“Given the failed launch of Obamacare, there’s a real chance that the entire scheme falls into an “insurance death spiral” — but not as visibly (or rapidly) as the way these sorts of unsuccessful insurance pools usually unravel. A death spiral happens when only the sickest beneficiaries get into an insurance pool, causing the cost of medical claims to rise, and in turn raising future premiums. These higher premiums, in turn, dissuade healthier beneficiaries from buying coverage. This exacerbates the strains and makes sure the pool continues to attract only the sickest consumers who are most in need of the medical coverage, and willing to pay the rising premiums. This is how the downward spiral ensues.”
The so-called Affordable Care Act provides a superb “real world” study of the consequences of adverse selection. This is further analyzed and illustrated in a Forbes article which was published today on the forbes.com website. The author of the article is Dr. Scott Gottlieb, who holds a research appointment with the American Enterprise Institute in Washington, DC. Also see “Adverse Selection – a definition, some examples, and some solutions” and the Wikipedia article about adverse selection (@ http://en.wikipedia.org/wiki/Adverse_selection).
“Given the failed launch of Obamacare, there’s a real chance that the entire scheme falls into an “insurance death spiral” — but not as visibly (or rapidly) as the way these sorts of unsuccessful insurance pools usually unravel. A death spiral happens when only the sickest beneficiaries get into an insurance pool, causing the cost of medical claims to rise, and in turn raising future premiums. These higher premiums, in turn, dissuade healthier beneficiaries from buying coverage. This exacerbates the strains and makes sure the pool continues to attract only the sickest consumers who are most in need of the medical coverage, and willing to pay the rising premiums. This is how the downward spiral ensues.”
I love the F Minus comic strip – yesterday’s was a classic, illustrating an important economic principle; specifically, how the presence of insurance can create a “moral hazard” problem…
This year’s Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (AKA the Nobel Prize in Economics) goes to Eugene F. Fama (University of Chicago), Lars Peter Hansen (University of Chicago) and Robert J. Shiller (Yale University) for “…their empirical analysis of asset prices”. In retrospect, it has never been a question of whether Fama would receive the Nobel Prize; it has always been a question of when, and when is now.
In a nutshell, Fama is famous for his “efficient market hypothesis” as well as a number of important empirical asset pricing contributions. Fama’s Chicago colleague Lars Hansen is famous for his work in financial econometrics, and Shiller provides an important behavioral counterpoint to the efficient market theory.
Here are articles worth reading about this prize:
1. The “official” announcement posted at Nobelprize.org: “The Prize in Economic Sciences 2013″. Nobelprize.org. Nobel Media AB 2013. Web. 14 Oct 2013. http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2013/
c. Understanding Asset Prices (this is the Nobel Committee’s “scientific background” paper which explains why the Fama, Hansen, and Shiller received this award)
This (an article entitled “Software, Design Defects Cripple Health-Care Website”) is THE page 1 story in today’s issue of the Wall Street Journal. It provides a fascinating case study which corroborates historian John Steele Gordon’s essay from May 2009 entitled “Why Government Can’t Run a Business” (available from http://on.wsj.com/BZpZW); in that essay, Gordon notes (among other things) that “Politicians need headlines. Executives need profits.”
The federal government acknowledged for the first time Sunday it needed to fix design and software problems that have kept customers from applying online for health-care coverage.
Wall Street Journal. It provides a fascinating case study which corroborates historian John Steele Gordon’s essay from May 2009 entitled “Why Government Can’t Run a Business” (available from http://on.wsj.com/BZpZW); in that essay, Gordon notes (among other things) that “Politicians need headlines. Executives need profits.”
Software, Design Defects Cripple Health-Care Website
online.wsj.com
The federal government acknowledged for the first time Sunday it needed to fix design and software problems that have kept customers from applying online for health-care coverage.
