Showing papers in "Journal of Economic Perspectives in 1989"

Social Norms and Economic Theory

Abstract: Elster contrasts two distinct and frequently opposing social science traditions. One was fostered by Adam Smith and is carried forward today by neoclassical economists and rational-choice theorists in political science. It views humans as “economic men,” that is, as motivated by egoistic material concerns. The other tradition has its roots in the work of the French sociologist Emile Durkheim, provides the basis for much contemporary sociology and has adherents among political scientists, particularly political culture theorists such as Eckstein (1988). It views humans as social creatures, having duty-based and other obligations to their fellows. “Sociological man’s” activity is thus constrained by shared social (cultural) norms. Elster is skeptical that these cultural norms generally realize individual self-interest as this is understood in the rational-choice tradition. Indeed, elsewhere he distinguishes “economic man” rationality and “nonra-tional” cultural norms even more sharply than he does in this chapter (Elster 1989b). Overall, Elster holds that, for the most part, cultural norms neither arise from rationality, as neoclassical economists understand it, nor do they serve it.

Auctions and Bidding: A Primer

Abstract: Maybe the contractor was right to think bid jobs are different, but it is more likely that he suffered from too simple a view of what is involved in preparing a competitive bid. Our analysis will show that even an experienced estimator working in familiar terrain can lose money if he doesn't understand the subtleties of competitive bidding. The phenomenon experienced by the painting contractor, known as the " Winner's Curse," is just one of the surprising and puzzling conclusions that have been turned up by modern research into auctions. Another is the theoretical proposition (supported also by some experimental evidence) that, for example, a sealed-bid Treasury bill auction in which each buyer pays a price equal to the highest rejected bid would yield more revenue to the Treasury than the current procedure in which the winning bidder pays the seemingly higher amount equal to his own bid. There are also subtle results that demonstrate the equivalence of such apparently different institutions as the standard sealed-bid auction, in which the auctioneer/seller sells the goods to the highest bidder for a price equal to his bid, and the Dutch auction, in which the auctioneer/seller begins by asking a high price and gradually lowers the price until

The Ricardian Approach to Budget Deficits

Abstract: Persistent budget deficits have increased economists' interest in theories and evidence about fiscal policy. This paper develops the Ricardian approach and contrasts it with standard models. The discussion considers from major theoretical objections to Ricardian equivalence-finite lifetimes, imperfect capital markets, uncertainty about future taxes and incomes, and the distorting effects of taxation Then the paper considers empirical evidence on interest rates, consumption and saving, and current-account deficits. The conclusion is that the Ricardian approach is a useful first-order approximation, and that this approach will probably become the benchwork model for assessing fiscal policy.

How Auctions Work for Wine and Art

Abstract: interview auctioneers, and even to buy a little wine.' In the meantime I have also had the opportunity (with John Abowd, 1988) to observe and collect data on the auction sale of impressionist and contemporary paintings. This paper reports on some of the empirical regularities that I and others have observed in the actual operation of the auction markets for these items. In view of the rich and diverse array of theoretical literature on auctions it seems high time economists began to spell out precisely what facts it is meant to explain.2

Economic Prescriptions for Environmental Problems: How the Patient Followed the Doctor's Orders

Abstract: O ne of the dangers with ivory tower theorizing is that it is easy to lose sight of the actual set of problems which need to be solved, and the range of potential solutions. As one who frequently engages in this exercise, I can attest to this fact. In my view, this loss of sight has become increasingly evident in the theoretical structure underlying environmental economics, which often emphasizes elegance at the expense of realism. In this paper, I will argue that both normative and positive theorizing could greatly benefit from a careful examination of the results of recent innovative approaches to environmental management. The particular set of policies examined here involves two tools which have received widespread support from the economics community: marketable permits and emission charges (Pigou, 1932; Dales, 1968; Kneese and Schultze, 1975). Both tools represent ways to induce businesses to search for lower cost methods of achieving environmental standards. They stand in stark contrast to the predominant "command-and-control" approach in which a regulator specifies the technology a firm must use to comply with regulations. Under highly restrictive conditions, it can be shown that both of the economic approaches share the desirable feature that any gains in environmental quality will be obtained at the lowest possible cost (Baumol and Oates, 1975). Until the 1960s, these tools only existed on blackboards and in academic journals, as products of the fertile imaginations of academics. However, some countries have recently begun to explore using these tools as part of a broader strategy for managing environmental problems.

