What are the economic impacts of different professions? Every dollar a research worker earns makes the economy \$5 better off and every dollar a finance worker makes costs the economy \$0.60

So Reddit Economics yesterday posited and later retracted the above claim, and I was wondering, in the field of econometrics, are there any guidelines for how professions impact the national economy.

The RIMS II and similar systems all focused on regional economies, and were largely driven by anticipated spending patterns, so consequently focused on the demand side of the equation.

Is there an equivalent concept for GDP based on productivity or supply? Like a worker productivity (which I know is available in aggregate for current and historical US workers) broken down by NAICS/SIC code or other industrial designation?

As a follow on, are there comparative studies I could reference that compare this measure across time and countries? (IE Mexican automanufacturer production post-NAFTA compared to Japanese electronic manufacturer ca ~1980).

Enrico Moretti (U.C. Berkeley) works on a related question: The multiplier effect. He finds that high tech industries have the largest multiplier. For each new high-tech job in a city, five additional jobs are created outside high-tech in that city over the next 10 years.

Moretti E. Local multipliers. American Economic Review 2010;100:1-7.
Moretti E. Local labor markets. In: Ashenfelter O, Card D E, editors. Handbook of Labor Economics. Amsterdam, The Netherlands: Elsevier; 2011.
Moretti, E. and P. Thulin, Local multipliers and human capital in the United States and Sweden, Ind Corp Change (2013) 22 (1): 339-362.

A quote from his book, The New Geography of Jobs:

  With only a fraction of the jobs, the innovation sector generates a
  disproportionate number of additional local jobs and therefore
  profoundly shapes the local economy. A healthy traded sector benefits
  the local economy directly, as it generates well-paid jobs, and
  indirectly as it creates additional jobs in the non-traded sector.
  What is truly remarkable is that this indirect effect o the local
  economy is much larger than the direct effect. My research, based on
  an analysis of 11 million American workers in 320 metropolitan areas,
  shows that for each new high-tech job in a metropolitan area, five
  additional local jobs are created outside of high tech in the long
  run.

  [And] it gets even more interesting. These five jobs benefit a diverse
  set of workers. Two of the jobs created by the multiplier effect are
  professional jobs—doctors and lawyers—while the other three benefit
  workers in nonprofessional occupations—waiters and store clerks. Take
  Apple, for example. It employs 12,000 workers in Cupertino. Through
  the multiplier effect, however, the company generates more than 60,000
  additional service jobs in the entire metropolitan area, of which
  36,000 are unskilled and 24,000 are skilled. Incredibly, this means
  that the main effect of Apple on the region’s employment is on jobs
  outside of high tech.

There is also a Wikipedia page on the Local multiplier effect.


Positive productivity shock with a fall in output I am modeling a two-country world. Within each country there exists a representative infinitely-lived agent, a representative final good producer, a continuum of domestic monopolistic competitive firms (owned by consumers), and a continuum of local retailers that import goods. The representative agent supplies labor and capital to the production process. Domestic firms use labor and capital as inputs to produce intermediate goods; local retailers import differentiated goods. Domestic producers sell to the home and foreign final good producers. Each representative final good producer is a competitive firm that bundles home and foreign intermediate goods into a non-tradable final good, which is consumed and used for investment by the domestic agent. Preferences and technologies are symmetric across both countries.

Domestic producers follow this:

\begin{gather}
Z_{H,t} + Z^*_{H,t} = Y_t = A_t K_t^\alpha L^{1-\alpha}_t
\end{gather}

so for the Foreign country, the production process is given by:

\begin{gather}
Z^*_{F,t} + Z_{F,t} = Y^*_t = A^*_t K^{* \alpha}_t L^{* 1-\alpha}_t
\end{gather}

where $Z^*_{F,}t$ is the intermediate good to produce final good $Z^*_t$ for Foreign country and $Z_{F,t}$ is the intermediate good that will be exported to the Home country.

When shocking the economy with a positive temporary productivity shock, I find that overall $Y^*_t$ decreases, while $Z^*_{F,t}$ decreases but $Z_{F,t}$ increases. However, $L^*_t$ increases, but $K^*_t$ decreases.

I understand that $Z_{F,t}$ increases as a response to the positive shock by the Home country, because there is an increase in the demand of goods. My question is, what would be the economic intuition in knowing that $Y^*_t$ decreases, but $L^*_t$ increases and $K^*_t$ decreases? I was thinking that a possible answer would be that, this occurs given that the Foreign country needs to produce more $Z_{F,t}$ to export to the Home country, and given that the share of labor needed in the production process is greater than the share of capital, in order to achieve the higher production of $Z_{F,t}$, only labor is needed as it is "relatively" more important than capital in the production process (I am assuming that capital share $\alpha = 1/3$).

Thank you,

Alejandro

It seems that a possible explanation is that the productivity shock was too persistent such that capital flow from one country to the other in order to exploit the higher return to capital. Capital is mobile while labor is not.


How do I confirm that the constraint set wL + rK < Q is convex Suppose a firm produces Q units using labour (L) for which the wage, w>0 and the price of capital (K) is r>0. It cannot employ negative amounts of its factors: L $\geq 0$, K $\geq 0$.

The firm's constraint can be written as $wL + rK$ $\leq Q$

How does one prove that such a set is convex? We know that if a constraint is convex, some vector, z = $\lambda x + (1-\lambda)y$ lies within the set.

Suppose I choose
$$z_1 = \lambda L_1 + (1-\lambda) L_2 $$

$$z_2 = \lambda K_1 + (1-\lambda) K_2 $$

where $\lambda  \exists [0,1]$

z = L + K

$$wz_1 + rz_2 =w[\lambda L_1 + (1-\lambda) L_2] + r[\lambda K_1 + (1-\lambda) K_2] $$
$$=\lambda[wL_1 + rK_1] +(1-\lambda)[wL_2 + rK_2]$$
$$\leq \lambda Q + (1-\lambda)Q$$
$$= Q$$

Thank you.

Consider an arbitrary pair of vectors $(L_{1},K_{1})$ and $(L_{2},K_{2})$ that satisfy $wL_{i} + rK_{i} \leq Q$ for $i = 1, 2$. To show that constraint set is convex, we need to show that any convex combination of that (arbitrary) pair of vectors lies in the constraint set. Namely,
for all $\gamma \in [0,1]$ we have

$$\begin{split}
w\left(\gamma L_{1} + (1-\gamma)L_{2}\right) + r\left(\gamma K_{1} + (1-\gamma)K_{2}\right) &= \gamma \left(w L_{1} + r K_{1}\right) + \left(1-\gamma \right)\left(w L_{2} + r K_{2}\right)\\
&\leq \gamma Q + (1-\gamma)Q = Q
\end{split}$$
Thus the vector, $(L_{3},K_{3})$, is also in the constraint set (where $L_{3} := \gamma L_{1} + (1-\gamma)L_{2}$, and $K_{3} := \gamma K_{1} + (1-\gamma)K_{2}$) and so the set is convex.

Your answer (or at least the rearranging of inequalities in your answer) is largely correct. However, it is important to note that you've shown this inequality for an arbitrary vector in the set and for an arbitrary convex combination and not for a particular one.


What is the main difference between FDI and short run capital inflows/outflows? What is the main difference between FDI and short run capital inflows/outflows? I feel like both are quite similar in their nature but I don't understand the distinction between the two fully. Many thanks!

The term FDI is generally reserved for foreign capital investment in domestic assets of the host country for business interests as opposed to hot flows which are generally aimed for quick capital gains.
Examples of FDI would include take-overs of firms, collaboration/merger with a domestic company, entry into a new market, etc. Such investment give returns over the years as profits or dividends.
Hot flows, on the other hand,  include capital flows to take advantage of interest rate and currency rate arbitrage (such as investments in sovereign bonds, currency markets, etc.) and domeatic Stock market without taking the control of the management. Such investment give mainly capital returns after sale of assets.
There are some technical differences that emerge from the host country's central bank classification process but they are essentially to reflect the above economic differences. For example, in India, an investment may not be classified as FDI in until the shares are allocated to the investment firm and money has been invested by the host firm.
Further there are many rules imposed by host countries relating to capital mobility that differ for the two types of investment.


Negative Risk Free Rate Sharpe Ratio currently I am writing my Master-Thesis about SRI-Fonds. For analysing Sharpe Ratios from different Fonds I need to use the risk free rate (e.g. Euribor 3M). Unfortunately I can‘t find anything about dealing with negative risk free rates. Is it useful to calculate with those negative rates or should I prefer a risk free rate about 0% in case it‘s negative?
Thanks a lot for your answers.
Maybe someone had the same problem before...

You should be fine to use negative interest rates for the risk-free rate when calculating a Sharpe ratio. If rates are negative, they are negative. That does not change the calculation of excess returns.
One point, however: EURIBOR and EONIA are interbank rates and thus are not risk-free but have a small credit spread above risk-free rates. The latest ECB recommendations call for €STR to become a risk-free overnight rate with a transition planned to set EONIA := €STR+8.5 bp going forward.


Why a new startup should ask a big investment company to value them as low as possible? In "Silicon Valley TV Series" (in first episode of the second season) a bunch of guys, designed a new algorithm, and asked big companies to invest in that project and value their product.

At a certain time in the episode, they realized that instead of negotiating with companies for higher investment and higher valuation, they must somehow negotiate for the lowest possible valuation as they are new to the market, otherwise they will be bankrupt.

I can't figure out the reason!

In a simple language (as I know nothing about economy) can anyone explain it?

Each startup typically attracts multiple investors, each having its own evaluation of the company. Investors participate in funding series, when equity is sold at the same per-share price. Otherwise, it's difficult to explain an investor why he paid more for the startup than others did.

When a startup finds investors who buy their stakes at high evaluation, the startup cuts off more reasonable investors. And reputable VC funds don't like overpaying.

So, the startup ends with some silly investors holding their equity, while unable to find more money at comparable prices.

In the end, founders are better off while targeting realistic evaluation, not milking a single naive investor.


I can't find (lny-lny0)/t meaning I  cannot understand what (lny-lny0)/t means. Of course we use this to show growth rate. But in the mathematical sense, I cannot know what it is. Is it diferrentiaion?

