This fellow doesn’t know it, but he’s trying to break signalling theory. Can he succeed? I don’t think so. My reasoning (second-order signalling) and a haiku behind the cut.

Given a homogeneous market (say, the job market for entry-level positions in a given industry), some candidates will be high-quality and some will be low-quality. It is in the hiring firm’s best interest to be able to differentiate between high- and low-quality job applicants, but it is not in the low-quality applicants’ best interest to communicate that they’re less than the best applicant for the job. As a result, it can be quite difficult to differentiate them.

In the same way, it is in a hunting lion’s best interest to pursue the slowest, least fit gazelle on the savannah, rather than the fastest, fittest gazelle. (This is a stock example and I think it comes from Charles Wheelan’s Naked Economics.) Obviously, the slow gazelles want to discourage lions from attacking them, and the fast gazelles want to discourage the lions from pursuing the fast gazelles. The best way to accomplish this is by showing that the gazelle can make a sacrifice and still be in better position than the others. Gazelles do this by stotting or pronging, a behavior in which the gazelle leaps high into the air several times before taking off in earnest. The gazelle sacrifices a head start from the predator, essentially showing that it can waste time and energy but still outrun the predator.

That example is a tad anthropomorphic, but the analogy holds. Signalling (or signaling – both spellings are common) is a way of undertaking a costly method of showing fitness as a way to differentiate oneself from the unwashed masses. The classic example, and the one used in Hal Varian’s Intermediate Economics: A Modern Approach, is “the Sheepskin Effect,” in which education is used as a signal of fitness for employment. Education is costly; not only is tuition required, but finishing a bachelor’s degree requires either that time be taken away from the workplace (by taking a less desirable job to get off-shift work to attend school during the day or by not working at all) or that school be attended part-time while working (siphoning resources to work from education while full-time students can devote more time and effort to their studies). Education is also selective; it’s much more difficult for a subpar student to finish a degree than for a talented student to do so. Education also serves as a sorting mechanism; generally speaking, it stands to reason that higher grades show higher levels of ability.

For this reason, many employers require college degrees for positions that don’t necessarily warrant them, and as a result, people who might not be interested in attending college do so anyway in order to avoid being signalled out of the market. For example, this gentleman attempted to signal his fitness for employment by pursuing a college degree at a for-profit institution.  My argument is that low-quality, for-profit colleges represent a method by which students attempt to circumvent the signalling mechanism of requiring degrees, and that the status of these colleges represents a second-order signalling mechanism by which these students can still be signalled out of the market.

The importance of signalling, as stated above, is that signalling is costly, selective, and a valid way of sorting. For-profit colleges are certainly costly, but they are not selective and are not a valid sorting mechanism. The signals provided by different colleges and universities are differentiable: a degree from Stanford, MIT, or the University of Chicago shows that the student had the ability to stay competitive at one of the top schools in the nation. A degree from a state school, such as the University at Buffalo, is less valuable but still signals that the student was either willing to put in a base level of effort or had a certain degree of intelligence necessary to get a degree.

A degree from the DeVry Institute or Everest College shows several things, none of which are very flattering. It shows that the student:

• is not aware of the reputation of for-profit schools (or else the student wouldn’t be representing the for-profit degree as equivalent to a standard degree);
• has trouble valuing the degrees (since many for-profit degrees are far more expensive than equivalent coursework at a community college), and either
• lacks research skills (since the reputation of the school and the extra costs associated with for-profit schools are readily determinable), or
• has poor judgment (knew these factors but decided to go with a for-profit school anyway).

As a result, this second-order signalling allows students like the subject of the video to be crowded out of the market due to his inability or refusal to understand the system by which he’s signalling his lack of true higher education. He essentially paid a tax in the form of higher tuition for his inability or unwillingness to research his options. He claims that the ease with which he could pass his New England Institute of Art courses shows that the United States can’t compete on the global stage; I think that perhaps his expense of $30,000 on a for-profit degree as opposed to spending a smaller amount on the same associate’s degree shows why he, personally, is unfit to compete.