The Corporate Bankruptcy Decision

Abstract: A central tenet in economics is that competition drives markets toward a state of long-run equilibrium in which those firms remaining in existence produce at minimum average costs. In the transition to long-run equilibrium, inefficient firms, firms using obsolete technologies and those producing products that are in excess supply are eliminated. Consumers benefit because in the long run, goods and services are produced and sold at the lowest possible prices. The legal mechanism through which inefficient firms most often are eliminated is that of bankruptcy. In 1984, around 62,000 business firms filed for bankruptcy. Two-thirds of them filed to liquidate in bankruptcy and the rest filed to reorganize in bankruptcy (Administrative Office of the U.S. Courts, 1985). The total liabilities of firms that filed for bankruptcy in 1985 came to approximately $33 billion (Dun & Bradstreet, 1986).1 Economic theory suggests that bankruptcy should serve as a screening process designed to eliminate only those firms that are economically inefficient and whose resources could be better used in some other activity. However, firms typically file for bankruptcy voluntarily. When they do, creditors are not all repaid in full and large redistributional effects occur. Managers of firms do not take creditors' losses fully into account in deciding either how to run the firm or whether and when to file for bankruptcy. This suggests that firms in bankruptcy might not always be economically inefficient and that inefficient firms might not always end up in bankruptcy. Rather, firms may shut down and file for bankruptcy versus continuing to operate because managers respond to the potential for redistribution from creditors to equity, rather

Chaos: Significance, Mechanism, and Economic Applications

Abstract: Imagine a bargaining model (say, involving diplomats negotiating tariff levels or a disarmament treaty) in which each party has been instructed by higher headquarters to respond to each new offer by her opposite number with a counteroffer that is to be calculated from a simple reaction function provided in advance. Both negotiating parties are prohibited from revealing their own reaction functions to the other. If the perfectly deterministic sequence of offers and counteroffers that must emerge from these simple rules were to begin to oscillate wildly and apparently at random, the negotiations could easily break down as each party, not understanding the source of the problem, came to suspect the other side of duplicity and sabotage. Yet all that may be involved, as we will see, is the phenomenon referred to as chaos, a case that is emphatically not pathological, but in which a dynamic mechanism that is very simple and deterministic yields a time path so complicated that it will pass most standard tests of randomness. Chaos has become a subject of great interest to specialists and nonspecialists alike. Besides economics, it has entered the literature of geometry, physics, ecology and meteorology. It has been written about at length in the New York Times Magazine and Scientific American, as well as technical publications. This article seeks to describe what it is, how it works, and what it means for economics.

Understanding Real Business Cycles

Abstract: he 1 960s were a time of great optimism for macroeconomists. Many economists viewed the business cycle as dead. The Keynesian model was the reigning paradigm and it provided all the necessary instructions for manipulating the levers of monetary and fiscal policy to control aggregate demand. Inflation occurred if aggregate demand was stimulated "excessively" and unemployment arose if demand was "insufficient." The only dilemma faced by policymakers was determining the most desirable location along this inflation-unemployment tradeoff or Phillips curve. The remaining intellectual challenge was to establish coherent microeconomic foundations for the aggregate behavioral relations posited by the Keynesian framework, but this was broadly regarded as a detail that should not deter policymakers in their efforts to "stabilize" the economy. The return of the business cycle in the 1970s after almost a decade of economic expansion, and the accompanying high rates of inflation, came as a rude awakening for many economists. It became increasingly apparent that the basic Keynesian framework was not the appropriate vehicle for understanding what happens during a business cycle nor did it seem capable of providing the empirically correct answers to questions involving changes in the economic environment or changes in monetary or fiscal policy. The view that Keynesian economics was an empirical success even if it lacked sound theoretical foundations could no longer be taken seriously. The essential flaw in the Keynesian interpretation of macroeconomic phenomenon was the absence of a consistent foundation based on the choice theoretic framework of microeconomics. Two important papers, one by Milton Friedman (1968) and the other by Robert Lucas (1976), forcefully demonstrated examples of