Generally ln is used to represent the natural logarithm.  I know of no notation system that uses it to represent differentiation.

Natural logarithm:

$$\frac{\ln{y} - \ln{y_0}}{t}$$

Differentiation would look more like

$$\frac{dy}{dt}$$

or

$$f'(t)$$

It is common to take logarithms of growth functions because they involve exponents and logarithms can simplify equations with exponents.  In particular,

$$ \ln{(1+g)^t} = t\ln{(1+g)}$$

is a basic property of logarithms.

A Maclaurin expansion is an alternative way to write the equation.  See Taylor series and Maclaurin's series for more information.  A Maclaurin expansion does in fact take advantage of differentiation.

This logarithm is referred to as natural because its base arises from normal mathematical calculations rather than being arbitrary, much like $\pi$.


Confusions about calculations in Utility Theory Paper Recently I was improving my knowledge of Utility Functions in finances. I stumped upon very nice (yet quite old) article: "An Introduction to Utility Theory" by John Norstad (1999).
What drove my attention was charts in section 4. They represent utility functions of wealth:

First chart (figure 2): $- \dfrac{10^6}{w^3}$
Second chart(figure 3): $-\dfrac{10^{10}}{w^5}$

(So basically $-\dfrac{10^{2c}}{w^c}$) with c as chosen constant)

Purely for learning purpose I was trying to recreate his example (by using Excel/R) from section 4 (details on page 7). In same page author stated that expected utility (of 105) will be equal to -0.98. It is also shown under figure 2 in table:

  Wealth   Utility
 $90   -1.37   Bad outcome
 $100   -1.00   Current wealth
 $105   -0.98   Expected outcome
 $120   -0.58   Good outcome

I run test and with those values and for \$105 it does not match. Using $- \frac{10^6}{105^3}$ I get -0.86. What is surprising other stated values are calculated correctly (90, 100, 120). At first I though it is nothing more than some kind of typo, but when I checked the second formula used to draft function in figure 3 the same situation occurred. For table:

Wealth   Utility
 $90   -1.69   Bad outcome
 $100   -1.00   Current wealth
 $105   -1.05   Expected outcome
 $120   -0.40   Good outcome

when I put value 105 to formula ($-\frac{10^{10}}{105^5}$) it seems to be incorrect (should be -0.78) while rest of them are right. This quite undermines my typo theory.  Additionally this contradicts further conclusions (page 9 under the chart) made by author.

So my question is: did I overlooked something? Or did I just find a mistake? Or I am the one who is mistaken?

The notation is a bit confusing but what the author is computing is the expected utility of the investment, not the utility of the expected outcome.

Since the investment results in a wealth of \$120 with probability 0.5 and a wealth of \$90 with probability 0.5, the expected utility equals
\begin{align*}
\mathbb{E}U & = 0.5 \times (-\dfrac{10^6}{90^3}) + 0.5 \times (-\dfrac{10^6}{120^3}) \\
& \sim -0.98
\end{align*}

Notice that this value is lower than the utility of the expected outcome, which is approximately equal to $-0.86$ as you wrote. This is because the agent is risk-averse and must therefore be compensated for the risk.


second order stochastic dominance without the same mean Let $F$ and $G$ be two distributions with the same mean. $F$ is said to second order stochastically dominate (SOSD) $G$ if
$$\int u(x)\mathrm dF(x)\ge \int u(x)\mathrm dG(x)\tag{1}$$
for all increasing and concave $u(\cdot)$.

This above definition is equivalent to
$$\int_{-\infty}^x F(t)\mathrm dt\le \int_{-\infty}^xG(t)\mathrm dt,\qquad\forall x\in\mathbb R.\tag{2}$$

I was told that the requirement for $F$ and $G$ to have the same mean is not really necessary. Suppose $F$ and $G$ do not have the same mean. Can we then still have the equivalence between $(1)$ and $(2)$?

N.B. I was able to show $(2)\Rightarrow (1)$ without the same mean condition, but not the other way around.

Let $u(x) = x$ which is increasing and concave. Then the defining condition of SOSD reads

$$\int x\mathrm dF(x)\ge \int x\mathrm dG(x) \implies E_F(X) \geq E_G(X) \tag{1}$$

..which would contradict the case  $E_F(X) < E_G(X)$ that would be permissible under a general "different means" postulate. On the other hand, we see that the "same mean" condition can be violated by the defining condition for SOSD itself. What does that tell us?

1) That $E_F(X) \geq E_G(X)$ is a necessary condition for $F$ to SOSD $G$.

2) ...And so that the requirement "$F$ and $G$ have the same mean" wrongly restricts the application of the concept of SOSD.


Marshallian demand curve elasticities I am stuck on a multiple choice question that came up on a Micro university past papers.

The question is:

  Marshallian demand curves derived from utility function: $U = log(x) +
log (y)$. What is the own price elasticity, cross price elasticity,
  and income elasticity?

The answers are -1, 0, and 1 respectively, yet I don't understand how.

Many thanks!

as you see that is a Cobb Douglas function(Monotonous transformation), I will assume you already know how to get the X* and Y* Marshallian . "w" is the wealth of the consumer. In case you dont know how to get the marshallians you have to maximize the utility ( "U = log(x) + log (y)") subject to the constrain budget (w = Xpx+Ypy)

$ X(*) = w/2px $

$ Y(*) = w/2py $

So let's start with the income elasticity, we want to know how the consumption of X will change when the income//price of x (own-price) //   (cross price )price of y changes, but we want it in terms of percentage/relative ( that's why we want elasticities ) .

So the income elasticity is :

$(\frac{\partial X}{\partial w})*(\frac{w}{X}) =(\frac{1}{2px} )(\frac{w}{\frac{w}{2px}})\ = 1 $

cross price elasticity:

$(\frac{\partial X}{\partial py})*(\frac{py}{X}) =(0)(\frac{py}{\frac{w}{2px}}) = 0 $

own price elasticity :

$ (\frac{\partial X}{\partial px})*(\frac{px}{X}) =(\frac{-w}{2px^{2}} )(\frac{px}{\frac{w}{2px}}) = -1 $

I will let you search what means that numbers! :D

Hope this helps you!


Why isn't the Federal Reserve bothered by the drawbacks of its unlimited Quantitative Easing? On Mar. 26 2020, Fed announces unlimited QE and sets up several new lending programs : finance. I know little on the U.S., as my B.A. economics degree is from a Ontario university. If I remember the IS-LM model, the Fed's Quantitative Easing so far can be pictured below. I reversed the arrow in the original diagram.

Putting All Markets Together: The AS-AD Model - ppt video online.

Isn't the Federal Reserve supposed to be rattled by inflation or increase in the Price Level, as per the right shift in AD'?

Let me know of other drawbacks. I haven't brought up lower interest rates because this doesn't appear a drawback. After all, the Federal Reserve aims for more investments and for people to spend money rather than deposit in securities that depend on high interest rates.

The Fed uses quantitative easing to provide ample liquidity and to prevent deflation.  Inflation has not been a problem in modern economies for over 12 years.

Deflation is much worse than inflation.

Technological advances, especially fin tech,  cause deflationary pressure.

I’ll say it again.  Deflation is the problem, not inflation.  Even the price of gold deflated this month.

There has not been a single reasonable economist worried about inflation in the u.s.  for 12 years.

A drawback to the Fed’s activity (and fintech) is that it would make it harder for banks to make money due to falling credit spreads.  Right now, though, the opposite is happening.  Credit spreads are skyrocketing due to stressed liquidity.

(My opinion) if the financial sector of the economy is making lower profit margins
 off the backs of people, then that should in theory be better for the economy as a whole.

As the Fed adds more government debt to its balance sheet at low rates, it makes it easier for the government to invest in infrastructure.  People have been complaining about national deficits since the 80’s.  Actually it was a lot worse in the 80’s than it is now.  At some point you can go too far with government spending (for example Greece).  Most other govt debt situations are far better than Greece.


Why does increasing the money supply decrease the interest rate in layman's terms? If money supply increases, then I will have more money in my pocket to spend more. I imagine that prices will also increase over time to adjust to there being more money in circulation. Is it because that now, fewer people want to save because they have so much money to spend that the interest rate in general decreases when the money supply increases? Can someone explain it to me from an average Joe perspective, as in how does the increase of the money supply affects me personally and why the interest rate would decrease?

On most fundamental level it is because interest rate is price for money. In the same way as price of milk goes down when supply of milk increases (ceteris paribus) price of money goes down when supply of money increases. For example, consider the following diagram from Blanchard et al. Macroeconomics below. You have supply of money (by central bank) and then you have demand for money by people. Interest rate ensures that demand for money = supply of money. If supply increases (shift to the right) interest rate has to decrease otherwise people would not be willing to get and hold that additional money.


Who said that growth would stop because of satiation? I have a vague recollection I am unsuccessfully trying to find an exact reference for.

I recall watching an interview of Jacques Attali about a new book of his (maybe 6 or 7 years ago) where he mentioned scholars who once (around 1700?) were convinced that economic growth would stop, not because of limits to technological progress, but because of satiation.

As I recall it, the argument from these scholars was something like "we may be able to produce 10 times more food, but there's only so much food an individual can eat in a day, so we'll never get to such levels of production because of a lack of demand".

Of course, we know that these scholars missed a number of important points, the main one being that growth occurs not only through producing more of the same old good, but by increasing the quality of these goods and by creating entirely new goods (which can easily break the satiation argument).

I am not interested in a discussion of the argument per se. Rather, I am looking for precise references (if any) to people who actually argued (or maybe are still arguing) about the purported "satiation" limit to growth.

Bonus points if someone can point me to Attali's interview or to the book where he mentions these people.

In an essay entitled Economic Possibilities for Our Grandchildren, Keynes famously argued that people would one day only need to work 15 hours per week (see bottom of p 4).  This was linked to an argument about satiation (see p 3, half way down), although he was careful to say that this applies to absolute needs, and that relative needs (ie needs to feel superior to others) may be insatiable.
Note that Keynes' essay is just pages 1-4 of the linked document.


Why are US equity prices and inflation inversely correlated? Many comments on this r/stockmarket Reddit thread hypothesize an inverse correlation between USD value and US equity prices. Why would this be true in theory?

