Friday, October 30, 2009

When does competition lead to higher prices?

When firms compete on quality:
Law school tuition has been rising since 1994, reaching as much as $50,000 per year when combined with fees at law schools such as Yale and the University of California at Hastings.
A new report (PDF) by the Government Accountability Office ... says the key reasons for higher costs are competition for higher rankings and "the move to a more hands-on, resource-intensive approach to legal education,” according to Inside Higher Ed and TaxProf Blog.

I suspect that competition would lead to lower prices if students paid their own way. But education is an industry like healthcare and academic journals where the people who consume the product do not pay for it.

Wednesday, October 28, 2009

Equity versus Efficiency – Climate Edition

As part of President Obama’s trip to China next month, he will try to reach an agreement on reducing global carbon emissions. China, understandably, is reluctant to do so and poses the argument that:
Countries should be held responsible not only for their current emissions but also for their cumulative historical emissions, given that greenhouse gases accumulate in the atmosphere over many decades.

They are probably right that the burden should be lighter for developing countries who have not contributed as much carbon in the past, but this is not the reason. I empathize that it is likely not fair that we got to release so much carbon as we developed while they may not be able to. But looking at what was done in the past is a retrospective view of what are essentially sunk costs that cannot be undone.

The point of a change in policy is to change our future lives for the better - a decidedly prospective view. If we agree that global emissions should fall* then it is efficient to reduce them where the burden is lightest. There are two reasons why the burden may be heavier in China. First, because China is growing so fast, the marginal effect of a given carbon emission reduction on GDP could be very well be higher in China. Second, if one believes in diminishing marginal utility, the utility loss from a dollar reduction in GDP in China is likely much greater than the utility loss from the same dollar reduction in GDP in the US. If I give up $5 a week, I buy fewer iTunes and Starbucks coffee whereas a Chinese peasant might miss meals. Either effect would argue for more of the burden to be shouldered by developed countries.

*I am skeptical of a carbon emission mitigation only strategy. Best estimates are that mitigation is very expensive, yielding small effects decades into the future. Alternative temperature reducing “geo-engineering” possibilities, while controversial, hold promise too.

Moral Hazard and Yuppie 911

What happens when you make it easier for hikers to be rescued if they get into trouble? Risky behavior increases, like more inexperienced hikers venturing into the wilderness - a clear example of moral hazard. This MSNBC article notes how inexperienced hikers abuse the use of personal locator beacons citing the case of two men and their teenage sons hiking the Grand Canyon's Royal Arch Loop. Over three days, they hit their panic button three times resulting in the mobilization of search and rescue personnel via helicopter (one of the "emergencies" was that their water tasted "too salty")

After being forced to evacuate after the third call, one of them noted that they would have never attempted the hike without the use of personal locator beacons. The abuse of these beacons has become common enough to have received its own descriptor: Yuppie 911.

Tuesday, October 27, 2009

Refugees from New York

Those damned incentives:
The average Manhattan taxpayer who left the state earned $93,264 a year. The average newcomer to Manhattan earned only $72,726. ...
It all adds up to staggering loss in taxable income. During 2006-2007, the "migration flow" out of New York to other states amounted to a loss of $4.3 billion.

Monday, October 26, 2009

McDonalds cannot compete in Iceland

After the credit bubble burst, and the Icelandic krona collapsed, McDonald's has decided to go out of business.
McDonald’s in Iceland, which imports most of the ingredients it uses in its meals, will shut after costs doubled over the past year, Lyst said in an e-mailed statement today. The franchise holder said it doesn’t expect the situation to change in the short term. ...
“Our competitors all use domestic meat and lettuce and so on, while we are flying in these materials, which is extremely expensive,” Ogmundsson said.

Should Apple be charging $0.99 per song?

