Thursday, December 31, 2009

Pay Limits and Adverse Selection

Some AIG executives are quitting over pay limitations imposed by the government. And, who do you think are the most likely people to quit? The better employees, of course.

Wednesday, December 30, 2009

Cut out the middleman

By going straight to a medical lab:
The name of one fast-growing chain of walk-in labs encapsulates the field's business model, Any Lab Test Now. The company says it can generally have testing results within 24 hours and at a cost that is as much as 80 percent less than going through a doctor. The lab franchises offer up to 1,500 tests, from a simple cholesterol check to more sophisticated packages of tests that address complex medical issues.

Tuesday, December 29, 2009

Everyone wants to go to heaven, but no one wants to die

The Secretary of Agriculture is concerned that farmers will respond to the incentives to reduce carbon by--get ready for ths--reducing carbon. 
According to the economic model used by the department and the Environmental Protection Agency, the legislation would give landowners incentives to convert up to 59 million acres of farmland into forests over the next 40 years. The reason: Trees clean the air of heat-trapping gases better than farming does.
"If landowners plant trees to the extent the model suggests, this would be disruptive to agriculture in some regions of the country," he said.

Monday, December 28, 2009

XKCD Learns the One Lesson of Business

The XKCD web comic takes the Spinal Tap "These go to eleven" scene to its logical business conclusion.

Note that the original's alt-text jokes about confusing averages for marginals.

Want to be Happy? Be a Teacher

The the Gallup-Healthways Well-Being Index indicates that teachers score highest "on how they evaluate their lives, access to resources needed to lead a healthy life, emotional health, and their the likelihood of engaging in healthy behaviors."

Tuesday, December 22, 2009

Increasing Incentives to Donate Organs

Continuing our interest in the issue of organ donation, here's some promising news from Israel. The country now gives higher priority in receiving donated organs to those who have volunteered to donate themselves. Close relatives of volunteers also receive higher priority.

The story quotes the head of science and ethics at the British Medical Association, who has some concerns. "Once you start prioritising certain groups, for example those that sign up to the organ register, patients who are really sick and in danger of dying if they don't receive an organ may end up being pushed to the back of the queue".

I think this really misses the point. If you don't do something to increase donation rates, patients who are really sick and dying aren't going to get an organ.

(HT: Marginal Revolution)

Monday, December 21, 2009

Last Minute Gift Idea

Shouldn't everyone have one of these?

Available from the American Economic Association for only $15. Uncle Miltie looks particularly happy.

Thursday, December 17, 2009

Lincoln Electric: how to align the incentives of employees with the goals of the organization

Zoning run amuck

Gallatin Pike is one of the main commercial corridors in Nashville.  It is home to pay day lenders, pawn shops, and used tire stores.  In July 2007, NIMBY residents rezoned it for coffee shops, art cafes, and book stores.  Here is my take on the likely effect of the zoning.
  • The Gallatin SP zoning creates mismatch between (zoned) supply and demand which causes reduced sales, investment, and tax revenue
  • The alternate view, that SP zoning would create new demographics (higher density) to support the zoned uses seems unlikely because the compliance trigger reduces incentive of existing firms to renovate or rebuild

Microfinance Impact

Tim Harford, the Undercover Economist, reviews recent evidence on the value of microfinance programs. The title of the article gives away the punchline: "Perhaps microfinance isn’t such a big deal after all"

Tuesday, December 15, 2009

Why don't bidders like auctions?

In the Berkshire Hathaway Annual report, Warren Buffet tells us how he buys companies.
We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer —customarily within five minutes — as to whether we’re interested. We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don’t participate in auctions.

When participation in an auction is costly, Buffet's dislike of auctions is explained by a recent article by Jeremy Bulow and Paul Klemperer.  They find that auctions are less efficient than sequential bargaining because too many bidders enter auctions.  But it is precisely because of this inefficiency that auctions return higher revenue to the seller, which is why Buffet doesn't participate in them.  And if you do find yourself in a sequential bargaining, try a pre-emptive offer to discourage the seller from searching further.

Harbinger of inflation?