It's not true in reality, right? Has the correlation of inflation and stock prices changed in the United States over the last two centuries? - ScienceDirect

Abstract
The relationship between stock prices and the inflation can be either negative or positive, depending on the strengths of various theoretical channels at work. In this study, we examine the dynamic conditional correlations of stock prices and inflation in the United States over the period of 1791–2015 under a time-varying framework. The results of our empirical analysis reveal that correlations between the inflation and stock prices in the United States evolve heterogeneously overtime. In particular, the correlations are significantly positive in the 1840s, 1860s, 1930s and 2011, and significantly negative otherwise. The policy implications of these findings are then discussed.

The price of a stock is the discounted value of its future expected payments. The rate for discounting includes inflation. If nothing else related to the stock except the expected inflation rate changed, the discount rate would increase, driving down the price of the stock. That's a theoretical/mechanical reason why prices might drop due to a change in inflation and only inflation.
But inflation doesn't tend to happen all by itself. It accompanies other macroeconomic changes.
If inflation is happening because of economic problems, such as a shortage of materials or trade problems driving up prices, then we might expect the cash flows to decrease at the same time as the discount rate increases.
If prices are moving up in a perfectly orderly and expected way and not because of economic problems, then we could imagine both the cash flows (numerator) and discount rate (denominator) increasing in such a way that they offset each other. In other words, the numeraire could be irrelevant.
If inflation is driven by increased demand, we might expect the cash flows to increase faster than the discount rate, leading to a rise in stock prices. And of course, there's also the mechanical relationship between today's inflation and prices. If suddenly a dollar is worth a lot less, you might expect everything to increase in price, including stocks.
Many aspects of macroeconomics are too complex or unstable to reduce to a few rules of thumb. Macro models help us understand what happens in a fairly specific set of circumstances. More specific than "inflation of unknown origin." Based on the wording of your question, it seems like you have a reasonable handle on this fact. You are correct in thinking that the relationship between inflation and stock prices is not reliably in one direction.


Why does every electronic transaction of USD legally take place on American territory? In an article of a respected German newspaper (Die Zeit) I found the following statement (translation by me):

  90 % of all foreign exchange trades are dealt in USD. Since every electronic transaction of USD legally takes place on American territory, the US authorities can almost always take legal action against the involved individuals and companies, even if they are not located in the US.

I´ve tried a Google search, but did not find an explanation, so I thought I´d ask here (also, I´m quite new to economics).

Are really 90 % of all foreign exchange trades dealt in USD?
Why does every electronic transaction of USD legally take place on American territory? What laws/processes are responsible? What about non-electronic transactions in USD?

I´d be interested in an explanation or suggestions for further research!

Are really 90 % of all foreign exchange trades dealt in USD?

The actual rate for the most recent year(2016) we have data is 88%.  This comes from the Bank for International Settlements.

  Why does every electronic transaction of USD legally take place on American territory? What laws/processes are responsible?

This isn't true.  The US handles about 20% of all FX trades and the UK about 40%, most of which are dollar trades.  However, it is probably the case that most trades in dollars could be considered regulated by the United States.  This is a practical result of several sets of laws and not one specific law.

For example, the US asserts jurisdiction over the entire world for its citizens.  If an American engages in some action that is legal in the country they are standing in, but not legal in the United States, then it is a crime in the US.  If they commit a crime in another country it can also be enforced in the United States.  For corporations, if they do any business in or with the United States then the United States acquires legal and regulatory jurisdiction.  Since the banks which trade foreign currency generally have offices in the United States, they are subject to US jurisdiction.

Additionally, while there are several wire and exchange firms, they end up being required to follow US law and to interact with the Federal Reserve System if they have any nexus with America.  As such anything that is fraudulent, that uses any form of wire, becomes liable under US wire fraud laws.

The statement isn't probably literally true, but since people don't have any physical control over which networks the institutions use, it is safe to assume the US has jurisdiction over the transaction along with any other countries that are directly or incidentally involved.

  What about non-electronic transactions in USD?

Non-electronic transactions in paper USD do not create US jurisdiction unless one of the parties has a tie to the United States.  All American fall under US jurisdiction at all times, everywhere.  The only paper transactions which would have automatic US involvement would be in counterfeiting.  If a Bolivian and an Argentian are standing in London and one buys a hamburger from another for a paper dollar, the US has no standing if a crime were committed.


What additional axiom to GARP do we need to generate a differentiable or smooth utility function After researching for a while, I find this:
https://www.jstor.org/stable/1913607?seq=2#metadata_info_tab_contents
They come up with an axiom called SSARP that generates a preference with smooth demand function. But what about smooth utility function? What axiom can guarantee that?

The axiom should be best on the demand data set just like GARP

None if the axiom is to be on preferences, as any smooth utility representation can be monotone transformed into a non-smooth utility function.


How does the central bank changing interest rates change interest rates in the commerical banking sector? I understand that the federal reserve manipulates the federal fund rate in order to change interest rates in the wider banking sector. What I am struggling to understand is how the changing the federal funds rate changes the interest rate charged by commercial banks, e.g. Bank of America, Wells Fargo, etc.

The federal fund rate is a cost for the commercial banks. They borrow at the federal fund rate and then they lend to the consumers.
The federal fund rate variation impacts the lending cost of the banks directly.
It's how it changes the interest rate charged by commercial banks.


Why can't we control for squares and quadratics of predicted values in regression? If my goal were prediction (e.g. of propensity scores), why couldn't I control for higher order terms of the model equation? For example, why not estimate the model and then control for squares and cubes of the predicted values in a second stage and get an even better estimate of the correct predicted values (rather than just a test of functional form)? I know the standard errors would be wrong but couldn't I bootstrap the process?

For prediction, yes you can consider the models
$$
y = \beta_0 + \beta_1 x_1 + \cdots + \beta_p x_p + \gamma_2 \hat{y}^2 + \cdots + \gamma_m \hat{y}^m + error,
$$
where $\hat{y}$ represents the first-step OLS fitted values and $m$ is chosen by something like cross validation.

I haven't seen this approach used before. My personal guess is that this approach is not as useful as other commonly used ones (SVM, splines, GAM, etc.). For example, if $p$ is large (in comparison to the number of observations $n$), the first-step OLS may already be overfitting so including $\hat{y}$ is not practical. (Yes, you can use lasso residuals but that's a different story.) If $p$ is small, nonlinearity can perhaps be better handled by splines or even by simply augmenting the equation with quadratic and cubic terms of the features. Some generalized additive models (GAM) are already there too.

My personal experience is that nonlinearity is not so important (for prediction using economic data). It is usually a lot more important to avoid overfitting nicely. To me, your suggestion seems to be useful in some cases but not in many.

That said, I do not want to dissuade you from pursuing this issue, although there is a (high) chance of ending up with the conclusion that it is not very useful given the availability of other methods. BTW, you would already know it, but just in case, Hastie, Tibshirani and Friedman's book (The Elements of Statistical Learning) is helpful.


Malaysia's national debt - who's correct? Malaysia recently changed governments. The new finance minister claimed the national debt is actually RM1.087 trillion, and that the previous government had understated the national debt by some RM400 billion:

The official Federal Government debt is RM686.8bil
"In addition, the Government is already committed to pay for government guarantees for various entities which are unable to service their debts. This amounts to RM199.1bil."
"...the Government also must make lease payments for "Public-Private Partnership" (PPP) projects such as construction of schools, roads, hospitals and police stations, which amount to RM201.4bil."

The former finance minister promptly responded by claiming that the new minister is overinflating figures, and that the original RM686.8 billion was according to "universally accepted" defined by the IMF and World Bank.

I don't understand what they're saying very well. Two questions:

What are the two extra terms mentioned by the new minister?
Is Malaysia's national debt RM1 trillion or RM686 billion?

From a quick glance, it looks like the difference is that the new finance minister is including promised payments that the government had previously made, but hasn't had to pay yet. For example, say I borrow \$10 from you. At the same time, say I had previously promised (in an unrelated interaction) to give you \$5 at the start of June. What's my current debt to you? Officially, it's \$10 (from the loan you had given me). But come the first of June, if I haven't paid you back yet, I'll find myself in debt to you for \$15: \$10 from the loan, and the additional \$5 from the promise. Effectively, the new finance minister is counting the debt to be the entire \$15 (that is, current debt obligations, as well as promised future payments to different projects in Malaysia), while the official figure only considers my debt to be \$10 (since I don't yet technically owe you the additional \$5).

Technically, the government official figures are correct, since the government can "get out" of the future payments by (I'd assume) changing the law to remove themselves from that responsibility. At the same time, since (it looks like) those payments are to Malaysian government/private company partnership projects, simply refusing to pay would ultimately undermine Malaysian projects, which would hurt citizens. Which is more important depends on the context, and the interests of the individual.


History of Municipal Bonds Does anyone have a good book on the history of Muni Bonds that focuses on the reasons why they grew in popularity, adoption, and gov policy souring them.

Background on why I need this info

I am writing a paper for my college history class, titled when wall street met main street. We are allowed to self select a topic and I chose to focus on the change in  the bond markets and that relationship with the public.

What I think could be a great topic is the rise lease revenue bonds for funding prisons, and how this has played out.

The Guidebook to Municipal Bonds: The History, the Industry, the Mechanics (1991) by George J. Malvin

The Tax Policy Center Briefing Book on The State of State (and Local) Tax Policy might be a good place to call.


Incentive compatibilty conditions for multi-item auctions In this paper by Myerson on optimal single item auctions, the incentive compatibility condition is shown to be equivalent to the following simpler conditions on the auction - (i) the allocation probability being monotonic in bid (ii) the form of the payment rule.

Is there a similar characterization for multi-item auctions? Any reference regarding this would be helpful.

Yes, it is essentially the same idea as with just one unit.
For example, see the text leading to Proposition 14.1 in the book "Auction Theory" by Vijay Krishna.
Let $x$ be the vector of willingness-to-pay.
Define $U(x) = \max_z \{ q(z)x - m(z)\}$ as the equilibrium utility of type $x$. The incentive compatibility (I am quoting Krishna now) "implies for all $x$,
the probability vector $q(x)$ is a subgradient of the payoff function $U$, which
is convex, at the point $x$. In other words, the vector $q(x)$ is perpendicular to
the hyperplane that supports the function $U$ at $x$ — the graph of the function $U$
lies above the hyperplane." He goes on to show that
$$U(x) = U(0) + \int_0^1 q (t \cdot x) x d t,$$
where instead of directly integrating over the type $x$ you integrate  over $t\in (0,1)$.


