Glossary

Welcome to the SwiftEconomics.com Glossary! Each word will come to life using witty jokes, satire, and colorful examples. The glossary is meant to amuse and educate; not to be traditional or academic. The SwiftEconomics.com team wants to hammer home a few vital ideas throughout the vocabulary lesson. For example, keep an eye on asymmetric information’s effect on health insurance. Please share the SwiftEconomics.com Glossary with colleagues, friends, and family!

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Absolute Advantage

Somebody is the best at everything. For my taste, Michael Jordan at basketball, Tiger Woods at golf and Lance Armstrong at being athletically phenomenal. Same goes for producing products and services. A country, organization or individual can produce a product or service at a lower absolute cost compared to another. Or said another way, if two countries use the same amount of resources to produce something (inputs), the one that produces more (output) has an absolute advantage. More productive and skilled workers could be one explanation for such a phenomenon.

This is one reason why trade is beneficial. If each country produces what they’re best at (aka most efficient at), and trades with one another, standard of living is maximized for all.

Contrast with comparative advantage.


Adverse Selection

Caused by asymmetric information, where one party knows more than another in a market setting. Adverse selection is what makes used car sales in the private market unpleasant and is a driving force why health insurance companies deny individual coverage.

As a customer you can thank adverse selection for receiving sub-par products or not receiving quality products at all.

As a business you can thank adverse selection for being unable to filter out sub-par customers. Take the health insurance example. A health insurance company cannot fully screen a person’s health or that person’s risk of medical mishaps in the future. If the company took a high percentage of individual claims that applied, they’d surely be stuck insuring people who take out enormous medical bills. One long weekend in the hospital these days and you’re looking at a six figure bill.

Let’s see how Chris Farley in “Tommy Boy” handles adverse selection. The following may not be fully appropriate for all eyes and ears…parental warning:

Tommy: Let’s think about this for a sec, Ted, why would somebody put a guarantee on a box? Hmmm, very interesting.

Ted Nelson (customer): Go on, I’m listening.

Tommy: Here’s the way I see it, Ted. Guy puts a fancy guarantee on a box ‘cause he wants you to feel all warm and toasty inside.

Ted Nelson (customer): Yeah, makes a man feel good.

Tommy: ‘Course it does. Why shouldn’t it? Ya figure you put that little box under your pillow at night, the Guarantee Fairy might come by and leave a quarter, am I right, Ted?
[chuckles until he sees that Ted is not laughing too]

Ted Nelson (customer): [impatiently] What’s your point?

Tommy: The point is, how do you know the fairy isn’t a crazy glue sniffer? “Building model airplanes” says the little fairy; well, we’re not buying it. He sneaks into your house once, that’s all it takes. The next thing you know, there’s money missing off the dresser and your daughter’s knocked up. I’ve seen it a hundred times.

Ted Nelson (customer): But why do they put a guarantee on the box?

Tommy: Because they know all they sold ya was a guaranteed piece of shit. That’s all it is, isn’t it? Hey, if you want me to take a dump in a box and mark it guaranteed, I will. I got spare time. But for now, for your customer’s sake, for your daughter’s sake, ya might wanna think about buying a quality product from me.

Ted Nelson (customer): [pause] Okay, I’ll buy from you.

Tommy: Well, that’s…

Tommy, Richard: …What?


Agency Costs

Personal interests don’t always align. In economics self-interests generally win out. If you’re a business manager, your boss hired you as an Alfred to their Batman. Alfred is the agent, Batman the principal. Batman may want you to maximize shareholder value with everything you do as a manager (increase profits). Being the self-interested old butler you are you want your employees to be comfortable. You negotiate remote work agreements with everyone allow them to work from home two days a week. Where some employees continue to get their work done and even increase productivity, most employees watch SpongeBob for the lion’s share of the work day. Agency costs arise in the friction between Batman’s desire to maximize profit and Alfred’s desire to be a relatable human being. You win some and you lose some, Alfred.


Altruism

The selfless act of caring about the welfare of others. Self-interests generally win out in economics but self-interests are driven by what makes a person smile on the inside (utility). Self-interests don’t necessarily come at another’s expense. Adam Smith’s invisible hand is built upon self-interests creating economic opportunity for many. The vast network of charitable giving and volunteerism throughout the world is living proof of self-interests capable of being selfless.

Neuroeconomics is a field that measures what parts of the brain light up during different thoughts, choices, and actions. Neuroeconomics research confirms that the areas in the brain activated from voluntary giving are similar with those activated during sex. Giving is that powerful and that rewarding. If you can sell sex, you can sell selfless giving. Altruism is sexy.


Animal Spirits

Everyone needs confidence to flourish; the economy is no exception. Individuals need the confidence of job security, future income, increasing home values and stock portfolios to participate in a U.S. economy made up of 70% consumption. Entrepreneurs need confidence that risks are manageable and the system is fair to create economic prosperity for themselves and their stakeholders. Animal spirits refers to instinctive confidence, often in the absence of facts. The instinctively optimistic person puts aside the prospect of loss in the naïve pursuit of economic glory. Confident indeed.


