Literature review of a seminal paper by George Akerlof and Rachel Kranton.
Inculcating in employees a sense of identity and attachment to the organization may do good to the well-functioning of the whole group. \
Monetary incentives remain a blunt instrument.
(1) Compensation schemes are based on observable variables. But these variables are at best a proxy of effort and ability of the employees. Information asymmetry still exists, incurring moral hazard and adverse selection.
(2) Monetary compensation may have negative effects. For example, employees may overperform on well rewarded tasks and underperform on poorly rewarded tasks. Workers may also backstab one another to be the best relative performer.
Vilfredo Pareto noticed that much of the utility depends not only on what economists usually think of as tastes, but also on norms as to how people think that they and others should behave. Another observation is how people should behave depends upon the particular situation.
The term identity is used to describe a person's social category---gender, race, group affiliation...It is also used to describe a person's self-image. IN a model of utility, a person's identity describes gains and losses in utility from behavior that conforms or departs from the norms for particular social categories in particular situations. In this model, individuals' utility function can change because people internalize norms at different time periods, triggered by different actions.
We add a new variable, identity to basic principal-agent model.
In this new model, the worker's utility varies with his category as either an insider or an outsider, and his utility depends on his effort from the ideal for his respective social category, depending on his identity and situation.
Effect of adding this new variable:
When the agent sees himself as an insider, he max his identity utility by exerting the high effort, and thus he doesn't need a large difference in monetary rewards to induce him to work hard. If the agent sees himself as an outsider, then he requires a higher wage differential to compensate him for the utility he loses when he works in the interests of the firm.
The firm may have incentive to change the agent from an outsider to an insider.
11/30/2013
11/27/2013
perfect rationality....wait are you kidding me?
In game theory, a fundamental assumption is that people are rational in making decision each time they are called upon to move. Sometimes counter-intuitive equilibria occur in stylized game theory models and it makes people wonder: are people really that rational in making every decision in their daily life? One thing I feel certain about is that I'm not...
For decades a new sub-field of economics, behavioral economics, has been challenging the orthodox assumptions of neo-classical econ that people are predictably rational. Behavioralists have a point right: people can't be as rational as economists assumed in their models. Our brains are not powerful enough to make choices with no consideration of emotion, and most people won't make consistent strategies in subject to Bayes' rule of probability.
Behavioralists come up with a definition, bounded rationality, to state that people's rationality of decision making is impaired by mental constraints on information processing and probability calculation.
Yes I admit that people are not rational all the time, but the market still doesn't fail because it induces participants to be more rational than they otherwise would be in an environment with no price. Trials and errors entail progress and as participants get more experienced, they would know the tacit rules and have better outcomes. In game theory terminology, this is called the refined equilibrium. Mathematically most games have an odd number Nash Equilibira and some equilibria don't make much economic sense. I call them "irrationally rational equilibrium". To winnow out the bad equilibrium, game theorists come up with some refinement strategies like trembling hand equilibrium, consistent belief and reasonable beliefs. One thing surprising is that...after all these delicate and smart manipulations, the final results of games are often what we see in daily life! That is, perfect rationality can mimic the outcome of seemingly irrational behavior in market context.
One drawback of behavioral econ experiments is that they are mostly done in labs, which is a different environment from market, and thus the result may not be compatible with what people really would choose given that they are in a more dynamic and chaotic atmosphere.
For decades a new sub-field of economics, behavioral economics, has been challenging the orthodox assumptions of neo-classical econ that people are predictably rational. Behavioralists have a point right: people can't be as rational as economists assumed in their models. Our brains are not powerful enough to make choices with no consideration of emotion, and most people won't make consistent strategies in subject to Bayes' rule of probability.
Behavioralists come up with a definition, bounded rationality, to state that people's rationality of decision making is impaired by mental constraints on information processing and probability calculation.