The Political Economy of Trade Policy

Abstract: International trade seems to be a subject where the advice of economists is routinely disregarded. Economists are nearly unanimous in their general opposition to protectionism, but the increase in U.S. protection in recent years in such sectors as automobiles, steel, textiles and apparel, machine tools, footwear and semiconductors demonstrates that economists lack political influence on trade policy. The type of protectionism chosen does not follow economists' advice, either. A frequently asked question on undergraduate trade exams is why a small country's welfare losses are less when it curtails imports with a tariff rather than by negotiating "voluntary" export-restraint agreements (VEAs) with foreign suppliers. Even though generations of students have correctly pointed out that the equivalent of the domestic tax revenues raised by a tariff is transferred as a windfall gain to foreign countries when VEAs are introduced, these agreements are now the preferred means by which countries pursue protectionism. Moreover, if the purpose of protection is to redistribute income to producers, production subsidies (financed by lump-sum taxes) dominate both tariffs and import quotas on efficiency grounds, since the consumption costs of protection are avoided. Yet governments generally prefer to assist industries by providing import protection rather than production subsidies. Economists have tended to attribute such disregard for their policy conclusions to a lack of economic education. However, while many consumers still do not seem to

A Neoclassical Perspective on Budget Deficits

Abstract: I n the 1988 presidential campaign, virtually every serious candidate spoke of the urgent need to trim government budget deficits. Public opinion polls have identified federal deficits as a key economic issue, second only to unemployment. While many economists are relieved by what they perceive to be a long overdue political response to a critical economic problem, others regard the fuss as much ado about nothing. It is indeed remarkable that economists can disagree so severely over an issue which commands such a uniform reaction from laymen of widely different ideologies and political affiliations. Generally speaking, there are three schools of thought concerning the economic effects of budget deficits: Neoclassical, Keynesian, and Ricardian. Before proceeding further, it is useful to review the basic structure and implications of each paradigm. The Neoclassical paradigm envisions farsighted individuals planning consumption over their own life cycles. Budget deficits raise total lifetime consumption by shifting taxes to subsequent generations. If economic resources are fully employed, increased consumption necessarily implies decreased saving. Interest rates must then rise to bring capital markets into balance. Thus, persistent deficits "crowd out" private capital accumulation. In the current economic environment, most economists would agree that these consequences would be highly detrimental.

Cash Distributions to Shareholders

Abstract: Economists have long been puzzled by why firms pay dividends when alternative methods of rewarding shareholders and financiers exist which involve less taxes. This paper will highlight the fact that firms can distribute cash to equity holders in ways more lightly taxed than dividends. The two methods we examine are share repurchase programs and cash-financed mergers and acquisitions. So why should cash distributions from firms to shareholders ever take the form of dividends? This paper first provides evidence on the explosive growth in dividend cash payments, and then discusses how this evidence should affect theories about corporate finance.

Theory, Experiment and Economics

Abstract: I t is now over thirty years since research was initiated in the laboratory experimental study of market behavior and performance.' This essay provides my interpretation of what the implications of this type of work are for the study of economics. The essay is not intended as a systematic survey of the field, although examples will be cited where appropriate and necessary. The reader can find the associated references in more general surveys (E. Hoffman and M. Spitzer, 1985; C. Plott, 1979, 1982, 1986a, 1986b; V. Smith, 1976, 1980, 1982a, 1982b, 1986).

