Ec101: Choices matter!

We’ve, in our Thursday posts this year, learnt about incentives and costs. But, and this is a really, really big “but” – they become operational only when we live in a world where we’re able to choose.

Tyler Cowen and Alex Tabbarok – two people who have probably done more for educating people in economics than anybody else over the last thirty years or so – have written two of the best textbooks on economics available anywhere – one on micro and the other on macro.

In the book on microeconomics, they summarize ten different “big ideas” in economics: incentives, the invisible hand is the best kind of magic*, trade-offs matter, thinking on the margin matters, trade matters, wealth matters, institutions matter, business cycles are unavoidable, printing more money will lead to inflation and central baking is hard.

*I’ve paraphrased practically all of the big ideas, but this in particular is my phrasing, not theirs.

Two other asides before we proceed: in retrospect, it is interesting (at least to me) that at least one of their PhD’s (Tyler Cowen’s) and quite a few of their books are based literally on nothing more complicated than an exposition of these big ideas. There’s a lesson in there somewhere.

Also, they say that the biggest idea of them all is that economics is fun. I’d paraphrase that too: learning about the world is fun, and economics is a great tool to use towards that end.

Now, that allows for a neat segue to the topic du jour. At the very start of the book, even before the table of contents, they provide their definition of economics, one that I agree with wholeheartedly: economics is the study of how to get the most out of life.

Here’s the two word version: choices matter!

Unless we live in a society that is free to choose, at an individual level or otherwise, none of the other big ideas even come into play. So, to me, economics is first and foremost about being free to choose – and then about the benefits and costs of the choices that you make.

Which, I’d argue, means that learning about choices is plenty important. Ergo, this post.

  1. First things first. What is choice?
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    I chose (see what happened there?) this Quora post not because it is the “best”, but simply because it is so typical. Here’s what I think choice is: it is an admission of the fact that you can’t have everything. A particularly relevant example for me: what to eat from a buffet at a five star restaurant? With every passing year, “everything!” becomes an increasingly unrealistic answer. So choose those dishes that are likely to taste the best (maximizing happiness), or those dishes that are likely to cause the least harm (minimizing unhappiness) along some dimensions such as spiciness, oiliness or what have you.
    Or hey, do both at the same time! Choose the dish that is likely to taste the best and the dish that is likely to do the least harm. That’s half your micro paper right there – the rest is just math and diagrams. (I am kidding, of course, but only a little bit.)
    Choice is an admission of the fact that you can’t have everything, but that’s a good thing! It forces you to go with the best. Which paintings should you look at when you’re at the Louvre? “Every single one!” is unrealistic. Force yourself to choose, therefore, the very best of the lot. Constraints help you understand your own tastes better: aesthetics is, among other things, a matter of acknowledging the existence of constraints.
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  2. So having too many choices is a bad thing? It would seem so:
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    “It all began with jam. In 2000, psychologists Sheena Iyengar and Mark Lepper published a remarkable study. On one day, shoppers at an upscale food market saw a display table with 24 varieties of gourmet jam. Those who sampled the spreads received a coupon for $1 off any jam. On another day, shoppers saw a similar table, except that only six varieties of the jam were on display. The large display attracted more interest than the small one. But when the time came to purchase, people who saw the large display were one-tenth as likely to buy as people who saw the small display.”
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  3. But hang on. Of what use is an economics theory that doesn’t have a on-the-other hand angle? Tim Harford, as is so often the case, to the rescue.
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    “But a curious thing happened almost immediately. They began by trying to replicate some classic experiments – such as the jam study, and a similar one with luxury chocolates. They couldn’t find any sign of the “choice is bad” effect. Neither the original Lepper-Iyengar experiments nor the new study appears to be at fault: the results are just different and we don’t know why.”
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  4. And on a related note, have you heard of Herbert Simon and satisficing? This excerpt is from a Wikipedia article on Barry Schwartz’s book, The Paradox of Choice, but it is actually about Herbert Simon.
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    “A maximizer is like a perfectionist, someone who needs to be assured that their every purchase or decision was the best that could be made. The way a maximizer knows for certain is to consider all the alternatives they can imagine. This creates a psychologically daunting task, which can become even more daunting as the number of options increases. The alternative to maximizing is to be a satisficer. A satisficer has criteria and standards, but a satisficer is not worried about the possibility that there might be something better. Ultimately, Schwartz agrees with Simon’s conclusion, that satisficing is, in fact, the maximizing strategy.”
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  5. And the final word goes to Tyler Cowen. Or is it Herbert Simon all over again? Choices, choices.
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    “What if you asked people the following: do you wish to choose your own means of limiting your (subsequent) choices, or do you wish to let someone else, perhaps the government, do the work? I suspect the answers would overwhelmingly favor the former option, namely voluntary choice at the meta-level. And if you reexamine the experiments mentioned above, they are all about ways in which people voluntarily limit their own choices. Maybe you don’t wish to run your own cancer treatments, but you wish to choose the doctor who will.”