From Knowledge@Wharton: “How do we know which of our successes and failures can be attributed to either skill or luck? That is the question that investment strategist Michael J. Mauboussin explores in his book “The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing”. Wharton management professor Adam M. Grant recently sat down with Mauboussin to talk about the paradox of skill, the conditions for luck and how to mitigate against overconfidence.”
I also recommend Mauboussin’s book entitled “Think Twice: Harnessing the Power of Counterintuition”. Mauboussin does a wonderful job explaining how to use modern social science findings (particularly behavioral finance) to become a better decision-maker when facing risk and uncertainty.
I think most people understand that the United States has a debt problem, but I am not sure all that many people necessarily understand the magnitude of this debt. According to the treasurydirect.gov website, US federal government debt (as of Monday, February 4) stands at $16.48 trillion (source: http://www.treasurydirect.gov/NP/BPDLogin?application=np)). Since US GDP (as of Q4 2012; see http://bit.ly/kM8cxa) is $15.83 trillion, this implies that the US debt to GDP ratio currently stands at more than 100%.
Using the resources cited in the previous paragraph, one can determine US debt totals and debt to GDP ratios at various points in recent history. On the day that George W. Bush was first inaugurated (January 20, 2001), US federal government debt stood at $5.73 trillion, and the US debt to GDP ratio at the time was 57%. By the time that President Bush’s second term came to an end (on January 20, 2009), US federal government debt had grown by $4.9 trillion (to $10.63 trillion), and the US debt to GDP ratio stood at 74%. Since President Obama first took office on January 20, 2009, US federal government debt has grown by an additional $5.85 trillion, going from $10.63 trillion to $16.48 trillion.
Thus, the Obama administration (after one full term plus two weeks into a second term in office) accounts for 5.85/16.48 = 35.5% of the current national debt, President Bush’s two administrations account for 4.9/16.48 = 29.7% of the current national debt, and the previous 42 presidents cumulatively account for 5.73/16.48 = 34.8% of total US federal government debt.
The graph below (source: http://bit.ly/PxbO63) shows the US debt to GDP ratio over the period 1966-2012. I don’t about y’all, but the fact that this ratio is accelerating as we move through time is very disconcerting. Economists Carmen Reinhart and Ken Rogoff note that episodes in world history where debt ratios exceed 90% are not only rare, but also impede economic growth (see “Debt and growth revisited” (source: http://www.voxeu.org/article/debt-and-growth-revisited)).
There’s a new NBC game show called Take it All which recreates a well-studied problem in game theory called the Prisoner’s dilemma. According to the Prisoner’s dilemma Wikipedia article, a “classic” example of this game is as follows:
“Two men are arrested, but the police do not have enough information for a conviction. The police separate the two men, and offer both the same deal: if one testifies against his partner (defects/betrays), and the other remains silent (cooperates with/assists his partner), the betrayer goes free and the one that remains silent gets a one-year sentence. If both remain silent, both are sentenced to only one month in jail on a minor charge. If each ‘rats out’ the other, each receives a three-month sentence. Each prisoner must choose either to betray or remain silent; the decision of each is kept secret from his partner until the sentence is announced. What should they do?”
This game is called the Prisoner’s dilemma because the solution to the game involves joint betrayal rather than joint cooperation, even though joint cooperation is the better outcome for both. To see this, consider the following “payoffs” (in terms of prison time) that Prisoner 1 and Prisoner 2 associate with the strategies “Betray” and “Keep Silent”.