Real Business Cycles: A New Keynesian Perspective

Abstract: The debate over the source and propagation of economic fluctuations rages as fiercely today as it did 50 years ago in the aftermath of Keynes’s The General Theory and in the midst of the Great Depression. Today, as then, there are two schools of thought. The classical school emphasizes the optimization of private economic actors, the adjustment of relative prices to equate supply and demand, and the efficiency of unfettered markets. The Keynesian school believes that understanding economic fluctuations requires not just studying the intricacies of general equilibrium, but also appreciating the possibility of market failure on a grand scale.

Seniority, Wages and Productivity: A Turbulent Decade

Abstract: Why does a worker's wage tend to grow with seniority in the firm, and what does this have to do with productivity? Two decades ago, neoclassical labor economists thought that the theory of human capital provided a good answer to this question. The last decade has, however, been one of puzzles and doubt. At this point few would give an unambiguous answer. And much hinges on the answer. An attractive feature of human capital theory is that it yields a consistent and coherent explanation for several aspects of the employer-employee relationship. For example, seniority systems, layoff policies that vary with skill, and the relationship between tenure and turnover can be explained in terms of human capital. The fact that these explanations are connected leads, however, to something like a domino effect: doubts about one cast doubt on the others. If the human capital explanation for the wage-seniority relationship is flawed, then human capital explanations for other phenomena may require reevaluation. In addition, an important body of empirical research is built around the assumption that, at any point in time, a person's wage indicates the person's productivity. Included here is the extensive literature on the human capital earnings function, as well as work on labor demand, market discrimination, and compensating differentials. That assumption has become controversial in recent years, in part because implicit contract theories predict that compensation will be redistributed over the period of the contract. If a person's spot wage has little to do with spot productivity, but rather is an instrument of a complex insurance or deferred compensation scheme, then a reassessment of the empirical research may be necessary.

Budget Deficits: Rhetoric and Reality

Abstract: W v T hatever the real or imagined ills of the economy, the news media, most politicians and a fair proportion of the economics profession are quick to point to the culprit: "the budget deficit." No matter that few appear to know or care precisely what deficit they are talking about or how it is measured. No matter that few bother to explain in terms of a relevant model just how government deficits may be expected to impact the economy. No matter that few offer any empirical data to sustain their judgments. So budget deficits cause inflation. Budget deficits raise interest rates. Budget deficits bring on the trade deficits. Budget deficits crowd out investment. Budget deficits are an irresponsible mortgage on the future. And budget deficits caused the October 1987 stock market crash and now threaten further financial cataclysms! Is there truth in any of these assertions? Or does it all depend? Budget deficits do matter and their effects, contrary to Barro's "Ricardian equivalence theorem," can be substantial. As most economists have recognized for at least half a century, budget deficits can, however, be too small as well as too large. To know which, you have to measure them right. And you have to analyze their role in the world in which we live. Pure Walrasian and rational-expectation market-clearing models may prove more useful for academic advancement than for promotion of economic health. I need not repeat many of the objections to the equivalence theorem raised by Bernheim and Gramlich and addressed by Barro in this symposium. However, there is

Self-Enforcing Contracts, Shirking, and Life Cycle Incentives

Abstract: he labor market is a rich and complicated place. When a worker takes a job he expects to earn a wage, but will also care about rates of wage growth, fringe benefits, levels of risk, retirement practices, pensions, promotion and layoff rules, seniority rights, and grievance procedures. In return the worker must give up some time, but he is also asked to upgrade his skills, train other workers, provide effort and ideas, and defer to authority in questions of how his time is spent. Great changes are occurring in the way labor market institutions such as these are modelled. Central to the new approach is the concept of a self-enforcing implicit contract. This is the latest in a series of variations on the ideas of Azariadis (1975), Baily (1974) and Gordon (1974), and is one of the more exciting new developments in the theory of labor markets. This essay will outline this approach and evaluate some of its accomplishments. The ideas will be presented in the context of an incentive model that is of some independent interest. The model was introduced by Becker and Stigler (1974), and was extended by Lazear (1979) to account for wage growth and mandatory retirement. In these papers the workers retire at a fixed age, lending the name "life cycle incentives" to the approach. More recently, Shapiro and Stiglitz (1984) have used a version without a fixed retirement date to account for unemployment. This version is often called the "shirking" model. These models have generated some controversy, but much of it can be resolved when the models are presented in the framework of self-enforcing contracts. In fact, this simple incentive model can do even more. It can provide a rationale for "competitive hierarchies," where firms place their workers in competition with

Bequest and Wealth Accumulation: Are Some Pieces of the Puzzle Missing?

