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Announcements: Tuesday

Announcements: Tuesday. Breakout sections: Nike case, hard midterm questions You have gotten an Oncourse email from me with details about the midterm grades. Your grade is posted on Oncourse. Next week: international trade. Look back to the economics readings. Announcements: Thursday.

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Announcements: Tuesday

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  1. Announcements: Tuesday • Breakout sections: Nike case, hard midterm questions • You have gotten an Oncourse email from me with details about the midterm grades. Your grade is posted on Oncourse. • Next week: international trade. Look back to the economics readings

  2. Announcements: Thursday • Breakout sections: Chiquita case • You have gotten an Oncourse email from me with details about the midterm grades. Your grade is posted on Oncourse.

  3. G302, Week 8Information

  4. ENRON Does this indicate market failure?

  5. ENRON EXXON

  6. Information is always imperfect. So why do we say imperfect information causes market failure? What you will learn today

  7. How Much Safety Do We Want? What are the leading causes of death in the United States?

  8. How Much Safety Do We Want? $$ Marginal Cost Of More Safety Marginal Benefit Of More Safety Safety features S*

  9. Car Safety Ratings http://www.nhtsa.dot.gov/NCAP/Cars/2001Cmpt.htmlPosted 01/15/2002 Compact Passenger Cars, front driver, side 2001 Chevrolet Cavalier 2-DR. 3 1 2001 Dodge Neon 4-DR. 4 3 2001 Ford Focus 2-DR. 5 4 2001 Honda Civic 4-DR. 5 4 2001 Pontiac Sunfire 4-DR. 4 1 See also: http://www.nhtsa.dot.gov/NCAP/Info.html#iq8

  10. How Much is a Life Worth? People take risks all the time. Suppose: • an office job pays $40,000 and has a 1/1000 chance of accidental death • a field job pays $50,000 but has a 3/1000 chance of accidental death • then the field job is paying $10,000 for a 2/1000 risk • If you take it, you value your life less than $5M ($10,000*1000/2)

  11. To Raise Your Annual Death Risk by One in 1 Million: • Smoke 1.4 cigarettes (cancer and heart disease) • Work 1 hour in a coal mine (black lung disease) • Travel 6 minutes by canoe (accident) • Travel 150 miles by car • Fly 1000 miles by jet • Live 2 months in Denver instead of Indiana (cancer) • Drink 1000 24-oz. drinks from banned plastic bottles (cancer) • Live 2 months in the average stone or brick building (cancer)

  12. How much would you have to be paid to accept a 1 in 100 probability of instant, painless, death? How about a 1 in 100,000 probability? Write the amount on a notecard.

  13. Summary: the Value of Safety • People do not really want to pay for maximum safety any more than for maximum quality. Otherwise they wouldn’t drive cars or live in New York. • By their deeds, people put dollar values on their own lives.

  14. Is there market failure? • Just because people buy unsafe products does not mean there is market failure • But if people consistently underestimate (or overestimate) the danger of what they do, that creates market failure.

  15. A car whose brakes sometimes fail... price supply 20 deceived demand 10 informed demand quantity 100

  16. 1. Did the sign-in sheet get around? 2. If you answered a question, bring up a notecard for me. The deadweight loss is... (a) A+B (b) B+F (c) G (d) E+F (e) D+E+F+G+H price supply A B C 20 E F D G deceived demand 10 H informed demand quantity 100

  17. People May Also Overestimate Danger... • 1962: DDT mosquito insecticide. It does not cause cancer • 1972: DES in beef. It does not cause cancer • 1976: Red Dye No. 2 • 1977: Saccharin sweetener • 1978: Love Canal toxic waste dump • 1979: Three Mile Island nuclear accident • 1979: Times Beach dioxin--town evacuated. • 1989: Alar • 1989: Electric blankets • 1990: Benzene in Perrier water • 1993: Asbestos in schools • 1990s: cigarette smoking (dangerous, but less than the hype)

  18. What did Enron do wrong? Write this on a notecard. I don’t care if you are right or wrong--- you haven’t had any readings on this. I just want you to think about what your impression is, as a rationally ignorant citizen.

  19. Enron’s Raptor I company • Enron put up $1000 cash, a note promising $50M, and $537M in Enron stock, restricted so it could not be sold for 3 years • Enron got back a note promising $400M • An outside company, LJM2 put up $30M cash • LJM2 got back a promise of $41M within 6 months

  20. Hedging Enron • Raptor hedged Enron’s Asset X using “swaps”. Suppose X is worth $40M now. If X went down to $20M, Raptor would owe money to Enron. • Thus, Enron would lose on X directly, but gain on its hedge with Raptor. This would make Enron’s earnings look better. • But what if Enron’s stock goes down? That’s about all the assets Raptor has. Then Raptor couldn’t pay what it owed Enron.

  21. Effect on Earnings of Raptors I, II, III, IV

  22. What to remember about Enron • Enron set up new companies solely to make its earnings look good • The main asset of these new companies was Enron stock, so when it crashed, they crashed • Certain Enron executives made a lot of money from the new companies, at Enron’s expense

  23. Worldcom • Worldcom’s CFO capitalized lots of expenses • There is no question this was against GAAP. It was outright fraud. • Where is the inefficiency?

  24. Martha Stewart and Imclone The FDA turned down Imclone’s application for a new cancer drug. She and her friend the CEO sold just before the crash Is there market failure here?

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