Can Autonomous Consumption be Greater than Income of individual? Autonomous consumption is done either through past savings or by borrowing money or selling asset to have minimum consumption in order to survive.

So can autonomous consumption be greater than our 1st level of consumption ?

Expressing consumption as

$$C = a + f(Y)$$

where $Y$ is income, there is nothing in the theory that forbids

$$a > f(Y)$$

even though the theoretical anticipation and the empirical regularity (i.e. for most people) is that $a < f(Y)$.


Determining subgame perfect Nash equilibriums Question
Three houses share exclusive access to a beach, but it is dirty due to trash washed ashore. A beach clean-up exercise costs $100$, but has a value of $200$ to each household. A clean-up company offers to take on the exercise and suggests that contributions be made sequentially. First, Household 1 will contribute some amount that is $x_1$. Then, after observing $x_1$, Household 2 will contribute some amount that is $x_2$. Finally, after observing $x_1$ and $x_2$, Household 3 will contribute some amount that is $x_3$. If $x_1 + x_2 + x_3 \geq 100$, then the company will go ahead with the clean-up and keep any proceeds. If $x_1 + x_2 + x_3 \leq 100$, then the company keeps all contributions and the clean-up is not done.
Find the subgame perfect Nash equilibrium.

My answer
Consider Household 1. Observe that it is always in Household 1's best interest to have the beach cleaned,  since $200 > 100$, so he should offer $100$. Now, Household 2 sees this and knows that enough contribution has been made for the clean-up to happen, since $100 \geq 100$, so he will offer $0$. A similar argument can be made for Household 3. Thus, the equilibrium outcome is $\{x_1 = 100, x_2 = 0, x_3 = 0\}$.

Note
I know that the question asked for the subgame perfect Nash equilibrium, but my professor has specifically stated that, for the purposes of the module we are taking, being able to come up with the equilibrium outcome is sufficient (i.e. We do not know how to solve for the actual subgame perfect Nash equilibrium).

I have two questions.

Is my equilibrium outcome correct?
May I know if my reasoning is sufficient/complete/logical to arrive at the outcome I had reached?

We have just covered game theory, so I am still trying to get used to answering such questions. Any help/thoughts on my answer will be greatly appreciated :)

Just for sake of acknowledgement, please note that the game described in the question is a variation of the famous Ultimatum game. Knowing this can help you get a ton of literature on such games.
Further note that your professor has made an extremely important point that coming up with answer is sufficient, solving is not necessary. My answer is also limited to showing that a given action profile is equilibrium (whether NE or SPNE). Solving games (such as these) is different ballgame altogether (something in which I have no expertise).
For Nash Equilibrium:
To check whether a given action profile is an NE or not, it suffices to show that each player's response is the best response (BR) given other players' actions. Now consider the set of action profiles:
$$X := \{(x_1,x_2,x_3) \,\,|\,\, x_1 + x_2+x_3 = 100\}$$
For any $x \in X$, we can see that pay-off for each player is $200$ and no player can do any better by changing their action, given other players' action. Hence all action in $X$ are NE (note here that since this game is sequential and not simultaneous, we are not considering mixed strategy profiles).
The problem is that intuitively, this does not seem reasonable to us because for player 1, offering anything more than $0$ doesn't seem smart.
This is where the refinement of NE, Subgame Perfect Nash Equilibrium comes in:
In SPNE, the equilibrium should be an NE for each subgame of the game as well. This puts some restrictions and is thus a smaller set. In the above game, since player 3's best response is to play $100-x_1-x_2$ (for example, if player 3 insists that she'll play $0$ if others don't pay $33.33$ each, it is really a non-credible threat because it would be irrational for her to play like that), the best response of player 2 and player 1 becomes, $0$ for each.
Therefore, the only subgame perfect NE is $(0,0,100)$


Why are many railroad rights-of-way held in easement rather than in fee simple? In the United States it is said that many railroad rights of way are held by railroad corporations in easement rather than in fee simple. It seems strange that it would be done that way when one considers that many railroad tracks continue to function for well over a century. Some tracks have probably been used for more than 150 years. Perhaps the only reason we cannot (yet) say that they typically last more than 250 years, or more than 2000 years, is that railways have not yet existed long enough for us to know that. So why would a railroad buy an easement rather than buying the land unconditionally? Might it be because in the 19th and early 20th centuries people thought railroads would be replaced by some other technology within a few decades?

Though these are only educated guesses (contract law is not my forte) I'd suppose that there might be a few reasons why this is:

It's best able to handle the competing interests of the parties involved. Historically, the US Federal Government was more willing to grant public lands to railroads (particularly in the little-settled west). However, due to shifts in the general public's will over the later part of the 19th century (stemming, apparently, from an 1871 decision Hash v. United States, which granted more explicit rights over the land to railroad companies) it became more difficult to either deed massive tracts of land to the railroad companies, or lease it to them at below market-competitive rates. (Note- much of this taken from this source.) Ultimately, this leads to a hold-up problem. The country needed railroads to cover the vast interior to ensure development, but without the earlier subsidies, laying tracks for thousands of miles was prohibitively expensive. Therefore, rights-of-way allow for a sort of middle ground, allowing cheap access to the land for the beneficial railroad lines, without giving them as large of subsidies as previously done.

It should also be noted, as in this source, that these agreements are the result of an incredibly tangled history, where many different private players, in addition to state and federal governments, all had vested interests in the outcomes. Newly formed territories and states needed the railroads to allow for their development; as linking commerce with reliable, cheap and relatively fast transportation was shown to be incredibly useful with the 1825 completion of the Erie Canal. Therefore, states had incentives to lower the development costs for railroads as much as possible. However, much of the burden of the cost fell to the federal government (who owned the lands being deeded), which was influenced by other individuals hesitant to provide such lucrative benefits for private corporations. Thus, the rights of way agreements came from a compromise-position.

Note, this source puts the major reason for the shift in agreement structure as federal dissatisfaction with how the railroads were handling their earlier deeded land. Instead of selling the granted land for commercial purposes, many railroads held onto the land (assuming it would only become more valuable), which delayed development.

Finally, by granting these easements, governments were able to ensure other public utilities used the same general routes (see page 1406)- something that railroads could have foreclosed had they owned the land outright.


Book recommendation: agent based modeling? Is there a book along these criteria?

introductory
discuss both theory and writing program
focus on social science (economics / politics / sociology)

There are bunch of tutorials on the Internet, but journal articles tend not to have code, and a lot of work is not relevant to social science. Thus I think I'll get better recommendation from Econs SE.

One book that comes to mind is "Economic Dynamics" by John Stachurski found here.

This book discusses programming methods that are applied to economics. All of its accompanying code is kept on this github repository.


Block pricing vs Perfect price discrimination I have just learned about Perfect price discrimination and block pricing. And I was wondering, in the case of these two graphs
Block pricing & Perfect price discrimination. Why, in case of the perfect discrimination, is the monopolist still willing to sell the quantity where reservation price is equal to marginal cost. while in the block pricing situation the "block" from 40 - 60 would have a price equal to MC but the producer is unwilling to sell it for a price equal to MC, thus ending up with a deadweight loss.
Perhaps I have a few conceptual misunderstandings but I would appreciate it if someone could explain what is different in these two cases.
Block pricing

Perfect price discrimination

In a nutshell, it is because people talk.

Information asymmetry happens at the firm/consumer level. The consumer does not know exactly how much it costs the firm to produce a given product, nor are they able to discern the actual quality of the product without expert knowledge. But what they do know is the price of the product, and whether or not individuals within their network have purchased the product (think reviews on amazon).

In a perfect discrimination situation, each individual will get their individual price for the product. If I buy a widget at $20, and learn that it cost my friend 10, I wouldn't buy the widget. I'd ask my friend to buy that widget for me. Hence the blocks. An analogy would be cars, why there are different 'trim' levels for at its core, the same car. Some people want alloy wheels, others want tinted windows. Different combinations of trim constitute different classes (blocks) and as a result, the firm can sell these seemingly similar products under different price ranges (Basic < Limited Edition)

At the same time, from a production perspective, the marginal cost for each product differs when you scale up or down. Your 100th widget will cost less on average than your 1st widget and vice versa. As a result, even if the monopolist wanted to, perfect price discrimination would be impractical given the varying production costs.

This might not capture the your question in full, but other people are free to chime in and I'll revise as needed.


How can a company run out of cash when its stock prices is dropping? For instance, in 2008, the Royal Bank of Scotland saw its stock price drop by ~30% in a day, and it was apparently impossible for the bank to make it till the end of the day because it would run out of cash.

Why is that so? How can its valuation affect in such a short term the cash it can disposes of?

It appears to me that it is the other way round: The RBS was running out of cash which is why the stock price was dropping.

Stocks usually don't affect the immediate operation of a company, since they are traded on secondary markets (stock exchanges) among stock owners, not bought from / sold to the actual company which issued the stock.


The Solow model and his 1956 paper Reading through Robert Solow's 1956 paper, entitled "The Theory of Economic Growth", I was hoping to find his fundamental difference equation. I was wondering if the following equation is indeed that very equation, $$\dot{r}=s(r)F(r,1)-nr.$$
In my textbook, the fundamental difference equation is given by $$\dot{K}=f(K,L)-\delta K. \tag1$$
I am having a bit of trouble reading through Solow's paper (am a novice at economics), and was wondering if someone can locate the equation that is similar to $(1)$.

I will assume that you are talking about the Solow, R. M. (1956). A contribution to the theory of economic growth. The quarterly journal of economics, 70(1), 65-94. as to my best knowledge Solow did not published paper entitled the "Theory of Economic Growth" in 1956 and the first equation you use in your question is from the paper.

