Economists and Virtual Worlds

I've just been reading an interesting article on economists and video games; it seems that a fair number of other economists have thought about the research potential provided by virtual worlds, and at least two gaming companies—Valve (Steam) and the company that runs Eve Online—have found it worth hiring economists to help run their virtual economies.

I tried putting in a comment, but their registration software seems to be broken at the moment, so I decided to put the comment here instead, in the hope that my readers may include other economists with similar interests. Here it is:

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Interesting article. I'm both an academic economist and a game player--WoW not EVE--and have been intrigued by the possibilities for years. Some time back, I had a blog post on the possibility of designing an economics course for students already active in WoW or something similar, using the game to teach economics.

Several years back my wife, who also plays, encountered a cartel on the auction house, was invited to join, declined, was threatened with predatory pricing—apparently the cartel operator wasn't familiar with the economics literature on the problems with that tactic. The attempt lasted for a couple of days before the cartel gave up. But I've observed continued, and apparently successful, efforts by the same player to push up the prices of various goods by buying up whatever anyone else puts up at a low price, then relisting it at a high price. Both my wife and I have engaged in occasional "auction house wars" with that player, undercutting her prices on something we produce in an attempt to drive the market price down.

On the general issue of arbitrage, it's worth noting that time is a cost and markets are often thin. So there may well be apparent profit opportunities that don't get exploited, due to the fact that the profit isn't enough to motivate someone to engage in arbitrage unless he also has fun doing it.

Reading your article, it occurred to me that someone ought to set up an email list for economists interested in virtual worlds.

Why did Airlines Start Charging for Bags and Meals?

Twenty years ago, it was taken for granted that the price of your airline ticket covered checked luggage—and a meal if the flight was long enough to justify one. Today most airlines—the major exception is South-western—charge for each checked bag. All airlines within the U.S., in my experience, charge for meals. Soft drinks and peanuts are still usually free.

Looking at it as an economist, charging for extras that cost the airline something to produce seems like a sensible enough policy. If it costs the airline five dollars to provide dinner in the air, passengers who want the meal should be indifferent between the current fare and a free meal and a fare five dollars lower, accompanied by a five dollar charge for eating. Passengers to whom the meal is worth less than five dollars should prefer the latter arrangement. So charging for a meal, or any other costly add-on, while adjusting fares accordingly, benefits some customers, hurts none, and costs the airline nothing.

Bag charges may be an exception. As my wife likes to point out, the result of charging for checked bags is that people carry more as carry on, making it harder for everyone to board. At least one small airline I know of solved that problem by charging for carry on luggage as well, but, so far as I know, none of the majors have imitated it.

Charging for things makes sense now. Not charging for them made sense forty years ago. Under airline regulation, the industry functioned as a cartel; an airline could not lower its price without CAB approval. That held fares well above their competitive level, making it in the interest of airlines to compete on non-price terms—including free meals.

If the airlines had switched to charging for meals and luggage in the late seventies or early eighties, shortly after deregulation, there would be no puzzle—but they didn't. As best I can determine by a quick google, the first airline to do so was American, which only started charging for checked luggage in 2008. Airlines started dropping free meals earlier, about 2001, and started offering meals for sale a few years later. Why then?

One possible explanation for when free meals started to disappear might be 9/11, which caused considerable financial problems for the airlines—perhaps they decided they could no longer afford them. But that does not make sense from an economic standpoint. After deregulation, the airlines were free to raise or lower their fares. If meals cost the airline more than they were worth to their customers, why not abolish them earlier and lower prices accordingly? If not, then dropping the free meals was a less attractive alternative to raising fares, so why do it?

The closest I can come to an explanation of this puzzle requires me to replace the economic assumption of rational behavior with a form of predictable irrationality—the widespread belief in just prices, a subject I discuss in an old article linking economics to evolutionary psychology. 

Many people act as if they believe that they have a moral right to continued transactions on whatever terms they are used to having them in the past—that a seller who raises his prices is somehow trying to cheat them. It is not an unqualified belief—evidence that the seller's cost has increased may sometimes rebut it—but it is at least a presumption. And one way of acting on it is to avoid doing business with sellers who act that way, who offer you the same transaction at the same price for a period of years, then suddenly raise the price or reduce what they are giving you in exchange. 