Yes I admit that people are not rational all the time, but the market still doesn't fail because it induces participants to be more rational than they otherwise would be in an environment with no price. Trials and errors entail progress and as participants get more experienced, they would know the tacit rules and have better outcomes. In game theory terminology, this is called the refined equilibrium. Mathematically most games have an odd number Nash Equilibira and some equilibria don't make much economic sense. I call them "irrationally rational equilibrium". To winnow out the bad equilibrium, game theorists come up with some refinement strategies like trembling hand equilibrium, consistent belief and reasonable beliefs. One thing surprising is that...after all these delicate and smart manipulations, the final results of games are often what we see in daily life! That is, perfect rationality can mimic the outcome of seemingly irrational behavior in market context.
One drawback of behavioral econ experiments is that they are mostly done in labs, which is a different environment from market, and thus the result may not be compatible with what people really would choose given that they are in a more dynamic and chaotic atmosphere.
11/03/2013
Unemployment insurance
The US unemployment insurance includes 53 separate jurisdictions, each with unique laws and operating procedures. The system is financed through a federal tax on payrolls, and the majority of the benefits paid by the system are collected by state-level taxes. During recessions, additional federal involvement kicks in.
Many unemployed workers are not covered either because they are recent entrants to the labor market or they quit jobs voluntarily. Some unemployed are not eligible for the insurance because they have not earned enough in their previous recent jobs or they have exhausted the insurance. Some unemployed don't get covered because they didn't file for the insurance in the first place.
Programs in different states vary due to difference in four general areas: rules of eligibility, what jobs are covered, variation in weekly benefit amounts, and variation in weeks for exhaustion.
Eligibility:
To be eligible, three conditions must be met:
(1) whether a worker has sufficient employment during some defined base period
(2) whether a worker has an acceptable reason for the job separation
(3) whether a worker continues to be unemployed, (in other words, determine if he actively searches new job while collecting the insurance)
The problem of condition (1): it may exclude low-wage, temporary workers and those who have a short labor history.
Condition(2): may be hard to differentiate voluntary quitting
Condition(3): information problem (Hayek's critique I guess...)
Unemployment insurance to some extent prevent major declines in consumption spending in response to layoffs, but we have to consider that variation across workers and those who don't collect insurance.
Design of unemployment insurance:
1) most models find that optimal replacement ratios are less than 1 when unemployment benefits pose significant disincentive to find work
2) models that allow for realistic levels of personal borrowing and saving lead to lower optimal replacement ratios than those that do not.
3) replacement rates that decline over the duration of the unemployment spell may be perferable to constant wage replacement rates
4) consider moral hazard when deciding the duration of insurance coverage.
Many unemployed workers are not covered either because they are recent entrants to the labor market or they quit jobs voluntarily. Some unemployed are not eligible for the insurance because they have not earned enough in their previous recent jobs or they have exhausted the insurance. Some unemployed don't get covered because they didn't file for the insurance in the first place.
Programs in different states vary due to difference in four general areas: rules of eligibility, what jobs are covered, variation in weekly benefit amounts, and variation in weeks for exhaustion.
Eligibility:
To be eligible, three conditions must be met:
(1) whether a worker has sufficient employment during some defined base period
(2) whether a worker has an acceptable reason for the job separation
(3) whether a worker continues to be unemployed, (in other words, determine if he actively searches new job while collecting the insurance)
The problem of condition (1): it may exclude low-wage, temporary workers and those who have a short labor history.
Condition(2): may be hard to differentiate voluntary quitting
Condition(3): information problem (Hayek's critique I guess...)
Unemployment insurance to some extent prevent major declines in consumption spending in response to layoffs, but we have to consider that variation across workers and those who don't collect insurance.
Design of unemployment insurance:
1) most models find that optimal replacement ratios are less than 1 when unemployment benefits pose significant disincentive to find work
2) models that allow for realistic levels of personal borrowing and saving lead to lower optimal replacement ratios than those that do not.
3) replacement rates that decline over the duration of the unemployment spell may be perferable to constant wage replacement rates
4) consider moral hazard when deciding the duration of insurance coverage.
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