Abstract: The lively debate between Laurence J. Kotlikoff and Franco Modigliani presented in the Spring 1988 issue of this journal concerns an old question: what is the main motivation for saving and therefore for the accumulation of wealth? More specifically, what are the respective contributions to aggregate wealth of (1) saving for retirement (also known as "hump" saving); (2) precautionary savings (and "unintended" bequests) due to uncertainty about the length of life; and (3) planned bequests? Of course, other wealth holding motives are possible, but let us follow Kotlikoff and Modigliani in setting them aside for now. If Modigliani's life cycle hypothesis is to be viewed as a close to approximation of reality, then the bulk of existing wealth should have resulted from some combination of hump and precautionary saving. Our comment on this dispute attempts to advance two issues. First, the controversy involves an enormous gap between empirical estimates of the share of "inherited wealth" in total accumulation, even though the estimates are often based on the same data. We hope to clarify why the estimates vary so widely. Second, the Kotlikoff/Modigliani dispute is presented as an American issue, with little extension abroad. We will present some results from other countries that bear on the controversy. (Some of the estimates from Kotlikofi's paper originated in a 1981 paper he wrote with Lawrence Summers, which is why we sometimes refer to his position as the "Kotlikoff-Summers" argument in this comment.) The problem of conceptualizing the contribution of bequest to aggregate savings can be summarized with a thought experiment. Assume all bequests were confiscated.

Economic Methodology in a Nutshell

Abstract: he literature on economic methodology is concerned mainly with questions of theory confirmation or disconfirmation or empirical theory choice. The central question is usually, "How one can tell whether a particular bit of economics is good science?" Economists would like methodologists to provide the algorithm for doing good economic science-and they want the algorithm to vindicate their own practice and to reveal the foolishness of those who do economics differently. For example, Milton Friedman (1953) tells economists that good theories are those that provide correct and useful predictions, while Paul Samuelson (1947, 1963) tells economists to formulate theories with "operational" concepts that are, ideally, logically equivalent to their descriptive consequences. In my view, not only are these (and most other) specific views on theory appraisal mistaken, but the concern with problems of empirical appraisal is exaggerated, for there are also interesting methodological questions to consider-both normative and descriptive-concerning the structure, strategy, goals and heuristics of various economic theories. For example, few writers on economic methodology recognize that the activities of formulating economic models and investigating their implications are a sort of conceptual exploration. Instead, most mistakenly regard these activities as offering empirical hypotheses and assess them in terms of some philosophical model of confirmation or falsification. As a tendentious survey of standard methodological literature, this essay will, however, share its preoccupation with the empirical appraisal of theory, microeconomic theory in particular. I shall in particular discuss four approaches to praising or damning microeconomic theory that have dominated methodological discussions.

Women in the Labor Market and in the Family

Abstract: T here are two themes in this paper. The first, an exercise in revisionist history, argues that the conventional wisdom of an absence of any substantial labor market progress for women is mistaken. Instead, throughout this century, women's wages have been steadily rising relative to those of men, a progress likely to accelerate in the next few decades. Our second theme contends that this labor market progress is not enough. Alongside their labor market advances, the relative economic plight of many women is worsening. The downside news is the increasing feminization of poverty, a reflection of the growing instability of the American family.

