Tag Archives: tim-harford

Grade Inflation

With news that Cambridge University is to demand A* grades at A-Level as a prerequisite for entry (a grade that currently doesn’t exist), there is much in the news about ‘grade inflation’.

However “grade inflation” is actually the answer; the problem is “grade distortion”:

True grade inflation would mean each grade was equally devalued, with A grades superseded by AA, AAA and AAAA as new labels for superlative performance became necessary. One hundred per cent would become 110 per cent.

Yet examiners are reluctant to award 110 per cent and there are no AAAA grades. What we see is not inflation but a classic price distortion. Eventually all students will get A grades and they will be meaningless. A* grades are a small, belated step in the right direction.

Grade distortion is a serious affair. Students and their teachers are forced to switch to grey market transactions denominated in alternative currencies: the letter of recommendation, for example. Like most alternative currencies, these are a hassle.

Grade distortions, like price distortions, destroy information and oblige people to look in strange places for some signal amid the noise. Students are judged not on their strongest subjects – A grade, of course – but on whether they also picked up A grades in their weakest. When excellence cannot be displayed, plaudits go instead to those who deliver pat answers without stumbling.

Unlikely Events Influenced by Financial Incentives

With the UK’s Chief Medical Officer, Sir Liam Donaldson, proposing that alcohol should cost a minimum of 50p per unit, many opposers are arguing that the increase would “punish ordinary drinkers without deterring the winos, brawlers and wife-beaters”. However, as Tim Harford notes, it may well work as the unlikeliest of events are influenced by financial incentives.

Economists Joshua Gans and Andrew Leigh have discovered that after the Australian government announced that it would abolish inheritance tax, effective 1 July 1979, the death rate fell in late June of that year before surging in early July. Gans and Leigh reckon that half the likely taxpayers managed to escape death long enough to escape the tax too.

More cheeringly, when the Australian government announced (with six weeks notice) a “baby bonus” of about £1,250 for families of children born on or after 1 July 2004, something very strange happened in the labour wards. The number of happy events on 1 July was an all-time record, and twice as many births as on 30 June.

Whether entering this world or leaving it, people respond to financial incentives.

For a primer on incentives, you can do worse than reading Russell Roberts’ Incentives Matter article—one of the Ten Key Ideas from the Library of Economics and Liberty.

via The Undercover Economist

Models of Racial Segregation

Tim Harford—the FT’s ‘Undercover Economist’—has produced a video demonstrating Thomas Schelling’s theory of racial segregation, in 2 minutes.

Schelling, who was awarded the 2005 Nobel Prize in Economics for “having enhanced our understanding of conflict and cooperation through game-theory analysis”, showed with his Models of Segregation that even a mild preference for the colour of your neighbour can lead to extreme segregation.

Harfords view on this:

Although we as individuals may be rational and we may be tolerant, the society that we produce together may be neither rational nor tolerant.

Planning for the Worst Case Scenario

Eliezer Yudkowsky on planning for the abyssal.

Never mind hindsight on the real-estate bubble – there are lots of things that could potentially trigger financial catastrophes.  I’m willing to bet the American government knows what it will do in terms of immediate rescue operations if an atomic bomb goes off in San Francisco.  But if the US government had any advance idea of under which circumstances it would nationalize Fannie Mae or guarantee Bear Stearns’s counterparties, this plan was not very much in evidence as various government officials gave every appearance of trying to figure everything out on the fly. […]

It’s questionable whether the government should be in the position of trying to forecast the abyss – to put a probability on financial meltdown in any given year due to any given cause.  But advance abyssal planning isn’t about the probability, as it would be in investing.  It’s about the possibility.  If you can realistically imagine global financial meltdowns of various types being possible, there’s no excuse for not war-gaming them.  If your brain doesn’t literally cease to exist upon facing systemic meltdowns at the time, you ought to be able to imagine plausible systemic meltdowns in advance.

This got me thinking about planning for our own abyss (be it employment or health). Why don’t we have plans for the worst case scenario? After all, as the Financial Times’ Tim Harford states, “[A] recently published research paper [shows] that most unemployed people are too cocky about their prospects of finding a new job. On average, they expect seven weeks of unemployment, but eventually endure 23 weeks. And this is using data from the mid-1990s, not recession years”.

A case of the planning fallacy?

The Inefficiency of Christmas Gifts

A letter to Tim Harford (The Undercover Economist) asks, What’s the best Christmas present?

Your letter obliges me to disinter the influential research of the economist Joel Waldfogel on the “deadweight loss of Christmas”. Fifteen years ago, Waldfogel published an academic article demonstrating that the recipients of gifts would not generally have been willing to pay what it cost to provide the gift. A £30 sweater was valued at £20, for example, creating a “deadweight loss” of £10. Siblings were not the most incompetent givers – that honour goes to aunts and uncles – but they were not especially competent either.

Waldfogel’s work is often misinterpreted as suggesting that gift-giving is pointless. That is not true. He explicitly excluded the sentimental value of gifts from his calculations, and, of course, the sentimental value is part of the purpose of giving presents. That may explain why the economists Sara Solnick and David Hemenway have discovered that we prefer unsolicited presents to those we have specifically requested. It may also explain why gift vouchers are a bad idea: they have no sentimental value but still create deadweight loss, since many expire without being used, or are sold at a loss on eBay – as the economist Jennifer Pate Offenberg has documented.

All this points to the optimal gift-giving strategy: you need to minimise the deadweight loss while maximising the sentimental value. This suggests buying small gifts and striving for emotional resonance. Look for something inexpensive, and consider supplementing it with a letter, a photo, or time spent together.

If you feel a financial transfer is necessary, slip a cheque into the envelope too.

For a more in-depth look at Waldfogel’s research—and the implications thereof—The Economist takes up the slack.

If the results are generalised, a waste of one dollar in ten represents a huge aggregate loss to society. It suggests that in America, where givers spend $40 billion on Christmas gifts, $4 billion is being lost annually in the process of gift-giving. Add in birthdays, weddings and non-Christian occasions, and the figure would balloon. So should economists advocate an end to gift-giving, or at least press for money to become the gift of choice?