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Trillion Dollar Economists: How Economists and Their Ideas have Transformed Business



“A tour de force showcase of progress attained by the marriage of economics and human imagination. A must read for innovators, entrepreneurs, policymakers, and students of economics hoping to chart a better future.”
—Jay Walker, founder of Priceline and Walker Digital

“Bob Litan’s combination of sprightly prose, personal touch, wide range, and enthusiasm for his subject–which might well be called ‘what economics has contributed to the economy’—makes this marvelous book a rare find. Pick it up and you’ll find yourself drawn into his infatuation with economic analysis. This book educates and entertains at the same time—quite a deal.”
—Alan S. Blinder, Professor of Economics at Princeton University and the author of After the Music Stopped

“Bob Litan is one of the most brilliant and versatile economists of the modern age. His book on the history of economist-innovators will open your eyes to some of the most important people in economics and their contributions to modern society. This is an inside story of breakthroughs from matchmaking to mathematical programming, from financial wizardry to the deregulation movement. Everyone from interested amateur to seasoned professional will learn greatly from this book.”
—William Nordhaus, Sterling Professor of Economics, Yale University

ROBERT LITAN has spent four decades publishing over 25 books and more than 200 articles about the U.S. economy and has directed economic research at some of the nation’s leading research organizations in both the for-profit and non-profit sectors: the Brookings Institution, the Kauffman Foundation, and Bloomberg Government. He is currently a non-resident senior fellow at the Brookings Institution, Of Counsel to the law firm of Korein Tillery (St. Louis and Chicago), and Chief Economist of Main Street Genome, a new company providing analytics to small companies. He is also a regular contributor to Wall Street Journal’s “Think Tank” blog.

Preface xi

Chapter 1 Introduction: Economists as Innovators 1

Organization of the Book 5

My Personal Interest (and Bias) 8

Chapter 2 An Easy Introduction to Economics 13

Rationality 13

Markets 19

Market Failures 22

The Macro-Micro Distinction 27

Economic Growth in the Short and Long Run 31

The Equity-Efficiency Tradeoff 32

Innovation and Growth: The Role of Economists 35

The Bottom Line 39

Part I: The Power of Economic Ideas: Direct Use in Business 43

Chapter 3 The Price Is Right 47

The Bloomberg Way of Pricing 49

Auctions 52

Different Prices for Different Folks 69

The Bottom Line 73

Chapter 4 Minimizing Costs 77

Optimization 78

Learning by Doing 87

The Bottom Line 91

Chapter 5 Beyond Moneyball 93

A Brief Guide to Regression Analysis 94

The Business of Forecasting 96

The Business of Economic Consulting 101

Data Analytics and Big Data 104

Econometrics and Sports: Moneyball 106

Regulatory Moneyball 110

The Bottom Line 112

Chapter 6 Experiments in Economics and Business 115

Economics in the Lab: Vernon Smith and Experimental Economics 117

Lab Experiments in Business: Focus Groups 120

Economic Experiments in the Field: Randomized Controlled Trials 121

Business Experimentation in the Field 122

Innovation and Entrepreneurship:

Experimentation as the Foundation of Growth 125

The Bottom Line 133

Chapter 7 Matchmaker, Matchmaker 137

A Gentle Introduction to Market Design and Matching Theory 138

Matchmaking in the Labor Market 146

Matchmaking and Online Dating 149

The Bottom Line 151

Chapter 8 Economists and Mostly Good Financial Engineering 155

Not Putting Your Eggs in One Basket: The Rise of Index Investing 156

Efficient Markets and Their Implications 159

Behavioral Finance 164

Valuing Options: Upsides and Downsides 167

The Bottom Line 173

Part II: Economist-Inspired Policy Platforms for Private Business 177

Chapter 9 Planes, Trains, and Trucks 185

Origins of Transportation Regulation 186

Airline Deregulation 189

Trucking Deregulation 197

Railroad Deregulation 202

Deregulation’s Impact:

The Transportation Industry 203

Deregulation as a Business Platform 207

The Bottom Line 210

Chapter 10 Economists and the Oil and Gas Revolution 213

The Origins and Decline of Price Regulation of Fossil Fuels 214

The Oil and Gas Supply Revolution 221

The Energy Revolution as a

Platform Technology 224

The Bottom Line 227

Chapter 11 Economists and the Telecommunications Revolution 229

Economists in a Quick History of Communications 230

When Natural Monopolies End: The Run-Up to the AT&T Antitrust Case 234

Competition in Telecommunications: The Benefits of AT&T’s Breakup 242

Economists and Price Cap Regulation 248

Economists and Spectrum Allocation 251

The Bottom Line 256

Chapter 12 Economists, Financial Policy, and Mostly Good Finance 261

Economists and Competition in Brokerage Commissions 262

Economists as Detectives: Accelerating Automated Trading 264

Economists and the Financial Crisis 270

How Did the Crisis Happen? A Quick and Easy Guide 271

Subprime Lending 276

Excessive Leverage: An Introduction 277

The Pre-crisis Demise of SEIR 281

The Glass-Steagall Debate 287

The Bottom Line 294

Part III: Looking Ahead 299

Chapter 13 Economic Ideas in Waiting: Business Applications 301

Prediction Markets 302

Potentially Good Financial Innovations 306

Congestion Pricing 312

The Bottom Line 317

Chapter 14 Economic Ideas and Challenges on the Policy Shelf: Business Implications 321

Federal Budget Deficits as Drivers of Policy Change 322

Premium Support for Medicare and Medicaid 326

Taxing Consumption 334

Taxing Carbon 343

The Bottom Line 350

Chapter 15 The Future of Economics: What It Means for Business and Economists 353

The Revolution in Economics 354

How Economics Will Continue to Affect Business 356

Implications for Economists 357

Concluding Thoughts 359

Appendix: Prizes in Economics 361

About the Author 365

Index 367