Knowledge that Transforms

Some have observed that individuals perform worse after being promoted. The Peter principle, which states that people are promoted to their level of incompetence, suggests that something is fundamentally misaligned in the promotion process. This view is unnecessary and inconsistent with the data. Below, it is argued that ability appears lower after promotion purely as a statistical matter. Being promoted is evidence that a standard has been met. Regression to the mean implies that future ability will be lower, on average. Firms optimally account for the regression bias in making promotion decisions, but the effect is never eliminated. Rather than evidence of a mistake, the Peter principle is a necessary consequence of any promotion rule. Furthermore, firms that take it into account appropriately adopt an optimal strategy. Usually, firms inflate the promotion criterion to offset the Peter principle effect, and the more important the transitory component is relative to total variation in ability, the larger the amount that the standard is inflated. The same logic applies to other situations. For example, it explains why movie sequels are worse than the original film on which they are based and why second visits to restaurants are less rewarding than the first.

We exploit the military mobilization for World War II to investigate the effects of female labor supply on the wage structure. The mobilization drew many women into the workforce permanently. But the impact was not uniform across states. In states with greater mobilization of men, women worked more after the war and in 1950, though not in 1940. These induced shifts in female labor supply lowered female and male wages and increased earnings inequality between high school– and college‐educated men. It appears that at midcentury, women were closer substitutes for high school men than for those with lower skills.

Walrasian tâtonnement has been a fundamental assumption in economics ever since Walras’ general equilibrium theory was introduced in 1874. Nearly a century after its introduction, Vernon Smith relaxed the Walrasian tâtonnement assumption by showing that neoclassical competitive market theory explains the equilibrating forces in “double‐auction” markets. I make a next step in this evolution by exploring the predictive power of neoclassical theory in decentralized naturally occurring markets. Using data gathered from two distinct markets—the sports card and collector pin markets—I find a tendency for exchange prices to approach the neoclassical competitive model prediction after a few market periods.

I study the interaction between imperfect labor contracts and international trade in a setting in which workers have private information about their own abilities. When an individual’s contribution to firm output can be measured accurately in some activities but not in others, the most able workers select occupations in which their pay most closely reflects their own performance. In a world economy with two otherwise similar countries that have different distributions of talent, the country with the more heterogeneous labor force exports the good that is produced by the most talented individuals. In this country, trade exacerbates the “polarization” of the labor force and often worsens the distribution of income.

We analyze entry, pricing, and product design in a model with differentiated products. Market equilibrium can be “separating,” with multiple sellers and a sorting of heterogeneous consumers across goods, or “exclusionary,” with one seller serving all customer types. Entry into an initially monopolized market can occur because of cost reductions or product improvements, but entry need not lower the incumbent’s price, improve efficiency, or raise consumer welfare. Postentry design incentives favor a softening of price competition and stronger market segmentation, whereas exclusionary design changes typically raise consumer welfare. Potential, as distinct from actual, entry always benefits consumers.

Taller workers receive a wage premium. Net of differences in family background, the disparity is similar in magnitude to the race and gender gaps. We exploit variation in an individual’s height over time to explore how height affects wages. Controlling for teen height essentially eliminates the effect of adult height on wages for white men. The teen height premium is not explained by differences in resources or endowments. The teen height premium is partially mediated through participation in high school sports and clubs. We estimate the monetary benefits of a medical treatment for children that increases height.

This paper measures the importance of borrowing constraints on education decisions. Empirical identification of borrowing constraints is secured by the economic prediction that opportunity costs and direct costs of schooling affect borrowing-constrained and unconstrained persons differently. Direct costs need to be financed during school and impose a larger burden on credit-constrained students. By contrast, gross forgone earnings do not have to be financed. We explore the implications of this idea using four methodologies: schooling attainment models, instrumental variable wage regressions, and two structural economic models that integrate both schooling choices and schooling returns into a unified framework. None of the methods produces evidence that borrowing constraints generate inefficiencies in the market for schooling in the current policy environment. We conclude that, on the margin, additional policies aimed at improving credit access will have little impact on schooling attainment.

We examine the frequency of price changes for 350 categories of goods and services covering about 70 percent of consumer spending, on the basis of unpublished data from the Bureau of Labor Statistics for 1995–97. In comparison with previous studies, we find much more frequent price changes, with half of prices lasting less than 4.3 months. Even excluding temporary price cuts (sales), we find that half of prices last 5.5 months or less. We also find that the frequency of price changes differs dramatically across goods. Compared to the predictions of popular sticky‐price models, actual inflation rates are far more volatile and transient for sticky‐price goods.

Fifty years ago, Harsanyi published the first of his seminal two papers on utilitarianism. His results were derived within the von Neumann Morgenstern expected utility theory. A year later, Savage incorporated subjective probability into expected utility theory in his famous book. In this note we extend Harsanyi’s utilitarianism to Savage’s framework. We show that a Pareto condition implies utilitarian aggregation: both society’s utility function and its probability measure are linear combinations of those of the individuals. This conclusion contrasts the impossibility of reconciling a Pareto condition and linear aggregation of beliefs and tastes, that was noted by several authors. We argue that the indiscriminate Pareto condition considered by these authors is not compelling. Society should not necessarily endorse a unanimous choice when it is based on contradictory beliefs. Restricting the Pareto condition to choices that only involve identical beliefs allows the extension of Harsanyi’s result to Savage’s framework.

Given adverse selection, durable goods that trade less frequently depreciate more quickly. Consistent with this prediction, I find an inverse relationship between depreciation and trading volume for less reliable brands of used business aircraft. Additionally, recent theoretical analyses suggest that leasing, by increasing the average quality of used goods offered for sale, may reduce adverse selection in durable goods markets. Indeed, I find an increase in the direct relationship between depreciation and trading volume for aircraft models with relatively high lease rates. Together these findings suggest that adverse selection is a prominent feature of the market for contemporary used business aircraft and that leasing mitigates the consequences of asymmetric information about the quality of used durable goods.