Chapter 6, Promotional Pricing Question

QUESTION:  In a supermarket, an end-of-aisle promotional display typically makes the demand more elastic (see link) by making customers more aware of price differences between products.  

Specifically, suppose that a promotional display changes the price elasticity of demand for a good from -2 to -3. If the normal price is $10, what should the promotional price be? 

ANSWER: 

• STEP 1: Use the optimal pricing formula from Chapter 6 to solve for Marginal Cost (MC) at the pre-promotional elasticity of -2.  
• (PRICE-MC)/PRICE=1/|Elasticity| 
• Margin=Target Margin 
• ($10-MC)/$10=1/2 
• $10-MC=$5 
• MC=$5 
• STEP 2: Use the optimal pricing formula to solve for the new price at elasticity of -3
• (Price-$5)/Price=1/3 
• 3*(Price-$5)=Price
• 2*Price=$15
• Price=$7.50
• CHECK ANSWER:  
• ($7.50-$5)/$7.50=1/3
• $2.50/$7.50=1/3
• 3*$2.50=$7.50
• $7.50=$7.50

The arthritis defense to price fixing

In the late 1980's, I was working at the Antitrust Division of the U.S. Dept of Justice, when I was sent to Iowa to support a price-fixing case against two gasoline stations at the same exit on Highway 35.  Every morning, one station owner would call up the other and ask "what are you charging for gasoline today?"  

He would answer, e.g., "$1.99," and then the first owner climbed up a ladder to change the numbers on her sign to match that price.  

These kinds of conversations are thought to be so bad that they are per-se illegal, i.e., there is no justification for having them other than to fix prices.  If convicted of criminal price fixing, the sentence is one-to-ten years in prison.  

This particular conspiracy was discovered when a disgruntled ex-employee reported it to the federal District Attorney's office, who then told us.  The FBI tapped their phones, and we recorded them having the same conversation every morning over the course of a week.   And just to make sure, we "flipped" the second station owner by offering immunity in exchange for his testimony against the "ring leader," the old lady who initiated the call.  Then the trial team flew out to Iowa to break up the conspiracy and put the bad guys in prison.  

At trial, we played the recordings, explained the law, and rested our case.  

I should have sensed that something was wrong when the the lanky defense attorney came out in a wrinkled, white linen suit, looking almost deliberately like Mark Twain.  He called his first and only witness, the "alleged ringleader of this pernicious conspiracy."

Once he established that if they charged different prices, the station with the higher price would not get any customers, he asked his client "Ms. Smith, can you tell me about your ar-thar-i-tis?"

"It hurts so bad that I can barely make it to the top of the ladder."

"Now you know that you are not supposed to discuss prices with your competitors?"

"Oh yes, but my ar-thar-i-tis hurts so bad that I can climb up only once a day.  If I don't make that phone call, I can be stuck with the wrong price.  

The jury deliberated an hour and then the foreman, came out wearing a John Deere baseball hat and ill-fitting blue jeans over which you could see his butt crack.  He pronounced her "not guilty" on all counts.  

Is the DOJ case against Google stupider than the FTC's tech cases?

The Dept of Justice (DOJ) is upset that Google pays Apple to be the default search engine on iPhones.  If the DOJ wins their case, the "relief" DOJ would seek would proscribe such payments, just as the EU did.  According to one observer, 

"In the wake of the European Commission’s 2018 Android decision, Google had to implement a choice screen (starting in 2019) on Android devices in Europe (which had confined the market to Android devices). No more Google default: users of new devices with the choice screens are presented a half-dozen choices—including Google and obvious alternatives—upon startup. Placement is shuffled at random."

Did this relief change Google's "illegally" acquired & sustained dominance in mobile search?

Well, not exactly.  Google’s share of general search on mobile phones in Europe is still greater than 96%.

QUESTION: So, why would Google pay for something that it would get anyway?  

TENTATIVE ANSWER: Apple has valuable real estate and they are creating ex-ante competition among search engines for the right to use that real estate.  But if search users are going to switch to Google anyway, even if, e.g., Bing outbids Google, then maybe the ex-ante competition is not very fierce.  I wonder how much Google makes on search ads served up on Apple devices, and how much Google pays Apple for the privilege.  

QUESTION: And why would the DOJ ask for relief they know will not work?

TENTATIVE ANSWER: DOJ doesn't care about ex-ante competition.  The see Google's big share of search after they won the ex-ante competition, not as a indicator that the  the most valuable search engine won the auction, but rather as an indicator that something is wrong--or at least could be made better by government interventiion.

Is the opportunity cost of net-zero too high?

For Sweden it is:

It cited the tough economic climate along with a plunging krona, expecting to also fall short on other targets for protecting the environment.

Prosecutorial Discretion: Attorney General Edition

In the late 1980's, I went with a friend to help her work the Ambassador's Ball at the French Embassy, a pay party and charity auction to support MS research.  I bought my first tuxedo and showed up early to sign people in and help set up.  After an hour or so, our job was done and we went inside to join the party.  

We grabbed a drink at the open bar, and into a big room containing the items being auctioned off: cases of rare wine, catered dinners, and vacation homes in exotic locales.  My favorite, or at least the one I might have bid on but for the money, was a week at a Chamonix chalet.  In front of each item was a lined piece of paper where people wrote down their bids.  

As the night wore on, I noticed two couples actively bidding for the chalet.  One couple would watch the other write down a bid, wait a while, and then walk over and bid again.  This went on for three or four bids, until I noticed the two couples talking to one another.  

