Knowledge that Transforms

Concerns of pride, dignity, and the desire to keep hope about future options often lead individuals and groups to walk away from rea sonable offers, try to shift blame for failure onto others or take refuge in political utopias. Costly impasses and conflicts result, such as trials, divorces, strikes, the scapegoating of minorities for economic hardships, and wars. A key and puzzling aspect of these processes is the role played by wishful rationalizations and delusions, as attested by field observers (e.g., Truman F. Bewley (1999) in the context of labor relations; Kevin Woods, James Lacey, and Williamson Murray (2006) in that of war), as well as controlled experiments. Leigh Thompson and George Loewenstein (1992) and Linda C. Babcock et al. (1995) thus demonstrate how subjects in bargaining situations with common knowledge spontaneously generate, through self-serving processing and recall of the same evidence, divergent beliefs about the fairness of their cause and wishful predictions of outcomes, and how these are associated to costly delays and disagreements.

Cash transfers to eligible households indirectly increase the consumption of ineligible households living in the same villages. This effect operates through insurance and credit markets: ineligible households benefit from the transfers by receiving more gifts and loans and by reducing their savings. Thus, the transfers benefit the local economy at large; looking only at the effect on the treated underestimates their impact. One should analyze the effects of this class of programs on the entire local economy, rather than on the treated only, and use a village-level randomization, rather than selecting treatment nd control subjects from the same community.

For some health goods, intrahousehold allocation may be more important in determining outcomes than household-level consumption. An example is the use of mosquito nets to prevent malaria. Malaria kills over one million people annually, 90 percent of them children under the age of five. The use of insecticide treated mosquito nets (ITNs) is considered the most costeffective available strategy for control of the disease. In 2000, 44 of the 50 malaria affected countries in Africa committed themselves to increasing the use of ITNs by vulnerable populations, in particular children under five years of age and pregnant women. Adults in malarious regions have typically acquired some immunity to the disease through repeated exposure over the course of their lives. The risk of severe malaria resulting in lifelong disability or death is highest for young children and pregnant women across transmission environments (Robert W. Snow et al. 2003). On the other hand, lost labor time often accounts for the largest portion of the private cost of the disease. This implies a trade-off between minimizing the income lost to malaria and minimizing the risk that a household member dies or is permanently disabled. Despite public health messages emphasizing the importance of using mosquito nets to protect young children from malaria, nets are often used by adults when a household does not have enough nets to cover all members (Eline L. Korenromp et al. 2003; Frederick Mugisha and Jacqueline Arinaitwe 2003). Determining the welfare-maximizing allocation of nets is Intrahousehold Allocation of Free and Purchased Mosquito Nets

As recently as two years ago there was a widespread consensus among economists that fiscal policy is not useful as a countercyclical instrument. Now governments in Washington and around the world are developing massive fiscal stimulus packages, supported by a wide range of economists in universities, governments, and businesses. Why has this change occurred? What are the principles for designing a potentially useful fiscal stimulus? And what will happen if the current fiscal stimulus fails?

We investigate the consequences of demographic change for business cycle analysis. We find that changes in the age composition of the labor force account for a significant fraction of the variation in cyclical volatility observed in the G7. Since World War II, these countries have experienced dramatic demographic changes, although details regarding timing and nature differ across countries. We exploit this variation to show that the workforce age composition has a large and significant effect on cyclical volatility. We relate our results to the recent decline in US macroeconomic volatility, finding that demographic change accounts for approximately one-fifth to one-third of this moderation.

Speeding tickets are determined not only by the speed of the offender, but also by incentives faced by police officers and their vote-maximizing principals. We hypothesize that police officers issue fines more frequently when drivers have a higher opportunity cost of contesting a ticket, and when drivers are not residents of the local municipality. We also predict that local officers are more likely to issue a ticket to out-of-town drivers when fiscal conditions are tight and legal limits prevent increases in property taxes. Using data from traffic stops in Massachusetts, we find support for our hypotheses.

The consumption of high-consumption households is more exposed to fluctuations in aggregate consumption and income than that of low-consumption households in the Consumer Expenditure (CEX) Survey. The exposure to aggregate consumption growth of households in the top 10 percent of the consumption distribution in the CEX is about five times that of households in the bottom 80 percent. Given real aggregate per capita consumption growth about 3 percentage points less than its historical mean during the past year, these figures predict that the ratio of consumption of the top 10 percent to the bottom 80 percent has fallen by about 15 percentage points (relative to trend). Using income data from Piketty and Saez (2003), we show that the income (especially the wage income) of rich households is more exposed to aggregate fluctuations, so their higher income exposure is a likely contributor to their higher consumption exposure. Finally, we find a striking change in the exposure of the incomes of high-income households: prior to the early 1980's, the incomes of high-income households were not more exposed to aggregate fluctuations. Thus, while high-income households currently bear an inordinately large share of aggregate fluctuations, this is a recent occurrence.

Entrepreneurs bear substantial risk, but empirical evidence shows no sign of a positive premium. This paper develops a theory of endogenous entrepreneurial risk taking that explains why self-financed entrepreneurs may find it optimal to invest in risky projects offering no risk premium. Consistently with empirical evidence, the model predicts that poorer entrepreneurs are more likely to undertake risky projects. It also finds that incentives for risk taking are stronger when agents are impatient.

Contrary to what is usually assumed, the expected revenue for lenders as a function of the loan rate cannot be globally hump-shaped in the Stiglitz-Weiss (1981) adverse selection model with a continuum of types. This has important implications. First, if there is credit rationing, there must be at least two equilibrium loan rates. Second, while at the low rate loans are rationed, all those applicants willing to pay the high rate are then served. Numerical analysis shows that unless the joint distribution of risk class and output is rather special, the two loan rate outcome with rationing is unlikely.

This paper examines how schools' choices of class size and households' choices of schools affect regression-discontinuity-based estimates of the effect of class size on student outcomes. We build a model in which schools are subject to a class-size cap and an integer constraint on the number of classrooms, and higher-income households sort into higher-quality schools. The key prediction, borne out in data from Chile's liberalized education market, is that schools at the class-size cap adjust prices (or enrollments) to avoid adding an additional classroom, which generates discontinuities in the relationship between enrollment and household characteristics, violating the assumptions underlying regression-discontinuity research designs.