Michael Munger, Bosses Don’t Wear Bunny Slippers, If Markets Are So Great, Why Are There Firms: Library of Economics and Liberty

The other day when we introduced our unit on market failure, we began by revisiting the concept of free markets as mechanisms for allocating scarce resources efficiently. As I was reading blogs tonight, I stumbled upon this blog post by Michael Munger, professor of political economy at Duke University, where he shares an anecdote he uses when introducing the allocating power of markets through the price mechanism:

When I teach political economy, I start with the neoclassical theory of consumption, and then cover production. And I show students how miraculous is it that the actions of millions of people who have never met can be directed by prices. Resources move toward their highest valued use, and consumption goods are delivered to the consumers who want them.

For example, the United States promoted ethanol as an auto fuel. This sharply increased the price of corn worldwide. As Brazilian reporter Kieran Gartlan put it: “Higher prices are leading Brazilian farmers to plant more second crop corn this year, and the country’s modest corn exports are expected to expand [from 42 million tonnes to 48 million tonnes, an increase of 230 million bushels.]” (DTN, March 2, 2007, emphasis mine).

No one directed the Brazilian farmers to shift to corn production. The article puts it perfectly: “Higher prices are leading farmers….” The leadership comes from the prices themselves! The farmers may have had no idea why the price of corn had increased, to $4.00 per bushel. (After all, Brazil uses sugar, not corn, to produce its ethanol.) But Brazilian corn production increased within a year, by nearly 15%. No one made the farmers switch; they made choices. Other corn producers, in Argentina, Mexico, and several African countries, followed suit. No one talked about it, no one gave any orders; prices led them.

The reason I post this excerpt from professor Munger’s blog now is that it serves as a great response to a student who on the first day of our market failure class posited that perhaps the government could do a better job of deciding what goods and services and how much of them should be produced in an economy.

Yes, markets fail, and for many reasons: a concentration of power among a few large firms, an underallocation of resources towards goods that have spillover benefits, the over-provision of goods that have spillover costs, the failure of the market to provide public goods: these are examples of how market fail.

But when markets work, they really work! The efficiency of resource allocation that results from free, competitive, markets is unrivaled by any central planning agency. Munger’s example above is a simple illustration of this allocative power of markets and prices.

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BBC NEWS | Technology | Nintendo warns of Wii shortages

Looks like Brits dreaming of the Wii from Nintendo may have to wait a while longer this holiday season, as British retailers are finding it nearly impossible to fill customers’ orders. It turns out there is quite a shortage for the hot new gaming system from Nintendo!

“Although we’re receiving regular deliveries from Nintendo, Sony and Microsoft and getting the products onto the shelves as fast as we can – it’s possible that demand will outstrip supplies on some products, for example the Nintendo Wii, which has been hugely popular all through the year,” read a statement from high street gaming specialist Game…

“The Nintendo Wii consoles have proved extremely popular with our customers and have been flying off the shelves whenever we get new stock in,” said a spokeswoman.

It seems like the shortage of Wii’s in the UK should send a message to Nintendo and its retailers: RAISE THE PRICE!! One way retailers have tried to do this is by bundling the consoles with up to three or four games, meaning to take home a console shoppers would have to fork over 300 GBP. This seems like a great strategy for retailers faced with strong demand from customers, given that they are probably not allowed to charge above Nintendos suggested retail price for the console itself. Continue Reading »

Freakonomics: Monkey Business: Keith Chen’s Monkey Research

No I’m not talking about the latest freshman class at an Ivy League school… rather a group of monkeys at Yale that have been taught how to use money:

The essential idea was to give a monkey a dollar and see what it did with it. The currency Chen settled on was a silver disc, one inch in diameter, with a hole in the middle — ”kind of like Chinese money,” he says. It took several months of rudimentary repetition to teach the monkeys that these tokens were valuable as a means of exchange for a treat and would be similarly valuable the next day. Having gained that understanding, a capuchin would then be presented with 12 tokens on a tray and have to decide how many to surrender for, say, Jell-O cubes versus grapes. This first step allowed each capuchin to reveal its preferences and to grasp the concept of budgeting.

Turns out the law of Demand is not only true for humans but for monkeys too. When Chen “lowered the price of grapes”, monkeys would buy more grapes and less Jell-O, following the basic rule of utility maximization. Interestingly, the introduction of money led to more than just the simple exchanges of currency for candy and cucumber; the monkeys were also taught to gamble. Through their observations of several gambling scenarios, the researchers found monkeys tended to display “loss averse” behavior in games of chance, leading to an amusing conclusion:

The data generated by the capuchin monkeys, Chen says, ”make them statistically indistinguishable from most stock-market investors.”

Sadly, gambling was not the only vice that accompanied the introduction of money in to monkey society:

Then there is the stealing. Santos has observed that the monkeys never deliberately save any money, but they do sometimes purloin a token or two during an experiment.

But the debauchery does not stop with gambling and theft:

Perhaps the most distinguishing characteristic of money, after all, is its fungibility, the fact that it can be used to buy not just food but anything. During the chaos in the monkey cage, Chen saw something out of the corner of his eye that he would later try to play down but in his heart of hearts he knew to be true. What he witnessed was probably the first observed exchange of money for sex in the history of monkeykind. (Further proof that the monkeys truly understood money: the monkey who was paid for sex immediately traded the token in for a grape.)

As if we needed any proof beyond the widespread immorality and loss of values that distinguish many rich human societies, the steep decline of monkey morality observed at Yale can only be attributed to the introduction of currency! The implications of the Yale study on economics are clear: humans are not necessarily unique in our understanding of currency as a means of exchange. As long as money has imbued human societies, the wont to enrich ourselves through immoral means such as gambling, theft and prostitution has stained civilizations from ancient Mesopotamia to modern America.

When taught to use money, a group of capuchin monkeys responded quite rationally to simple incentives; responded irrationally to risky gambles; failed to save; stole when they could; used money for food and, on occasion, sex. In other words, they behaved a good bit like the creature that most of Chen’s more traditional colleagues study: Homo sapiens.

To make a more poignant observation, one thing is clear and disturbing, among the human societies today, Americans are most like monkeys when it comes to saving.

Discussion Questions:

1. Of the various functions of money, which role does money play for monkeys?
2. What gives the money used by the monkeys its value?
3. Discuss the evidence from this article suggesting that monkeys follow the law of demand.
4. What is the utility maximization rule and what evidence from this article supports the suggestion that monkeys follow this rule?
5. How are monkeys more similar to American consumers than to, say, Japanese or Chinese consumers?

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