For instance, airlines that stop providing you with free meals.

Of course, airline prices change all the time. But then, they also vary according to where you are flying, when you are flying, and how long in advance you bought your ticket, a pattern complicated enough so that the average passenger cannot easily keep track of whether the airline is offering the same fares this year as last. He can notice if the airline stops offering free meals or starts charging for checked luggage. And resent it.

If this analysis is correct, an airline that stopped offering meals with no obvious reason would suffer a reputational loss. Customers would decide that that airline was not their friend, was trying to exploit them, and would avoid it when possible. 9/11 offered an excuse. I do not know what set off the later switch to bag charges, but it may be significant that, within a fairly short period of time, most airlines were doing it, perhaps because the later ones had the practice of the earlier movers to justify their charges. And it may be significant that South-western, a very successful firm, continues to carry bags for free and makes a large point of that fact in their advertising.

This is a possible, partial, explanation of what happened, but not a very convincing one. Readers with better answers to my puzzle are invited to offer them.

When Costs Aren't

From the standpoint of an economist, the logic of global warming is  straightforward. There are costs to letting it happen, there are costs to preventing it, and by comparing the two we decide what, if anything, ought to be done. I am fairly sure, however, that  many of those who are sure we should be doing something about it do not see the question that way. What I see as costs, they see as benefits.

Reduced energy use is a cost if you approve of other people being able to do what they want, which includes choosing to live in the suburbs, drive cars instead of taking mass transit, heat or air condition their homes to what they find a comfortable temperature. But it is a benefit if you believe that you know better than other people how they should best live their lives—know that a European style inner city with a dense population, local stores, local jobs, mass transit instead of private cars, is a better, more human, lifestyle than living in the anonymous suburbs, commuting to work, knowing few of your neighbors. It is an attitude that I associate with an old song about little houses made of ticky-tacky—meaning houses the singer didn't like and was therefore confident that other people shouldn't be living in, occupied by people whose life style she thought she knew and was confident she disapproved of. A very arrogant, and very human, attitude.

There are least three obvious candidates for reducing global warming that do not require a reduction in energy use. One is nuclear power—a well established, if somewhat expensive, technology that produces no CO2 and can be expanded more or less without limit. One is natural gas, which produces considerably less carbon dioxide per unit of power than coal, for which it is the obvious substitute. Fracking has now sharply lowered the price of natural gas, with the result that U.S. output of CO2 has actually fallen. The third and more speculative candidate is geoengineering—one or another of several approaches that have been suggested for cooling earth without reducing CO2 output.

One would expect that someone seriously worried about global warming would take an interest in all three alternatives. Of course, in each case, there are arguments against as well as arguments for. But if one believes that global warming is a very serious problem and alternative solutions are costly, one ought to be biased in favor of each of them, inclined to look for arguments for, not arguments against.

In my experience, that is not how people who campaign against global warming act. They are less likely than others, not more, to support nuclear power, to approve of fracking as a way of producing lots of cheap natural gas, or to be in favor of experiments to see whether one or another version of geoengineering will work. That makes little sense if they see a reduction in power consumption as a cost, but quite a lot of sense if they see it as a benefit.

I have focused on global warming, but the pattern exists in other contexts and across the political spectrum. When 9/11 happened, a lot of the people who insisted that the threat of terrorism now made it unfortunately necessary to restrict individual privacy and civil liberties in a variety of ways were people who were in favor of the same policies before 9/11.

The general approach is perhaps best summed up in a quote attributed to Rahm Emanuel, back when he was working for Obama: 

 You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before.

The argument for sharply increasing federal spending and doing it with borrowed money was that it was an emergency measure made necessary by the economic crisis. For Emanuel, and presumably his boss, it was an opportunity to do things they would have wanted to do whether or not there was a crisis. The argument for using regulation or carbon taxes to reduce the output of carbon dioxide is that it is made necessary by the threat of global warming. For many of those who make that argument, it is an opportunity to make other people live the way those people think they should.