Yield curve is getting steeper. (SOURCE: Laffer Associates)

Monday, December 14, 2009

How the French discourage innovation in winemaking

Incentives Matter - Airline Bathroom Edition

In an interview with the Wall Street Journal, Michael O'Leary, CEO of Ryanair, discusses some "mad ideas" he has for improving his airline's performance. One of them is installing pay toilets on planes.
Now we're looking at charging for toilets on board—not because we want revenue from toilet fees. We'd happily give the money away to some incontinent charity. What it means is, if by charging for toilets on board, more people would use the toilets in the terminals before or after flights, I could take out maybe two of the three toilets on board, add six extra seats and reduce fares across the aircraft by another three or four percent.

So, there's always new ways of lowering costs, but you have to come at it with some imagination and some passion.
Nice to see that someone has passion for toilets.

Price Discrimination is "Unethical?"

MR has a link to a pricing scheme relevant here. A shop owner searches her soul but maximizes profits anyway.
Mata says she knows it's "unethical," but she sizes people up and names a price that she thinks fits the client.
My students like to argue with me about the "fairness" of price discrimination but I try not to take the bait. I would love to debate philosophy with them but have to point out that this is irrelevant. Fair, ethical or otherwise, it is often profitable. Those who eschew the practice will be replaced by those who do not.

Thursday, December 10, 2009

The final victory of form over content

As the season of grading is upon us, I have been reading too many sentences like this one:
To foster cost effective content, failure to enter solution mode requires restructuring the subtle overhaul.  

Generate more than 40 million sentences like this--from real MBA papers--with Mike Shor's MBA writer.  But if you want to learn to think so that you don't have to BS, READ THIS BOOK.

Wednesday, December 9, 2009

Does anyone want a pound cake?

If the cost of a gift to the giver is bigger than the value of the gift to the recipient, then gift-giving is inefficient. Joel Waldfogel estimates that we lose 20% of our $65B annual gift giving this way:
It's bad enough that we buy a lot of stuff that no one wants. It turns out we buy it using money we don't yet have. It wasn't always this way. In the 1930s, almost 10 percent of Christmas spending was financed with money squirreled away into Christmas clubs—bank accounts paying little interest but helping consumers save for the holiday. Participants promised to contribute weekly, frequently as little as $0.25 at a time. These accounts were popular because they helped even unsophisticated consumers—many of whom didn't have another bank account—avoid the temptation to fritter their money away. Since 1970, by contrast, the explosive growth in consumer credit has had the opposite effect, helping consumers fall prey to their lack of self-control when it comes to borrowing. In recent years, one-third of holiday spending is still not paid off two months after Christmas.

Volcker Disses Financial Innovation

Paul Volcker, former chairman of the Federal Reserve and current chairman of the President's Economic Recovery Advisory Board, took a shot at the banking and finance industry yesterday during the Future of Finance Initiative sponsored by the Wall Street Journal: “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”

He wasn't totally critical of the industry, however: "The most important financial innovation I've seen in the last 25 years is the automatic teller machine." Ouch!

Euro dollars, dollar-denominated savings accounts from European banks not subject to US regulation, have allowed lenders and borrowers to by pass usury ceilings on interest rates.   Surely that counts as an unambiguous contributor to economic well being.  --Luke

Tuesday, December 8, 2009

Does extending unemployment benefits...

...lead to longer unemployment duration?

SOURCE:  Laffer Associates

Lincoln Electric headcount reductions

One of the best examples of how to align the incentives of employees with the goals of the organization is Lincoln Electric.  I show a 15 year old video (Lincoln Electric 11-08-92, distributed by Ambrose Video Publishing, Inc., 800-843-0048.), and students invariably ask how they are currently doing. Despite the downturn, their recent financials look great. 
For example, we began to implement headcount reductions and reduced work schedules throughout our global operations in the latter half of 2008, and improved our purchasing practices to take advantage of lower raw material costs. Further, on February 2, 2009, we announced a 10% global workforce reduction for annualized savings of approximately $80 million, a minimum of $20 million reduction in capital expenditures, a freeze on salary increases and external hiring, and a base pay reduction for all executive management. These actions will help to further lower our cost structure and better align our business to the current weak economic conditions.

