Risk-Pricing, Adverse Selection and Moral Hazard

There's an entertaining article in today's edition of The Wall Street Journal that has all kinds of possibilities for the classroom. The article is about subway riders in Scandinavia who ride for free. Instead of buying tickets, they contribute to a pool that pays their fines if they get caught. They've set up a kind of "insurance" pool.

But if we think about it, we have an excellent example of adverse selection. I suspect the only ones who are paying into the pool are those who have no intention of purchasing a ticket and thus know they run the risk of being caught. Once a person has purchased the "insurance", they will likely be even less inclined to pay a fare.

So what keeps the premium from being the same as the amount of the fine? It's the likelihood or risk of being caught. If chances were 100% that you would be caught and fined, the pool would have charge a premium equal to the fine. This scheme can only work as long as enforcement by the authorities is lax enough to keep the premium less than the fare. Once the risk rises to the point where the premium costs more than the fare, it is cheaper to buy the ticket.

There is much more to this issue, as you'll see when you read the article. I'm sure you will see more possibilities. I did. But I hope you will share your ideas.

Behavioral Economics

One of the great things about economics is that the models are fundamentally simple, particularly for Microeconomics. By simple, I don't mean that all of the implications are obvious or that that we can figure out what those implications are without doing some math. However, much of economics is encompassed by the idea that people are trying to do the best that they can with their limited resources, and as a result we would expect voluntary exchange between fully informed parties to make both players better off (or at least no worse off).

Part of the joy of behavioral economics is how it demonstrates where predictions from the reductionist economics approach to modeling human interactions badly and consistently miss how actual humans behave. An illustration of this comes from a recent Dilbert.

Human Capital and Growth

If you're looking for an example of the role of human capital on growth and the production function, look no farther than this article from today's edition of The Wall Street Journal. (Subscriber content at this writing but put the story title in your browser and you should be able to find an ungated version.) The story is about Portugal and the low level of education in that country. As you would expect, it has a significant impact on growth and standard of living.

The video below is from the story and explains some of the institutional aspects of the problem. And as we understand, you can change the law but changing culture and tradition can take a while.



I think this would make a great example for that production function discussion. Please share your thoughts.

Economics in Weird Places

Last week I linked to a story about an "anti-tragedy" of the commons. Now here's a story from The Washington Post about price elasticity of demand and terrorism (HT to Marginal Revolution).

A Matter of Perspective

There is a quote from St. Augustine's City of God comparing governments to robberies. (HT Cafe Hayek) I'm not sure I'm in total agreement, and one may ask whether St. Augustine was just an early libertarian or is quoted out of a larger context. But the parallels drawn in the quote are intriguing. Of particular interest was his recounting of a meeting between Alexander the Great and a pirate who had been brought before him. If true, it would have been an interesting exchange.

Now I'm even more interested in reading Peter Leeson's The Invisible Hook.  I just need to find the time to do so.

More to Read

For those of you who can't get enough of this stuff, The Brookings Papers on Economic Activity are now freely available. (HT to Econlog) That includes the current issue as well as the archives.  So if you're looking for some "beach reading" during spring break (for those of you who haven't had it yet); download and enjoy.

Which Weighs More

It's always interesting to hear the "but we don't make anything anymore" argument when it comes to economic activity. But this article from the BBC (HT to Cafe Hayek) makes a case that can be summed up as “a dollar is a dollar is a dollar.” (Or a pound is a pound is a pound if you prefer.) Maybe the biggest concern is change. (See next post on "creative destruction." I was reminded of the great children's riddle, "which weighs more, a ton of bricks or a ton of feathers?"

More Creative Destruction

What are some good, current examples of "creative destruction" to use when discussing economic growth?  This report has 10 answers. (HT to Carpe Diem) Do you need to call your broker?

What Are You Willing to Give Up?

What if you had the chance to sit in on a course by a Nobel Prize winning economist?  What if it was "free"? Well, “free” in the sense that there's not a monetary payment necessary. As we all know, there's an opportunity cost. This may take about 25 hours or so of your time. You probably won't get a lot that you can use directly with your students, but I suspect you'll gain a lot more understanding of an important topic that your students will benefit from.

Follow this link and you will have the chance to sit in on Gary Becker's lectures on human capital at the University of Chicago (HT to Marginal Revolution). I know I'm going to enjoy them.

March Madness Econ Style

For those of you who are looking for a different take on March Madness to share with your classes, Greg Mankiw gets a HT for pointing us to this blog. I'll let you read what the author used to determine each outcome. Suffice it to say “Princeton to win it all.” (I wonder what would constitute a "bracket buster"?)