Why A Chapter in Game Theory is So Important, Particularly for Partygoer Students

One day, two procrastinating economics students decided to go for a party in a campus instead of studying for exam. They knew that the next Monday is Microeconomics Analysis 1 exam (let’s say so). But it's so worthy not to be missed. This party would be getting crazy and hang out (a bit hang-over) with ladies in the next campus could be a lot of fun. A party which must be put on not-to-be missed party list. Besides, they should not worry about exam anyway. The party is on Saturday and there is a plenty of time for reviewing the materials. Since they thought they are smart students and, of course, good party goers, 6 hours on Sunday for refreshing the course is enough.

Then they went to the party. They’re right. At least the party got crazy and many were unconscious-including them. Getting hang-over….back home and oh sleeping the whole day on Sunday. After all, Shit!..no time for covering the whole materials. They just reviewed Social Welfare I and II and no much time for studying A chapter on Game-Theory. In a very decisive time, one of them realized, raised a brilliant idea and thought that they could use special consideration for delaying exam.

They would tell the Prof that they attended a seminar (or workshop…or whatever academic things) in Econ program at the neighbour university. And when they were on the way back home, there was something wrong with one of the wheels. The wheel was broken and it took a whole day for fixing it. “Mmmm it sounds reasonable….” replied another smart but artful student. They did and they were allowed to take the exam in the next week after.

What a brilliant idea. Then they would have a plenty of time for studying lovely microeconomics. The exam time was coming. They sat separately (of course this is an exam and not a study group). Both were surprised since there were only two questions.

The first question was about consumer theory which account for only 10 % of total grade. Even, there was no question about game-theory. The second question was only one sentence but significant and account for 90 % of total grade. The question is like this: “which wheel was broken?”

Well the Prof just applied one important part of a chapter in game theory, namely, Prisoner’s Dilemma. Yeah..they once again missed that part.

*Note: this is a common joke and ,of course, not a real story :D

A New Look and Blabbing...guh..Babbling

As you can see we got a new look for our blog. What do you think? By the way, did any of you ever read this blog? No? Or just skimming? No? Just looking at the pretty pictures? What pretty pictures?? Pictures that someday we might put in this blog. WHAT?? Sure, someday people won't have to write or read blogs anymore, they look at pretty pictures. Didn't the porn industry already done that?? Riiiiiiiight. Nevermind, here's Calvin and Hobbes taking a shot at economics (just click the comic for a bigger picture).

Something to Laugh About

Given my previous post, apparently Jorge and I were thinking of the same thing, but with a different twist. So much for this one.

So...What Have You Been Up To Lately?

I ran into a friend the other day, we went to the same school by the way. As usual, when you ran into someone you know in the summer, you'll be asked the "what are you doing this summer?" type of question. Thus, I was asked that philosophical question. A typical graduate student answer would be "Oh, I'm doing an intership at this blablabla..." or "Well, I'm doing my research on bla...". Ok, I'm a graduate student but I'm not doing any internship this summer. I kind of doing research but not quite sure yet due to some administration problem. Trust me, it's complicated. "So what do I have to say as an answer?", I thought to myself.

Let's see, I finished reading this, which is quite interesting. I also read this, which kept me up for three days (once you start reading the first sentence, it's hard to put it down). Not only that, this and this just arrived from Amazon which will keep me busy for the rest of the summer. I'm in the first few chapters of this. I also enjoyed reading this, I was quite taken by its surprise ending. In all my years as a reader and collector of this, it was the first time in a long while I felt excited reading page after page (Well done Geoff!).

Aside from reading I saw this, which was not as good as the second one. The filmakers tried to tell too many things in just under three hours which convoluted the story. A few days after that I moved into a new apartment. Not only that, I also help some of my friends move out from their apartment, which is a good exercise for the summer. It builds your upper and lower body, not to mention you get free lunch...well not exactly free...rather you're compensated for being a goood samaritan. I highly recommend it. Then, two weeks ago I went in the movie theater and spend $9 to see this, which was not the best $9 I've ever spent. Thank you Michael Bay for ruining my childhood heroes. To me, this version is better, despite that it's corny and he died in it. But at least he died fighting and not that lame fighting sequence in the new movie. Him killed by him, come on. The franchise is about robots not humans! Fortunately, I still have this and this to fall back to every evening. To enhance my cultural experience, I went to this concert which was very entertaining, But mostly I'm preparing myself for this. And right now I'm pondering whether or not I should enter this contest.