Monday, December 7, 2009

Incentives Matter – DARPA Balloon Contest Edition

Did you happen to notice any large red balloons in your area this past weekend? The Defense Advanced Research Projects Agency (DARPA) of the Department of Defense held its Network Challenge on Saturday, a competition that challenged participants to find and submit the locations of ten 8-foot red weather balloons across the continental United States. The prize to the winning participant: $40,000. The purpose of the challenge was to:
to explore how broad-scope problems can be tackled using social networking tools. The Challenge explores basic research issues such as mobilization, collaboration, and trust in diverse social networking constructs and could serve to fuel innovation across a wide spectrum of applications. DARPA plans to meet with teams to review the approaches and strategies used to build networks, collect information, and participate in the Challenge.
Well, you might imagine that incentives were a big part of the winning team’s formula. The MIT Red Balloon Challenge Team offered $2,000 to any individual who sent them a correct location of a balloon. But, to exploit the networks of individuals, they offered additional incentives. If you invited someone to participate in the MIT group and that person found a balloon, you would receive $1,000. If someone invited you (and you invited someone who found the balloon), that person would receive $500 and so on.

How effective was the approach? It took the MIT team less than 9 hours to submit the location of all ten balloons.

Thursday, December 3, 2009

How much will students bid for a jar of coins?

If you are behind on your mortgage, try auctioning off a jar of coins in class.  These are the bids from two sections of Managerial Economics (for MBA's) for a jar with $26 in it.  Justify the profit by saying you were only teaching them how to avoid the winner's curse in common value auctions. 

Why can't homeowners walk away from under-water mortgages?

Because they carry too much emotional baggage to make rational decisions:
1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to induce homeowners to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision.

Wednesday, December 2, 2009

All Pay Auctions

The folks over at have implemented something like an all-pay auction. You pay "the house" a small amount with each bid and each bid extends the closing time a bit. This makes all past bids sunk costs and can raise much more money than the object's value. The best strategy is usually not to bid at all.

The Reputation of Business in the Dumps

The Pew Research Center recently released results of a telephone survey of US adults regarding (among other things) their opinions of various professions. Apparently, most people don't share the opinion of Goldman Sachs CEO Lloyd Blankfein who said his firm is doing "God's work" in helping companies grow. Here are the professions ordered by the percent of people who think the profession contributes a lot to the well-being of society.
  • Members of the Military 84%
  • Teachers 77%
  • Scientists 70%
  • Medical Doctors 69%
  • Engineers 64%
  • Clergy 40%
  • Journalists 38%
  • Artists 31%
  • Lawyers 23%
  • Business Executives 21%
Doesn't moving assets to higher-valued uses contribute a lot to the well-being of society? Sad

Tuesday, December 1, 2009

Bargaining exam question

Suppose that a grocery store knows that 50% of its customers are Coke Loyalists (they consume only Coke); 25% are Pepsi Loyalists (they consume only Pepsi); and 25% are Switchers (they will consume either Coke or Pepsi).  If the Grocery store did not carry Pepsi, they would earn $15 million on Coke sales (before payment to Coke);  and if the store did not carry Coke, it would earn $10 million on Pepsi sales (before payment to Pepsi).  Currently the store carries both Coke and Pepsi, and earns 20 million on total soft drink sales (before payment to Coke and Pepsi). 
  1. How is the $20 million profit split between Coke, Pepsi, and the Grocery store?
  2. How would the profit be split if Coke and Pepsi merged and bargained jointly?
HINT:  the alternatives to agreement determine the terms of agreement.

NOTE:  Professors, e mail me for the answer.

REFERENCE:  Werden, Gregory and Luke Froeb, Unilateral Competitive Effects of Horizontal Mergers II: Auctions and Bargaining, Issues in Competition Law and Policy, W. Dale Collins (ed.), ABA Section of Antitrust Law, 2008, vol. 2, 1343. Available at SSRN:

Monday, November 30, 2009

MSFT's exclusivity strategy

Is MSFT trying to "tip" the search engine market in their favor:
In an effort to keep News Corp.'s (NWS) newspaper content out of Google's search results, Murdoch's media giant has held early-stage talks to forge a deal that would put content from The Wall Street Journal, and possibly other company-owned publications, exclusively in Microsoft's Bing search engine, a person familiar with the talks says. The discussions come amid Murdoch's mounting frustration that Google (GOOG) benefits at the expense of his own media outlets when Web users search for news online. But analysts and antitrust experts say the move will do more to hurt Murdoch than Google.

In exchange for the exclusive content, Microsoft (MSFT) would pay an undisclosed fee, according to the Financial Times, which initially reported the discussions. Microsoft has also approached other news outlets about a similar agreement, the report said.

