Vernacular Knowledge

Abstract

This chapter argues that an empirical analysis of an economic phenomenon should be rooted in a thorough understanding of that phenomenon’s social, institutional, and technical context. It discusses what it means for a study to be so rooted, and how to go about acquiring the appropriate level of knowledge required. These ideas come to life in applications to whaling, sports betting, participation in union certification elections, and more.

Food for Thought

Answering these problems may necessitate a modest amount of groundwork. This is intentional, since this is how most vernacular knowledge is acquired.

• 1. Another provocative sports economics paper, Romer (2006), concluded that professional football teams punt far too often on fourth down, instead of going for another first down by running or passing. Using a dynamic programming model, Romer concludes that, at midfield, one should go for it on any fourth down with five yards or less to go (to earn another first down), and that it should do so even on its ten yard line if it needs only three yards to go.

  Skepticism should meet these findings, because teams’ actual choices concur with them only 10% of the time. The weak link is that, because “going for it” on fourth down is so rare, Romer analyzes third down plays instead, arguing without formal evidence that “one would not expect either side (offense or defense) to behave very differently on the two downs.” Evaluate this claim informally using vernacular knowledge. Do football aficionados agree that the fourth down plays offenses usually run, and the defenses that are used against them, resemble those used on third downs?

• 2. The best known paper on the topic of job networking involves the “strength of weak ties,” based on Granovetter’s (1973) finding that people find more jobs through acquaintances that they don’t know all that well, rather than from friends that they do. Treating the job hunter’s friends and acquaintances as a network, sketch the idea of information flow that underlies Granovetter’s conclusions (which have been recently questioned). Compare this information flow with that underlying Hayek’s “The Use of Knowledge in Society” (1945).

• 3. Jensen and Murphy (1990) argued that the compensation of chief executive officers (CEOs) was not sufficiently performance-based, harming firms’ stock values as a result. The following decade saw dramatic growth in use of a form of executive compensation that is particularly sensitive to the value of the firm: stock options. Yet Jensen (2001) explicitly disavowed conventional stock options, arguing they actually encouraged poorer CEO decision-making.

  • (a) The growing use of stock options in the 1990s, and its reversal in the following decade, had little to do with incentivizing sound managerial decision-making. What did it have to do with instead? The answer to this puzzle involves vernacular knowledge.

  • (b) The use of performance-based incentives is supposed to remedy the principal-agent problem and align the objectives of the CEO with those of stockholders. Yet much about the reward structure of CEOs suggests that the principal-agent problem applies to board of directors as well. Give at least two significant examples, which can involve, but are not limited to, the facts reported by Jensen and Murphy and the treatment of stock options.

• 4. The acquisition of a large body of vernacular knowledge has been key to the work of several Nobel Laureates. Illustrate with regard to the work Coase and Ostrom.

• 5. The effect of malpractice liability on the physician services market is a big subject of study in health economics . Consider a federal law that decreases the number of malpractice suits against physicians, either by making it harder to sue or by reducing the payout in the event the suit is successful. This should reduce the premiums that physicians pay for malpractice insurance .

  • (a) In the U.S., what kinds of laws have been used to accomplish this goal? As a matter of scale, are malpractice premiums a practice cost of sufficient magnitude to merit attention?

  • (b) Using a standard price setting graph, illustrate the short run effects of such a law on the price and quantity of physician services. The price and quantity effects on this graph depend on whether malpractice insurance is a fixed cost or a variable cost. Which is it?

  • (c) Using a standard price setting graph, illustrate the long run effects of such a law on the price of physician services. Approximately what period length would correspond to the long run in this context ? Why?

  • (d) The price effect on the graph you just drew depends on the degree to which increased profits can draw new doctors into the profession. How flexible is entry into U.S. physician services over the long run period that you specified above?

• 6. A well-known study of job displacement, Jacobson et al. (1993), finds that high-tenure, prime age, continuously-employed Pennsylvanian workers who lost their jobs between 1980 and 1986 received a persistent wage penalty in excess of 20%.

  • (a) Which aspects of this study would affect the generality of its conclusions? Comment on how this study’s findings might depend on the institutional, demographic , and macroeconomic aspects of the data it uses. Overall, would these aspects tend to push the wage effects of displacement up or down?

  • (b) How do you think the extent of wage loss differs by industry? Compare your guesses to the authors’ empirical findings.