New research by Joel Waldfogel suggests that the optimal price for a song is about $2.30, and that charging higher prices for more popular songs would raise revenue only by 3%:
One alternative is song-specific pricing, much favoured by record companies. (Apple has already moved a bit in this direction with its multi-tier system.) But the research suggested that this would increase profits by a mere 3%. Part of the problem was that people who valued one song highly also tended to place a high value on others. This implies that person-specific, rather than song-specific, pricing would be more efficient. But sellers’ data are not refined enough to set different prices for different people. People may resent such pricing anyway, so it could harm sellers’ brands. Crude profiling—by race or sex, say—would be illegal. In any case, the authors found that basic demographic information did not tell them much about musical tastes.

It's the Form of the Incentives, Stupid

I think that some of the more interesting work in economics looks at how people respond differently to monetary and non-monetary incentives. For example, one might initially think that if you offered people money to donate blood, they would donate more blood; however, the offering of money tends to somehow de-value the altruistic motives people have for donating blood, leading to less willingness to donate.

Here's a study that indicates the form of the payment is what really matters. When people are offered money for donation, they are less interested in donation; however, an offer of a voucher of similar value doesn't have the same negative effect. In a survey of 467 donors:
A substantial share of respondents declared they would stop being donors if paid a small amount of cash, but we do not find such effects when a voucher of the same nominal value is offered instead. The aversion to direct cash payments is particularly marked among women and older respondents, while there are neither gender nor age differences in the response to the voucher.

Sunday, October 25, 2009

Defending the undefendable: insider trading

Before there was Freakonomics and the Armchair Economist, there was Walter Block Defending the Undefendable. These arguments force students to think instead of simply regurgitating knowledge. 

Don Boudreaux channels Block (and Henry Manne) with his defense of insider trading:
Suppose that unscrupulous management drives Acme Inc. to the verge of bankruptcy. Being unscrupulous, Acme's managers succeed for a time in hiding its perilous financial condition from the public. During this lying time, Acme's share price will be too high. Investors will buy Acme shares at prices that conceal the company's imminent doom. Creditors will extend financing to Acme on terms that do not compensate those creditors for the true risks that they are unknowingly undertaking. Perhaps some of Acme's employees will turn down good job offers at other firms in order to remain at what they are misled to believe is a financially solid Acme Inc.
Insider trading would force the stock price closer to its true value, and prevent all of these mistakes.
...when prices lie, market participants are misled into behaving in ways that harm not only themselves but also the economy writ large.

Friday, October 23, 2009

What is the cost of a Snickers bar?

It depends on what you have to give up to get one.

Why are kids in continental Europe so feckless?

Its the incentives, stupid:
In continental Europe a big part of an estate (often around half) is reserved for the surviving children of the deceased and must be equally divided between them. This “forced heirship” makes it impossible to disinherit feckless children (though several countries exclude bequests to “unworthy” children, who have for example murdered a parent or two). ...

Europe’s inheritance laws pit the Anglo-Saxon emphasis on freedom and markets against a continental focus on social “solidarity”, meaning the belief that shielding people from the vagaries of fate is an overriding public interest (even if that sometimes rewards the feckless). It is no coincidence that Europe is equally divided over labour laws that favour competition, versus those that protect workers from the whims of markets and bosses alike.
HT: Claire

Thursday, October 22, 2009

How to Destroy $2,000,000 in Just Hours

Yesterday, Treasury Department’s special master for compensation under President Obama, Kenneth Feinberg, put severe limits on compensation to top earners at seven companies that received “exceptional help.” This is getting the expected commentaries around the economics blogosphere here, here and here.

It is possible that shareholders are being duped into offering “excessive” compensation. If so, such outside help would mean that shareholders get to keep more of the profits from company operations. On the other hand, it is possible that these were efficient labor contracts that “incentivized” top earners to work hard. If the former, market value of affected firms should rise. If the latter, it should fall.

As they say, let’s role the tape from yesterday. I was able to find intra-day stock market data on three of the affected firms, AIG, BofA, and Citigroup. (I am not smart enough to find General Motors, Chrysler and the financing arms of the two automakers.) The drop off in share price in the late afternoon after the announcement for all three was pretty consistent. They each fell about 2.3% but the market as a whole fell too. Subtracting off the fall in the S&P500 of -1.8% over the same period yields returns in excess of general market trends. (For you finance guys, this assumes beta is one). The closest I could find for market value this morning was the shares outstanding in December, 2008 from CRSP. Multiplying shares outstanding by the “excess” change in price sums to ~$1.8 million for these three firms.