Microsoft would use exclusives with widely read publications as a way to gain share in the lucrative market for online search. Bing has a mere 9.9% of search traffic, vs. Google's 65.4%, according to October data from ComScore (SCOR).

Europe is mad at China

Because their trade deficit is growing:
The yuan is tightly linked to the dollar, not the euro. As the dollar has declined against the euro, the yuan has fallen with it, making Chinese goods cheaper in Europe and European goods more expensive in China.

Why are so many companies buying suppliers or distributors?

From Wall St. Journal:

The real meaning of Thanksgiving

From Stossel:
When the Pilgrims first settled the Plymouth Colony, they organized their farm economy along communal lines. The goal was to share everything equally, work and produce.

They nearly all starved. ...

The people of Plymouth moved from socialism to private farming. The results were dramatic.

"This had very good success," Bradford wrote, "for it made all hands very industrious, so as much more corn was planted than otherwise would have been. ... By this time harvest was come, and instead of famine, now God gave them plenty, and the face of things was changed, to the rejoicing of the hearts of many. ... "

Incentives Matter - Pink Jail Edition

The Ben Hill County jail in Georgia is going pink - as in walls painted Pepto pink, pink coveralls, as well as "pink shower shoes, pink wash clothes, pink towels, pink sheets and pink blankets" The sheriff is hoping for an additional deterrence effect from making criminals live in a tween girl paradise.
"This is our decor and if they don't like our decor then they don't have to come back to our jail," said the Sheriff.
What's next, forced viewing of "Twilight?"

Kelo v. City of New London Update

In 2005, the US Supreme Court ruled (in a controversial decision) that government could use its power of eminent domain to transfer land from one private owner to another to further economic development. The City of New London had created the New London Development Corporation, a private body, to re-develop a neighborhood area surrounding Fort Trumbull and a new Pfizer research facility. The plan promised over 3,000 new jobs and increased annual tax revenue of a million-plus dollars a year.

So, how are things working out four years later? No re-development has occurred, and Pfizer just recently announced that they will be closing its facility in the area.

Tuesday, November 24, 2009

What was Lehman thinking?: McAllister Ranch


Should the H1N1 Vaccine be Sold? III

Earlier, I speculated on the effects of allocating the H1N1 vaccine without price signals and then suggested that doing so could increase theft. I forgot to mention that doing so also encourages the emergence of black markets that tend to undermine the intended allocation mechanism.

Monday, November 23, 2009

Optimizing Clothing Coverage

According to researchers from the University of Leeds, who studied the drawing power of women in a nightclub setting, women should bare 40 percent of their body in order to attract the most men.
The study, published in the journal Behaviour, found that the most popular women combined the 40 per cent rule with tight clothing and provocative dancing. The 15 per cent that combined all three criteria were approached by 40 men each.

Friday, November 20, 2009

Stupak Amendment Economics

Normally, I would refrain from weighing in on the landmine-strewn issue of abortion. But an NPR Morning Edition story today made me think of some economics of insurance coverage for abortions. It appears that swing votes on health care reform in the Senate will hinge on the Stupak amendment determining how restrictive the federal government will be in allowing insurance payments for abortions. The quote that piqued my interest was:

"Democrats who support abortion rights said the Stupak language would put such a regulatory burden on private insurers that cover abortion that they would stop. And for the first time, private citizens would be blocked from obtaining a legal medical procedure."

Not covered by insurance is not the same as being blocked. This begs the question of the efficiency of insuring abortions, or live deliveries by-the-way, at all. Because we know what causes it, pregnancy is an almost completely preventable condition where insurance could induce moral hazard. That is, if the average family has 2.2 children and the average delivery costs $5,000, then the family could pay the $12,000 in higher insurance premiums or at the "point-of-purchase." Insuring deliveries may induce more of them (though I doubt this is a big effect) or more expensive deliveries (whither the mid-wife?).

There is a claim, with little evidence that I know of, that many young couples substitute abortion for contraception. That is, couples are less willing to use contraception because they know that abortion is available. This too would be moral hazard. While access to cheap and safe abortions likely reduces unwanted births, it is also plausible that it increases unwanted pregnancies, the difference representing more terminations. If so, blocking insurance coverage for abortion would raise its marginal cost, leading more couples to use the contraception substitute. As a consequence, I would expect to see an increase in contraception and a decrease in unwanted pregnancies, but a likely increase in unwanted births as the substitution would not be perfect. The magnitudes of these effects could possibly be estimated if the Stupak amendment passes.

