“A science that claims to interpret demand fails every time it explains consumer behaviour as irrational”
Douglas, M., and Isherwood, B., 1979, The World of Goods (1996, Routledge, p.xvi)
This session surveys the key findings of behavioural economics and explains how they relate to day-to-day management. Participants will receive a thorough understanding of how economic insights for decision making can be augmented with experimental economics.
After this lecture you should be able to: Apply a range of examples of behavioural anomalies to real business situations. Understand behavioural anomalies in light of an ecologically rational framework.
Here is an explanation of the Birthday Paradox. Notice that the probability calculation assumes a uniform distribution (i.e. that there’s a 1/365 chance of being born on any given day). In fact, birthdays in July, August and September are more common than other months.
We had a dreadful 2020. To be fair, nobody could have reasonably expected the executive team to predict a global pandemic which resulted in widespread economic shutdowns. But by the same token, if managers aren’t at least partly responsible during the bad times, they shouldn’t take full credit for the good times. Most executives are riding on the backs of central bankers who have slashed the cost of capital and on technology pioneers who have made it easier to transact and communicate… So, given that my fellow executives took bonuses in the boom years, we are slashing their salaries by half.
If you are familiar with the Amanda Knox case you should find this essay fascinating, where she identifies a wide range of behavioural biases that played a role in her wrongful conviction and ongoing reputational damage: “A Surprising Gift from my Wrongful Conviction“.
Although I take behavioural economics seriously, I don’t think it majorly restricts the usefulness Efficient Market Hypothesis:
The reason for this is (partly) explained in Vernon Smith’s Nobel prize address:
Smith, V. L. 2003, “Constructivist and Ecological Rationality in Economics†”. American Economic Review. 93 (3): 465–508
Poundstone, William (2010) Priceless: The Hidden Psychology Of Value Oneworld
Kahneman, Daniel (2011) Thinking, Fast and Slow Farrar Straus and Giroux
Lambert, Craig “The Marketplace of Perceptions”, Harvard Magazine, March-April 2006 – A summary of chief insights from behavioural economics and neuroeconomics
Poundstone, W., (2011) “Prospect Theory” (Chapter 16) and “Ultimatum Game” (chapter 18) from Priceless: The Hidden Psychology of Value, One World – Good introductions to key concepts
Tabarrok, A., “A Phool and His Money” Review of PHISHING FOR PHOOLS: The Economics of Manipulation and Deception, by George A. Akerlof and Robert Shiller, Princeton University Press – A defence of standard economic theory against behavioural claims
The incredible data visualisation used at the beginning of my lecture is from Gapminder. I strongly encourage you to visit their website and play around with the tools. In particular, try to create a chart showing GDP per capita against infant mortality and then see how the data has changed over time.
The increases in global income have been incredible. In Factfulness, Hans Rosling tells us that 100,000 years ago everyone was poor and most children didn’t survive long enough to become parents. 200 years ago, 85% of the world were still in extreme poverty. Today, most people live in middle-income countries, with living standards similar to Western Europe and North America in the 1950s (see p.38).
Reduced population growth – poor communities have lots of children because many will die early, and they need a contribution to family income. As they get richer, the need for more extra children declines and parents focus on quality not quantity… based on current growth projections total global population is due to stabilise at ~11 bn people. As Rosling says, “Once parents see children survive, once the children are no longer needed for child labour, and once the women are educated and have information about and access to contraceptives, across cultures and religion both the men and the women instead start dreaming of having fewer, well-educated children” (p.91)
Greater concern for the environment
More resources for humanitarian assistance (e.g. for natural disasters or global pandemics)
One of the most important contributions to the rise in global living standards was the Green Revolution. A 2021 paper found that “if the Green Revolution had never happened GDP per capita in the developing world would be half of its current level… More realistically, if the Green Revolution had been delayed by ten years incomes in the developing world would be 17% lower today. In terms of cumulative GDP what this means is that the investments which made the Green Revolution possible were responsible for some US $83 trillion in benefits” (summary from Alex Tabarrok). Unfortunately, we missed out on similar benefits from Golden Rice.
In the lecture I argue that infant mortality figures are better proxies for living standards than life expectancy. As Hans Rosling argues, “this measure takes the temperature of the whole society” (p.20). This is because children are fragile, and you therefore require lots of good circumstances in order for children to routinely survive – it tells us about access to basic health care, the literacy of mothers, etc.