Firm Share Price Pre Share Price Post Percent change Excess Returns Market Value
Excess Return
AIG 39.97 39.03 -2.35% -0.87% -$911,591
BofA 16.90 16.51 -2.31% -0.82% -$683,071
Citigroup 4.53 4.42 -2.43% -0.95% -$227,651


  • Rarely does one see such stark and quick confirmation of the government’s ability to destroy wealth.
  • Perhaps the problem is that the pay czar is only concerned with bridging the chasm between Wall Street and Main Street and not on shareholder wealth. Perhaps his compensation should be tied to the performance of the firms he oversees.

David from the comments is right that my "back of the envelope" exercise misses some key subtleties. I agree that these assets are likely riskier than average (beta may be greater than one) meaning that the announcement would have had a smaller effect. Also, as he points out, Pr(intervention) > 0 before the announcement and Pr(intervention) <1 afterward, which would inflate my estimates. Moreover, some of my “control group” (the S&P500) were likely also 'treated.' That is, the announcement may have lead market participants to think there is greater chance for government oversight of management compensation more broadly and some of the drop in the S&P is due to the announcement. To tease this out, one might compare the affect on firms based on the likelihood that they are immune to the intervention (healthier, lower compensation levels). All said, the back of the envelope calculation is a just that and my claim about that this was ‘stark confirmation’ was too strong.

Still, for a policy intervention, I would shift the burden of proof. One should have evidence that the intervention has positive and significant effects before a decision to implement.

Wednesday, October 21, 2009

Email Addresses and Credit Scores

We previously blogged about using credit scores in pricing auto insurance and hospital care. Some states, however, have banned using this information to price insurance.

Here's an interesting chart that indicates companies might be able to use other indicators to get an idea of your credit score. Based on an analysis of over 20,000 credit scores by Credit Karma, an online credit checking service, email addresses appear to give an indication of credit score. I can understand why we might see higher scores for Comcast and Bellsouth email addresses (you have to buy something to get those), but the differences in the free accounts seem to indicate that there are different types of users for each service. Here's the chart.

Monday, October 19, 2009

Housing, credit, commodity and equity bubbles are re-inflating

... floating on a sea of liquidity (Didn't anyone read chapter 11?)
We did not need to wait until the Dow Jones Industrial Average hit 10,000. It has been clear for some time that global equity markets are bubbling again. On the surface, this looks like 2003 and 2004 when the previous housing, credit, commodity and equity bubbles started to inflate, helped by low nominal interest rates and a lack of inflation. There is one big difference, though. This bubble will burst sooner.
So how do we know this is a bubble? My two favourite metrics of stock market valuation are Cape, which stands for the cyclically adjusted price/earnings ratio, and Q. Cape was invented by Robert Shiller, professor of economics and finance at Yale University. It measures the 10-year moving average of the inflation-adjusted p/e ratio. Q is a metric of market capitalisation divided by net worth. Andrew Smithers* has collected the data on Q, a concept invented by the economist James Tobin.

Employment Changes by Geography

Here's a really cool animated map that shows changes in employment across the top 100 Metropolitan Statistical Areas (MSAs) from January 2004 through July 2009. The starting point looks like this:

Thursday, October 15, 2009

Chinese Real Estate Bubble?

We call "bubble: when one market price gets too high relative to a related market. The Chinese residential real estate market seems out of whack with its labor market:
In Dongguan, a coastal second-tier city in Guangdong province, land prices averaged 4,957 yuan ($726.42) per square meter in 2007, a more than 500 percent increase from 2003, while personal disposable income increased 24 percent during the same period (from 20,526 yuan [$3,008] to 27,025 yuan [$3,960] per year).

Is there any room for optimism?