I have tried to stay morally neutral in this analysis. A moral calculus of the Stupack amendment, it seems to me, would then place weights on the social benefits of fewer pregnancy terminations versus the social costs of more unwanted births. The magnitudes of these benefits and costs are largely outside of the realm of economics.

Wednesday, November 18, 2009

Why are New Car Prices so Low on Black Friday?

According to research by, the day after Thanksgiving is the best day of the year to buy a new car.
The average new car discount on Nov. 27 is projected to be 7.5%. The average discount the day before and after is expected to be just over 6%. On a typical day throughout the year, car shoppers usually pay about 4.7% less than the sticker price. projected particularly large Black Friday discounts on certain models. For instance, consumers should be able to pay about 28% off sticker price for a 2009 Suzuki SX4 compact car, 26% off for a 2009 Nissan Titan or Ford F-150 pick-up or 20% off a 2009 Hyundai Sonata sedan.
The article notes that one explanation is that Black Friday falls toward the end of the month when dealers are feeling the pressure to fill monthly quotas. So, that explains why discounts might be higher relative to days earlier in the month. There are also a lot fewer people shopping on Black Friday compared to days near the end of other months. With no one else around, the salesperson's outside alternative to selling to you is pretty poor, so you can bargain for better deals.

Tuesday, November 17, 2009

Satire of the bailout

This Saturday Night Live skit was allegedly banned by NBC.

St. Lloyd

I finally got around to reading the Times of London piece in which Goldman Sachs chaiman and CEO, Lloyd Blankfien, claims to be "doing God's Work." A key quote is:

"We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle." To drive home his point, he makes a remarkably bold claim. "We have a social purpose."

Despite the article's swipes (why is this claim bold?) at the investment banking culture, I am convinced. These guys are singularly driven to make money and they succeed spectacularly. They are arrogant, brash, hyper-ambitious and probably not much fun at a tailgate party. But the rest of us are wealthier for their effort. It would be an impossible bar bet to settle but I would conjecture that Goldman Sachs has had as much of a positive impact on the lives of the poor worldwide as has Muhammad Yunus's Grameen Bank.

Oyster Strategy

Also on Morning Edition today was a story about the FDA protecting us from contracting Vibrio from eating raw oysters. Two snippets caught my attention.

First, it appears that the FDA will put this on hold to study the costs and benefits. Just what should the threshold costs be to the industry to justify not saving 30 people from getting sick and half dieing? Were these costs not studied over the last decade since "the public health debate over Vibrio was getting national attention in the mid-1990s?"

Second, Mike Voisin of Motivatit Seafood, a firm already protecting us from bad oysters, wants to FDA to back off. The usual "Raising Rival's Costs" theory is that early adopters want to impose the adoption costs on other firms by making the government mandate the adoption. He is clearly doing the opposite. Another possibility is that his firm derives market power from the product differentiation from "dirty" oysters and does not want the competition from more firms with closer substitutes. A third possibility is that this is what he truly believes and is advocating against his firm's own interest. We may not expect such an public exercise in moral hazard from the hired help, but since Mr. Voisin is also the owner, it may be plausible.

Will the Internet Undermine Movie Pricing?

Movie pricing has been a classic example of price discrimination. Get the most money from those willing to go to theaters. Get a little less later from DVD sales. Drop the price a bit more from viewing it on HBO. Finally, get what you can from "free TV" advertising.

So where does Internet delivery fit into the mix? There will be piracy, but this does not appear to be as big a problem as with music. This Morning Edition story claims that Internet delivery combined with HDTV is beginning to upset the whole deal.

Monday, November 16, 2009

Now only 3 blocks from the beach

One of my students built a house four houses away from the beach in Nags Head (pictured at left), partially due to subsidized FEMA flood insurance. Thanks to Tropical Storm Ida,they are now one house closer to the beach. 

Three more storms like Ida and my student will own beach front property.

UDPATE:  FEMA insurance offers $1million coverage for $2000/month.  

iPhone App for Organ Donation

We have often discussed the problem of the shortage of organs available for donation. In a recent New York Times column, Richard Thaler of the University of Chicago (and one of the authors of Nudge) urged Steve Jobs to develop an iPhone app that would facilitate more people donating organs.