Arbitrage

Evil hedge funds are the main “arbs” still in practice. In the good ole days, pure arbitrage offered guaranteed profits free from risk. Now, international financial markets are so intertwined and information is shared so quickly between so many people over the web, these opportunities have dried up. Whether its currency, a derivative, or a stock, arbitrage occurs when an asset is bought on one marketplace and a matching asset is simultaneously sold on another at a higher price. For example, currency could be sold on an exchange in Shanghai and New York simultaneously.


Asymmetric Information

The opposite of symmetric information. Think of symmetric features on someone’s face. The left and the right side have symmetric and equal information. Symmetry has been found as a driving characteristic for physical “attraction.” If the sides of someone’s face are asymmetric, and contain unequal information, they will not be able to form an attractive transaction.

The most significant reason tens of millions of Americans do not have health insurance (currently 47 million plus), is asymmetric information. Politicians do not talk about asymmetric information because they’re ignorant, or don’t believe the public will have any clue what they’re talking about. Likely, asymmetric information would not be a winning stump speech topic for election.

Most people are insured as a member of a group: employees of a company, a sitting senator, a congregate of a church, etc. Risk is greatly lowered to insurance companies that do this, compared to insuring on an individual basis. In large groups, a distribution of potential health outcomes can be mapped out and a more accurate estimate of costs can be established.

An individual knows much more about their own health, lifestyle and risk factors than an insurance company does. An insurance company has to assume, by the fact a person is seeking health insurance, that they anticipate high medical bills looming in the future.

I’m a solutions-oriented person. Here’s what any politician could propose to help find an efficient solution to the American health insurance dilemma: take the 47 million plus uninsured people and place them in groups. Group them by age, trade, at random…whatever, I can’t do everything for them. The important thing is to group them together and present the groups to insurance companies. If they were to be distributed by equal age distribution across the groups, you’d have a lot of healthy twenty-somethings to work with. Many uninsured people are young and healthy and don’t feel their risk of medical catastrophe is high enough to pay insurance premiums every month. Insurance companies could lower their risk in insuring the same people they turn down on an individual basis. Pretty neat, huh?

A more extreme way of helping ease asymmetric information in health insurance markets would be to require, by law, that all Americans obtain health insurance. This would immediately stop insurance companies from assuming an individual, seeking insurance, automatically expects high medical bills in the near future. Instead, people would just be law-abiding citizens seeking insurance. It’s a paternal solution, that has its drawbacks of freedom, but is an economic juggernaut of logic. More Americans would be prepared for a medical emergency, even if they believe health insurance policies are not actuarially fair (worth paying given the risk). Such a law would increase demand for health insurance in the free market, help individuals get insurance policies and help drive down prices for all. Want a cherry on top? Lift bans on people taking out-of-state health insurance policies. The competition brought by a Californian, seeking cheaper insurance in Columbia, Missouri, would drive prices down ever further.


Asymmetric Shock

Think unbalanced and unequal when the word “asymmetric” pops up. A shock to the economy is an unforeseen event. It could be a natural event like a hurricane or man-made like the mismanagement of an industry. The asymmetric part is that the shock affects certain parts of the economy more than the rest. The collapse of the U.S. auto industry affects Detroit and the state of Michigan far more then any other place. Similarly, the gulf coast annually braces for hurricanes which affect their infrastructure and well-being more so than the same hurricanes affect other regions.


Auctions

I can always use some more eBay feedback. Check out seller ID, swifteconomics, for your future bidding. Now you really know where to find me.

eBay auctions are English auctions where competitive bidding starts at a minimum bid and goes back and forth until bidders exceed their willingness to pay. Dutch auctions throw in an interesting twist. The auctioneer starts at a high figure and counts down. The first bidder claims the item at that price.

Sellers like auctions because it helps reveal a buyer’s willingness to pay. Sellers can ensure that of all potential buyers involved in bidding, the item will end up in the hands of the bidder willing to spend the most. It can also create an enhanced marketplace of competition due to an auction’s thrill, reactive bids in the moment, and one buyer outbidding another for the sake of punishing them; say a person decides they don’t want their chief social rival across the room to walk away with the Rembrandt up for auction.

Beware of the winner’s curse. If the value of the object up for auction is unknown, the winning bidder will probably bid more then its actual value. Common value items have the same value to every bidder and are subject to the winner’s curse. Auctions for oil-rich land are an example of a common value item. Only estimates indicate the amount of oil that can be recovered. It’s difficult to value an unknown amount of oil so the winner’s curse will likely rear its ugly head.


Austrian Economics

Vienna’s on my mind; a school of economics endorsing free markets in the late 19th and early 20th centuries. Friedrich August von Hayek is their poster child. Austrian economists strongly oppose government intervention in the free market and promote creative destruction. In creative destruction failure is a good thing. The best entrepreneurial ideas succeed failing ones and consistently produce an innovative, state-of-the-art economy.

Austrian economists first studied economics as “the allocation of scarce resources.” These economists cared about actual human choices, human behavior, and the resulting opportunity cost.

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