For the fiscal year that ended Sept. 30, the final deficit tally will be about $1.4 trillion. Measured against the size of the economy, that's 9.9% of gross domestic product, bigger than any year since 1945. As a share of GDP, tax and other revenues are lower (15%) and spending higher (25%) than anytime in the past 50 years.

The U.S. has confronted big deficits before. "Numbers like this will eventually prompt corrective measures, just as a stark but less worrisome budget outlook did in 1990," Goldman Sachs economists assured clients last week.
This time will be tougher.
We are starting from a much deeper hole. When the economy began climbing out of the deep recession of the early 1980s, federal debt -- the sum of every annual budget deficit -- amounted to less than 30% of the nation's GDP, the value of all the goods and services produced in a year. At the beginning of the 1990s, it was less than 40%. Today, it exceeds 50% of GDP and is rising toward 80%, perhaps 100% of GDP over the next 10 years. Even at today's low interest rates, the federal government spent about $195 billion on interest in fiscal 2009, more than 10 times the entire NASA budget. A rising debt-to-GDP ratio means interest takes an ever-greater slice of the budget, much of that going to the foreigners.

The other shoe is dropping

Our defined benefits catastrophe is beginning to bite:
The cost of shoring up Calpers, the troubled $200 billion pension fund for California public employees, will ultimately fall on the state's 38 million residents, who are already dealing with tax increases and reduced public services.
The state and local governments are contractually bound to increase their payments to Calpers to help it make up for its investment losses of more than $50 billion in the fiscal year ended June 30.   ...
In the Orange County city of Fullerton, officials said they were notified by Calpers in August that their city would have to pay a total of $5.5 million more in the four-year period beginning in 2011 to fully fund city employees' retirements. The city, which passed a balanced budget in June that included a hiring freeze, has already dipped another $4 million into the red and now plans to cut employee pay by an as-yet-undetermined amount.

Beware politicians in sheep's clothing

I figured something like this would eventually happen:
Maneuvering to boost prospects for sweeping health care legislation, Senate Democrats hope first to win quick approval for a bill that grants doctors a $247 billion increase in Medicare fees over a decade but raises federal deficits in the process, officials said Wednesday.

By creating a two-bill approach, Democrats intend to claim the more comprehensive health care measure meets President Barack Obama's conditions -- that it will neither add to deficits nor exceed $900 billion in costs over 10 years.

If approved and signed into law, the legislation would avert a 21 percent reduction in Medicare fees paid to doctors that is scheduled to take effect in January as well as additional cuts in future years.

Wednesday, October 14, 2009

Best cities to launch a business

From CNN Money
Growing economies, affordable workers, stable housing markets, low crime -- these metro areas have all the features entrepreneurs need to thrive
  1. Oklahoma City
  2. Pittsburgh
  3. Raleigh
  4. Houston
  5. Hartford
  6. Washington, D.C.
  7. Charlotte
  8. Austin
  9. New York City
  10. Baltimore

A Negotiating Ploy?

The airline industry is fun for economists to observe because there are so many deviations from perfect competition that are explainable using managerial economics concepts. However, I did not see this coming. American Airlines and British Airways are seeking approval for an alliance (like a merger but not quite) but are facing opposition from antitrust authorities and Senators. Presumably,the airlines are pursuing the alliance because it would make each carrier more profitable. If labor is supplied by a monopoly (union), usually the workers share in any additional company earnings. (Certainly, airline workers took big pay cuts when demand fell after 9/11.) So why are they opposed to greater company earnings that they might get a share of?

It could be that the reason that this is believed to profitable is that it would decrease demand for unionized employees thus reducing costs. This would be consistent with raising prices and decreasing supply after acquiring a substitute. Further, it could be a negotiation ploy by management to decrease union bargaining power. This is what the Allied Pilots Association (APA) is arguing:
"If permitted to expand their scope, immunized airline alliances may lead to increased foreign control of U.S. airline operations, including maintenance practices and crew training," the association said in a release.
Alternatively, the lost jobs to feriners could be a red herring and union opposition is the negotiation ploy. The APA is levering potential political clout so as to maximize its share of any potential spoils.