Turns out, you don't have to wait for Apple. A company called Serenity Integration developed an app called Donate Lives that identifies where users live and then directs them to the web site from the state where they live that lets them sign up to be an organ donor.

Wednesday, November 11, 2009

"Results not typical" disclaimer is no longer enough

The most effective testimonial advertising mentions a number, like "I lost 74 pounds wearing Slimming Insoles."  Not only are some consumers too naive to realize that the number (if truthful) is being drawn from the tail of a distribution, but they also have the Lake Wobegon bias (where everyone is above average) that tells them that they can probably do better than the person in the testimonial.  For these reasons, virtually all the fraudulent advertising at the FTC involves testimonial advertisements that mention a number. 

Now the FTC is trying to limit the use of testimonials

Under the revised Guides, advertisements that feature a consumer and convey his or her experience with a product or service as typical when that is not the case will be required to clearly disclose the results that consumers can generally expect. In contrast to the 1980 version of the Guides – which allowed advertisers to describe unusual results in a testimonial as long as they included a disclaimer such as “results not typical” – the revised Guides no longer contain this safe harbor.

But remember that testimonials can be used for good or for evil. Jenny Craig, the legitimate weight loss system, uses testimonials throughout their website, e.g.

Kristen S. Age: 32
Weight Lost: 28 lbs*

I had a baby not too long ago, and found myself struggling to get the weight off. It was easy to put the weight on, but getting if off was another story. I love caring for my baby, but would ...

*Results not typical

Now it looks as if they will have to qualify these testimonials with formal statistical studies, raising the cost and reducing the effectiveness of their weight loss message.

Best site on the web  Click on South Africa and Zimbabwe and watch the tragedy unfold.

How to Convey Free Trade Arguments

When I want to see an Economic argument made in its simplest and clearest form, I am usually led to Steven Landsburg.

The Costs and Benefits of Off-Label Marketing of Pharmaceuticals

Pharmaceutical companies are prohibited from marketing products for uses other than those approved by the FDA. Despite this prohibition, the practice seems to remain fairly widespread according to this Bloomberg article. As just one example, Pfizer recently paid the largest criminal fine in history, $2.2 billion, for off-label promotion of Bextra. Bextra was approved only for the relief of pain associated with arthritis and menstrual discomfort; however, the company had been promoting it for all types of pain relief.

With such huge potential fines, why would pharmaceutical companies engage in this type of behavior? Perhaps it’s a rational calculation of the costs and benefits. Another example discussed in the article is the epilepsy drug Neurontin. Pfizer paid a $430 million penalty in 2004 for promoting off-label use. But, the drug has brought in over $12 billion in revenue, a large portion of which came from off-label use.

Let’s see if we can calculate the expected costs and benefits. The article notes that the prosecutor’s sentencing memo claimed the 94% of Neurontin’s 2004 revenue came from off-label use. Assuming off-label uses might have grown over the years (and just to be conservative), let’s assume that 50% of the $12 billion in Neurontin revenue came from off-label uses. In the early 2000’s, Pfizer’s net margins were running around 20%, meaning that off-label Neurontin sales generated around $1.2 billion in profit. Not too hard to see why companies might be engaging in this behavior (and it’s even more obvious if you think in terms of expected costs – if you figure there’s only a 50% chance of getting caught and paying a $400 million fine, the expected cost drops to $200 million).

Monday, November 9, 2009

Latest from Merle Hazard

With his latest tune, Merle comes out of the policy closet.

Maddening Mattress Market

The mattress industry in pretty interesting from an economic perspective. If I want to buy a new car, a new appliance, or some other sort of major purchase, it's pretty easy for me to compare products across manufacturers and across retailers. Ever tried to do this when buying a mattress? It's nearly impossible. First, there's a bunch of gibberish used to describe all the different attributes of a mattress. More importantly, manufacturers tend not to sell the same mattress to different retailers. While the functional attributes of a particular mattress will be the same across retailers (assuming you could ever figure that out), there will be some sort of minor change along with a different product name to make it extremely difficult to comparison shop.