Given all this. I come up with one perfect answer, "Not much".

Gaming for Economics

Here's an interesting development. The University of North Carolina at Greensboro (UNCG) has created an online course for introductory level economics. You're probably wondering, "So what? There's a gazillion online courses anyway on the net". Well, to make it interesting, the course is in the form of an online game, where the students play an alien race that crash landed on Earth. In the game, students have to make decisions to ensure the survival of the alien race. This is a very interesting way to introduce the basic concepts of the economics to students, such as opportunity cost.

To play the game you have to enroll in the course in the fall semester, which is open to those who are interested. Will this method of teaching catch on? We'll just have to wait and see. Besides, you don't really have to play this game to learn basics economics. If you're a game fanatic, playing games such as civillization IV or the now classic sim city, or any other strategy based game already taught you economics without you even realizing it.

Growth Theory and the Wealth of Nations (2)

Here's Ap with his second part of the article:

So, once again, why a country can be rich, and the other poor?

Most of research on growth empirics are trying to look how far do these variables explain the cross-country per-capita income differences: investment, human capital, population growth, or trade. Such analysis will be subject to the usual problems of empirical analysis: correlation does not mean causality!

True, the higher the country's investment, or schooling rate, or trade volume, and the lower the population growth rate, the higher is the GDP per capita. But can we say that education (or investment or trade) that makes a country rich, or vice versa? Or, perhaps, there are other unobservable things that affect both education and GDP per capita simultaneously.

Economic historian Angus Madison once show that the world has been unequal since even before the industrial revolution (see his graph here). That means, world's inequality is not just a recent issue. The question is, of course, what makes the world unequal? Some studies try to go further to find 'deeper' explanations. To do so, we must find an exogenous factor; something that affects countries' per-capita income differences, but not affected by per-capita income.

One possible explanation is geography. If we look at the distribution of countries by income per capita, almost all of the poorest countries are close to the equator, and most of the richest ones are in the temperate zone. Maybe it was not just a coincidence. Maybe something with the temperate climate that affects productivity (lower energy intake required to do a similar thing). Maybe being in the tropical zone has something to do with germs and contagious disease (virus and germs are less aggressive in cold weather; this is what Jeffrey Sachs keeps arguing).

Geographical position is also important in the sense isolation. If a region is isolated from the rest of the world by hills or mountains, lacking of access to the sea or navigable river, then the society won't be able to benefit from trade, technology and knowledge diffusion.

Another theory related to geography is what Jared Diamond proposed in his seminal Guns, Germs and Steel. He wrote that world inequality started as early as 13,000 years ago, when human invented the agriculture system and switched from hunting-gathering to food producing. Development of food production has enabled society to generate food surplus and live a sedentary lifestyle. Food surplus and sedentary lifestyle then led to division of labor and more complex political structure. Such lifestyle then paved the way for important inventions (wheel, alphabet) and technology.

The thing is, the earth has been exogenously unfair, meaning not all societies were lucky enough to get close to available domesticated plants and animals. That explains why Europeans, who were close to the Fertile Crescent, and China, had a head start than the Americas, Africa, Australia and New Guineas. That explains why it was the Europeans who sailed to the New World, not vice versa.

While geography hypothesis is interesting, it seems to be too deterministic. It also fails to explain why some big ancient civilizations (like Egypt, Aztec) failed to sustain, while the current rich were far behind those (read my account on this similar issue here).

If we see the history of modern economic growth, two main drivers are: i) commercial activities, and ii) the advance of knowledge, technology and innovations (the variable A in Solow's model). In both cases, there are some pre-requisites:

1. Individual freedom and autonomy, be it from the ruler or the church.
2. Incentives to pursue trade and innovations.

Both (1) and (2) were enabled by, among other things, the inventions of property rights. But property rights alone is not enough. One needs to find an agreeable mechanism on how to: i) acquire it, ii) prove it, iii) protect it, and iv) enforce (iii). All of those conditions require good and strong institutional setting (see Douglass North's 1990 book for more discussion).

To make the story short, the institutional hypothesis argues that the disparity of today's world income per capita is the product of the variations of institutional quality: rule of law, bureaucracy, governance regulatory quality, corruption, risk of property expropriation, even democracy.

One tricky question. How can we be sure that it is institution that affects economic performance? Can it be that when a country gets richer, it can afford to have better institution, better governance, lower corruption or better democracy?