Was this Serious or Ironic?

I learn a lot from the funnies. Today's Pluggers suggests just why post offices are closing.

I know that my purchases of stamps fell dramatically when I fully embraced online bill payments.

The November 2 comic suggest that it was serious.

Tuesday, October 13, 2009

Anticipate moral hazard

Will consumers respond to this incentive?:
Democrats and their allies scrambled on Monday to knock down a new industry-funded study forecasting that Senate legislation, over time, will add thousands of dollars to the cost of a typical policy. "Distorted and flawed," said White House spokeswoman Linda Douglass. "Fundamentally dishonest," said AARP's senior policy strategist, John Rother. "A hatchet job," said a spokesman for Senate Finance Committee chairman Max Baucus, D-Mont.

At the heart of the industry's complaint is a decision by lawmakers to weaken the requirement that millions more Americans get coverage. Since the legislation would ban insurance companies from denying coverage on account of poor health, many people will wait to sign up until they get sick, the industry says. And that will drive up costs for everybody else.

"Legalized extortion?"

Congress debates the Community Reinvestment Act which gives community organizers the ability to delay or block bank mergers by filing complaints against them. 
"In order to avoid these filings, financial institutions would either lower their lending requirements to meet the needs of ACORN associates or they would simply pay out funds to one of the many ACORN-affiliated organizations," Royce wrote in an article posted on his House Web site.
Archived ACORN testimony on the Federal Reserve Board Web site shows ACORN has spoken against bank mergers, contending that banks weren't living up to the CRA. In at least one case, however, ACORN supported a merger. The group acknowledged in the 1998 testimony that it was unusual for it do so, but said one of the banks involved, NationsBank, was a leader in community reinvestment, and that its partnership with ACORN Housing Corp. had produced at least $236 million in mortgages. 

Monday, October 12, 2009

Maybe he is trying to protect us from ourselves

By making sugar more expensive.
a coalition of sugar-using industries petitioned the administration to lift quotas on imported sugar to bring more competition and lower prices to the U.S. market. Bowing to the American Sugar Alliance, the powerful lobby for sugar growers that Obama courted during the presidential campaign, the U.S. Department of Agriculture decided instead to keep the quotas at their current restrictive level. So much for change.

Thursday, October 8, 2009

When to Expect Good Tech Support

My son, off at college, noted that getting useful tech support for his iPod has been a dream compared to the tech support run around he got with his laptop. He asked if higher quality tech support could be a factor in their pricing structures and product markets.

Bright kid, that boy of mine.

This can be viewed as an application of pricing complementary goods. With complements, a price decrease (or quality increase) in B increases the demand for A. If you offer both A and B, it is possible that the lost profits from under-pricing B (or over-investing in quality) is more than made up for with the increase in demand for A. For example, Microsoft gave away their IE browser so as to sell more operating systems (preloaded onto 90% of computers) but Netscape could not.

Many firms give away ancillary services so as to increase demand for the underlying product. This can get tricky with tech support because there is a time lag between the consumption decisions for A and B (i.e., tech support after the initial purchase). Purchasers of A (iPods) have to foresee 1) that they may need B (tech support) later on and 2) that A's producer has better than average price/quality for B (tech support). In this case, developing such a reputation is extremely valuable.

Increasing demand this way is more profitable when the underlying product has a larger price-cost margin. As a consequence, we expect excellent reputations for ancillary services to be more common for products that benefit more from the shift in demand. That is, when it faces less competition. For most laptops, brands are pretty interchangeable. However, various versions of the Apple iPod still command more than half the portable digital player market with significant price premiums. Apple's choice of reputation is no accident.

Per recent FTC rules, I will disclose that I have not received the new iPhone from my brother who works at Apple. Well not yet, hint, hint.

