fourth lecture - Economics 101 Lecture 4 First order of...

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Economics 101 Lecture 4
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First order of business
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Prediction Markets
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Going for it on fourth? Paul Romer (Stanford professor and founder of Aplia), “Do Firm’s Maximize; Evidence from Professional Football”
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Remember Problem 1.4 Fixed fee versus a tagged system of garbage collection MC = 0 implies “excessive” consumption “Eating off the Table”, Inside Higher Education (posted on Aplia) Waste reduced by 50%
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Another situation You are a middle manager. You approved a costly project whose prospects seemed good when you started. Half of the money has been spent when bad news arrives about the project. The probability is 2/3 that any more money plowed into the project will be wasted and 1/3 that the project will pay back further investment.
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Rational decision-maker If you had not spent the first half of the money, you would not choose to assume the risk of the second half. Should you cancel the project after having spent half the money. Rationality says Yes.
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Face-saving tactics Suppose that if you cancel the project, you will be fired for having started a failing project. If you “stay the course”, there is a chance of 1/3 that the project will succeed and you will be praised and a chance of 2/3 that the project will fail and you are fired. What will a self-interested manager do?
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Agency problem Manager in this example is acting rationally in his own behalf, but not rationally on behalf of owners’ interests. Owners’ interest is for him to cancel the project. The tension between what is good for the group and what is good for the individual
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How to solve agency problems? Hard problem in general (Nobel Prize 2007) For specific cases, many creative solutions have been “discovered”. How to pay the middle manager? Why do fast-food (employee managed) restaurants offer you a free meal if the cashier does not give you a receipt at the time of purchase?
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The story moving forward From the individual to the group – how do groups decide what to do in the face of scarcity, i.e., opportunity costs. The power of economic ideas comes to life when moving from the individual to the group.
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