been performed.  They should be familiar already, based on what you've been exposed to in Econ 202 and 203.  There may be some new stuff on risk preference.  I'd be curious to learn what is old hat and what is new for you.  Note that there is a bit of overlap between each of these.  Nonetheless, I strongly encourage you to review them all, so you have a firm understanding of the fundamentals. The second one emphasizes and algebraic approach.  The third, a graphical approach.  You should be familiar with both.

Notes on the Math and Philosophy of Probability  (This is a pdf file.)

Increasing Risk and Risk Aversion (This a video in YouTube.  You can find a link to the PowerPoint file on which it is based in the description of the video.)

Expected Utility and Jensen's Inequality (This a video in YouTube.  You can find a link to the PowerPoint file on which it is based in the description of the video.)

You should be able to get through all of this in under 45 minutes.  Of course, the less familiar it is to you, the longer it will take to get a good understanding.

Wednesday, October 8, 2014

Akerlof's Gift Exchange Model - For Tuesday 10/14

Akerlof's theory is rather simple to articulate, as is the debate over how best to do compensate employees to make them most productive.  (Akerlof's model is the basis of one side of the debate.  The model for the other side is the principal-agent model.)  The quintessential issue is whether pay should be performance based and hence vary from individual to individual who hold the same job (one view of compensation that is associated with the principal-agent model) or if instead pay should be position based and not feature such idiosyncratic variation, except perhaps on a seniority basis (the alternative view of compensation that comes out of Akerlof's model).   Of course, those in the second camp don't deny that performance matters.  Where they differ with those in the first camp is on how excellent performance should be rewarded.  For those in the second camp promotion should be the primary reward for exceptional performance.  They believe that within a job classification, the workers need to be managed fairly, which provides the basis for equal treatment.  This is the essence of the view that emerges from Akerlof's model.  

The vision for why this alternative to the principal-agent model produces superior performance was supplied by Dumas père in The Three Musketeers.  It is embedded in the relationship between Athos, Porthos, and Aramis (the workers doing the same job) and D'Artagnan (their manager) and is captured in the phrase, "All for one and one for all."  Akerlof crafts that vision and related ideas from sociology to make an economic model of it.  For the non-economist, it might be framed as collegiality-driven productivity.  Here are the model's basic elements.

There is a minimal performance standard below which the employee will get fired.  There is a performance norm, substantially above the minimal standard, that typifies what workers produce.  The difference between the minimal standard and the higher norm constitutes a gift that workers give to the firm.  Likewise, there is a minimal wage below which workers would quit and find work elsewhere and there is an actual wage above that minimum that the firm pays to workers.  The difference is a gift that the firm gives to its employees.  Gift giving demands reciprocation for it to be sustained.  When that happens all involved feel good about the place of work and productivity is high as a consequence.

There is one more piece to the puzzle in the Akerlof approach.  This regards how productivity is observed and what explains variation in productivity from one worker to the next and for one worker over time.  From the worker's own perspective, this is mainly due to random factors - circumstances beyond the employee's control.  Or, in the case where there is clearly a drop off in a particular employee's performance, it can be attributed to outside of work stresses (e.g., a sick child at home) that are apt to be temporary in nature.  The correct response in this case is not to punish the employee but rather for co-workers to chip in and pick up the slack.  Sometime in the future, the employee who received such help will lend a hand when another co-worker has a similar problem.

Applying the approach specifically to how teachers in K-12 should be compensated, because that has gotten a lot of attention in public debate, the principal-agent approach is consistent with pay performance pay based on student test scores, while the Akerlof approach would avoid that in favor of seniority based pay.  An advocate of the principal-agent approach but with an open mind might grant that collegiality-driven productivity can be a good thing, as long as the fire burns within all the workers, but will argue that eventually a worker burns out and turns into dead wood.  That is not temporary.  It is a permanent change.  Then the follow up argument is that seniority based pay sustains the dead wood, who act as a drag on the entire system.  One needs, instead, a time-consistent way to purge the system of the dead wood.  Performance based pay does that.

Akerlof's model does not address that critique.  I will provide my own answer below, but before I do  let me take a slight detour.  The Akerlof gift exchange model is essentially social in nature.  There is a different reason to depart from performance based pay that is intellectual in nature and is particular to knowledge work.  This other view is articulated by Daniel Pink in this RSA Animiate video and focuses on psychological explanations for productivity.  There can be performance anxiety or, if you prefer, writer's block. High performance is achieved when intrinsic motivation is strong and the individual becomes so involved in the work as to entirely lose a sense of self.  Making extrinsic rewards overt moves the individual's focus away from the intrinsic motivation and thereby lessons productivity.  Better to have the economic rewards provided up front so that one can put them out of mind when the real work commences.  While I have critiqued this video on how it represents the economics, I concur with its representation of the importance of intrinsic motivation. 

Burnout then can be thought of as the disappearance of intrinsic motivation.  The response on the burnout issue is to look at the causes for why intrinsic motivation should disappear.  One possible cause is a sense of plateauing in the work.  There is little left to learn, no inherently new challenges.  For the most part it is a rehash of what's come before - been there, done that.  This cause is consistent with the principal-agent view.  When it happens, it would seem to make sense that the worker should move onto a new challenge; do something else, especially if one has a sense that new challenges would rekindle a fire in the person.  There is, however, a different cause that is also possible.  It is that the individual confronts organizational barriers that seem arbitrary and anti-productive and those barriers repeatedly thwart the individual's creative efforts.  Eventually, the individual wears down from not seeming able to accomplish sensible change.  Gallows humor becomes part of the routine as the individual loses the desire to fight the system.  This second cause might reasonably dictate that more fundamental organizational change is necessary.  The burden shouldn't be placed on the individual to accommodate organizational inertia.

It is this second cause that forms the basis of for tying the motivational issue to the organizational ones.  The Akerlof gift exchange approach must happen within a dynamic organization that makes organizational learning paramount.  (See Senge's The Fifth Discipline.)  Employee burnout might still happen in such organizations, but it would be far rarer.  When it does happen the appropriate organizational response should be job reassignment rather than immediate severance, this in accord with the gift exchange view.  Collegiality, in tone and actual practice, then characterizes good jobs and is at the heart of how the organization remains productive.

The above is in accord with my experience as a campus administrator.  In my years working in learning technology, everyone I've encountered knows the benefits of collegiality for productivity, though I expect that the vast majority of them were not acquainted with Akerlof's gift exchange model.  Performance based pay seems logical and in certain instances (sales, in particular) even those who believe in collegiality will acknowledge the benefits of performance based pay.  But, as it de-emphasizes collegiality in favor of individual performance, in other contexts performance-based pay can be counter-productive.  

Thursday, October 2, 2014

Algebra of quality choice under transfer pricing

This is now a completed post.  It includes a link to a PowerPoint with all the algebra.  I've made an animated version of this PowerPoint and then made a screen capture movie of that with my voice over.  You may find it sufficient to watch the embedded video below.  Alternatively, you may want to full screen the video so you can read things more clearly.

Wednesday, October 1, 2014

Grades Updated in Moodle

There were two more Excel homeworks and three more blog posts since the last update.