Top posts of all time

Cheap commercial filler while we vacate like the rest of you.

1. Consult an economist before buying a wedding dress...
2. Adverse selection vs. moral hazard
3. The Cost of Protecting Ironing Board Makers
4. Projecting Marijuana Prices Post-Legalization
5. WARNING: this post has nothing to do with Manager...
6. Top 5 problem-solving mistakes by MBA's
7. What's the difference between "quantitative easing...
8. XKCD Money Poster
9. The contractual view of marriage

Legalizing Black Markets in Video Game 'Gold'

In many online video games, like World of Warcraft or EVE, players can have their characters trade for new abilities or weapons or all sorts of things. They acquire currency within the game to come up with the means to acquire these add-ons. And if they don't have the time or inclination to perform these more menial tasks, they can trade with other players for the currency. This created an incentive for 'gold farmers' to sell their game currency to other players for real cash on websites outside of the game environment. There are thousands of 'players' in less developed countries who earn a modest living selling the 'gold' they farm. Game publishers generally discourage this and so it became a 'black market' activity moderately suppressed by the game publisher.

In its recent release, the game Diablo III will embraced this activity and even expects to generate earnings by taking a percentage of each transaction. A nice discussion of this can be found at Penny Arcade's video of this market place.

Hat Tip: A Ward

Holiday Gift ideas

 

Bath and Beauty Products from the Good People at Thistle Farms

Funny book:  Awkward Family Photos

Niall Ferguson, historian of the apocalypse, explains everything

e-book contracting

The Wall Street Journal has an interesting article, "E-Book Readers Face Sticker Shock ," (gated) about pricing of e-books versus physical book. It seems that publishers are preventing retailer discounting of e-books even though they cannot do so for physical books. As a result, the discount for the electronic version is shrinking considerably.

Under the old book arrangement, major publishers charged the same wholesale price for e-books as they received for hardcovers. For a new novel priced at $25, for example, they received $12.50 for the e-book and $12.50 for the hardcover. When Amazon.com discounted the e-book at $9.99, Amazon took the loss.

But under the new pricing model, a $25 hardcover is often priced at $12.99 for the e-book. And because publishers receive 70% of the e-book retail price -- while retailers retain 30% -- that means publishers receive only $9.09. Publishers were willing to accept the lower profits because they felt the new arrangement preserved the value of books and encouraged other retailers to enter the e-book market.

I have a possible explanation after spending only 30 minutes thinking about this (meaning I very well could be wrong).

The publisher/retailer contract includes a different sort of sharing arrangement than before. With a fixed wholesale price, it would seem that, previously, retailers bore more risk but I believe that they were not charged for unsold physical books. This means that publishers bore a a substantial risk of eating the costs of a poor selling book. This gave them an incentive to exercise quality control in order to publish books that would sell well. With e-books, there are less costs to publishing a poor seller. To have similar quality control incentives, the new contract must make publisher payment a fraction of sales rather than a fixed wholesale price. But if it is a fraction, then retailers may want to discount too much. To solve this problem, publishers have prohibit e-book discounting.

Unfortunately, this may be illegal.

The Justice Department confirmed last week that it was investigating whether there was improper collusion between the publishers and Apple to prevent discounting. Publishers last week either disagreed with the allegations, said they were cooperating with regulators or declined to comment. Random House said it isn't part of the probe and otherwise declined to comment. Apple declined to comment at the time.

Hat tip to Dr. Jane

Cell Phones, Driving, and Decision Errors

I suspect that the NTSB is right that, on net, the costs from distracted driving while talking on a mobile phone outweigh the benefits. But this is a classic example of how decision errors can creep into decision making. Consider the hypothesis that banning mobile phone use while driving will save lives.

	Ban mobile phone use while driving	Don't ban mobile phone use while driving
Mobile phone use while driving causes more deaths than it saves	0	Type I Error (false negative)
Mobile phone use while driving saves more deaths than it causes	Type II Error (false positive)	0

Type I Error Costs If distracted drivers only killed themselves, why stop them? The hidden cost is that they typically run into someone else or they take their passengers with them. Drivers may be less careful with other peoples' lives. So, the Type I error costs are all the innocents killed by distracted drivers. This has been the focus of most of the studies and the policy.