Some great videos to watch that explore the themes from the lecture:
Although as Tim Harford (“50 Things that Made the Modern Economy”) points out we tend to have more clothes and wash them more regularly, and therefore haven’t saved much time. A better example for a household technology that has unambiguously increased leisure time may be TV dinners and other forms of processed food
In the lecture I included some data on the long term declines in violence. You can see more about this in Steven Pinker’s Enlightenment Now, but one common rejoinder is U.S. gun crime. According to this article by Pew Research, gun murder has increased in recent years, but are still below their 1968 values.
This review of Bryan Burrough’s 2015 book, ‘Days of Rage’, highlights a separatist movement that “bombed NYC like 300 times, killed people, shot up Congress, tried to kill POTUS (Truman). Nobody remembers it.” In the 1970s they “bombed 2 theaters in the Bronx, injuring eleven, in 1970. NYT gave it 6 paragraphs.” For those who think street violence is new , “You have to understand: in 1968, many radicals absolutely believed that the United States was getting ready to collapse.”
If our focus is on Development Economics, and a set of policy prescriptions that can improve the quality of life for the world’s most desperate people, a relatively simple solution is more free migration. For a thorough and highly readable defense of open borders see Caplan, B., and Weinersmith, Z., 2019, Open Borders: The Science and Ethics of Immigration, First Second New York.
Learning Objectives: Test understanding and utilisation of important macro concepts.
Focus on diversity: In 2014 Janet Yellen became the first female chair of the Federal Reserve. In 2020 she was widely tipped to become the first female U.S. Treasury secretary. This would mean that she’s occupied the twin positions of being in charge of monetary and fiscal policy. You can learn more about her here.
a medicine with 280 different components, manufactured in 86 different sites across 19 countries, driven partly by the research of a son and daughter of Turkish migrants to Germany. That’s globalization in a needle
This guy attempted to make a sandwich from scratch. It cost $1500 and took 3 months. It’s remarkable how cheap and plentiful sandwiches are, due to an extended global supply chain and division of labour.
This video shows the history of globalisation through some important maps:
Here we use basic demand and supply analysis to look at the welfare effects of trade intervention:
Learning Objectives: Estimate the welfare effects of trade intervention
Textbook Reading: Chapter 7 (Section 7.1 and 7.5; pp. 200-211 and pp. 227-236) and Chapter 8 (Intro, Section 8.1 and 8.2; pp. 237-278)
This lecture covers a lot of ground but tries to give you a relatively simple, usable framework to relate monetary economics to monetary policy decisions. One problem when studying macroeconomics is the belief that it equips us with an ability to forecast. See my video on Economic Prediction for why I think we need to be careful (and here is a short follow up quiz). Ultimately, we shouldn’t expect central banks to be able to forecast a recession because if they could predict them they can prevent them. To predict a (demand side) recession, therefore, we are really trying to predict central bank incompetence.
You may think that I am being harsh on economic forecasters. But I agree with Andy Haldane when he said, “It has been argued that these models were not designed to explain such extreme events. For me, this is not really a defence. Economics is important because of the social costs of extreme events. Economic policy matters precisely because of these events. If our models are silent about these events, this jeopardises the very thing that makes economics interesting and economic policy important.”
Conventional monetary policy is a simple link between a target (usually inflation) and a tool (interest rates). During the lecture I implied that central bankers change interest rates relative to the current rate. In some cases, however, they may be trying to move the policy rate closer to some sort of benchmark. A common benchmark can be calculate using a Taylor Rule. For examples, see Kaleidic Economics.
Recent changes to central bank targets include:
In August 2020 the Fed announced that it would replace a flexible 2% inflation target with a flexible average 2% inflation target (see here).
In July 2021 the ECB announced that it would replace a target of “below but close to 2%” with a symmetric 2% target over the medium term (see here).
To get a feel for how central bankers should respond to changing conditions, try these simulators:
The lecture also introduces the concept of the signal extraction problem. This isn’t the most intuitive concept to grasp, but it explains how nominal shocks can have real effects. In other words how changes in the money supply can affect inflation and real growth. A good article on this is Steve Horwitz’s ‘The Parable of the Broken Traffic Lights“.
Scott Sumner has been described as “the blogger who saved the economy” due to the influence he had over the Fed’s late 2012 QE3 program. He also contributed to the “market monetarist” movement which potentially influenced the Fed’s decision to adopt average inflation targeting and use market forecasts when cutting interest rates in 2019.
For my account of the 2007-2008 financial crisis:
What is a yield curve:
Learning Objectives: Understand the root causes of inflation, and contribute to policy discussions. Understand how monetary policy affects business decision-making and thus generates macroeconomic fluctuations. See the operation of a conventional monetary policy regime in practice. Contrast the ways in which the Fed and the ECB acted during the global financial crisis.