 

Ec101: Understanding Opportunity Costs

I mean, come on. Who doesn’t understand opportunity costs?

The cost of the next best alternative, of the opportunity foregone. We could have told you this in our sleep.

So answer me this (and please don’t cheat):

“Imagine that you have a free ticket (which you cannot resell) to see Radiohead performing. But, by staggering coincidence, you could also go to see Lady Gaga – there are tickets on sale for £40. You’d be willing to pay £50 to see Lady Gaga on any given night, and her concert is the best alternative to seeing Radiohead. Assume there are no other costs of seeing either gig. What is the opportunity cost of seeing Radiohead? (a) £0, (b), £10, (c) £40, or (d) £50.”

  1. That is from Tim Harford, and is unfortunately behind an FT paywall. But here’s the original paper.
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    “We were surprised by the diversity of opinion regarding the value to which the
    term “opportunity cost” applies. As Table 2 indicates, the most popular answer
    was $50, with 27.6% of respondents choosing this answer. The second most
    popular answer was $40, with 25.6% of respondents choosing this answer. The
    third most popular answer was $0, with 25.1% of respondents choosing this
    answer. The correct answer, $10, was the least popular, with only 21.6% of
    respondents choosing this answer. In essence, the answers given to us by well trained economists appear to be randomly distributed across possible answers.” (Emphasis added)
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    So what did you guess?
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  2. People got plenty upset about the whole thing – check the comments, especially,
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  3. “I don’t have any quarrel with Alex’s economics; as far as I can see this point is semantic. (I’ll also admit that my gross perspective on opportunity cost is somewhat anachronistic; it is one reason why mainstream economists work directly with consumer surplus.) What disturbs me is how few economists gave $50 or $40 as the right answer; the actual answers were close to randomly distributed. Most Web-based sources appear confused on the net vs. gross issue, but at least they hover across the $40 and $50 options.”
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    Economists don’t always agree, but it mostly comes to down to splitting hairs? If only it were so
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  4. “This paper analyzes the relationship between opportunity costs of waiting and bribery in rationing by waiting situations. Assuming that a uniform waiting time clears the market for any given bribe and the bureaucrat chooses a bribe to maximize profit, the market equilibrium is characterized in terms of individual valuations of the good and opportunity costs of waiting. If individual valuations take discrete values and opportunity costs of waiting are uniformly distributed, then in an equilibrium individuals with low costs of waiting choose to wait while those with high opportunity costs pay the bribe”
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    While traveling on India’s highways, have you ever seen trucks waiting by the highway for no apparent reason?
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  5. For interested students, a big fat list of examples, drawn from multiple walks of life.

Ec101: Links for 9th January, 2020

Five articles on sunk costs today.