Type II Error Costs Drivers with mobile phones have related information during Amber alerts. They have notified media outlets when traffic was bad due to wrecks and thus saved thousands of hours in commute time - during which some wreck could have occurred. They have been able to coordinate with their called parties, getting directions, etc., which saves time which has some value. And of course, they derive utility from the call. But if your job is highway safety, as board member of NTSB, how much do you value these? Since no one writes news stories about the wreck that did not occur from accurate traffic updates, they are largely hidden. Also, if your job is highway safety, you may not value lost time and utility as much as those who must give it up.

Let me repeat that I suspect that banning mobile phone use while driving is likely appropriate. I am just not certain that all the costs went into the decision.

Q: Are vaccines safe?

Penn and Teller demonstrate Type I and Type II errors as only they can. Do not watch if you are offended by strong language (this IS Penn and Teller after all).

Video Game Pricing

An article in Geekwire, "How Valve experiments with the economics of video games," contains some fascinating applications of managerial economics concepts. Evidently, consumer demand information is quite important:

We don’t understand what’s going on. All we know is we’re going to keep running these experiments to try and understand better what it is that our customers are telling us.

They use the tools we teach MBAs:

Now we did something where we decided to look at price elasticity. Without making announcements, we varied the price of one of our products. We have Steam so we can watch user behavior in real time. That gives us a useful tool for making experiments which you can’t really do through a lot of other distribution mechanisms. What we saw was that pricing was perfectly elastic. In other words, our gross revenue would remain constant.

And this has changed the current business practices:

We’ve gone from a situation where we dream up a game, we spend three years making it, we put it in a box, we put it out in stores, we hope it sells, to a situation that’s incredibly more fluid and dynamic, where we’re constantly modifying the game with the participation of the customers themselves

Hat tip Marginal Revolution

Why God is a Republican and Santa Claus is a Democrat

The previous post made me think of PJ O'Rourke's classic essay from Republican Party Reptile

God is an elderly or, at any rate, middle-aged male, a stern fellow, patriarchal rather than paternal and a great believer in rules and regulations. He holds men strictly accountable for their actions. He has little apparent concern for the material well-being of the disadvantaged. He is politically connected, socially powerful and holds the mortgage on literally everything in the world. God is difficult. God is unsentimental. It is very hard to get into God's heavenly country club.

Santa Claus is another matter. He's cute. He's nonthreatening. He's always cheerful. And he loves animals. He may know who's been naughty and who's been nice, but he never does anything about it. He gives everyone everything they want without thought of a quid pro quo. He works hard for charities, and he's famously generous to the poor. Santa Claus is preferable to God in every way but one: There is no such thing as Santa Claus.

Angela Merkel is a Conservative and President Obama is a Liberal

A major rift has opened between Germany and the US on how to address the crisis now threatening the existence of the European Union.  President Obama wants the European Central Bank to print money to buy debt from indebted countries (the PIIGS) to prevent them, and the banks that lent money to them, from going broke.

On the other side of the Atlantic, Chancellor Merkel is concerned about the incentives that bailing out profligate borrowers creates:

Mrs. Merkel views the financial industry with profound skepticism and argues, in almost moralistic fashion, that real change is impossible unless lenders and borrowers pay a high price for their mistakes.

Althought the NY Times suspects a political motive:

President Obama, of course, faces re-election and sees the crisis in Europe as one of the biggest threats to his chances, as it could tip the American economy back into recession if austerity worsens the slump there. German officials are well aware of that and complain privately that electoral results are Mr. Obama’s chief concern

I think the two positions are emblematic of the deeper philosophical difference:

Charles L. Schultze, chief economist for former President Jimmy Carter, once proposed a simple test for telling a conservative economist from a liberal one. Ask each to fill in the blanks in this sentence with the words “long” and “short”: “Take care of the ____ run and the ____ run will take care of itself.”

