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Outsmarting the crowds at the Shanghai airport

As many of you, my students, know, I spent the weekend in Sichuan Province previewing a China Alive trip for next year's freshman and sophomores. While I waited to board my plane on Thursday night, after a day of teaching economics, I found myself reading a fascinating book called The Wisdom of Crowds by James Surowiecki.



Well, the thesis of this book is that groups of diverse individuals tend to make better decisions and solve complex problems more skillfully than the smartest individual in the group could have done on his or her own. Interesting hypothesis, right? In fact, the basic theory here is one we've recently employed in our Econ classes through collaborative activities such as Welker's Wikinomics Page, where 36 AP students are supposed to work together to create something better than any one of you could have created on your own! Three weeks into this experiment in group wisdom and I think I can say we've at least to some extent supported Surowiecki's hypothesis!



Surowiecki introduces his thesis with a story set in a county fair somewhere in rural England, not unlike a 4-H fair you may have heard of if you grew up in the Midwest like myself. At this particular fair a farmer decided to offer a prize to the fairgoer who could most accurately guess the weight of a healthy bull he had put on display. Over 800 individuals placed their estimates, writing them on a slip of paper and depositing their guesses into a jar. At the end of the day, the guesses were collected, the bull was weighed, and the closest individual missed by only about 10 pounds, not bad considering the bull weighed in at 785 pounds! What's most interesting, however, is that when all of the 800 guesses were added up and averaged (the sum of the guessed weights divided by the total number of guesses) the result was a mere 1.4 pounds off of the bull's actual weight: 786.4 pounds.



Now, this could be a fluke, a random feat of pure luck or freakish happenstance... but Suroweicki only points to this as one illustration of a phenomenon that he believes holds true in countless realms of society. He goes on to point to the corporate structure, the stock market, sports betting, TV game shows and several other arenas where "group think" outperforms the smartest or most experienced "experts" in various fields.



You're probably wondering what this has to do with me sitting in the Shanghai airport last Thursday evening, right? Well, there I was reading this book when I notice a stir in the crowd of people around me. Before I know it everyone is jumping out of their seats and rushing towards the gate, and I find myself doing the same! What has become of me? Why am I joining this throng of Chinese travelers in a mad dash towards a narrow gap that obviously cannot fit more than one person through at a time? Is this kind of behavior rational? Does the crowd know something that I, as an individual, don't? Is the behavior of the crowd somehow wiser than the behavior of any individual within that crowd? These questions ran through my head as I jockeyed for position in the rapidly expanding queue.



Apparently, there is a shared belief among travelers in China that being among the first to board an airplane is desirable, and therefore boarding later is undesirable. I myself hate sitting on airplanes, therefore the rational thing for me to do would be to sit in the boarding lounge for as long as possible and try to be the last one to board the plane, thereby minimizing the amount of time I am forced to sit in an uncomfortable airplane seat.



But no, there I was, shoving my way towards a single lane among 200 Chinese travelers, all vying for a superior position in the chaotic proto-queue. As I continue reading The Wisdom of Crowds, I will try to identify what it is that makes humans sometimes behave irrationally in situations where the crowd decides that a particular decision is the right decision. In the case of the boarding of planes in China, the crowd seems to have decided that boarding first is best. The next time I'm about to get on a plane, I'm going to challenge myself and see if I can overcome the persuasion of the crowd, remain in the relatively spacious boarding lounge until that final call has been made; only then will I act in an individually rational manner and board the plane at my leisure. Or, am I really missing something here? Is there a rational outcome that results when individuals follow the group and act on their cue? What about you? Do you board planes when the crowd decides it's appropriate to do so? Or do you know something the crowd doesn't? Are you wiser than the crowd, or is the crowd wiser than you?



Comments welcome!

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Market Failure? Or Policy Failure? Throwing fuel on the Ethanol fire...

Ethanol's Growing List of Enemies

Here's an interesting article on the backlash against the US government's overzealous promotion of corn-based ethanol as a fuel alternative to foreign oil. This article presents a perfect application of economic theories as learned in AP and IB economics. Government subsidies to ethanol refiners is shifting out the individual ethanol firms' Supply curves and as a result the market Supply curve for ethanol outward. In order to produce all this new fuel, the demand for ethanol's main ingredient (corn) is shifting out as well, leading to higher corn prices. So what, you say? Well, turns out corn is an important ingredient in almost everything Americans eat, not just the tasty yellow corn on the cob, but thousands of other food products, including MEAT! Yes, our meat is made out of corn, who would have thought! (Of course, this is because cows and chickens and pigs EAT corn themselves.)

