I develop a model of bilateral conversations in which players honestly exchange ideas with their competitors. The key to incentive compatibility is complementarity in the information structure: a player can generate a new insight only if he has access to his counterpart's previous thoughts on a topic. I then examine a social network in which A has a conversation with B, then B has a conversation with C, and so on. Relatively underdeveloped ideas can travel long distances over the network. More valuable ideas, by contrast, tend to remain localized among small groups of agents. (JEL D83)

Alice and Bob live in the forest. To sustain themselves, they collect fruits and berries and snare an occasional animal. The nights get cold, but Alice is a skillful fire-builder. Bob has never mastered this art. His fires fizzle and he never seems to collect the right kind of wood. Alice divides her time between collecting food and gathering wood. She does this in such a way that her marginal benefit from time spent collecting food is the same as that from gathering wood. Bob does not attempt to build fires. He spends all of his time gathering food, and every night slinks up and huddles beside Alice’s fire. Bob appreciates the fire’s warmth, but wishes it were larger. Bob has learned to leave morsels of food by the fire for Alice. Warmth and food are both “normal goods ” for Alice. The extra food that Bob leaves induces her to increase her total food consumption, but not by the total amount that Bob leaves for her. She uses some of the time saved by Bob’s gifts to gather more firewood. 1.1 Equilibrium with Unilateral Gifts–An Example Alice’s utility function is U(cA, y) = cAy where cA is the amount of food that she eats and y is the amount of wood on the fire. She has T hours to allocate between collecting food and wood. In an hour, she can collect either one unit of wood or πA units of food. If Bob leaves g units of food by the fire, she maximizes her utility by choosing y = 1

Nobel Prize Lecture, December 8, 2005

How should benefit-cost analysis account for the value that benevolent individuals place on others' enjoyment of public goods? When adding up the benefits to be compared with costs, should we sum the private valuations, the altruistic valuations, or something else? This paper argues that private valuations are appropriate if concern for the well-being of others respects their private preferences. The discussion has implications for family decision-making, welfare economics, and the design of applied contingent valuation studies.

This essay examines interconnections between "race" and economic inequality in the United States, focusing on the case of African-Americans. I will argue that it is crucially important to distinguish between racial discrimination and racial stigma in the study of this problem. Racial discrimination has to do with how blacks are treated, while racial stigma is concerned with how black people are perceived. My view is that what I call reward bias (unfair treatment of persons in formal economic transactions based on racial identity) is now a less significant barrier to the full participation by African-Americans in U.S. society than is what I will call development bias (blocked access to resources critical for personal development but available only via non-market-mediated social transactions). By making these points in the specific cultural and historical context of the black experience in U.S. society, I hope to contribute to a deeper conceptualization of the worldwide problem of race and economic marginality.

Prosperity and depression are relative concepts. Today both France and Japan are depressed relative to the United States; equivalently, the United States is prosperous relative to these countries. I say these countries are depressed relative to the United States because their output per working-age person is 30 percent less than the U.S. level. An interesting and important policy question is: Why are these countries depressed? The answers for these two countries turn out to be very different. The United States is prosperous relative to France because the U.S. intratemporal tax wedge that distorts the trade-off between consumption and leisure is much smaller than the French wedge. I will show that, if France modified its intratemporal tax wedge so that its value was the same as the U.S. value, French welfare in consumption equivalents would increase by 19 percent. Consumption would have to increase by 19 percent now and in all future periods to achieve as large a welfare gain as that resulting from this tax reform. The United States is prosperous relative to Japan because production efficiency is higher in the United States. In the United States, total factor productivity is approximately 20 percent higher than in Japan. If Japan suddenly became as efficient in production as the United States, its welfare gain in consumption equivalents would be 39 percent. Equally interesting and important are big changes over time in relative output (per working-age person) across countries. Why are New Zealand’s and Switzerland’s economies depressed by over 30 percent relative to their 1970 trend-corrected levels? Both of these countries have small populations, but depressions are not restricted to small countries. Japan, with its 125 million people, is now depressed by 20 percent relative to its 1991 trend-corrected level. On the prosperity side, why are Ireland and South Korea so prosperous now relative to their 1970 trend-corrected levels? This lecture is concerned primarily with big international differences among relatively rich industrial countries and changes in these differences over time. The countries that receive primary attention all have market economies and healthy, well-educated populations. In the countries considered, the variations in aggregate output per working-age person are large, and reasonably good measures of the factor inputs are available. This permits, in many cases, the identification of the change in policy or the difference in policy that gave rise to prosperity or depression. This is in contrast to business-cycle theory, which provides little guidance to policy except for the important policy implication that a stabilization effort will have either no effect or a perverse effect. The output variations studied and analyzed in this lecture are big: an order of magnitude larger than the much-studied business-cycle fluctuations. The variations studied, however, are an order of magnitude smaller than the muchstudied differences between the richest and poorest countries. Surprisingly, only recently have depressions been systematically studied from the perspective of growth theory, which is the theory used * University of Minnesota and Federal Reserve Bank of Minneapolis. I thank my colleagues at the University of Minnesota and the Federal Reserve Bank of Minneapolis for helpful discussions and comments. In particular, I thank Tim Kehoe, Ellen McGrattan, and Nancy Stokey for their help. I also thank Martin Weale and Franck Portier for providing some British and French tax information used in this lecture. Thanks also go to Sami Alpanda and James MacGee for research assistance and helpful discussions. This lecture draws heavily on collaborative research with Fumio Hayashi. I thank the Economic and Social Research Institute, Cabinet Office, Government of Japan and the U.S. National Science Foundation for financial support. The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.