Overpriced degree
Failed attempt at signalling
Sheepskin effect holds

In microeconomics as we know it, however, the market-clearing price of a widget is the point at which its supply curve intersects its demand curve – that is, the price where suppliers want to sell exactly as many widgets as customers want to buy. Price theory doesn’t take ethics into account. From the academic standpoint, it’s impossible for a price to be an undue inducement because price is based on the indifference point of the supplier.

Can a price be an unethical inducement to action? How can that be determined? Is it right, ethically, to set price controls under certain circumstances?

Here, BioEdge discusses the change to Singapore’s legislation:

Singapore is to allow compensation for kidney transplants and for eggs. A government proposal has been approved by a bioethics committee and legislation will be introduced early next year. The committee declared that reimbursement for kidney donation was acceptable as long as it is not “an undue inducement, nor amounting to organ trading”. … Other changes to Singapore’s legislation are contemplated: lifting the age of dead donors, which is now capped at 60 and allowing paired donation, in which a donor whose kidney is not a match for a relative, gives it to someone else, who also has a relative willing to give up a kidney.

I’d like to consider some of the ways in which this setup deviates from the theoretical perfect-competition model of supply, demand, and market-clearing price.

1. Most obviously, demand is perfectly inelastic. That may not be quite true, since a viable substitute good (dialysis) exists, but dialysis is both expensive and inconvenient. If the price of a kidney plus transplant was equal to the discounted present cost of continuing dialysis, I think it’s fair to say that the transplant would win every time. Bryan Caplan of Econlog agrees.
2. Supply, on the other hand, is more or less perfectly elastic. With rare exceptions, people are born with two functioning kidneys, of which, presuming they take care of themselves, they can function using only one. People have, presumably, a very high point of indifference for money versus kidney, but it exists for everyone. Therefore, supply will be entirely dependent on the government’s compensation limit.
3. Transaction costs are much higher than most goods. Black-market trade in organs to donate exists, of course, but to engage safely in a black-market kidney sale requires the cooperation of someone with at least some medical training.
4. Kidneys are not exactly fungible because of blood types, leading to a problem of double coincidence of wants. This is ameliorated in the law by allowing paired donation.
5. The government of Singapore isn’t interested in finding a fair price for kidneys. It does not want compensation to unduly influence the decision to donate an organ, nor to encourage organ trading. The problem with this position is that it doesn’t make sense. Given an enforced compensation of zero, a certain number of people are going to enter the market for kidneys for other reasons, generally in private transactions. The compensation in utility of giving a kidney to a friend or family member has, in the past, proven enough for some people; meanwhile, others will refuse.

The upshot of all of this is that there will be a substantial deadweight loss with regard to a perfectly competitive market, as in the case of any price ceiling with high transaction costs blocking a black-market escape hatch. The recipients will generate extra utility, of course, from their extended lifespans, and depending on the availability of kidneys on the black market currently, the compensation will likely induce additional organ donors to supply kidneys to the market. Since prices do not float freely, there will be no period in which prices are imperfectly determined, so those with an indifference point below the government-set price will derive additional producer surplus from selling their kidneys at above their minimum rate. Additionally, the effective price is slightly higher than the actual amount of compensation, because the government is providing long-term care, short-term life insurance, and priority status on organ donation lists.

The overall value can’t be determined without more information – the BioEdge article implies that the government will reimburse donors, but also states that the government will “allow” compensation. In the case of recipient payment, the utility gained will be offset by the payment, particularly if the price of a kidney is set and not allowed to vary. If the government behaves as a monopsony and acts as a broker for kidneys, then that cost will be spread across the taxpayers of Singapore, in which case the analysis is slightly more complicated.

As Caplan said, though, if I were on dialysis, I’d be booking my ticket right now.

Market created
Body’s filter may be sold
Elasticity

The rules of international wrestling have changed over the past few years. Right now, matches are decided under a two-of-three-periods system with multiple victory conditions. At the time I was involved in refereeing, the match was longer (two three-minute periods) and the victory conditions were simpler (a pin or a ten-point differential ended the match immediately, with the winner being decided based on points at the end of the match if neither occurred). If the wrestlers were tied after the six-minute match, they wrestled an additional three-minute overtime period, and if at the end of that period they remained tied, the match was decided on criteria. For simplicity, the only criterion I’ll consider is the one that decided most tied matches – passivities, warnings for refusing to wrestle aggressively. The wrestler with fewer passivities won the match. In addition, I’m going to consider the older rules, since the passivity criterion has been eliminated by forced scoring under the new rules.