  1. First up, a somewhat basic introductory article. Feel free to skip it if you’re sure you know what sunk costs are (pausing only to note that it is not so much the knowing that matters with sunk costs, but remembering to apply it)
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  2. “The United States has invested much in attempting to achieve its objectives. In addition to the many millions of dollars that have been spent, many thousands of lives have been lost, and an even greater number of lives have been irreparably damaged. If the United States withdraws from Vietnam without achieving its objectives, then all of these undeniably significant sacrifices would be wasted”
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    The quote itself is a quote (if you see what I mean) from this paper, which is a wonderful rumination on sunk costs. Read Taleb on the subject (and not just his tweets!)
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  3. This entire post by Alex Tabarrok is very short (and I have linked to it before, I think), but it is worth reading. Especially the last sentence: do think about it, if you are an economics student.
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  4. “Once your model of choice is at all complex, no one knows what a sunk cost means any more. So a theoretical scolding of those who honor “sunk costs” is not completely well-defined. That being said, there is still the empirical question of whether most people attach too much weight to previous plans and have a status quo bias. The experimental evidence suggests that we are more rigid than we need to be. The propensity to honor previous commitments may have efficiency properties, but we cannot discard this proclivity when we ought to.”
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    The bottom line from Tyler Cowen’s post on the topic. He was responding to Tabarrok’s post above.
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  5. “Suppose that you are trying to pursue a morally worthy goal, but cannot do so without incurring some moral costs. At the outset, you believed that achieving your goal was worth no more than a given moral cost. And suppose that, time having passed, you have wrought only harm and injustice, without advancing your cause. You can now reflect on whether to continue. Your goal is within reach. What’s more, you believe you can achieve it by incurring—from this point forward—no more cost than it warranted at the outset. If you now succeed, the total cost will exceed the upper bound marked at the beginning. But the additional cost from this point is below that upper bound. And the good you will achieve is undiminished. How do the moral costs you have already inflicted bear upon your decision now?”
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    I am reminded, very strongly indeed, of the Mahabharata. That is the abstract of this paper.

Ec101: Links for 2nd January, 2020

Five links to help us better understand incentives

  1. Wikipedia gives us the inside dope on economic incentives.
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  2. Quora remains a reasonably good place to get answers…
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  3. The Econlib page on incentives is full of interesting snippets…
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  4. But beware! Incentives aren’t easy to design!
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    “Studies show that offering incentives for losing weight, quitting smoking, using seat belts, or (in the case of children) acting generously is not only less effective than other strategies but often proves worse than doing nothing at all. Incentives, a version of what psychologists call extrinsic motivators, do not alter the attitudes that underlie our behaviors. They do not create an enduring commitment to any value or action. Rather, incentives merely—and temporarily—change what we do.”
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  5. A Forbes article that tells you how might mitigate some of the problems with incentive design.

EC101: Links for 26th December, 2019

  1. On some articles about Baumol’s cost disease.
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  2. A topic that is very, very dear to my heart: teaching economics better, and to younger folks.
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  3. A topic on which I changed my mind this year, and therefore this year ought to count as a success. Props to Murali Neelakantan for helping me do so! On patents.
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  4. Two sets of links about this year’s Nobel. One set is rather informative
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  5. While the other is more critical.

Ec101: Links for 19th December, 2019

  1. “Based on the provided support, it is apparent then that it’s advantageous to be as random as possible for generation of ideas, but sticking with a particular response is predictive of creative originality. So next time your friends say that you are “sooo random,” hold your head up high and keep at it. But don’t forget to spot those brilliant ideas among the dis-order, and focus. Such is the recipe for creativity.”
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    On the benefits of being random.
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  2. “Convex functions play an important role in many areas of mathematics. They are especially important in the study of optimization problems where they are distinguished by a number of convenient properties. For instance, a strictly convex function on an open set has no more than one minimum. Even in infinite-dimensional spaces, under suitable additional hypotheses, convex functions continue to satisfy such properties and as a result, they are the most well-understood functionals in the calculus of variations. In probability theory, a convex function applied to the expected value of a random variable is always bounded above by the expected value of the convex function of the random variable.”
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    That is from the Wikipedia article on convexity, and the next sentence after the excerpt leads us to…
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  3. Jensen’s inequality!
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  4. “The point is subtle and widely misunderstood. Here’s a simple example. Suppose that the average return is 10%. If $100 is invested for two periods the average payoff is $100(1.1)^2=$121. But on average that is not what happens. More typically, you get say 0% in the first period and 20% in the second period, i.e. $100(1.0)*(1.2)=$120. Notice that the average return is exactly the same, 10%, but the total payoff is smaller in the second and more realistic case”
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    And Alex Tabbarok explain why Jensen’s Inequality matters
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  5. As does Nassim Nicholas Taleb.