Ticketmaster/LiveNation merger challenged

The UK's Competition Commission is worried about the loss in competition in the market for live event ticketing services:
Prior to the announcement of the merger, Live Nation had signed an agreement with CTS to provide ticketing services for its live music events and venues in the UK. The CC believes that this agreement with Live Nation would have provided CTS with a foothold in the UK market from which it would have grown, increasing significantly the degree of competition in a market which is currently dominated by Ticketmaster and one other large ticketing agent.
Apparently, they didn't think much of the claimed efficiencies, or maybe they missed my characterization of them:
Vertical mergers often yield tangible benefits, which can be characterized under the broad heading of incentive alignment.5 When firms producing complementary services do business with one another, incentive conflicts naturally arise. These conflicts can be over what price to charge, how much to spend on promotion, or on how best to innovate in response to changing conditions. A merger among the providers of these services would likely help manage these incentive conflicts and result in levels of price, promotion, and innovation that would both reduce the size of the wedge between what consumers pay and what performers receive, as well as increase output.
Perhaps the most common incentive conflict is over what price to charge. The double markup occurs when a producer marks up the price of its product or service above marginal cost, and the next producer in the supply chain then marks up its price again, above these already marked-up input costs. You end up with a price that is too high, with too few tickets sold, or too few concerts performed. With vertical integration, the double mark-up can be reduced to a single mark-up, which would reduce size of the wedge between what consumers pay and what performers receive. This would result in lower prices, more tickets sold, more concerts performed, or all three. In popular jargon this is known as “eliminating the middleman.”

Better than the UK; worse than Germany

The world wide housing bubble seems to have missed some countries

Netflix kills its set top box

Don Marron applauds them for ignoring sunk costs:
In short, Reed Hastings is not a man who gets locked in by sunk costs: he’s willing to kill projects (or, in this case, spin them off) even if he’s got years invested in them. A good example for my students when we discusses costs in a few weeks. And just another example of the strengths of Netflix’s culture.

What happens if courts move more slowly than the economy?

You get remedies that don't matter:
"Things change so quickly that you're litigating a case that might be a year, two, three years old, and nobody cares about it now because we're on to completely new and different issues," Froeb said.

The landscape has changed significantly for the industry. Internet Explorer has already lost significant share to Mozilla's Firefox browser. Many, including Microsoft, have raised concerns about Google's monopoly in online search, and regulators in the U.S. and in Europe are examining a proposed Oracle-Sun merger and the Microsoft-Yahoo partnership.

Wednesday, October 7, 2009

How to say "no."

Larry Summers tries to lower expectations in Detroit:
The future of activist government was at stake, he warned. If Obama’s programs wasted money, they would discredit progressivism itself. “I would have guessed that bailing out big banks was going to be unpopular, and bailing out real companies where people work was going to be popular,” he said. “But I was wrong. They were both unpopular. There’s a lot of suspicion around. Why this business but not that business? Is this industrial policy? Is this socialism? Why is the government moving in?”

Looking Ahead and Reasoning Back - Housing Crisis Edition

This one is so easy that it's almost too obvious to post. What do you think buyers of shared appreciation mortgages (SAMs) are doing now that they regret ever taking these loans out? (SAMs offered low or even zero interest rate loans on homes while claiming up to 75 per cent of the any value increase in the homes when the mortgages were repaid.) They are suing, of course.

I think it's interesting that this post follows the one just below discussing that part of the solution to health care cost problems is to force people to bear more responsibility for their decisions. The problem is that people don't want to do this. If something goes wrong with their decisions, they want to go crying to momma and be forgiven.

Tuesday, October 6, 2009

Incentive alignment, anyone?

Colleague Larry Van Horn wants President Obama to stop subsidizing his slovenly lifestyle:
I start each day with my morning “cocktail” of an ACE inhibitor, Beta blocker, and Statin - all grossly subsidized by my health plan. I pay the same monthly premium as every other employee at my workplace with a family health plan. My wages have been reduced to fund the insurance premium behind the scenes, so I never know how much was taken from me. I know the only way to get my money back is to consume the services and drugs.