Moreover, I also think that you either made a mistake or your textbook assumed whole output is saved (which would be most unorthodox) because normally the equation (1) should be looking like this:

$$\dot{K} = s F(K,L) - \delta K$$

See for example the Romer's Advanced Macroeconomics or Blanchard's et al Macroeconomics an European Perspective (both authors use slightly different notation but the point is both textbooks show that change in capital depends on the fraction of saved output not the whole output).

In the 1956 paper the closest equivalent of equation (1) in your question would be equation (3) in Solow's paper:

$$ \dot{K} = sF(K,L)$$

The reason why the depreciation is not explicitly there as a separate term is that Solow assumes that "Output is to be understood as net output after making good the depreciation of capital".


Would it be correct to use exchange rates of the biggest trading partners to the dollar as an explanatory variable? I'm trying to study the relationship of general macro factors and their effect on credit in the private sector.

The country in question has a fixed exchange regime with the dollar, would it be correct to use exchange rates of the country's biggest trading partners to the dollar as an explanatory variable.

I'm not sure if should be regressing on the absolute figure of credit, or the year to year change in credit. My reasoning for the latter is that since I'll be using GDP growth rate, CPI based inflation, it's best to see how their changes effect changes in credit. If that's the case, should I use changes in oil price and the stock index, or their yearly averages?

When a variable is measured over a period of time, it is a flow variable.  When measured at a single point in time, it is a stock variable.  In your case, I think you are looking to explain the year/year change in credit, a flow.

Think about the case with the level of credit as the dependent variable.  Does one year GDP growth explain the overall level of credit in this economy?  Most likely not.

Try to be cautious here on how you interpret the regression coefficients.  For instance, if your coefficient on GDP is 1, you cannot argue that GDP growth is causing increased credit flows.  This is because this model likely suffers from endogeneity.

To make the case for causality, an important step is showing the reader that your model satisfies conditional independence.  That is, the variables on the right hand side of the regression are uncorrelated with the error term.

Otherwise, it's useful to disclose that an attempt at identification was not made, and that the coefficients are more are less statistical summaries of how the data move together.


General government debt vs central government debt? The IMF's Global Debt Database (Excel, Stata) lists data for:

General government debt (GG); and
Central government debt (CG).

What are the conceptual differences between these two items?

For convenience here are some of the data on a Google spreadsheet.

Quick observations:

For many countries, only data for one of these two items are listed.
And for those countries for which data for both are listed, the difference $d = CG - GG$ is small. Exceptions include Cyprus ($d = 41.2\%$) and Canada ($d = -50.6\%$).

Both concepts refer to different levels of government. For the U.S., for example, central government debt refers to the debt by the federal government, while general government debt refers to overall debt, including states and municipalities. Depending on how fiscal federalism is designed, different levels might be affected differently by the business cycle.

The OECD offers the same indicators, with some information on how they are defined. I copy from there:

  Data are within the framework of the System of National Accounts (SNA), a set of internationally agreed concepts, definitions, classifications and rules for national accounting. Using SNA terminology, general government consists of central, state and local governments, and social security funds. State government is only applicable to the nine OECD countries that are federal states: Australia, Austria, Belgium, Canada, Germany, Mexico, Spain (considered a quasi-federal country), Switzerland and the United States. Debt is a commonly used concept, defined as a specific subset of liabilities identified according to the types of financial instruments included or excluded. Generally, it is defined as all liabilities that require payment or payments of interest or principal by the debtor to the creditor at a date or dates in the future. All debt instruments are liabilities, but some liabilities such as shares, equity and financial derivatives are not debt.
  Debt is thus obtained as the sum of the following liability categories, whenever available/applicable in the financial balance sheet of the general government sector: currency and deposits; debt securities; loans; and other liabilities (i.e. insurance, pension and standardised guarantee schemes, other accounts payable, as well as, in some cases special drawing rights - SDRs). According to the SNA, most debt instruments are valued at market prices, when appropriate (although some countries might not apply this valuation, in particular for debt securities).
  The treatment of government liabilities in respect of their employee pension plans is diverse across countries, making international comparability difficult. In particular, according to the former 1993 SNA, only the funded component of the government employee pension plans was reflected in its liabilities. However, the 2008 SNA recognises the importance of the liabilities of employers’ pension schemes, regardless of whether they are funded or unfunded. For pensions provided by government to their employees, countries have some flexibility in the recording of the unfunded liabilities in the core tables; this has also been followed by the ESA 2010, its European equivalent (although a new supplementary table will be added showing liabilities and associated flows of all pension schemes, whether funded or unfunded). Some OECD countries, such as Australia, Canada, Iceland, Sweden and the United States (including others whose data source is the IMF Economic Outlook) record employment-related pension liabilities, funded or unfunded, in government debt data. For those countries (except non-OECD ones), an adjusted government debt ratio is calculated by excluding from the debt these unfunded pension liabilities. Government debt used here is recorded on a gross basis, not adjusted by the value of government-held assets.
  The SNA definition of debt differs from the definition applied under the Maastricht Treaty, which is used to assess EU fiscal positions.
  Gross domestic product (GDP) is the standard measure of the value of goods and services produced by a country during a period.

The reason for countries reporting only one indicator could be that the respective statistical office simply only report one number. For small countries, general government debt might be by and large equated with central government debt if there is no relevant fiscal capacity below the central government.

The explanation for Cyprus might be that the central government had to bail out banks recently, leaving the non-negligible budgets of municipalities unaffected, but this is a bit speculative.


Graphically detecting heteroscedasticity in OLS I wonder how do I check heteroscedasticity in the OLS regression model using graph.

What kind of plot should I use? Plotting residual against what? Independent variables?

You can visually inspect for heteroscedasticity in the disturbances by plotting the regression residuals against the fitted values and then checking if you can discern some pattern to the spread of the residuals in the scatterplot. The idea here is that the variance (spread) of heteroscedastic errors $\varepsilon_i$, conditional on the explanatory variables $X_i$, is not constant:

$$ Var(\varepsilon_i | X_i) \neq \sigma^2.$$

You can also explicitly test for heteroscedasticity in a linear regression by using statistical tests such as Breusch-Pagan or White.


Why does global suspension of economic activity result in catastrophic loss/debt? Covid-19 has forced a suspension of at least 50% of financial transactions and business activities.

Materially, not much has been lost: consumables have been spared, equipment is dormant, maintenance is mostly inexpensive. Why is the health crisis expected to bankrupt many businesses? Is most of the loss speculative?

Propery tax + land rental = 20-25% of yearly rent, so a landlord can waive rent for 6 months and still make profit! enough to pay 2 years of tax and maintenance.

I naively imagine that using government moratoriums on bank-debt-interest rates and fees, It is possible for companies to organize a state of dormancy and maintenance for an extended period, without incurring significant loss.

Can you give a summary of why it is not so simple, and why the losses are a lot worse than a financial and material dormancy?

It creates losses.

First, many businesses don’t own their own building/land/equipment. It’s very common to lease these things. Moreover, many business take out insurance that again has to be paid on monthly basis. In Europe in many countries you need to pay workers certain portion of wages even when you can’t call worker to work or even if they stay home sick.

The list here is not exclusive. The point is many business have non-trivial fixed costs that have to be payed whether business operates or it doesn’t. Furthermore, in short run even some variable costs - like wages to employees on production line are fixed (and in many countries this can be up to several months). Hence, it’s not like a dormant business have no costs.

You might ask why then we don’t suspend for example these leases etc. but that just moves the problem to the different parties and does not eliminate this issue.

Moreover, very large business might have enough financial cushion to absorb losses for few months, but there are many small-medium size business that can’t do that. For example, consider a sole trader (a form of business organization where one person embodies a business) who has a repair shop with no employees just living month to month. That kind of businessman can not afford to go on hiatus for very long.

Furthermore, if by long you mean not just weeks but several months or even year that would be issue even for the best cushioned business.

So yes the impact could be catastrophic. For example according to this VOX blog the impact under some scenarios could be worse than recent 2008 crisis.


Difference between chained CPI and normal CPI in simple terms I am taking a community college level intro to macro course, and while self-studying the text, I came across the concept of C-CPI or chained CPI. While I feel I have a grasp as to what CPI is, I have found explanations of chained CPI confusing.

Can anyone ELI5 (explain like I'm 5)?

The consumer price index is used to measure the rate at which prices increase. It is calculated by taking a basked of common goods that people buy all the time (groceries, appliances,  etc.) and looking at how their average prices change over time.

Suppose we are calculating the CPI using a basket of goods that contains only cinema tickets. Last year a cinema ticket cost \$15, but now it costs \$30. The CPI would then have doubled to reflect that fact that the prices in the basket of goods have doubled.

Some argue that this isn't a very good way to measure consumer price inflation. Here's why: if the price of cinema tickets doubles then people will buy fewer cinema tickets and buy, for example, more Netflix subscriptions instead. So although the price of cinema tickets doubled, people aren't spending twice as much on cinema tickets (because they aren't buying cinema tickets any more!) So, in some respects, the fact that the CPI has doubled doesn't tell us very much.

There are two ways to deal with this:

the approach used when computing the CPI is to say that since people aren't buying cinema tickets we need to update the basket of goods we use to calculate inflation (remember the basket is supposed to be representative of peoples' consumption habits so if they buy fewer cinema tickets it should contain fewer cinema tickets). The problem here is that the basket is only updated infrequently so it takes time for the CPI to "catch up" with consumption habits.
the other approach (used in chained CPI) is to statistically adjust the standard CPI measure to account for the fact that we know people will substitute to different goods when the goods they were buying become more expensive.

To do this, the statistical authority gathers data on expenditure for each category in the basket of goods then then weights that category's contribution to the index by its share in expenditure. In the US, this is done on a monthly basis, so the chained CPI uses a more up to date measure of substitution between product categories.


Are terrorists rational? Terrorism in general, and suicidal terrorism in particular, is
  popularly seen as “irrational,” but many economists and political
  scientists argue otherwise.

This quote is from Terrorism: The relevance of the rational choice model by Bryan Caplan. This paper has been published in 2006 in Public Choice. In relation with the recent terrorist attacks in Paris (Nov. 15), is there any new (economic) development on the question of the rationality of terrorism?

Edit: the title is intentionally short but by saying “is X rational?" I definitely mean "Can X be rationalized?"