Etc: Links for 13th December, 2019

  1. Via Girish U, a lovely read on video games, and archeology… of mind bending types.
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    “The mystery maze table in Entombed reminds us that, even with a good record, fully understanding a game is another thing entirely. Maybe we’ll never quite grasp it. Entombed presents us – somewhat ironically – with a dead-end.

    The instruction manual, to be fair, did warn us. “Before you know it,” it read, “you’ll be entombed!””
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  2. “Gods begins with a sweeping proposition Modern thinking began when man abandoned the belief that events are due to the whim of the gods and embraced the notion that we are active, independent agents who can manage risks. Thus in the worldview of ancient Greece, a man’s destiny swayed with the whim of the gods, logic prevailed over experimentation, and the use of letters for numbers inhibited man’s ability to calculate. But by the thirteenth century, new mental tools were in place the Hindu-Arabic numbering system, algebra, accounting, and other necessary equipment for the first insights into the laws of chance.”
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    A review of Against the Gods, by Peter Bernstein. Lovely book, lovely review. Do read both!
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  3. “Even if you don’t consider yourself a particularly superstitious person, you probably say “bless you” when someone sneezes, just in case the devil should decide to steal their soul – as our ancestors thought possible during a sneeze.”
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    The Conversation on superstitions.
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  4. Via the Browser, from the Paris Review, a thought-provoking article on superstitions.
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  5. And why all the talk about superstitions? Check the date! Well, and the day!

EC101: Links for 12th December, 2019

What do economists have to say about (ahem) immigration?

  1. The Wikipedia article on Harris-Todaro.
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  2. Feeling ambitious? Use this CV as a jumping board for stuff to read about immigration. Douglas Massey.
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  3. One of my favorite papers to read about immigration (and you can see where my sympathies lie, I suppose, where immigration is concerned).
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  4. George Borjas – his Wikipedia page.
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  5. I’ll pink to this again: Chinmay Tumbe’s excellent book on migration into and within India.

EC101: Links for 5th December, 2019

If you think of one’s opinion about RCT’s as a spectrum, I fall on the “I think it’s not a bad idea at all” part of it. How might I be wrong? Five articles that help me understand this.

  1. “Lately I find myself cringing at the question “what works in development?” I think it’s a mistake to think that way. That is why I now try hard not to talk in terms of “program evaluation”.“Does it work?” is how I approached at least two of the studies. One example: Would a few months of agricultural skills training coax a bunch of ex-combatants out of illegal gold mining, settle them in villages, and make it less likely they join the next mercenary movement that forms?

    But instead of asking, “does the program work?”, I should have asked, “How does the world work?” What we want is a reasonably accurate model of the world: why people or communities or institutions behave the way they do, and how they will respond to an incentive, or a constraint relieved. Randomized trials, designed right, can help move us to better models.”
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    Chris Blattman on the issue. (Note that this was written in 2016)
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  2. “In the early 2000s a group emerged arguing that important improvements to development and hence to human well-being could be achieved through the wide spread use of independent impact evaluations of development programs and projects using randomized control trial methods (RCT) of choosing randomly “treatment” and “control” individuals. I have been arguing, since about that time, that this argument for RCT in IIE gets one small thing right (that it is hard to recover methodologically sound estimates of project/program causal impact with non-experimental methods) but all the big things wrong.”
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    You can’t write anything about RCT’s without writing about Lant Pritchett’s opinion about them.
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  3. “Like other methods of investigation, they are often useful, and, like other methods, they have dangers and drawbacks. Methodological prejudice can only tie our hands. Context is always important, and we must adapt our methods to the problem at hand. It is not true that an RCT, when feasible, will always do better than an observational study. This should not be controversial, but my reading of the rhetoric in the literature suggests that the following statements might still make some uncomfortable, particularly the second: (a) RCTs are affected by the same problems of inference and estimation that economists have faced using other methods, and (b) no RCT can ever legitimately claim to have established causality.”
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    Angus Deaton weighs in (and if you ask me, this is my favorite out of the five)
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  4. “The economists, like the medical researchers, seem to have lost touch
    with their proper role. They are not ethically assigned to master our lives.
    The mastering assignment is what they assume when they focus on
    “policy,” understood as tricking or bribing or coercing people to do what’s
    best. It sounds fine, until you realize that it is what your mother did to you
    when you were 2 years old, and had properly stopped doing to you by the
    time you were 21. The field experimenters scorn adult liberty. And that is
    the other way many economists have lost touch. As noted by the
    economist William Easterly, another critic of the experimental work, and as
    argued at length by your reporter in numerous books, the real way to solve
    world poverty is liberty. Not dubious, fiddly, bossy little policies handed
    down from the elite. ”
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    Dierdre McCloskey (as usual) doesn’t pull punches.
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  5. A set of links about the topic from Oxfam.

