The Games Economists Play: Interactive Public Policy Pennsylvania Capital Campus March 19, 2008

1. The Games Economists Play: Interactive Public Policy Pennsylvania Capital Campus March 19, 2008 copies of this presentation can be found at www.business.duq.edu/faculty/davies

2. The purpose of this simulation is to create a competitive market and to observe the market as it achieves equilibrium. In this simulation, you will experience real market forces. The same human traits and behaviors that govern real markets exist in the simulation. What are artificial are your surroundings. The market forces are real.

3. The Players and the Goals In this experiment, there are CONSUMERS and FIRMS. FIRMS manufacture stuff. CONSUMERS buy stuff from FIRMS.

4. The Players and the Goals • Two types of firms • Red Firms produce Red Stuff. • Blue Firms produce Blue Stuff. • Firms sell stuff to consumers. • Each firm’s goal: Maximize profit

5. The Objects = 1 unit of Blue Stuff Stuff = 1 unit of Red Stuff Stuff = 1 dollar $ = 50 cents (each)

6. Each firm can produce a maximum of 30 units of stuff. Every chip you sell constitutes 1 unit produced. Chart shows the total cost of producing and selling various quantities.

7. For example: Firm starts with 30 units of Red Stuff. Firm sells a total of 22 units at an average price of $4.00 per unit. Production = 22 units. Total cost = $83.40. Total sales = ($4.00) (22) = $88.00 Profit = $4.60

8. You do not have to sell all your stuff. In fact, depending on what price you can get for your stuff, you’ll want to hold back. For example: Suppose you can sell your stuff for $4 per unit. How much should you sell?

9. Sell 0 units Sales = ($4.00) (0) = $0.00 Cost = $35.00 Profit = – $35.00 Sell 15 units Sales = ($4.00) (15) = $60.00 Cost = $57.50 Profit = $2.50 Sell 30 units Sales = ($4.00) (30) = $120.00 Cost = $125.00 Profit = – $5.00

10. An easy way to decide whether or not you should sell more is to compare the price you get from selling one more unit to the additional cost of selling one more unit. For example: Suppose you have already sold 7 units. A consumer offers you $5 for another unit. Should you sell one more unit? What is your current total cost? 7 units of output  $39.90 What will selling one more unit do to your costs? Increase total cost by $1.50 $5 extra sales exceeds $1.50 extra cost  sell it!

11. The Players and the Goals • Workers consume stuff they buy from firms Each worker’s goal: Maximize happiness

12. Consumers buy Red Stuff and Blue Stuff from the firms. Consumers consume every-thing they buy. Chart shows the happiness the consumer gets from consuming various quantities of stuff.

13. For example: Suppose the consumer buys a total of 5 units of Red Stuff and 8 units of Blue Stuff. The consumer’s total happiness is 54.

14. For example: Consumer starts with $50. Suppose that the price of Red Stuff is $2.00 per unit and that the price of Blue Stuff is $6.00 per unit. What can the consumer buy? ($2.00) (1 Red) + ($6.00) (8 Blue) = $50 ($2.00) (4 Red) + ($6.00) (7 Blue) = $50 ($2.00) (7 Red) + ($6.00) (6 Blue) = $50 ($2.00) (10 Red) + ($6.00) (5 Blue) = $50

15. For example: Of these possibilities, the combination of 10 Red and 5 Blue yields the greatest happiness. That is the combination the consumer should buy. ($2.00) (1 Red) + ($6.00) (8 Blue) = $50 ($2.00) (4 Red) + ($6.00) (7 Blue) = $50 ($2.00) (7 Red) + ($6.00) (6 Blue) = $50 ($2.00) (10 Red) + ($6.00) (5 Blue) = $50

16. Accounting Phase • After all trading is done, players add up their chips. •  Consumers report: • Units of Red Stuff purchased. • Units of Blue Stuff purchased. •  Firms report: • Units of stuff remaining (i.e., unsold). • Money earned.

17. Trading Rules Firms must remain in their seats. Firms display cards indicating their ask prices. Consumers may only purchase 1 unit of stuff at a time.  Purchase the unit, takes it back to your seat, go back and purchase another unit, etc.

18. Ready to begin…

19. Consumers: Spend all your $. Firms: Only sell if it is profitable to do so.

20. Accounting Phase • Workers report: • Income earned • Unsold labor • Firms report: • Blue labor hired • Red labor hired • Money remaining

21. Publicly Provided Good The government has taxed each consumer $30. The government used the tax revenue to provide each consumer with 8 units of Blue Stuff. Each consumer begins this round with 8 units of Blue Stuff. Each Blue firm begins this round having already sold 16 units of Blue Stuff.

22. Ready to begin…

23. Consumers: Spend all your $. Firms: Only sell if it is profitable to do so.

24. Calculation Round • Workers report: • Income earned • Unsold labor • Firms report: • Blue labor hired • Red labor hired • Money remaining

25. Results…

27. 27

29. 29

31. 31

32. 32

33. 33

34. When the government taxes to provide a good publicly, it forces consumers to consumer a quantity of the good that they may not want to consume.

35. For non-economic reasons, it may be desirable to force consumers to consume a specific quantity of a product. But, it is important to be aware of the tradeoffs – what do you force the consumer to give up?

36. What has been happening to the cost of health care over time?

37. Price of medical care has increased 349% since 1980 versus 135% for other consumer prices. Source: Bureau of Labor Statistics (www.economy.com)

38. Hospital services + 576% Drugs and supplies + 402% Physician services + 282% Other consumer prices + 135% Source: Bureau of Labor Statistics (www.economy.com)

39. Source: Bureau of Labor Statistics (www.economy.com)

40. The cost of health care is only one-half of the transaction. What has been happening to the quality of health care?

41. Source: Statistical Abstract of the United States, 2008, Table 77.

42. Source: Statistical Abstract of the United States, 2008, Table 77.

43. Source: Statistical Abstract of the United States, 2008, Table 110.

44. How does one measure the quality of health care? • What is “quality?” • How do we account for health care that has become routine but didn’t exist in the past (e.g., pre-natal care)? • How do we weigh qualities across different types of care (e.g., dental, catastrophic, preventative)?

45. How does one measure the quality of health care? An easy measure of the effectiveness of health care is the mortality rate. Some health care may have little or no impact on the mortality rate (e.g., orthodonture). But, it is not unreasonable to assume that the quality of other types of health care grow at the same rate as types of health care that directly contribute to reductions in the mortality rate.

46. Measuring quality of health care is difficult. We can use changes in the mortality rate as a proxy for changes in the quality of health care. Source: Derived from Statistical Abstract of the United States, and the Bureau of Economic Analysis.

47. In 1974, it was necessary to spend more than 9% of GDP on health care to reduce mortality by the equivalent of 100,000 lives (versus the mortality rate for 1960). By 2006, spending less than 4% of GDP on health care reduced mortality by the equivalent of 100,000 lives (versus the mortality rate for 1960). Source: Derived from Statistical Abstract of the United States, and the Bureau of Economic Analysis.

48. The percentage of the population that is uninsured has remained stable over time. Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.

49. Percentage of uninsured in each age group has remained relatively constant for the young and the old – the two groups for whom there is the least incentive to tradeoff of health care for spending on other things. Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.

50. Pattern of uninsured is commensurate with the hypothesis that, as the price of health care rises, the more healthy willingly choose not to be insured. Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.