Women and Affirmative Action

Abstract: This paper reviews evidence indicating that, as it has been enforced so far, affirmative action has contributed negligibly to women's progress in the workplace. Affirmative action can be modeled as a tax on employers whose female employment growth falls below a certain rate. Clearly, if labor supply shifts result in female employment growth greater than the regulatory standard, the tax constraint will not be binding. As we shall see, this may help explain an affirmative action program that is generally ineffective for women, although it has been effective for minorities. Federal anti-bias policies in general, and the system of affirmative action goals in particular, have been accused of instituting employment quotas. This paper reviews evidence on the homogenization of the workplace predicted by the quota theory, as well as considering more direct evidence on whether affirmative action goals are really quotas in lambs' clothing. I shall also review the slim evidence on the most fundamental and co...

The Role of Potential Competition in Industrial Organization

Abstract: Potential competition has been recognized as a mechanism to control the exploitation of market power at least since the work of J.B. Clark (1902), but it was not until 50 years later that economists, most notably Joe Bain and Paolo Sylos-Labini, refocused attention on the idea. With inputs from the theories of imperfect competition, optimal control, and dynamic games, their work evolved into ever more sophisticated models of the reactions of existing competitors to the threat of new competition. Although the most appropriate models of competitive interaction are those which begin with a specific industry, a number of theories have been proposed which attempt to develop more general conclusions. My purpose in this paper is to develop an understanding of the strengths and limitations of these alternative theories by examining the available theoretical, empirical and institutional knowledge. Rather than attempt the Sisyphean task of recounting every model which relates conditions of entry and market performance, I have partitioned the analysis into four major schools of thought, according to their most central propositions. These are the traditional model of limit pricing, dynamic limit pricing, the theory of contestable markets, and the market efficiency model. Traditional limit pricing models rest on the assumption that firms respond to entry, but are able to earn persistent profits when the structural characteristics of markets make entry difficult. Dynamic limit pricing is similar, but emphasizes that markets can only be temporarily protected from entry. Contestability theory, in its pure form, asserts that potential competition is as effective as actual competition in controlling market performance. The efficient markets hypothesis, broadly interpreted, states that markets are workably competitive and that the market structure reflects differential efficiency, not strategic behavior. While one can construct many other hypotheses about potential competition, these classifications

Does the Market for Women's Labor Need Fixing?

Abstract: T he difference in pay between men and women workers in the American economy is currently averaging 30 to 35 percent, depending on the measure used. Underlying these large pay differences are the continuing segregation of work by sex, a sparsity of promotions for women, and differences in the respect accorded men and women. Low wages for women workers mean a low standard of living for the large and growing fraction of women who do not share the income of a husband, and for the children who live with them. Because of their lack of access to all jobs on an equal basis, women have a disproportionately small share of the interesting jobs, of the jobs that allow a person to grow and to advance. Gains for working women are occurring, but even assuming the continuation of the current rate of change, the substantial equality of women and men in the labor market is decades away. This article concerns the appropriate policy response to this situation. Some economists imply that the appropriate response is none at all. They view the inferior labor market position of women as something women have freely chosen, as a normal and generally benign adaptation to "their responsibilities" for housework and child rearing. Low-wage work is seen as appropriate for people who behave as they do. The laws against discrimination and the apparatus designed to enforce them are, in this view, superfluous or of minor value. After all, the discipline of the competitive marketplace has kept things fair and always will. There is, however, considerable evidence for the alternative view that widespread, severe, ongoing discrimination by employers and fellow workers continues to hamper women. If this is true, systematic government action to interfere in the marketplace can be justified on grounds of equity and efficiency. The question then arises as to the