It’s ironic that I rarely speed on my way to my favorite fast food restaurant.  The consequence of speeding is real and immediate.  I would like to speed and given the opportunity – free of consequences – I’d light up my big-block V8 all the way to the drive-through.  Let’s take it a step further. What if I purchased auto insurance the way I receive health insurance— priced independently of conduct, with a true premium cost hidden from view, which covered all preventive maintenance?  I would drive like a bat out of hell.  The insurance would also be so costly that I wouldn’t be able to afford it.

... unlike my auto insurance, my health insurance rates are not based on my underlying lifestyle choices, which are the primary determiner of how much health care I’m going to consume. We need to get to a world where I’m held individually accountable for the decisions that I make.

Monday, October 5, 2009

Should the H1N1 Vaccine be Sold?

We are big believers in markets to distribute products to those who value the product most. However, economic theory recognizes that personal willingness-to-pay may not be a good measure of economic value when the product is homogeneous and when income differences among customers are large. That is, I have no reason to believe that the marginal utility from avoiding the flu is greater for my college president than for his secretary, but I suspect his willingness-to-pay would be many multiples of hers. In fact, even if his marginal utility was a fraction of hers, he might outbid her simply because he has more income. Thus, if we allocate based on price alone, we are not likely to maximize total utility.

OK, a price system may be less than perfect, but is it better than the alternative? Is there a simple mechanism for discerning where the value is highest? We know that health professionals are at greater risk and we know the age cohorts that are more at risk. We know how the flu is spread and so can target areas where transmission is highest. In this case, I would argue that an average bureaucrat could devise a low cost, yet high return rationing scheme.

What is lost by not selling? First, one loses the the price signal. I suspect that, were it sold, the vaccine price would be quite high initially and then fall dramatically as it mitigates the effect of epidemics. How fast it falls and where would be valuable information for allocating supplies. Second, one loses the profit motive. Not only does the price identify where demand is highest, it also provides an incentive for distributors to meet demand. I suspect these supplies would flow to the greatest need faster than if allocated solely by bureaucrats. Third, one can price discriminate. For some the personal willingness-to-pay will be low, too low. I mean that they will not incorporate the positive externality that they confer onto others in their personal calculations. A reserve of funds from initial high demanders can subsidize these low demanders.

Avoiding the "Chicken Tax"

In 1963, the US imposed a tax on imports of foreign-made trucks and commercial vans in response to European tariffs on imported chicken. These restrictions remain in place today, which puts US automaker Ford in a strange position.

Ford builds its Transit Connect vehicle in Turkey and imports it to the US. To avoid having the vehicle defined as a commercial van, Ford ships them with windows and seats. Once they have passed through customs, however, Ford strips out the seats and removes a number of the windows. Installing and removing the seats and windows costs hundreds of dollars per van but reducing the import tax saves thousands.

One of the worst things you can do to a boss

Box him or her in
By openly declaring their views on the Afghan war, US military leaders have placed President Barack Obama in a bind as he faces a fraught decision over the troubled US-led mission. 
But while a war council takes place behind closed doors at the White House, top military officers have made no secret of their view that without a vast ground force, the Afghan mission could end in failure.
Instead of going public, the military leaders should have provided analysis--instead of conclusions--to the Commander in Chief. 

If the organizational structure is broken, then fix it.  Otherwise, respect the organizational structure that you have.  For bosses this means not jumping over subordinates to get directly involved in their decisions; and for subordinates, this means sending information up the chain of command, and not around the chain of command to your boss's boss, i.e., to the people of the United States.

Friday, October 2, 2009

Govt. subsidy vs. govt. subsidy

An Al Gore-backed company received a $500 million government loan to design and build a care like Nissan's Leaf, due out this Spring. Demand for the Leaf's is also dependent on government subsidies:
Key to its success will be bringing down the cost of the batteries, which currently cost around $10,000 per car to make. Sensibly, Nissan plans to lease the batteries to customers rather than try to sell the car at an inflated price. Initially, the carmaker will share the burden by taking advantage of government subsidies and cheap loans to ensure sales are profitable from day one. The challenge will be to get costs down to a sufficient level by the time governments begin scaling back incentives. Mass production should help.