Smart coaches managed their wrestlers to avoid passivity calls, and would often tell the wrestler with fewer passivities that he had a half-point advantage. That is, if the points were equal, the wrestler with fewer passivities would win, but a technical point scored against him would put him behind again. That seemed imprecise to me, since it didn’t take into account the marginal value of additional passivities.

I decided that each marginal passivity could be evaluated using an inverse power function of two; that is, the value of a lead in passivities was Σ(1/2ⁿ), where n is the difference between the passivity totals. A wrestler ahead by one passivity is indeed ahead by half a point; a wrestler ahead by two passivities has a lead equivalent to 3/4 of a point (1/2 + 1/4), and so on. The inverse power function captures the diminishing returns of a strategy designed to maximize a lead in passivities – the sum will never reach one, and each passivity is worth less than the one before it. However, each passivity does slightly lower the probability of the trailing wrestler making up the difference and forces him to try to score technical points, which are worth more because they’re more difficult to score.

I’m sure it’s also possible to do a finance-style discount analysis of the value of a particular lead in points based on the amount of time remaining in the match. A lead would have to be discounted based on the expected number of points to be scored by each wrestler in the time remaining, since a lead at the very beginning of the match is much less safe than a lead in the final seconds. That would require data analysis to determine the expected value of the points to be scored by the leading wrestler and by the trailing wrestler given the time remaining and the point spread. Research project idea: determine a method of discounting the value of a lead in points based on the number of seconds remaining.

I’m sure he’ll be gentle.

I made a rough outline of Stever’s blog post. I think this is a fair summary of his argument (in my words, not his, and ordered to group premises rather than preserve the order of the post):

Financial corporations, whether first- or second-tier owners, have the specialized knowledge and ability to evaluate consumers and the instruments they sell to consumers. Specifically, they overrelied on rating agencies, failed in due diligence, failed to insure themselves against risk that was difficult or impossible to fairly evaluate, and pushed financially illiterate consumers into poorly-structured and hard-to-value financial arrangements.

Because many of the consumers were financially illiterate, the financial corporations are more to blame than the consumers.

I don’t think Robbins’ argument fails, necessarily, although I disagree with some of the more hyperbolic statements referring to legal concepts (Use eminent domain to reclaim investment bank salaries? This business model “implicitly defraud[ed]“* consumers?). I do, however, feel that Robbins has created a false dilemma in which the blame must be shouldered by either the financial corporations or the consumers.

In my opinion, the proper division of blame is closer to equal, for two reasons. (Well, okay, more like one and a half.) The first is that I do not consider ignorance to be an excuse for engaging in a bad deal. It can certainly be a reason one entered into a bad business deal, and it can be very sad, but not understanding the parameters of the agreement is not an excuse to treat a business deal as less than valid.

The second is that if a consumer is unable to understand the parameters of a deal, the consumer – not the salesman – bears the responsibility for gaining that understanding. If a first-time homebuyer is unable to understand the terms of a mortgage, then that homebuyer should take it upon himself to ask questions, discuss the deal with people more knowledgeable than he is, and generally seek out the available information. It’s foolish to buy a car without a test drive and a look under the hood; many people are car-illiterate, but that doesn’t absolve them of the responsibility of having a mechanic or a trusted car-literate friend examine a car before they buy it.

(For the record, I think that a more realistic allocation of blame must involve the moral hazard problems inherent in one party writing a mortgage and another party administering it. The incentives are all wrong. Fixing that problem, however, is beyond the scope of this silly little MA student’s abilities.)

I think Stever is right about a lot of important things in this post: the corporations were irresponsible, everyone needs a better grounding in personal finance, personal finance education would be a great priority item for tax dollars, and the corporations should suffer for their failure to conform to standards. I just think that he should be a bit more even-handed in allocating blame.

* Obviously, in cases where the legal definition of ‘fraud’ is satisfied, there should be appropriate criminal and civil remedies, but those need not be crafted specifically for this situation. Fraud is fraud, whether it involves mortgages or anything else.