So, applying what you've learned about supply and demand, you should be picturing in your head thousands of meat and other food producers' individual supply curves shifting inward, as the resource cost (corn) goes up! How does this affect us, the consumers? Well, what happens to the price of all those food products that rely on corn when their supply curves shift in? Ah ha, now you see the big picture.

We want cleaner air, less glacial ice melt, stable sea levels, and energy independence... all good things, right? And the US government seems to have decided that ethanol is the solution... so what's the problem? Well, for one, the government has placed high tariffs on ethanol made from sugar. Why? Think about it... where is sugar grown? Or better yet, where is sugar NOT grown? (think of all those voters across the Great Plains states... are they in their fields hacking down sugar cane? I don't think so). So, now we see maybe this ethanol program is about more than just clean air, stable sea levels, and so on... could it be about politics too? Why, as the article says, are all the main presidential candidates in support of corn-based ethanol subsidies? Hmm... can anyone spell "Iowa Primary"?

Politics aside, this article also makes interesting connections to our recent units on Market Failure. Could it be that the true social cost of ethanol is not being realized in the prices paid by consumers? What externalities may result from the production of this so-called "clean" source of energy?

Here's a couple of key quotes that relate to our studies in AP and IB economics that I found interesting:

"The government thinks it can pick a winner, but they should allow consumers to pick their own."

"The government should stay out of energy markets and let the best fuels win."

"Why are we supporting ethanol with a mandate, but not wind and solar?"

In my view, these are some interesting points rooted in basic economic theory. Perhaps rather than lavishing the corn-based ethanol industry with billions in subsidies, the US government should focus more on internalizing the external costs of the oil industry... whether through taxation, tradeable permits, or other methods we learned about in class. If, after all, the goal is (as politicians claim) to clean up the environment, then we should start by correcting one market failure (overconsumption of dirty fuels), before attempting to tackle another (underconsumption of clean fuels). Then let the market decide which clean fuels it prefers... and leave politics OUT of it!

Students, please contribute your comments... this is right up your alley as AP and IB students!

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If Ali G were the Chairman of the Fed...

YouTube - Ali G - Economics and Selling Stocks High

Alan Greenspan, Ben Bernanke, you could seriously learn from this genius of monetary policy.

"Listen up, pay attention, and be careful wif' yo' cash... if you wanna get to be wearin' bling." -Ali G

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Oh my, oh Mao... a bourgeois revolution in China?

Leader: Property rights in China | China's next revolution | Economist.com

Full article: Governing China | Caught between right and left, town and country | Economist.com

Interesting article about the emerging development of property rights in China. The question is, whose rights will the new laws protect? The peasants in the countryside who have farmed their land for generations but technically still "lease" it from the communist party? Or the middle class elite who have "looted the state as it has privatized assets". The article suggests two possible revolutions on the horizon, one decidedly anti-Maoist: the one led by the "property-owning middle class" that new property right laws will help, and the other the backlash of the frustrated peasant class in the countryside who may be left behind by the proposed laws.

"Clearer, enforceable property rights are essential if China's fantastic 30-year boom is to continue and if the tensions it has generated are to be managed without widespread violence."

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Our fearless president's incredible understanding of Economic theory

Bushism of the day. - By Jacob Weisberg - Slate Magazine

"Trade is an important subject here at Caterpillar, and the reason why is because a lot of the product you make here, you sell to somebody else, sell overseas to another country. That's trade. And yet it's—it's a topic of hot debate."—Speaking to workers at the Caterpillar equipment company, East Peoria, Ill., Jan. 30, 2007

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Hip Hop Economics

YouTube - Def Poet Tommy Bottoms

Is AP or IB Econ getting you down? McConnell and Brue just doesn't do it for you? How about some hip hop economics. Check out the YouTube video linked above and post your comments below. Here's some of the lyrics from this enlightening take on the dismal science.

“Basic Economics,” by Tommy Bottoms

"...See America is designed for the get rich. There’s a million and one ways for you to get paid off of this bitch. And most of them’s legit. Just find a market you want to target, produce a service and/or product and your revenue minus your expenses is going to equal your profit. See, it’s just basic economics. As long as you have the haves, you’ll always have the have nots, so it’s up to you to decide whether or not you’re happy with what you got...

Now, I know I spit this poem with a whole lot of Ebonics, but it don’t matter who say it or how it’s been said, it’s still just basic economics."

