Economic Fables

1. Economic Fables The goose that lays the Golden Eggs Our understanding of the way the world works is related to the stories that we use to explain it. Using a few simple stories, we can see the challenges we face in a different way. Richard D. Marcus marcus@uwm.edu Slide 1 Shorewood Men’s Club

2. Milwaukee Economic Models Chicago • Models are “Stories” • simplified assumptions from which which conclusions and predictions are deduced. • Example: simplified road maps as "abstractions". • The "Best" Model is the one which predicts the best, not the most descriptive. • Demand & Supply Curves are useful models. • Language is filled with idioms based on stories • Can say, “I fell like Charlie Brown kicking a football”

3. Fable: There’s no such thing as a Free Lunch • Has anyone ever received a free lunch? • Clearly we receive things we didn’t pay for • So what is the meaning of the saying then? • Hidden costs of gifts • Costs due to a sense of obligation • Costs of the next best alternative, often called Opportunity Costs • If everything has an alternative use of our time or money, then everything has a price or cost • Winston Churchill’s comments to Lady Astor Lady Nancy Astor in 1909 First Women to be seated In Parliament as an MP in 1919

4. The Winston Churchill & Lady Astor interaction. • "Lady Astor, would you sleep with me for a million pounds?” asks Churchill • "Sir Winston, I'd probably sleep even with you for a million pounds,” she replies. • “Lady, would you sleep with me for 20 quid?” • Incensed Lady Astor answers, "Of course not! What sort of a woman do you think I am?” • Winston says, "We've already established that. We are simply quibbling about the price!" • This conversation was likely made up by others.

5. Fable of the Broken Window • Frederic Bastiat • Kid throws a rock and breaks the baker’s window • Baker hires a window glazer for 15 francs • The glazer spends the francs on wine • Viola! – a story of a multiplier in 1850. • Bastiat’s Essay: What is Seen and Unseen • We don’t see what 15 francs would have purchased. • http://bastiat.org/en/twisatwins.html • Stimulus Package: spending on a train means not spending on something else.

6. The Fable of the Good and Bad Driver • The good driver is careful and has no accidents. • The bad drivers hit a tree last year, hit a fence the year before, etc. • Enact a Rule: No insurance company can reject drivers from coverage. • Result: Rates rise so that good drivers subsidize bad drivers. • What happens in the health care bill with a rule of not rejecting “pre-existing conditions?” • Why enroll in health care until needed? Why buy auto insurance until you have an accident?

7. Fable that Helmet Laws Save Lives • Wisconsin does not require helmets except for those under age 18 • We have HQ of Harley Davidson! • Michigan requires helmets for all riders • HQ of Ford, Chrysler, and GM! • 63% of fatally injured motorcycle riders were not wearing a helmet in states without all-rider helmet laws, compared with only 14% in states with all-rider helmet laws in 2007. (NHTSA, 2008) • But researchers found that helmets affect the lateral vision of riders and hearing of experienced riders

8. Moral Hazard for bike riders • Requiring motorcycle helmets poses moral hazard because it invites reckless biking. • The helmet is viewed as protection in case of an accident • Why ride safely, when the helmet “protects” you? • Wisconsin accidents per 10,000 register riders is 132, whereas that number in Michigan is 268 – twice as large ( http://www.abate-of-maryland.org/xhmt_pa.htm 1993 data ) • Similarly, the Federal Reserve's rescue of Bear Stearns invites reckless investment banking. • When someone is there to rescue, why play it safe?

9. Even the statistics on fatalities shows greater risk of death in Mandatory Helmet Law states

10. Fable of Crying over the Spilled Milk • You are told not to cry over spilled milk, but why? • Can’t undo the accident, so why dwell on it. • Economists talk about Sunk Costs. • Sunk Costs Are Sunk! • But we tend psychologically to want to justify earlier decisions • WPPSS – Washington Public Power Supply Bonds, a.k.a., Whoops Bonds • Every train funded or new government policy has a built in problem with Sunk Costs.