This problem was answered by a paper by Acemoglu, Johnson and Robinson (2001). The authors argue that the quality of a country's institution today is shaped by the institutional setting brought by the colonial power. The decision to build different types of institution in the colonies were determined by the colonists' strategy, which range from 'extractive state' at one extreme (Congo, Latin America to a lesser extent) to 'New Europe' at the other extreme (USA, Canada, Australia, New Zealand).

What then determined different strategy? The challenges faced by the colonists. If the colonists faced hostile environment like tropical disease or resistance from indigenous people, they don't find an incentive to build settlements, and end up pursuing extractive state strategy. On the other hand, the Europeans in North America or Australia did not find hostile environment, and the indigenous population was relatively easy to defeat. In this circumstances, it was possible to build a New Europe, copying the same type of institution that they have had in the Old Europe.

There are other theories. For example, David Landes in his 2001 book explained that it was culture that matters. Culture, he argued, especially scientific and secular culture of the Europeans explained why it was Europe, not China nor the Islamic world who dominated the world. Other theory points to the ethnic, language or religious fractionalization of a country.

At the end, the question 'why a country can be rich, and the other poor' remains a mystery. But we don't have to find a single explanation, because it will be impossible. More important is the process on how do we get the answer.

Growth theory and the wealth of nations (1)

Our friend Ap from cafe salemba, and frequent visitor of "ruang 413" (literally...in the real world) is starting his stint as guess blogger this month. So, without futher ado, here's what Ap has written for our enjoyment...

Growth theory and the wealth of nations

Judging from his posts here, here and here, Yudo seems to be in the 'fascinated' stage with the (neoclassical) growth theory. Indeed, since Robert Solow's 1956 paper, the field of economic growth has become a very interesting subject. The paper provided a scientific framework to analyze what makes a country grow faster while the other don't.

Then, thanks to the availability of both empirical data on cross-country national income, and the advance of statistical tools, starting in the 1980s-1990s economists were able to do empirical analysis on economic growth. Some people have even devoted their life and career on doing such regression, like Harvard's Robert Barro.

The basic, fundamental question for doing cross-country growth analysis is: why some countries are rich and some other poor? Moreover: why some countries have successfully become rich while some others failed?

The irony is, the more we try to explain it, the more likely we fail to do so. The reason became the mechanism of economic growth is very complex to fit into a single model. Consider Solow's famous model. As explained by Yudo, the model predicts that a country's income per worker will grow faster if: i) it can accumulate physical capital ('investment') faster than the rate of its population growth and depreciation ('net depreciation'), ii) its capital-per-worker stock is relatively low.

By way of corollary, Solow model than provides the basic for the famous 'convergence' analysis: at a given rate of investment and net depreciation, poorer countries would grow faster in terms of income per worker, and soon they will catch up the richer ones, who are growing only at the 'steady-state' rate.

In the context of economic development, Solow model suggests that:

1. Level of physical capital should explain cross-country income differential.
2. Investment should affect only the short-run economic growth.
3. In the long-run, economic growth would be determined by the growth rate of something exogenous. Solow labeled it A for technology. What is A, and what affects it, we don't know (he didn't provide any explanations). It is something like the 'manna from heaven.'

When people did the empirical testing for Solow model, (1) and (2) are generally confirmed, but unsatisfactorily. For example, Mankiw (1995) found that variation of physical capital only explains about a third of cross-country income per capita differences in the 1990s. He suggested the term 'capital' should be re-formulated by including 'human' capital. Using secondary school enrollment rate as the proxy for human capital, Mankiw showed that the combination could explain around 80% of income differences.

But still the puzzle still remains. Does secondary enrollment make a good proxy for education in general? Does it mean that poor countries should invest more in schooling? One may tempted to say 'yes.' But other empirical analysis show that Africa remains poor despite heavy investment in education (in terms of school enrollment), as mentioned by William Easterly in his 2001 book. (A chapter in the book discussed how the idea of controlling population growth also did not work well).

There are even bigger puzzles. First, the fact that rich countries are able to sustain, even increase, their growth rates for a very long period. This suggests that the exogenous variable A is more important that just a residual. Perhaps it is not even exogenous; it may be endogenous .

Second, the model has little to say about historical path of economic development. Some today's poor countries were not poor some hundreds and thousands years ago, while the rich group only recently – in the human civilization history scale – became rich. What explains this reversal of fortune? It is very likely that the current per-capita income differences that we observe now have a long and deep historical determinants.

Therefore, the basic, fundamental questions I raised earlier still unanswered by the existing growth models.