Good News, Bad News

The bad news is that it looks as though Obama is going to win. The good news is that it looks as though Romney is going to lose.

As I commented a few elections back, the problem with electing a Republican is that he does about the same bad things the Democrat would have done, with about the same bad consequences—for which we, people who believe in the free markets he pretends to believe in, get blamed.

Physics, Economics, and Hurricane Arguments

I just finished an interview, via Skype, that will eventually be up on the web. One question I was asked was how knowledge of one field feeds into thinking about another. It occurred to me that I had an interesting example, a case where two unrelated fields, both of which I have worked in, showed that two different arguments for a conclusion in a third field were both wrong.

The three fields are physics, economics, and climate science. The conclusion, widely repeated, is that global warming will result in either more frequent or more violent hurricanes, or both. The conclusion may, for all I know, be correct. Two common arguments for it, however, are both wrong.

The first argument is that hurricanes get their energy from heat, so can be expected to be more violent or more frequent if there is more heat to feed them. That sounds plausible—provided you don't know the relevant physics. A hurricane is a heat engine, converting thermal energy to mechanical energy in the form of moving air. A heat engine does not, indeed cannot, simply convert thermal energy to work—one that did that and nothing else, say a ship that ran without fuel on the heat of the ocean, would be what is called a perpetual motion machine of the second kind and is impossible because it violates the second law of thermodynamics.

A heat engine works by taking heat from a high temperature source, turning some of it into work, and dumping the rest into a lower temperature sink. The amount of work it can get out depends not simply on the temperature of the source but on the temperature difference (if my memory from long ago studies is correct, actually the difference in 1/T) between source and sink. So if you warm both source and sink, air and sea in the case of a hurricane, there is no particular reason to expect that more work will be available, hence no particular reason to expect hurricanes to get either more frequent or more violent.

The second argument is empirical. It is claimed—I presume correctly—that on average you get more hurricanes in hot weather. The obvious conclusion is that if earth's climate gets warmer, we will have more (or more powerful) hurricanes. This time it is economics, in particular the history of ideas in economics, that points out the mistake.

Quite a long time ago, William Phillips, an economist from New Zealand, noticed an interesting empirical relation—on average, when inflation was high, unemployment was low. The relation got labeled the "Phillips Curve." The obvious conclusion was that one could hold down unemployment at the cost of tolerating some inflation. A variety of governments tried to implement such policies. Their failure in the U.S. got labeled "stagflation," a situation with both high unemployment and high inflation.

What was wrong with the Phillips Curve was not the empirical evidence but the causal conclusion. What was really going on, as the evidence is now widely interpreted, was that unemployment tended to be low when inflation was higher than people expected. That makes sense on a fairly simple model. If workers underestimate inflation, they will see wage offers as more attractive than they really are and so be more willing to accept them, less willing to wait for a better job, than they would be if they correctly estimated future inflation. If employers underestimate inflation, they will observe high demand for their products at current prices and see that as a reason to hire more workers and expand production.

Times when inflation is high are also, on average, times when it is higher than people expect, giving you the empirical relation Phillips had observed. But if a government tries to exploit the relation by maintaining an inflation rate of (say) five percent a year, after a while people adjust their expectations accordingly and the unemployment rate goes back up. Raise it to ten percent, unemployment falls briefly, people adjust their expectations, and unemployment goes back up again.

The same argument applies in the case of temperature and hurricanes. On average, times when air temperature are higher than normal are also times when the temperature difference between air and sea is larger than normal—the sea, after all, has enormous heat capacity, and so tends to average out short term fluctuations in air temperature. So the observation that hurricanes are more likely in hot weather does not imply that they would be more likely if both sea and air got warmer, as, in a global warming scenario, they do. 

None of this implies that global warming does not make hurricanes more frequent or more violent. I have seen empirical claims in both directions—both that hurricanes are and are not increasing—and do not know enough about the field to evaluate them. But it does mean that two apparently persuasive arguments for why we should expect such a relation are wrong. 

And in each case, I spotted the error because of my background in a different, in one case entirely unrelated, field.