I guess you might already know this, but I wanted to add a little detail to the other answers for the sake of any layman who comes here and gets the wrong end of the stick.

What is meant by rationality?

It is important to begin by saying that when economics use the term rational they have in mind a fairly precise definition that does not perfectly coincide with the way the word is sometimes used colloquially:

  We say that a decision maker is rational if

  s/he has preferences that are transitive and complete
  s/he acts in a manner consistent with optimization with respect to those preferences.

On the first bullet: suppose some one has to make a decision. We say that they have transitive and complete preferences if (i) they are able to rank the alternatives among which they choose from "most preferred" to "least preferred", and (ii) that ranking is internally consistent.

On the second bullet: A person acts in an optimal manner given their preferences if they choose the alternative that is 'most preferred' among the set of all feasible alternatives.

So are terrorists rational?

As others have noted, the literal answer to the question is that we can't really (empirically) verify that terrorists are rational. This is because observing one rational decision does not rule-out the possibility that the individual concerned made an irrational decision at some point in the past (or that they will make an irrational decision in the future). The best we can manage is to look for behavior that violates the two conditions above and take observations of such violations to be evidence of irrationality.

But, to address the spirit of the question: just because voluntarilly committing suicide and murder in the name of your beliefs may seem irrational in the colloquial sense does not mean that it is necessarily so. Indeed, if a person has carefully considered the alternatives available to them and decided that the option they find most attractive is to conduct a suicide attack then this behaviour is entirely consistent with rationality.

Rational terrorism in context

It is important to stress that there is no value judgement implicit in an eocnomist describing behaviour as rational. Just because something is rational behaviour does not mean that it is good or desirable or can be condoned. Rather, it just means that we think we have a systematic way of understanding why people might choose to behave in a certain way. Building a systematic understanding of a phenomenon is an important first step in deciding upon the best way to respond to it.


Papers on measuring institutions I'm new to this subject, and I'm looking for papers on measuring the 'quality' of institutions and their possible role in the development of a country.

ANy help would be appreciated.

Daron Acemoglu's papers on institution could be a very good way to enter in this kind of issues.


Can resource be considered scarce if its supply is limited, while quantity of the resource is practically unlimited? Let's consider energy of our Sun for an example. The Sun will be able to give us lots of energy for millions of years (and even its annual energy output is enormous), it's practically unlimited energy. We would have practically unlimited supply of solar energy if we built Dyson sphere. Yet there is limited amount of solar energy that we can collect, save and distribute due to our limited technologies, limited resources and other considerations (like we can't just replace all forests with solar panels, it will be huge blow to our ecology). We can't increase supply of solar energy to satisfy global total demand for energy.

Given this situation, can we say that in our current situation solar energy is a scarce resource? And if yes, then can we generalize this conclusion from this particular example to any case where we have limited supply of unlimited resource?

UPDATE: from comments:"you don’t need any other price than zero for this check, you need to check if at price 0 D>S". Now it seems to make sense.

Economists view everything people want, strive for, or can’t achieve effortlessly as scarce (you can read this nice article at EconLib). Under such broad definition virtually everything is scarce as anything requires at least some minuscule amounts of effort.

However, if you want it is possible to narrow this definition down and be more specific as in most models a scarcity can be checked and defined by looking whether at zero price there is still excess demand or not - if there is equilibrium then price must be positive, and we would say that this indicates scarcity.

Breathable atmosphere on land and outside extremely polluted city under such definition would not be considered scarce because supply is so high that at 0 price all demand is completely satisfied, but if you need some breathable atmosphere for scuba diving or in those cities where they sell oxygen tanks, or in space breathable atmosphere would be scarce because supply there is not large enough so that the equilibrium price is 0 and all demand is satisfied (there is no excess demand).

Now we can try to apply this to your example of Dyson sphere. First, I doubt this sphere will just pop out into existence and it will require no maintenance. There will be very likely exorbitant fixed and maintenance costs of such structure. Since the energy output will depend on how well the sphere is maintained I doubt it is even feasible to say equilibrium price of energy could ever be driven to zero as the supply depends on marginal costs which won’t be zero in that case.

Second, let’s say that as a thought experiment that marginal costs of operating the sphere are 0, it would still not be enough. Sun gives out a lot of energy approximately (rounding up) $4 (10^{26})$ joules per second or wats. Now that is a large amount of energy but to build a Dyson sphere or Dyson Swarm (a more realistic version of the concept) you have to be at least type II civilization on Kardashev scale and such civilization would also have insatiable lust for more and more energy. Before I became economist I was studying astrophysics. We did not discussed Dyson sphere or swarm much but when it was brought up during break/after class discussions etc. it was always in context of being necessary to satisfy the needs of type II civilization which will probably want to run some ancestor simulations, or for building kugelblitz black holes that could serve as engines for starships or do other stuff that requires unfathomable amounts of energy. So even with output of whole start being collected such civilization would most likely still have such exorbitant demands for energy that it would still be expensive and price would be nowhere near zero, and there would be huge excess demand even at zero price.

This being said assuming that such civilization would only need small fraction of the energy, and Dyson sphere/swarm would have no marginal costs, so everyone’s demand is satisfied (at zero price there is no excess demand) then you could argue energy ceases to be scarce. Also you can use the general definitions and this example to generalize this for any good/service.


Simplifying a monoplist's objective function under incomplete information I am working through Rochet and Stohle (2003) chapter on multi-dimensional screening, and I am struggling filling in the blanks between equation (2.1) p. 154, and its simplified form on page 155. In particular, my question concerns:

Consumers are of type $\theta$ $\in$ $\Theta$ = [$\underline\theta$, $\bar\theta$] with associated cdf $F(\theta)$, which is absolutely continuous, and associated density function $f(\theta)$ = $F'(\theta)$. This is the distribution of types.

There also is a preference relation for each consumer for $q \in Q = [0,\bar q]$: $u = v(q, \theta) - P$ with the single crossing property $v_{q\theta} > 0 $. I am adding this for context, but all information may not be necessary for my particular question.

This renders an indirect utility function defined by:

$u(\theta) = \max_{\rm {q\in Q}} \{v(q, \theta) - P(q)\}$

The monopoly firm is using a non-linear tariff, $P(q)$, and wants to maximize its expected payoff (I am skipping some information not needed for my question on what renders this equation):

$E(\pi) = \int^\bar\theta_\underline\theta [S(q(\theta), \theta) - u(\theta)] dF(\theta)$ equation (2.1) in text

subject to:

$du/d\theta = v_\theta(q(\theta), \theta)$

$dq(\theta)/d\theta\geq0 $

$IR\space constraint$

Note that the function $S(q(\theta), \theta)$ is not important for my question, hence, I am not including its definition here.

Now to my question. The authors makes a simplification of the problem:

$E(\pi) = \int^\bar\theta_\underline\theta [S(q(\theta), \theta) - \frac {1-F(\theta)}{f(\theta)}v_\theta(q(\theta), \theta) - u(\underline\theta)]dF(\theta)$

subject to:

$dq(\theta)/d\theta\geq0 $

$IR\space constraint$

Now, this to me is the same as saying:

$\int^\bar\theta_\underline\theta u(\theta) dF(\theta) = \int^\bar\theta_\underline\theta [\frac {1-F(\theta)}{f(\theta)}v_\theta(q(\theta), \theta) + u(\underline\theta)]dF(\theta) $

And here is where I need help to fill in the steps. As the authors explain, this is done by integration by parts, and using one of the constraints. I get something like this:

$\int^\bar\theta_\underline\theta u(\theta) dF(\theta) = u(\theta)F(\theta)|^\bar\theta_\underline\theta - \int^\bar\theta_\underline\theta F(\theta)v_\theta(q(\theta),\theta)d\theta$

I can simplify this a bit further, but it does not simplify to the authors' expression. Hence, can anybody help me fill in the blanks?

I hope that I have left sufficient information, otherwise, please let me know what I need to clarify.

I'll start from your last equation.

\begin{align*}
\int_{\underline{\theta}}^{\bar{\theta}}{u(\theta) dF(\theta)} & = \Big[ u(\theta)F(\theta) \Big]_{\underline{\theta}}^{\bar{\theta}} - \int_{\underline{\theta}}^{\bar{\theta}}{F(\theta) v_{\theta}(q(\theta),\theta) d\theta} \\
& = u(\bar{\theta})F(\bar{\theta})-u(\underline{\theta})F(\underline{\theta})-\int_{\underline{\theta}}^{\bar{\theta}}{F(\theta) v_{\theta}(q(\theta),\theta) d\theta} \\
& = u(\bar{\theta})-\int_{\underline{\theta}}^{\bar{\theta}}{F(\theta) v_{\theta}(q(\theta),\theta) d\theta} \text{ since } F(\bar{\theta})=1, F(\underline{\theta})=0\\
& = u(\underline{\theta})+(u(\bar{\theta})-u(\underline{\theta}))-\int_{\underline{\theta}}^{\bar{\theta}}{F(\theta) v_{\theta}(q(\theta),\theta) d\theta} \\
& = u(\underline{\theta})+\int_{\underline{\theta}}^{\bar{\theta}}{u'(\theta) d\theta}-\int_{\underline{\theta}}^{\bar{\theta}}{F(\theta) v_{\theta}(q(\theta),\theta) d\theta} \\
& = u(\underline{\theta})+\int_{\underline{\theta}}^{\bar{\theta}}{v_{\theta}(q(\theta),\theta) d\theta}-\int_{\underline{\theta}}^{\bar{\theta}}{F(\theta) v_{\theta}(q(\theta),\theta) d\theta} \text{ since } u'=v_{\theta}\\
& = u(\underline{\theta})+\int_{\underline{\theta}}^{\bar{\theta}}{(1-F(\theta)) v_{\theta}(q(\theta),\theta) d\theta} \\
& = u(\underline{\theta})+\int_{\underline{\theta}}^{\bar{\theta}}{\dfrac{1-F(\theta)}{f(\theta)} v_{\theta}(q(\theta),\theta) dF(\theta)} \\
& = \int_{\underline{\theta}}^{\bar{\theta}}{u(\underline{\theta})dF(\theta)}+\int_{\underline{\theta}}^{\bar{\theta}}{\dfrac{1-F(\theta)}{f(\theta)} v_{\theta}(q(\theta),\theta) dF(\theta)} \\
& = \int_{\underline{\theta}}^{\bar{\theta}}{\Big[u(\underline{\theta})+\dfrac{1-F(\theta)}{f(\theta)} v_{\theta}(q(\theta),\theta) \Big]dF(\theta)}
\end{align*}


Interest rate determination in the real world I have just learnt about the demand and supply framework for money and how the equilibrium interest rate in an economy can be determined. In theory, based on that framework, an increase in nominal incomes would lead to an increase in the demand for money, causing interest rates to rise. However, in reality, I don't see that occurring. In fact, in reality, say in the United States, rates are often set by the Federal Reserve through manipulation of the money supply. To me, rates don't seem to change as a result of changes in nominal incomes. Why is this so?

