Why house prices go up

Car Wash Industry Dynamics

"The Economics of Everyday Things" a recent episode on Car Washes. Lots has happened to transform this industry.

•  Growth - The industry is growing fast thanks, in part, to less "home production."

  When we started in— back in 1996, more than half of people with cars in the U.S. reported that they most frequently wash their car themselves in the driveway. Our most recent survey, we’re approaching 80 percent now use a professional car wash.

• Bundling - New technology has allowed new pricing schemes more like subscription services or gym memberships that are likely to increase consumer surplus capture.

We fix a little RFID sticker in the bottom corner of your window. And it knows exactly what wash to get, how often you’ve washed and what vehicle you’re in, any contact information. It’s kind of like a barcode, if you will, for your vehicle. And when you pull up to the pay station the gate goes up immediately.

• Input Substitution - Increasing use of technology has reduced labor costs.

A modern car wash today can be run with three or fewer employees versus having, you know, 12 to 25 at some stores back in the day. In those days, car wash owners were almost like farmers. I mean, you’re always watching the weather. You’re always trying to anticipate what demand is going to be so you can manage that labor expense.

All these changes have manager implications. Growth often allows firms to exploit sale economies. Bundling is easier with multiple establishments run under the same brand. Fewer workers could mean more decision rights to each one suggesting more incentive compensation.

Shirking at Hotels

A new paper by Matthew Freedman and Renáta Kosová titled, "Agency and Compensation: Evidence from the Hotel Industry" examines franchising as a way to motivate hotel managers to limit shirking by their employees. The money quote is actually from the travel magazine Budget Travel in which a housekeeper relates:

I cut corners everywhere I could. Instead of vacuuming, I found that just picking up the larger crumbs from the carpet would do. Rather than scrub the tub with hot water, sometimes it was just a spray-and-wipe kind of day… After several weeks on the job, I discovered that the staff leader who inspected the rooms couldn't tell the difference between a clean sink and one that was simply dry, so I would often just run a rag over the wet spots… I apologize to you now if you ever stayed in one of my rooms. You deserved better. But if housekeepers were paid more than minimum wage — and the tips were a bit better — I might have cleaned your toilet rather than just flushed it.

Since it is pretty difficult to monitor this behavior, you might want to use an incentive contract with employees. To get hotel managers to have a motive to implement such contracts, you might want to franchise the hotels. In a pretty carefully done study, Freedman and Kosová find that, relative to company owned hotels, franchise operations rely more on hiring practices characterized by low initial pay with more bonuses and more merit based pay.

Today's youngsters (under 40) will not enjoy anything like the returns their parents made

From The Economist:

... the four decades to 2021 were a golden age for investors. A broad index of global shares posted an annualised real return of 7.4%, .., global bonds posted annualised real returns of 6.3% ...

That golden age is now almost certainly over. It was brought about in the first place by globalisation, quiescent inflation and, most of all, a long decline in interest rates. Each of these trends has now kicked into reverse. As a consequence, youngsters must confront a more difficult set of investment choices

...these long-run averages are 5% and 1.7% a year for stocks and bonds respectively

Advice to the under-40 "youngsters,"

• Don't hold so much cash, ... "young investors’ preference for cash leaves them exposed to inflation and the opportunity cost of missing out on returns elsewhere." [but money market funds are yielding 5% right now]
• Hold more bonds, ... "...they have a tendency to outpace inflation that cash does not."
• Avoid “thematic investing”, ... "...Niche strategies are nothing new, and nor are their deficiencies. Investors who use them face more volatility, less liquidity and chunky fees.."

 

Why housing prices are going up, despite higher interest rates

 

From The Economist:

Three factors, however, explain why housing markets have so far brushed off higher rates. 

1. Increased Demand: The pandemic seems to have made people more hermit-like: they work from home more and spend relatively more time on home entertainment than on going out. People thus place a higher value on their living space, raising demand for housing. 
2. Fixed-rate mortgages: Between 2011 and 2021 the share of mortgages in eu countries on variable rates fell from nearly 40% to less than 15% (although some of the rest are fixed for only a few years). The effect has been to delay the impact of rate rises. Since 2021, the average mortgage rate across the rich world has only risen by half as much as the average central-bank policy rate. 
3. Richer Homeowners: Following the property crisis that began in 2007, many governments introduced tougher regulations, shutting out less creditworthy borrowers. Richer folk find it easier to weather higher interest bills. In addition, many borrowers are still sitting on large “excess savings” accumulated during the pandemic...

Nash Equilibrium Intuition from "A Beautiful Mind"

 

I could quibble but it does pretty good in under a minute.

How PBM's and Government bargain

When the US government buys drugs, they penalize drug companies with huge taxes if they don't reach agreement.  From Marginal Revolution:  

The “negotiation,” if you want to call it that, is “your money or your life” and fairness has little to do with it. The IRA also requires very costly inflation rebates, i.e. a price control/tax.

This reduces the gains to innovation, equivalent to weakening patent protections at a time when the gains to innovation in pharma are big.

In contrast, the private sector uses PBM's to create bargaining competition to reduce drug prices (Froeb and Shor, 2023) 

For 181 million Americans not on Medicare or Medicaid but insured through their employer, labor union, or private insurance health plan, the primary restraints on pharmaceutical prices are pharmaceutical benefit managers (PBMs) who administer health plan drug benefits. PBMs use the aggregate demand of their constituent plan sponsor clients — employers, unions, government agencies, health insurers, and others — to negotiate lower prices

These PBM's create competition between drugs within a therapeutic class by setting up formularies (lists of covered drugs) for Health Plans. Drug manufacturers compete by offering lower prices to get onto the preferred tiers of formulary, those with lower co-pays.

... Consider Lipitor and Crestor, two leading statins, or lipid-lowering cholesterol medications. The placement of one drug on a more favorable tier than the other can considerably shift sales volume in favor of the preferred drug. Economists at MIT and Wharton estimate that the statin manufacturers are willing to offer rebates of up to 54% in return for favorable placement.

2019 REPOST: 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.

Equity risk premium for stocks at all time low

 

WSJ:  Whatever happens to change it, there is a consensus on Wall Street that the equity-risk premium can’t stay this low forever.

ANALYSIS:  This is the Chapter 9 logic to value stocks relative to bonds, and right now it looks as if the stock market is over valued relative to bonds. 

DISCLAIMER:  if I really knew, I wouldn't be teaching school and I would charge you for the information.

House prices going up again

 

• Home prices came in exceptionally strong in August, rising a seasonally adjusted +0.68% from July; August’s non-adjusted gain (+0.24%) was more than 60% larger than the 25-year same-month average (+0.15%)