This paper explores a monetary-policy model with habit formation for consumers, in which consumers' utility depends in part on current consumption relative to past consumption. The empirical tests developed in the paper show that one can reject the hypothesis of no habit formation with tremendous confidence, largely because the habit-formation model captures the gradual hump-shaped response of real spending to various shocks. The paper then embeds the habit-consumption specification in a monetary-policy model and finds that the responses of both spending and inflation to monetary-policy actions are significantly improved by this modification. (JEL D12, E52, E43)

This paper introduces a new cost dataset for a commercial aircraft firm and uses this data to analyze the dynamics of learning in commercial aircraft production. This dataset is found to be inconsistent with the simple learning hypothesis, and particularly the prediction that a firm's unit cost must decline with its cumulative production. Instead, strong support is found for the hypothesis of organizational forgetting, a more general learning model where unit costs are similarly dependent on a firm's past production experience, but where that experience depreciates over time. Additionally, it is found that some, but not all, of a firm's production experience transfers from one generation of an aircraft to the next. This evidence adds to our understanding of productivity in industries with learning and thus has implications to many fields of economics.

The Finance Committee of the American Economic Association met at the Chicago Club, Chicago, IL, at 12:30 P.M. on December 9, 1998. Present were John Cochrane, Robert Dederick, Robert Hamada, C. Elton Hinshaw (Chair) , and John Siegfried (Secretary of the Association ) ; Representing Stein Roe & Farnham, investment counsel for the Association, were Robert McNeill, Scott W. Vogg, and Debbie Jansen. In 1987, the Committee reviewed recommendations presented by the AEA Committee on indexing Association funds concerning the long-term allocation of the Association’s investment assets. As a result of that recommendation, it was agreed that the Association’s portfolio comprise a combination of an S&P 500 Index Fund, Stein Roe & Farnham’s specialty equity mutual funds, and a bond portion managed by Stein Roe & Farnham. This restructuring took place at the end of June 1988. The current portfolio includes holdings in the Vanguard Index Trust Fund, as well as several special Growth Funds and an International Fund, under the supervision of Stein Roe & Farnham (SRF) . The Fixed Income portion of the portfolio is currently invested in SRF’s Intermediate Term Government and Corporate taxable funds. With respect to the calendar-year 1998 performance of the Association’s portfolio, the total return including cash, bonds, and equity holdings was approximately 17.2 percent. The benchmark, which consisted of 5 percent cash, 25 percent Lehman G/C Intermediate Bond Index, 60 percent S&P 500 Index, and 10 percent EAFE index returned 16.7 percent. The returns from the AEA portfolio have now outperformed the benchmark portfolio for six years in a row. The Committee discussed a change to the allocation of the portfolio and the benchmark. It was approved that the benchmark portfolio would become 0 percent cash, 25 percent Lehman G/C Intermediate Bond Index, 60 percent S&P 500 index, 5 percent Russell 2000 index, and 10 percent EAFE index. Additionally, it was agreed to move 5 percent of the assets in the S&P 500 Index Fund into the bond portion of the portfolio immediately. Members can obtain a list of the assets in the portfolio by writing the Treasurer.