There is one more element to take into account into this demand and supply schedule: how does the central bank conduct it's (traditional) monetary policy? There are two options:

decide on base money supplied and let the money market interest rate be determined endogenously as the money market equilibrium. In this case, for a given money multiplier, the supply of money is vertical and the interest rate adjusts to clear the market. In this case: an increase in money demand does affect money market rates;
decide on the appropriate interest rate and let the amount of base money supplied to the market be endogenously determined by the money market equilibrium. In this case, supply of money is horizontal and, at the central bank will supply all the base money that is demanded by the financial sector at the chosen interest rate. An increase in money demand is now completely accommodated by increased money supply.

The role of nominal incomes in shifting money demand seems, at least to me, mostly related to periods of volatile inflation rates: if prices suddenly increase by 5% you'll need 5% more money to finance all transactions. So, households, firms, banks, ... will want to keep a slightly higher cash balance.
So, two reasons why rates may not respond to nominal income:

nominal income affects money demand, but increases in money demand may be, depending on the policy instrument, completely accommodated by increased supply;
fluctuations in nominal income may not be a dominant driver of changes in money demand. In this case there may still be a causal effect, but it's just of crazy small importance compared to other factors that shift money demand.


IS-LM-BP Model: How will income and interest rate change if government expenditure is increased? I'm currently learning the Mundell Fleming model, and so from my textbook and other sources I've figured out the effect of increase in money supply and government expenditure increase for the following conditions:

Fixed & floating exchange rates (perfect capital mobility / BP horizontal)
Fixed & floating exchange rates (imperfect capital mobility, BP flatter than LM curve)
Fixed exchange rate (imperfect capital mobility, BP steeper than LM curve)

I'm stuck at figuring out the effect of a fiscal expansion in the case of floating exchange rate with the BP curve steeper than the LM curve. My textbook has not mentioned it but I'd like to how it'd turn out.

Here's my guess:

The economy is initially at the point A. There is fiscal expansion:

IS moves to the right (1 to 2)
At B, there is a deficit in BOP, which causes the domestic currency to depreciate.
This increases exports and decreases imports, which causes net exports to increase, which then causes Y to increase, which shifts IS further up (IS 3).
At B, because of increase in net exports, BOP improve and so BP also shifts to the right.
The economy settles at the new equilibrium C.

Am I correct?

Yes, the diagram represented in the question is correct. Assuming imperfect capital mobility (with the BP curve steeper than the LM curve), an increase in G will:

Move the IS curve to the right.
At this point (B), there will be a BOP deficit because the point is below the BP curve.
Thus, the domestic currency will depreciate.
Exports will rise, imports will decrease and thus net exports will rise.
This will have two effects: (a) this will shift the IS curve further to the right (because net exports have risen, and so Y has risen) and (b) this will shift the BP curve to the right (because net exports have risen, improving the current account balance).
The new equilibrium is at C.

I found a better diagram illustrating this (the diagram includes two cases: one with the BP flatter than the LM and one steeper; the points and movements marked with an asterik (*) are the ones concerned with the case of BP being steeper than the LM). (Image Courtesy of Polinomics: http://policonomics.com/is-lm-bp/)


Determining the elasticity of Hicksian Demands If we have Hicksian (compensated) demand functions, how can we determine the income elasticity and own price elasticity?

Is the procedure the same as for Marshallian (uncompensated) demands?

Let variable $y$ be determined as a function of variable $x$: $y=f(x)$.

Then the "$x$-elasticity of $y$" is computed as $$\frac{\partial y}{\partial x}\frac{x}{y}.$$

We are used to seeing the "price-elasticity of demand" where $y$ is the quantity demanded, $f$ is the Marshallian demand function, and $x$ is the price. But the same concept can be applied more generally.

For example, if $x$ is income, $y$ is quantity, and $f$ is the Hicksian demand function then we could compute the "income elasticity of Hicksian demand" using the above formula.


Nash equilibrium for Bertrand Model with Spatial Differentiation Consider a town with consumers represented by a closed interval $[0,2]$ with the consumers spread continuously and uniformly. There are two stores, $A$ and $B$ who sell the same product at $p_A$ and $p_B$ at no cost.

A consumer has a gross utility of 4 from having the product which is reduced by price paid and travel costs, which is determined as distance traveled. Each consumer only buys 1 unit of the product, and if the consumer does not buy from either store, he has a utility of 0. For example, if a consumer is located at $x=1.5$ and buys from store B at $p_B=1$ which is located at $x_B=2$, then his utility is $4-1-|2-1.5| = 2.5$.

Suppose that $A$ is located at $x_A=0$ and $B$ is located at $x_B=2$. Also, suppose stores much charge at $p \le 4$.

Suppose stores are profit maximizers. What are the equilibrium prices, quantities, and profits for both stores?

My initial thoughts are that, in this scenario, the profit functions for each store is denoted as:

$$ \pi_A=p_A+p_A(\frac{p_B-p_A}{2}) $$

$$ \pi_B=p_B-p_B(\frac{p_B-p_A}{2}) $$

We can take the first order condition for each, to get the maximizing profit.

$$ \frac{\partial \pi_A}{p_A} = 1 + \frac{p_B}{2} - p_A = 0 \implies p_A = \frac{p_B}{2} + 1 $$

$$ \frac{\partial \pi_B}{p_B} = 1 - p_B + \frac{p_A}{2} = 0 \implies p_B = 1 + \frac{p_A}{2} $$

By substituting one into the other, we have that $p_A=p_B=2$, $q_A=q_B=1$ and $\pi_A=\pi_B=2$.

I'm not very sure about this solution or the direction I took to solve it. Any advice here would be appreciated on what other direction I should try.

This is a version of Hotelling's Model of Spatial Differentiation

The easiest solution to this is to find an "X" in-between [0,2] such that the customer is indifferent between going to Firm A or Firm B.

This will happen when
$ P(A) + Distance(X-A) - Utility = P(B) + Distance(B-X) - Utility $

Then demand [0, X] would go to A, and demand [X, 2] will go to B. Then using Best Response Functions for this Simultaneous game we can compute prices, quantity, and profits.

I have attached my solution below. For more information, you can see -  SNYDER NICHOLSON HOTELLING'S BEACH EXAMPLE


How does raising interest rates calm inflation? My understanding is that by raising interest rates, domestic CPI indices are less likely to rise signicantly. However, raising interest rates also attracts capital inflows and can create asset bubbles. Can these asset bubbles not influence the level of inflation? It seems that a high demand for a country’s currency might indirectly cause inflation through asset bubbles even in a floating system. (I’m thinking specifically about the Bundesbank using rates to combat inflation)

Any thoughts appreciated.

I will give you some simplified thoughts in three brief sections:

The traditional view is that higher rates increase the cost of investment and increase the opportunity cost of spending (rather than saving). This places downward pressure on prices. Another way to think about this (opportunity cost part) is considering that higher rates reduce liquidity, which in turn reduces the demand for goods and services.

Asset prices typically move in the opposite direction of interest rates. So, raising rates to cool inflation would actually, according to the common understanding, place downward pressure on asset prices. However, if one looks into the data, one can see that there are co-movements in asset prices and rates. These co-movements are the basis of Karadi's newest paper that is currently R&R'd. However, Gali does have a paper suggesting a link between rates and asset bubbles wherein increasing interest rates can impact the short-run behavior of rational bubbles.

Higher rates can encourage capital inflows. This can cause currency appreciation. This generates its own set of issues.


The Effect of Two income Households on Housing Prices In the book The Two-Income Trap: Why Middle-Class Parents Are Going Broke) by Warren and her daughter, she states the following in chapter 1:

  If two-income families had saved the second paycheck, they would
  have built a different kind of safety net—the kind that comes from
  having plenty of money in the bank. But families didn't save that
  money. Even as millions of mothers marched into the workforce, savings
  declined, and not, as we will show, because families were frittering
  away their paychecks on toys for themselves or their children. Instead,
  families were swept up in a bidding war, competing furiously
  with one another for their most important possession: a house in a decent
  school district. As confidence in the school system crumbled, the
  bidding war for family housing intensified, and parents soon found
  themselves bidding up the price for other opportunities for their kids,
  such as a slot in a decent preschool or admission to a good college.
  Mom's extra income fit in perfectly, coming at just the right time to
  give each family extra ammunition to compete in the bidding wars --
  and to drive the prices even higher for the things they all wanted.

Could someone provide some references for this? I'd like to see when this happened, and some evidence. And is this what economists call a "bubble"?

Todd Zywicki has tried to directly evaluate this claim. He finds that it housing prices and other costs are much lower than the increase in the tax burden.

  Thus, taxes increase in the example by \$13,086. By contrast, annual
  mortgage obligations increased by only \$3690 and automobile
  obligations by \$2860 and health insurance \$620. Those increases are
  not trivial, but they are swamped by the increase in tax obligations.
  Too put this in perspective, the increase in tax obligations is over
  three times as large as the increase in the mortgage (the supposed
  driver of the "two income trap") and about double the increase in the
  combined obligations of mortgage and automobile payments. This also
  leaves aside the peculiarity that the 2000s family is paying \$9670 in
  new child care and \$2860 in new automobile expenses supposedly to meet
  a \$3690 increase in mortgage expenses, the supposed driver of the
  model.