Libertarian Books: Sales vs Downloads

I recently came across a web page listing libertarian books in order of their rating on Amazon.com; my Machinery of Freedom was number 70, not surprising given its Amazon rating.

The book is also available as a free pdf from my web page, so I checked the download statistics and was pleasantly surprised to find that it is being downloaded at a rate of almost two thousand downloads a month, plus about 300 more of the .prc (ebook) version. That got me curious—what would the list look like if it was restricted to books available as free downloads, ordered by the rate at which they were downloaded?

The Mises site has a lot of libertarian books on it. Are there any of my readers who are connected with that site and willing to report download rates, or who know of public information on the subject?

The Half-life of Euphemisms

For no particular reason, I was recently thinking about the futility of the euphemism strategy—replacing a word that has negative connotations in the hope that the change will get rid of the connotations. The problem  is that if, as is usually the case, the connotations are based on what the word means not how it sounds, they will rapidly transfer to the substitute. The record for sequence length may be held by what we now usually refer to as a toilet. I do not know what the earliest term was, but the string includes "privy," "guarderobe," "WC," "lavatory," "bathroom," "toilet," and probably more that I have missed.

A different example that I noticed a few years ago was "gay." It was introduced as a substitute for "homosexual" on the theory that the latter was an insulting term. The problem, as usual, was that what made it insulting was that many people regarded what it described as immoral, disgusting, or both—and although  such feelings may weaken over time, they are not eliminated by a change in label. 

Not only did the negative connotations spread to the new word, the effect was not limited to its euphemistic use—a fact I discovered listening to casual chatter on World of Warcraft. Posters routinely used "gay" as a general purpose negative term, often with no connection to homosexuality. "That's gay" meant, more or less, "isn't that terrible."

There used to be a theory known as the Sapir-Whorf hypothesis, according to which language shaped thought. As best I can tell, the supposed evidence for it was mostly bogus. The euphemism strategy is the applied version.

And doesn't work.

Anyone in Europe Want a Talk?

It looks as though I'm going to be visiting Spain sometime early next year. Given how long the trip is, I would like to combine that visit with something else, and one obvious possibility is giving a talk or talks somewhere else in that part of the world--which, seen from California, covers most of Europe. 

It occurred to me that a blog post might be one way of seeing if anyone was interested. Some of my talks can be found online.

Macro and Micro Predators, Territorial Behavior and the Tragedy of the Commons

There are no large organisms that support themselves primarily by preying on humans; so far as I know, there have been none for several thousand years. There are lots of microscopic organisms that do so. Why the difference?

One possible answer is that macro predators face a tragedy of the commons—the deer I don't eat today will not be around, and fatter, next season because someone else will have eaten it. Micro-predators, on the other hand, have an "incentive" to preserve their food supply, both because the bacteria or viruses on me are all close kin to each other and so face evolutionary pressure to act in their common interest and because I am much larger and much longer lived than they are, so that many generations of them are dependent on a single me. From which it follows that a lethal disease is a mistake. From an evolutionary standpoint, diseases want to live off me while doing as little damage as possible.

When I made this point to my wife, she pointed out that some macro-predators solve the problem the same way humans do—via property rights. Their version is territorial behavior. If a single tiger succeeds in monopolizing his chunk of jungle, it is in his interest to let the fawn grow up today to be a better meal next year. 

Which leads to an interesting conjecture. Territorial behavior solves the tragedy of the commons only if the prey species is not too mobile—if the fawn spared today is likely, as an adult deer, to still be within the range of the tiger that spared it. It would be interesting to know whether there is an inverse relation between the probability that a species is territorial and the mobility of its prey.

All of which gets me some distance from my original point, which was about humans, not deer. One special reasons macro-predators have reason not to choose humans as prey is that humans fight back. Until recently, we have had no similar ability with regard to micro-predators.

With regard to fighting back, the tragedy of the commons point is still relevant. A prudent macro-predator might hunt humans in a fashion sufficiently selective not to provoke any major retaliation, tiger hunts or the equivalent. But doing so means giving up today's meal for a benefit shared with the rest of his species, making the incentive for prudence a weak one.