Prisoner 2
Prisoner 1
Betray
Keep Silent
Betray
A) 3 months in jail, 3 months in jail
C) Go free, 1 year in jail
Keep Silent
B) 1 year in jail, Go free
D) 1 month in jail, 1 month in jail
Suppose Prisoner 2 decides to betray Prisoner 1. Under the “Prisoner 2 Betrays Prisoner 1” scenario, Prisoner 1 will only have to spend 3 months in jail if he betrays Prisoner 2 (corresponding to cell A above), and a full year in jail if he keeps silent (corresponding to cell B above). Now suppose Prisoner 2 decides to keep silent. Under the “Prisoner 2 keeps silent” scenario, Prisoner 1 goes free if he betrays Prisoner 2 (corresponding to cell C above), and spends 1 month in jail if he keeps silent (corresponding to cell D above). So no matter what Prisoner 2 does, Prisoner 1 always spends less time in jail if he betrays Prisoner 2. By symmetry, no matter what Prisoner 1 does, Prisoner 2 always spends less time in jail if he betrays Prisoner 1. Thus the dilemma…
Now, let’s consider how Take it All recreates the Prisoner’s dilemma. The show begins with five contestants playing a first round, four contestants playing a second round, and three contestants playing a third round. The final two contestants after round three advance to the “Prize Fight” which mimics the Prisoner’s dilemma game shown above. In the Prize Fight, the strategy pair for each contestant is “Keep Mine” (i.e., keep my winnings from Rounds 1–3) and “Take it All” (i.e., keep my winnings from Rounds 1–3 and also take my opponent’s winnings from Rounds 1–3). If both contestants choose to “Keep Mine,” they will each keep the prizes they have won in the prior rounds (this is analogous to ending up in cell D in the Prisoner’s dilemma payoff matrix shown above). If one contestant chooses “Keep Mine” and the other chooses to “Take it All,” the contestant that chose “Take it All” will go home with all the prizes — theirs and their opponents (this is analogous to ending up in either cell B or cell C D in the Prisoner’s dilemma payoff matrix). But if both choose “Take it All,” they both go home with nothing (this is analogous to ending up in cell A in the Prisoner’s dilemma payoff matrix). If one were to play this game purely on the basis of self-interested action, then the obvious strategy would be to always “Take it All”, in which case NBC doesn’t have to pay out at all. However, the interesting (and somewhat creepy and provocative twist) here is that the show’s host (Howie Mandel) gives both contestants time to try to convince each other that they won’t betray each other. Thus, the “suspense” is whether one’s opponent follows through on his or her verbal “promise” to “Keep Mine”.
Now consider what happened earlier this week on a “Take it All” episode:
From a business perspective, I think that it is quite clever to produce a game show based upon a prisoner’s dilemma game. The production costs for a show like this are nominal, and most of the time the production company won’t have to pay out a jackpot. It doesn’t take a game theory expert to figure out that the incentive structure of the game is incompatible with a (Keep Mine, Keep Mine) outcome. The likely outcome is (Take It All, Take It All), in which case no prize is paid. Occasionally one can expect a (Keep Mine, Take It All) outcome, as was the case earlier this week. This also works to the NBC’s benefit; the “drama” of the game creates a buzz and possibly more viewership (thus bringing in more revenue from commercials). In all likelihood, NBC also manages the risk of a (Keep Mine, Take It All) outcome by purchasing an insurance policy covering the cost of the jackpot from Lloyds of London…
Let me make one final point about Prisoners Dilemmas and television shows. The next time you watch a Law and Order re-run, keep in mind that virtually every Law and Order episode is organized around some variation of a Prisoners Dilemma game. The downside of realizing this is that this makes Law and Order much less interesting to watch, since you can often deduce what will likely happen just a few minutes into each episode!
Take it All which recreates a well-studied problem in game theory called the Prisoner’s dilemma. According to the Prisoner’s dilemma Wikipedia article, a “classic” example of this game is as follows:
“Two men are arrested, but the police do not have enough information for a conviction. The police separate the two men, and offer both the same deal: if one testifies against his partner (defects/betrays), and the other remains silent (cooperates with/assists his partner), the betrayer goes free and the one that remains silent gets a one-year sentence. If both remain silent, both are sentenced to only one month in jail on a minor charge. If each ‘rats out’ the other, each receives a three-month sentence. Each prisoner must choose either to betray or remain silent; the decision of each is kept secret from his partner until the sentence is announced. What should they do?”