Iranian kidney sales

Interesting documentary about kidney markets in Iran (60 minutes).

Slums as green engines of development: (fascinating 16 min. video)

Make sure you see the train scene at 6:00-6:50

Thursday, October 1, 2009

Is this collusion?

We report, you decide:
If you are looking for an interesting case to discuss with your classes, I recommend to you the Commission’s complaint against Valassis.  The product at issue in the case was free-standing inserts – the booklets of coupons that come in Sunday newspapers. Historically, two companies each had about half the market – Valassis and News America Marketing, a subsidiary of NewsCorp. According to the complaint, in June 2001, Valassis raised its prices by 5%. When News America did not follow suit, it gained market share.

With News America sticking to its old prices, Valassis decided in February 2002 to abandon its attempts to raise prices and instead to try to regain its lost market share. From February 2002 until the middle of 2004, a price war ensued, with prices dropping more than 15% from those that prevailed in June 2001. At that point, the complaint alleges, Valassis decided to give up on recovering its market share and instead decided to raise prices. It did not, however, want to repeat the experience of raising prices without having News America follow suit. As a result (again, according to the complaint), Valassis decided to communicate its plans during a stock analyst conference call. In that call, the CEO announced 1) that it was raising its prices, 2) that it would not cut prices in order to attract News America’s customers, 3) that it would cut prices to whatever it had to in order to retain its existing customers, and 4) it would only stick with its strategy if News America made it clear that it was not going to try to take Valassis’s existing customers. It even provided details about specific outstanding pricing offers. The text of the conference call is available as Exhibit A to the Commission’s complaint in the case. I suggest you take a look at it and consider using it as case material in your courses.

It's the Incentives, Stupid, IV

It is an encouraging sign that even the NY Times is beginning to look beyond Canada for alternative health care delivery models:
On average, [Swiss] out-of-pocket payments come to $1,350 annually. That is the highest among the 30 countries tracked by the O.E.C.D. and well above the $890 average for the United States, which comes in second.
It is not a surprise that these higher co-payments are associated with lower medical care consumption (11% of income, as opposed to 16% in the US).

Anticipate failure

Rene Stulz explains five type of risk management failures:
  1. Failure to use appropirate risk metrics
  2. Mismeasurement of known risks
  3. Mismeasurement stemming from overlooked risks
  4. Failure to communicate risks to top management
  5. Failure to monitor and manage risk

Ethics and the Financial Crisis

Marketplace interviewed political philosopher Michael Sandel yesterday on ethical issues surrounding the financial crisis. Evidently, he has learned the one lesson of business:

You go up to someone on one of those street corners down by Wall Street. And you ask him or her in a quiet moment, how do you justify this frenzied way of life that you're engaged in? I suspect they would give you in a reflective moment an answer something like this: "By pursuing gain and engaging in risk, we are providing the lubricant for the financial system and therefore for the economic system as a whole. And we are helping contribute to allocating capital to those projects and innovations in the economy that will make everybody better off."

Pretty good. I do have a nit to pick at another point though.
The chief justice of the U.S. Supreme Court, Justice Roberts, makes about $220,000 a year. There's another judge, Judge Judy, a television judge, you know how much she makes? . . . Twenty-five million [dollars] a year. Now that's the result of markets, market supply and demand. Television program people like to watch. Is there any reason to assume that simply because the market has delivered that outcome, that Judge Judy deserves to make 100 times more than Chief Justice Roberts? I would say not.

Please define terms. What do you mean by "deserves?" Chief Justice Roberts also receives the prestige of being Chief Justice while Judge Judy gets the disdain of being a TV judge. Is this deserved too? Unless there is an identifiable market failure (perhaps more likely for Roberts than Judy), I assume that each are generating value in excess of their compensation. Regardless of what they deserve, we third parties receive the excess value that they generate (whether we deserve it or not).