The Reform of Federal Deposit Insurance

Abstract: I n early 1989, the system of deposit insurance in the United States was in crisis The Federal Savings and Loan Insurance Corporation (FSLIC), the US government agency that provided deposit insurance for savings and loan (thrift) institutions, had sustained massive losses from the insolvencies of hundreds of thrifts Tens of billions of dollars of general Treasury revenues will be necessary to make good the losses in the insurance fund, which had previously been financed solely through premiums assessed on thrifts' deposits The Federal Deposit Insurance Corporation (FDIC), which provides similar insurance for deposits in commercial banks, has sustained much smaller losses but is considered to be in poor enough financial condition that its premium assessments will increase substantially The deposit insurance system has two goals: to provide a safe investment vehicle for unsophisticated savers and to stabilize depositories against runs (FDIC, 1989a; Baer, 1985) Runs are a potential problem because the assets of depositories are relatively illiquid, while their liabilities are mostly short-term instruments that are used as money or near-money (Diamond and Dybvig, 1983) Depositors expect to be able to redeem these instruments at par-withdraw their money-at any time Though a credible and fast-reacting lender of last resort could probably solve the runs problem alone, the presence of credible deposit insurance clearly helps dampen any tendency toward runs' The crisis in deposit insurance is clearly of great policy importance This article will review the current system of deposit insurance and advocate a set of necessary reforms

Business Ascendancy and Economic Impasse: A Structural Retrospective on Conservative Economics, 1979-87

Abstract: Conservatives have been waging economic revolution since the late Carter years. Have they succeeded? Some argue in the affirmative, pointing to lower rates of inflation and the long expansion since early 1983, insisting that "the fundamentals are sound." Others argue in the negative, emphasizing the huge twin (trade and federal budget) deficits and the financial fragility underscored by the October 1987 stock market crash, warning that "the party's over." Both sides of this argument concentrate primarily on short-term phenomena in the 1980s; neither pays much attention to the experience of the conservative regime since 1979 in long-term historical perspective. Ronald Reagan and the early architects of conservative economic policy made no such mistake. They sought their place in the history books as institutional innovators, not economic tinkerers. In this light, scrutiny of the usual cyclical macroeconomic indicators may miss far-reaching changes in economic structure which promise a sustained economic expansion in years to come. The budget and trade imbalances of the late 1980s, for example, may reflect nothing more than the growing pains of a new economic order whose long run prospects are as bright as the Reagan administration promised. Had the economic record of the New Deal been evaluated in the eighth year of Roosevelt's presidency, one may doubt that we would have found in the standard economic aggregates signs of the profound institutional changes which were to provide the foundations for the long postwar boom.

Expected Revenue from Open and Sealed Bid Auctions

Abstract: In his preceding piece, Paul Milgrom has neatly laid out many of the core results of the recent literature on the theory of competitive bidding. My immediate goal here is to provide the simplest possible derivation of three basic revenue ranking theorems. Each of these compares the expected revenue obtained from open bidding, as in the typical art auction, with the expected revenue obtained when bids are sealed and the winner pays his bid. The first of the ranking theorems is the revenue equivalence theorem which establishes conditions under which these two seemingly very different auctions generate the same expected revenue for the seller. The other two theorems establish the effect of relaxing one of the key assumptions. When buyers are risk averse, the seller gains if buyers submit sealed bids and the winner pays his bid. On the other hand, if valuations of different buyers are positively correlated, rather than unrelated, the seller extracts more revenue in an open ascending bid auction. In reducing these theorems to their basic elements, my deeper goal is to provide the reader with a better intuitive understanding of the results.

Love and Spaghetti, The Opportunity Cost of Virtue

Abstract: This paper was written in the form of two puzzles. One puzzle concerns Romeo and Juliet who love spaghetti and each other. They wear flimsy clothing and have abdominal hedonimeters. The other puzzle asks who benefits from tax deductions to the rich for charitable deductions.

Puzzles: The Other Person's Envelope Is Always Greener

Abstract: The Puzzles feature in this issue is devoted to answering a puzzle that appeared in the Spring 1988 issue: "The Other Person's Envelope is Always Greener" The response to this puzzle was overwhelming Below, I recap the problem and then discuss the myriad of proposed solutions In the next column, we will return to the regular format of a few speed puzzles and one or two longer questions Contributions from readers are always valued; now they will be rewarded We will begin providing JEP T-shirts to those contributing new puzzles and innovative answers These T-shirts cannot be bought, only earned Please send your answers, comments, and favorite puzzles to me directly: Barry Nalebuff, "Puzzles," Department of Economics, Princeton University, Princeton, NJ 08544-1017