EC101: Links for 28th November, 2019

  1. “The zeroth step, of course, is being open to the process of unlearning. We come with our own biases, shaped by our varied experiences and perceptions. But our experience or knowledge is not always indicative of the macroreality. An unrelenting hold on what we have already learnt is the equivalent of the sunk cost fallacy in economics.”
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    Pranay Kotasthane has a new newsletter out, and it is worth subscribing to. Stay humble and curious is the gist of his zeroth lesson, and the other points are equally important. Go read, and in my opinion, subscribe.
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  2. “China is still a one-party state, but it owes much of its current prosperity to an increase in liberty. Since Mao died, his former subjects have won greater freedom to grow the crops they choose, to set up businesses and keep the profits, to own property, and to move around the country. The freedom to move, though far from absolute, has been transformational. Under Mao, peasants were banned from leaving their home area and, if they somehow made it to a city, they were barred from buying food, notes Bradley Gardner in “China’s Great Migration”. Now, there are more rural migrants in China than there are cross-border migrants in the world.”
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    The rest of this article from the Economist is about migration to the cities – and I find myself in complete agreement – many, many more people in India need to live in her cities. But also see this!
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  3. “Mazzucato traced the provenance of every technology that made the iPhone. The HTTP protocol, of course, had been developed by British scientist Tim Berners-Lee and implemented on the computers at CERN, in Geneva. The internet began as a network of computers called Arpanet, funded by the US Department of Defense (DoD) in the 60s to solve the problem of satellite communication. The DoD was also behind the development of GPS during the 70s, initially to determine the location of military equipment. The hard disk drive, microprocessors, memory chips and LCD display had also been funded by the DoD. Siri was the outcome of a Stanford Research Institute project to develop a virtual assistant for military staff, commissioned by the Defense Advanced Research Projects Agency (DARPA). The touchscreen was the result of graduate research at the University of Delaware, funded by the National Science Foundation and the CIA.”
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    Mariana Mazzucato, about whom more people should know, on the role of the government in today’s economy.
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  4. “Back in the early 1970s, Xerox had figured out a strategy to block competitors in the photocopying business. It took out lots of patents, more than 1,000 of them, on every aspect of the photocopy machine. As old patents expired, new ones kicked in at a rate of several hundred new patents each year. Some of the patents were actually used by Xerox in producing the photocopy machine; some were not. There was no serious complaint about the validity of any individual patent. But taken as a whole, Xerox seemed to be using the patent system to lock up its monopoly position in perpetuity. Under antitrust pressure from the Federal Trade Commission, Xerox in 1975 signed a consent decree which, along with a number of other steps, required licensing its 1,700 photocopier patents to other firms.”
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    Timothy Taylor adds grist to the anti-patent mill.
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    “Thinking about how to facilitate a faster and broader dispersion of knowledge and productivity gains seems like a potentially important part of explaining the current economic picture and suggesting a policy agenda.”
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    That’s the concluding part of the blog post. Just sayin’!
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  5. Every time I begin to think I kind of understand macroeconomics