This game is called the Prisoner’s dilemma because the solution to the game involves joint betrayal rather than joint cooperation, even though joint cooperation is the better outcome for both. To see this, consider the following “payoffs” (in terms of prison time) that Prisoner 1 and Prisoner 2 associate with the strategies “Betray” and “Keep Silent”.
Prisoner 2
Prisoner 1
Betray
Keep Silent
Betray
A) 3 months in jail, 3 months in jail
C) Go free, 1 year in jail
Keep Silent
B) 1 year in jail, Go free
D) 1 month in jail, 1 month in jail
Suppose Prisoner 2 decides to betray Prisoner 1. Under the “Prisoner 2 Betrays Prisoner 1” scenario, Prisoner 1 will only have to spend 3 months in jail if he betrays Prisoner 2 (corresponding to cell A above), and a full year in jail if he keeps silent (corresponding to cell B above). Now suppose Prisoner 2 decides to keep silent. Under the “Prisoner 2 keeps silent” scenario, Prisoner 1 goes free if he betrays Prisoner 2 (corresponding to cell C above), and spends 1 month in jail if he keeps silent (corresponding to cell D above). So no matter what Prisoner 2 does, Prisoner 1 always spends less time in jail if he betrays Prisoner 2. By symmetry, no matter what Prisoner 1 does, Prisoner 2 always spends less time in jail if he betrays Prisoner 1. Thus the dilemma…
Now, let’s consider how Take it All recreates the Prisoner’s dilemma. The show begins with five contestants playing a first round, four contestants playing a second round, and three contestants playing a third round. The final two contestants after round three advance to the “Prize Fight” which mimics the Prisoner’s dilemma game shown above. In the Prize Fight, the strategy pair for each contestant is “Keep Mine” (i.e., keep my winnings from Rounds 1–3) and “Take it All” (i.e., keep my winnings from Rounds 1–3 and also take my opponent’s winnings from Rounds 1–3). If both contestants choose to “Keep Mine,” they will each keep the prizes they have won in the prior rounds (this is analogous to ending up in cell D in the Prisoner’s dilemma payoff matrix shown above). If one contestant chooses “Keep Mine” and the other chooses to “Take it All,” the contestant that chose “Take it All” will go home with all the prizes — theirs and their opponents (this is analogous to ending up in either cell B or cell C D in the Prisoner’s dilemma payoff matrix). But if both choose “Take it All,” they both go home with nothing (this is analogous to ending up in cell A in the Prisoner’s dilemma payoff matrix). If one were to play this game purely on the basis of self-interested action, then the obvious strategy would be to always “Take it All”, in which case NBC doesn’t have to pay out at all. However, the interesting (and somewhat creepy and provocative twist) here is that the show’s host (Howie Mandel) gives both contestants time to try to convince each other that they won’t betray each other. Thus, the “suspense” is whether one’s opponent follows through on his or her verbal “promise” to “Keep Mine”.
Now consider what happened earlier this week on a “Take it All” episode:
From a business perspective, I think that it is quite clever to produce a game show based upon a prisoner’s dilemma game. The production costs for a show like this are nominal, and most of the time the production company won’t have to pay out a jackpot. It doesn’t take a game theory expert to figure out that the incentive structure of the game is incompatible with a (Keep Mine, Keep Mine) outcome. The likely outcome is (Take It All, Take It All), in which case no prize is paid. Occasionally one can expect a (Keep Mine, Take It All) outcome, as was the case earlier this week. This also works to the NBC’s benefit; the “drama” of the game creates a buzz and possibly more viewership (thus bringing in more revenue from commercials). In all likelihood, NBC also manages the risk of a (Keep Mine, Take It All) outcome by purchasing an insurance policy covering the cost of the jackpot from Lloyds of London…
Let me make one final point about Prisoners Dilemmas and television shows. The next time you watch a Law and Order re-run, keep in mind that virtually every Law and Order episode is organized around some variation of a Prisoners Dilemma game. The downside of realizing this is that this makes Law and Order much less interesting to watch, since you can often deduce what will likely happen just a few minutes into each episode!
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