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Response to Marco's bashing of the Coase Theorem

Marco's IB Economics Blog: The Coase Theorem Is The Low Point Of Economic Study

In the above post, Marco bashes the Coase Theorem as a means of externality reduction pretty badly. While some of his ideas are founded, I've decided to respond with my own...

Interesting argument, Marco. I like the idea of Dick buying more and more dogs to extort money from Jane! Classic! I believe the point of the Coase theorem is to show that if property rights are clearly defined, and the number of parties involved in an externality is limited, direct negotiation can result in a socially optimal result. All it's saying is that government may not be required in all cases! Of course the example of dick and jane is silly, but in some cases such a theory could be more applicable.

One example I think is better involves you and your next door neighbor. Let's say "Dick", your neighbor, has a large sycamore tree in his yard that provides your yard with shade on hot summer days. Dick believes, however, that in a lightening storm the tree could fall on his house, so he goes out in the yard with a chainsaw to cut it down. You, seeing Dick with his chainsaw, approach him and explain that you would prefer he leave the tree standing. Of course, unless you offer Dick some renumeration in exchange for leaving the tree standing, he has no incentive to do so and will cut it down. The externality here is the lack of shade and the increased air conditioning bills you'll have to pay when the tree is gone... but with clearly defined property rights, perhaps you and Dick could come to an agreement. Maybe you agree that if the tree should ever fall on Dick's house, you'd help pay for the remodelling.

See how clear property rights and negotiations can result in the elimination of a negative externality? You never had to SUE the Dick next door and he were able to convince him to leave the tree standing in exchange for your assurance that his roof would be fixed if it fell. Hualla, the Coase Theorem, sans dog.

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AP Econ: How do Banks Create Money?

The following is a rather clear explanation of the process that leads to the creation of new money by banks, written by Econ educator Dick Brunelle. I find this much more straightforward and easier to understand than your text.

How is money created? In addition to currency that is printed by the government and put into circulation by the FED, money is created through the fractional reserve banking system. Banks when they receive a checkable deposit from a customer will keep some of that money in reserve and lend the balance. The bank is required to keep a certain amount in required reserves. Any additional reserves are referred to as excess reserves. Let’s follow a $10,000 deposit of a customer. We will assume a 10% reserve requirement. The T account for the bank will look like this:

Assets: Required reserve = $1,000 and Excess reserve = $9,000
Liabilities: Checkable deposits = $10,000

The bank will now have a liability to the customer of $10,000. It will also have required reserves of $1,000 and excess reserves of $9,000. It can choose to make a loan of $9,000 with the excess reserves. Let’s take a look at what happens if the bank makes that loan.

Assets: Required reserves = $1,000, Excess reserves = $0, and Loans = $9,000

Liabilities: Checkable deposits = $10,000

Now what happens to that $9,000 that was lent to another customer? Let’s assume that person deposits the $9,000 into her bank and creates the following change in the T account for that bank:

• Assets: Required reserves = $900, Excess reserves = $0 and Loans = $8,100
• Liabilities: Checkable deposits = $9,000
  

We have assumed that the bank has made loans with the full additional $8,100 available from Excess reserves. This process will continue in the banking system until there is no more to lend from the initial deposit. We can calculate the entire amount of money created from the initial deposit by using the banking or money multiplier. The following is the formula:

Money Multiplier (m) = 1 / RR (reserve requirement)

Our reserve requirement is 10%. The money multiplier is 1/.1=10

The initial deposit of $10,000 will lead to a total in money supply of $100,000. Now here is where we need to be careful semantically. Since the original $10,000 was already a part of the money supply, the additional amount of money created is $100,000 minus the original $10,000 or $ 90,000.

If the original $10,000 came from the FED then the total amount of money creation would be $100,000 since money at the FED is not part of the money supply.

The banking multiplier leakages

There are two events that can minimize the banking multiplier:

1. Banks keeping excess reserves
2. Borrowers keeping currency and not redepositing the amount of the loan.

Note: Students will frequently be asked to compute how much money will be created given a certain circumstance. If the banking multiplier is 5 and the FED adds new money into circulation by buying bonds, lowering discount rate or lowering the reserve requirement, then multiply the amount by: Example Fed buys $10,000 of bonds, how much money is created? $10,000 X 5 = $50,000

But if the question states that the Bank has excess reserves and uses this money to make a $10,000 loan, how much money is created? $10,000 X 5 = $50,000 minus $10,000 (original amount already in reserves) = $40,000. The same would hold true if a person took $10,000 of cash in put it in the bank. Students must account for the fact that the original $10,000 was already in existence.