Cutting edge theory: Nominal income targeting and surveying current monetary indicators.
If monetary policy is deemed to be ineffective the government can switch to fiscal policy:
Encourage private spending by cutting taxes
Boosting spending directly through government purchases
The only reason we need to turn to fiscal policy is if monetary policy isn’t working. This may be because it looses its power at the ZLB, or it may be because it is not being implemented properly
To some extent, monetary policy determines the amount of total spending, fiscal policy affects its composition. Its main impact comes from shifting spending from the future to the present. The balance of spending between the public and private sector is a contentious issue because it gets to the heart of the argument about the optimal size of the state.
What’s the conventional definition of a recession?
How does the NBER officially define recessions?
The content on policymakers feeling pressurized to “do something” is an element of crisis management more generally. An interesting example of the types of trade off that policymakers face is BBC Radio 4’s ‘Discussion Time: Coronavirus‘. Even though it relates to an epidemiology situation, it is relevant for any PR situation. Policymakers face a balance between maintaining public confidence, being seen to be providing a quick and clear response, without inciting a general panic. This relies on having good frameworks and tools that relate to the specific situation (the Radio 4 panel explain how important expert forecasts of the spread of foot and mouth disease were, in a recession economic impact studies play a critical role); but also an ability to manage public expectations. The goal of successful crisis management is to balance these things without introducing new uncertainties.
MMT is also invoked to claim that governments can make spending commitments (such as welfare spending) without having to raise taxes. Recollect the three main forms of government finance: (1) taxes; (2) borrowing; and (3) inflation. MMT essentially says that 1 & 2 are only necessary to prevent inflation, and therefore at full employment (i.e. with stable inflation) taxes or borrowing aren’t acting as a constraint on spending. Technically this is true, but I believe that it is an exercise in semantic word games to distinguish between their claim – that “taxes don’t fund the welfare state” – and the fact that taxes are required to offset the inflation that would otherwise be caused by the money printing used to fund the welfare state. (see here). Ultimately the achilles heel of MMT is real resource constraints. The problem with public finance has never been a shortage of cash, but the scarcity of the real factors of production. Printing money can bid those resources away from the private sector, but cannot create more of them.
Learning Objectives: Assess the efficacy of fiscal stimulus and aggregate demand management. Perform back of the envelope calculations to estimate the fiscal multiplier for a range of different countries.
Focus on diversity: Christina Romer was the Chair of Obama’s Council of Economic Advisors during the stimulus. You can learn more about her here.
Textbook Reading: Chapter 7 (Intro, Section 7.1 and 7.2; pp. 199-216) and Chapter 12 (Section 12.1; pp. 399-403)
When talking about macroeconomics I think it’s important to distinguish between the overall economy and the circumstances of an individual firm. We can’t always assume that macro conditions are felt the same by each company within it. I explain more in this video:
In 2011 the Mirrlees Review published ‘Tax by Design‘, a comprehensive overview of UK tax reform.
Regarding public finance more generally, in 2012 I participated in the 2020 Tax Commission. You can read our report here.
Regarding tax compliance, you may hear things like:
Apple can pretty much choose how much tax it wants to pay and to whom. One EU estimate was that it paid less than 0.01% tax on profits of over $100 billion (Frisby 2019, p.175)
This may be true, but it doesn’t mean that tax is voluntary. The choice that Apple have is over what activities they undertake, each of which have different tax implications. So they can affect their tax obligations, but only in as much as they alter their business decisions.
In 1945 Hong Kong was a poor territory. After war and Japanese occupation many of its 600,000 people were starving. They had no traditionally considered natural resources, and yet soon became a major manufacturing location, the busiest port in the world, and a centre of the global financial market.
What happened? In 1945 civil servant John Cowperthwaite made Hong Kong a free port, which meant no tariffs for most goods, no export subsidies, and few restrictions on imports. Trade grew quickly.
On the supply side, it is not as though Hong Kong’s services lack in any way. The territory has the fourth best education system in the world, according to Pearson, and it ranks top of Bloomberg’s healthcare index. Its public transport system was ranked the world’s best last year, and it is consistently used as a model elsewhere (Frisby, 2019, p.13)
Perhaps even more powerfully, Hong Kong has been used as a model for other areas on mainland China. In 1980 Shenzhen became a “special economic zone” with low taxes and market-friendly regulation. The population rose from 30,000 to 13 million. Here’s Hong Kong in 12 amazing photos.
In 2014 I attended a Mont Pelerin Society meeting in Hong Kong. Here I am in front of that amazing skyline, with my undergraduate econ study partner!