Evaluating The Two-Income Trap Hypothesis

Arnold Kling (Taxes and the Two-Income Trap) notes that Zywicki's estimate doesn't include payroll taxes and therefore underestimates the change in tax burden.


UK stock historical data Where can I find UK stock data over the last 70-80 years? Preferably adjusted to to the inflation.

There are more and more free database available. Here are a few that I like:

Quandl: this platform gathers data from many providers. Not all database are free, but there are enough data to play around with. One of the best things about Quandl is the APIs and the Excel macro, which allow you to easly send requests and download data.
Yahoo Finance: one of the most popular I guess. It is also possible to use some excel macros to download the data, see for example this macro from InvestExcel
GOOGLEFINANCE: If you like Google Sheets, then the function GOOGLEFINANCE is very handy and works quite well. It allows you to get real time data as well as historical data.


How to efficiently study and learn Economics? I read there are a couple of questions asked in this regard, but I am not quite satisfied with the provided answers.

I am currently doing my master's degree (expecting to pursue a PhD) in Economics, and I have been very exposed to the Mas-Colell and the book of Advanced Macroeconomics by David Romer. Just reading the books, and taking notes, I end up rewriting each book myself again.

Therefore, I want to ask what it means to you to study Economics, how is it possible to learn economics, without actually memorizing (since I think that is my problem, I try to memorize everything)? What is an efficient way to take notes (in class or from the textbook), going through the textbook and actually understanding what is being exposed?

I hope my question is appropriate for this space, just to have a little discussion if there was someone who went through similar while pursuing graduate studies.

I am a ph.D Student in Economics, and I am sharing my experience.

It is not necessary to be able to prove everything. Each time you will have to tackle a specific issue you will have to go back to handbooks and articles that have been made.

I think what is important to memorize is the global story of each chapter of these kinds of handbooks (as Mas Colell for instance). The most useful things to memorize is probably the tool you will constantly use in Microeconomics (such as optimization, linear algebra, topology), Econometrics, Games Theory and so on.
Maybe craft your own handbook based on what you learned from different lectures, books and write as many tips as you can when you are inside the subject. Then if you have to go back to your notes you will be way faster.

If you have this basis, what matters is to be able to take some perspective with your subject, and to be the most relevant is the hardest thing.
Studying economics permits to shed lights on (not all) human behaviors, never forget that behind your proofs and lemmas !


Car prices haven't changed in 20 years, no inflation? I notice that there seems to be little or no change in car prices over the last 20 years and they seem to be unaffected by inflation.

For example, a Toyota Camry sold for about \$23,000 +/- \$2,000 (MSRP) around 1999-2000, and currently it sells for about the same.

Why is this?

Inflation is measured against a basket of goods. It's a symptom of what's going on in markets. Some products go up in price over time. Some go down in time. Some stay the same price, but change their specification.

So it's looking down the wrong end of the microscope, to ask why inflation hasn't affected car prices. Car prices are part of inflation. Changes in car prices affect inflation.

The causal link the other way is very very weak. Inflation puts pressure on wages. If this causes wages to rise, then the cost curve shifts, and equilibrium prices change. But for cars, wage costs are a very small part of total car manufacturing cost. And the market for labourers in the industry has shrinking demand and over-supply, so upward pressures are very weak.

The inflation experienced by car manufacturers is very different to the inflation experienced by the public. We've been through a global financial crisis and a super-cycle in commodities. A general-public inflation measure is a very poor measure of input-cost inflation for car manufacturers.


Using another person's guess as an IV In Estimates of the Economic Return to Schooling from a New Sample of Twins by Orley Ashenfelter and Alan Krueger, they correct sampling error with an IV. They claim that their results imply a larger effect of education on earnings than what was found before.

Each respondent has a twin. Each respondent is asked how much money they make, which has inherent sampling error. Then, the respondent's twin is asked how much money the first respondent makes. That estimate is used as an IV, and together they reveal the true income of the first respondent.

Can this work for revealing how many pennies are in a jar? Or how much a person likes a political candidate?

Or how does this work? I see this as magic. If I want to get the truth about something, I just have to get a second opinion?

There's no magic. What you have to realize is that the result is conditional on the validity of the assumptions:

A) Under the assumption that there is measurement error, then yes, the average of two measurements will be on average closer to the truth than a single opinion. This is very believable. We all do this kind of thing all the time. For example, when we actually get 'a second opinion' from a doctor, we think that adding another opinion gets us closer to the truth.

B) Under the assumption that there is a smaller incentive to lie to the interviewer about your twin's education than about yours, then one way to get closer to the truth is to use the twin's information about his sibling's education rather than the self-reported one. The authors show that the variances and covariances among the different variables are consistent with this hypothesis. The intuition is that you are less likely to try to hide your sibling's lack of education than you are to hide your own lack of education.

Of course that doesn't make the preferred interpretation by the authors necessarily true. It could still be the case that there is a particular bias in the reporting of your twin's education which they did not consider.  Say for example that you exaggerate the difference between your education and his or hers exactly when there is a large wage difference. That could break their result I think.

Lastly, the precise idea of using it as an instrument is not that it is a second opinion.  Instead, the assumption is that the 'error'  in this second measurement is uncorrelated with income in contrast to the error of the self reported income which is assumed to be correlated with income.  This means that the income effects of education estimated using the sibling report is unbiased, while the one using self-reported income is biased. The authors claim the self-reported one leads to a coefficient that is downward biased, resulting in an estimate of a smaller return to education than the real one.


Do unsold goods still make it into the GDP? Assuming Car Motors in Tiny Country has 1m USD and it spends it on workers and suppliers to produce 1m USD worth of cars (cost) for export at 2m USD (1m USD profit).

A tsunami hits and drags all the cars under the ocean rendering them worthless.

Assuming the workers and suppliers spent 500k USD (of the 1m USD from Car Motors) to produce the car and hid the other 500k USD under their pillows.

Will the GDP of Tiny Country be zero? 500k USD? or 1m USD?

2.5 m. Because GDP calculates the final price of Factory goods produced,consumption- which the workers and suppliers spent their cash, and a few other components.


What is the importance of Epstein-Zin preferences? I've heard that there is a lot of work being done recently that applies Epstein-Zin preferences. The Wikipedia page doesn't seem to be very full.

Why are Epstein-Zin preferences important?
How does recursive utility differ from other preference models in general? What do they capture that can't be captured otherwise?
What are some good resources to learn more about them?

This is only a quick answer, unfortunately. The key intuitive insight for Epstein-Zin is that they separate two distinct properties of preferences: risk aversion ("I'd prefer less uncertainty to more uncertainty*") and intertemporal substitution ("I may want to shift consumption forward or backwards in time**").

In the very popular Constant Relative Risk Aversion class of preferences (CRRA), risk aversion and intertemporal elasticity of substitution are tied together as inverses of one another. Recursive preferences, and specifically Epstein-Zin, use certainty equivalence in a clever way to split out the parameter which controls intertemporal substitution from the parameter which controls risk aversion in a static gamble.

The static risk aversion parameter is embedded in the function which imposes the certainty equivalence, and the intertemporal elasticity of substitution parameter is imposed over today's certain consumption and the certainty equivalence value for utility of consumption tomorrow.

That's my attempt to describe it intuitively/verbally. It's much more precise in mathematical form -- one good exposition that I like a lot is Francios Gourio's Asset Pricing field's course notes (EC745 is the course number). You can currently find these notes, titled "Lecture Notes on Macroeconomics and Finance
Ec 745," on his website here; see section 8 on page 36.

Work through the math a few times and hopefully it will suddenly "click." The analytical idea is really quite clever. Gourio goes on to discuss how to actually estimate these models, which is very helpful.

(*The proper definitions involves preferences over "lotteries," but I think discussion of that would cloud what we care about here.)

(** by a certain percent, as a function of the interest rate.)


MNCs income greater than origin GDP Can anyone explain why the net income of some MNCs overwhelmingly surpass the GDP of countries/regions, where their sources of labor/raw materials are located? Accompanying references are welcome.
P.S. :- My academic training is in history, and am not really familiar with nitty-gritty aspects of economics. Apologies, if this is a stupid question.

The most simple answer I could give is this; they have more revenue and less costs.
A multinational company, has branches all over the Earth and utilizes these and their resources to their fullest extend, with utmost efficiency.
Kindly note how a company is much easier to run than a nation, with regards to uncertainty, risk - danger and of course, budget management.
On the politics side of things, which is arguably less naive;
It is a structuralist theory that MNCs are a tool of developed nations that sucks the life force out of developing nations (by obtaining their resources and bringing profits with them), therefore there is also a relation of causality, between the great net income of an MNC and the lower GDP of such nations.
With this theory, I have to say, I'm fairly skeptical.
If you'd like to read on the politics of such matters, I'd suggest Theodore Cohn's "Global Political Economy: Theory and Practice". In fact, any Political Economy textbook that dwells on the global economy will probably contain a chapter or two concerning multinational companies.


What is the relevance of economic growth? Economic policies often mention high economic growth as a desirable path. For example,

"We started to lay a new foundation for stronger, more durable economic growth."
-- President Obama, Speech in 2013

But also

"Jeb Bush pledged Monday to give the U.S. an economic growth rate of 4 percent a year"
-- Politico

and many others in the USA and abroad (Hollande, Merkel, etc.)
Politicians from different sides seem to agree that economic growth is desired. For example, some of them say that growth helps against misery. Some of them say that higher growth helps a government with paying back their debt.
How does economic growth help the economy and the society? Through which mechanism does that work?
See also How do economies grow?

World population currently is estimated at $7.3$ billion people, while world GDP at $74.5$ trillion USD (nominal). So the global average of per capita GDP currently stands at USD $10,205$, again nominal, not adjusted for purchasing-power-parity. But in any case, this number, although not negligible, it is small enough so that, even if we had absolute global equidistribution, we would hardly be in an "Affluent Society".

This alone could justify why Growth is still the main economic target of societies all over the world: even if inequality was out of the picture, we will still be far from living really "comfortably".

Add inequality to the picture, and one realizes that Growth is also seen as something that can help mitigate possible social tensions due to inequality: one accepts the existence of inequality easier, if ones sees his own fortunes getting better (this requires of course that everybody gets something out of Growth, even in unequal shares).