At the time, I worked as a staff economist at the Antitrust Division of the US Dept. of Justice, challenging  anticompetitive mergers and prosecuting conspiracies to fix prices, allocate customers, or rig bids.  For these kinds of criminal conspiracies, the Sentencing Guidelines recommend prison terms up to ten years.  

I had worked on and written about a number of bid-rigging conspiracies--dealers at antique auctions, loggers at Forest Service timber auctions, and Frozen Perch sellers at Navy Procurement auctions--so I was excited to actually witness one.  [note: The Economist has reported on my articles on bid rigging albeit with a small mistake].  

The event was chaired by Ursula Meese, whose husband Ed was my big boss, the Attorney General.   I saw him standing by himself in the center of the room, so I walked over, showed him my badge--that's what I liked to call my work ID--and told him what was going on. 

"Do you want me to take 'em down?" I asked.  

He smiled and said "Book 'em Danno."  [reference for those too young]

========

Middle panel of my first-day class slide shows Attorney General Meese and me in the Reagan Justice Dept.  

How would you align the incentives of a Data Protection Officer with the goals of the organization?

 In a previous posts, we have blogged about the onerous EU privacy rules.  Just came across another, a GDPR Data Protection Officer or DPO.

According to Article 38, other employees in the organization aren’t allowed to issue any instructions to the DPO regarding the performance of their tasks. So, not only does the DPO have wide-ranging responsibilities, but the position is shielded from potential interference from the organization.

Wow. What is the performance metric, and are you prohibited by law from tying pay to performance as it could constitute "interference?"

Capital Gains Taxes destroy wealth in these EU countries

If you tax something, you get less of it.  In EU countries without capital gains taxes (Switzerland, Belgium, Luxembourg, Turkey, Slovenia, Czech Republic and Slovakia), an investment that costs $100, but returns $150 after five years has an annualized Internal Rate of Return (IRR) of 8.45%.  In other words, this investment is not profitable unless your cost of capital is less than 8.45%.

For the countries with the highest capital gains rates, Denmark (42%), Norway (35.2%), and France (34%), this investment won't get made unless capital costs are less than 5.2%, 5.7%,  and 5.9%, respectively.  

BOTTOM LINE:  the higher the capital gains rate, the smaller the investment, and the poorer is the country, compared to what it would be without a capital gains tax.

In-class question (Ch1): Wells-Fargo

QUESTION:  In 2016, Wells Fargo was fined $185 million for fraudulent sales practices. The bank's employees had opened as many as 2 million unauthorized bank and credit card accounts in customers' names. Figure out what the problem is and select the best way to fix it.   

 1. Let someone else make the decision.

 2. Change the incentives.

 3. Give the decision-maker more information. 

DEBRIEF (LINK): 

1. Let someone else make the decision: Replacing the CEO and firing thousands of employees was part of the response, but it doesn't address the root problem - the sales-oriented incentive system. 

 2. Change the incentives: This would be the most effective solution. After the scandal, Wells Fargo had to review and change its sales practices and incentive systems to focus on customer satisfaction rather than solely on sales volume. 

 3. Giving the decision-maker more information: This alone would not have been sufficient. The executives were aware of the aggressive sales culture. The issue was the incentive system, which encouraged employees to open unauthorized accounts. 

How Saudi Aramco, world's largest oil company, became "Green"

Irony is my favorite kind of humor!  From Bloomberg:

The unlikely tie-up between Aramco and ESG began with the creation of two subsidiaries — the Aramco Oil Pipelines Company and the Aramco Gas Pipelines Company. Aramco sold 49% of the shares in each unit to consortiums led by EIG Global Energy Partners LLC and BlackRock Inc., respectively. These investors used bridge loans from banks to fund those transactions.

In order to generate cash to repay the bank loans, the EIG and BlackRock consortiums created two special purpose vehicles: EIG Pearl Holdings and GreenSaif Pipelines Bidco, both registered at the same Luxembourg address. These SPVs then sold bonds, which, since they had no direct links to the fossil-fuel industry, ended up getting an above-average score in a widely-used JPMorgan Chase & Co. sustainability screening based on third-party ESG scores.

From there, the bonds made their way into JPMorgan’s ESG indexes, which are cumulatively tracked by about $40 billion of assets under management. Investors in the SPV bonds include funds managed by UBS Group AG, Legal & General Investment Management and the investment arm of HSBC Holdings Plc.”

BOTTOM LINE: if you cannot measure it (ESG), you cannot control it.

What is a debt coverage ratio, and how does it affect apartment rents in Nashville ($1880)?

 From investopedia:

• The debt-service coverage ratio (DSCR) measures a business’s cash flow (Net Operating Income) divided by its debt payments, including principal and interest. 
• Lenders use a DSCR between 1.15 and 1.5 to determine whether to make a loan to a developer.

Here is an example, involving the cheapest loan available.

• A Nashville builder can build apartments for $167K/unit= $150K(construction) + $17K(land)
• FHA is willing to lend at $167K at 6% for 40-years, resulting in a debt payment of $986/month.  
• With FHA's DSCR of 1.15, the builder must make at least $1134/month in Net Operating Income (NOI) to qualify for a loan.  
• With 7% vacancy the expected NOI increases to $1213/month
• Add operating cost to NOI to get Rent=$667+$1213=$1880/month 

New apartment supply will enter the market when Nashville rents rise 20% to $1880.

HT:  Bill H.