Aside from the frustration of trying to buy in this market, it's interesting to think about why these obfuscation practices persist. Sure, I see that it helps retailers keep margins higher. But, why doesn't some low-cost competitor step in and offer straight-forward pricing that would appeal to consumers (maybe such a company is out there, but I didn't see it)? And why does this practice persist in the mattress industry but not other home products? I suspect part of it has to do with the limited number of manufacturers. Hmmm.

Friday, November 6, 2009

Should the H1N1 Vaccine be Sold? II

Earlier, I was speculating about the benefits of using the price system to allocate H1N1 vaccine. I forgot to mention that an artificially low price encourages "other means of procurement." Yesterday, the AP reported thieves stealing a truckload.

Wednesday, November 4, 2009

How well do you know your economists?

Find out with this quiz that asks you to identify ten famous economists (thanks to Robert Whaples via Marginal Revolution)

He's Giving Away the Secrets

Here are Dan Dresner's Ten Timeless Tips to becoming a management consultant. Relatedly, my Chinese co-author's recent email strategized on methods to embiggin our upcoming event's exposure through dynamic Powerpoint links, cross-promotion synergies at MangEcon, and "going Texan" in appearance. BTW, while most lists contain ten items "mine goes to eleven." Let me know what you think!

Monday, November 2, 2009

This is unexpected

A new research paper finds that target CEO's do NOT sell out their shareholders in order to keep their jobs in a merger:
CEOs have a potential conflict of interest when their company is acquired: they can bargain to be retained by the acquirer and for private benefits rather than for a higher premium to be paid to the shareholders. ... we find no evidence that the premium paid is lower when the CEO is retained by the acquirer. Strikingly, the target stock price increases more at the announcement of an acquisition by a private firm when the CEO is retained than when she is not. This result holds whether the private acquirer is a private equity firm or an operating company and for management buyouts.

More on iTunes pricing

The most profitable scheme would be two-part pricing, with an "entry" fee and a low cost per song:
The most revenue, according to the 2009 survey data, would be generated by charging the students $21.19 for entry and 37 cents a song. This could raise the producer surplus by 30% compared with uniform pricing. Consumer surplus would also rise in this instance, because some people would buy songs they would have not have done at a higher uniform price. Spotify, a rival to iTunes, has a model somewhat like this for its premium service, where it charges a monthly fee for songs without limit.

Demand for Hand Sanitizer

H1N1 has caused demand for hand sanitizer to more than double.

Should I have gotten my flu shot in September? I am always on the margin for this decision. I am at low risk for transmission, but the cost is low (though transactions costs could be high). Hand sanitizing is effective against transmission of the H1N1 flu as well as the run-of-the-mill annual flu bug. Because of this, the non-H1N1 flu is likely not to be as big a problem this Winter (it will be interesting to see how much). Since there is a smaller chance that I would catch non-H1N1 flu from some contagious student, my willingness-to-pay for the non-H1N1 shot should have fallen. As it turns out, my physician offered it to me at zero marginal price at my annual check up. My willingness-to-pay fell but the price fell even more.

Hat tip: Craig Depken

White House Promises Kept

This AP Fact Check by Calvin Woodward takes exception with Republican claims that the stimulus package generated jobs at a cost of $246,000 a job. The main criticism of this estimate is that not all of the effects, or spending, have been felt yet.
"Hundreds of such projects have been on the books, in which the full value of the contracts is already counted in the spending totals, but few or no jobs have been reported yet because the work is only getting started."

Quite right. Back in January, there were plenty of warnings about how long the process would take. Rather than the 600,000 jobs claimed for just this Summer, the White House's longer term claim is that "The recovery plan will save or create about 3.5 million jobs ..." At a $787 billion price tag for the stimulus package, that comes to a mere $225,000 per job. The only surprise is that the Republicans could not inflate it more. In fact, it looks like looks like the president is delivering on this promise.

Paying for Bone Marrow Donation

If I needed to pick up a little extra cash, I could go to one of the many plasma collection facilities in the area and probably make $50 for a couple of hours work. Or, I could try to make a heck of a lot more by hawking one of my kidneys. The government has no problem with my doing the first but has some serious objections to the second. Why?

One argument is that plasma is renewable, so the decision to donate doesn't involve irrevocably parting with a portion of my body that won't grow back. If you find this line of argument to be at least partially persuasive, what do you think about the ban on compensating bone marrow donors? It seems to me that it's pretty similar to the plasma case. Others appear to agree and are pressuring Congress to repeal the ban.

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.