Liberals, Mr. Schultze suggested, tend to worry most about short run, while conservatives are more concerned with the long run. Here Chancellor Merkel seems as if she has just read chapter 20, and is worried that unless we punish profligate borrowers, and those who lend to them, we will get more of both.

Consult an economist before buying ski boots

It turns out that ski boots require point-of-sales fitting services, similar to those required to sell wedding dresses and golf clubs.  But rather than using exclusivity and resale price maintenance to eliminate competition from discounters, ski and boot shops have started charging customers $25-$50 for boot fittings, but only if they end up purchasing elsewhere.

I wonder if this is enough.  Boots that sell for $600 in a retail ski shop, can sell for $372 online.

HT:  Jay

Finally, a solution to the Euro crisis that might work

Pay the politicians with bonds whose values are tied to the market's estimate of their credit worthiness:

...allow euro-zone countries to issue so-called "blue bonds" and "red bonds." Blue bonds would be jointly guaranteed by all members of the euro zone and allow member states to borrow up to 60% of GDP. To fund borrowing beyond that, countries would have to issue red bonds, which would be backed only by their national treasuries and therefore trade, under most circumstances, at higher yields.

To complement joint bond issuance, I would suggest that all euro-zone politicians receive a significant part of their compensation in the form of blue or red bonds. If a country has to issue red bonds because its debt-to-GDP ratio exceeds 60%, politicians would be paid in red bonds.

Otherwise they would be paid in blue bonds. Bonds would have to be held for five years but would be convertible: If the debt-to-GDP ratio falls below 60%, red bonds would be converted into blue. Likewise, if this ratio rises above 60%, blue bonds would be mandatorily converted into red bonds.

This way, politicians would be rewarded when their countries are able to borrow cheaply and punished when their countries' cost of funds goes up. Politicians would be well-compensated when their countries are perceived as solvent; they would take heavy losses if their countries fell into serious financial difficulty.

Physicians don't die like we do

Instead they shun the expensive, intrusive, costly, and futile end-of-life-care they give to the rest of us:

Almost all medical professionals have seen what we call “futile care” being performed on people. That’s when doctors bring the cutting edge of technology to bear on a grievously ill person near the end of life. The patient will get cut open, perforated with tubes, hooked up to machines, and assaulted with drugs. All of this occurs in the Intensive Care Unit at a cost of tens of thousands of dollars a day. What it buys is misery we would not inflict on a terrorist. I cannot count the number of times fellow physicians have told me, in words that vary only slightly, “Promise me if you find me like this that you’ll kill me.” They mean it. Some medical personnel wear medallions stamped “NO CODE” to tell physicians not to perform CPR on them. I have even seen it as a tattoo.

Link.   HT: marginalrevolution.com

Dilbert incentives

Will the EU break apart?

Martin Feldstein (paper) suggests that Greece and some of the other PIIGS (Portugal, Italy, Ireland, Greece and Spain) may be better off leaving the Euro:

If Greece were not part of the Eurozone, its exchange rate with the rest of the world would adjust over time to prevent this type of large and growing trade deficit. More specifically, the need to finance that trade deficit would cause the value of the Greek currency to decline, making Greek exports more attractive to foreign buyers and encouraging Greek consumers to substitute Greek goods and services for imports. The rising cost of imports would also reduce real personal incomes in Greece, leading to less consumer spending and freeing up Greek output to be exported to foreign buyers.  

What is rational behavior?

The NY Times has a good book review of Daniel Kahneman's Thinking Fast and Slow. Kahneman, a psychologist, won the Nobel Prize in Economics for documenting departures from rationality. Students will recognize his work in sections from our textbook from Chapters 3 (Psychological Biases in Decision Making) and in Chapter 12 (Psychological Pricing).

What interested me in the review was the bigger idea that these departures from rationality--documented in psychology labs using student subjects--may actually be rational in the bigger sense:

Even if we could rid ourselves of the biases and illusions identified in this book — and Kahneman, citing his own lack of progress in overcoming them, doubts that we can — it is by no means clear that this would make our lives go better. And that raises a fundamental question: What is the point of rationality? We are, after all, Darwinian survivors. Our everyday reasoning abilities have evolved to cope efficiently with a complex and dynamic environment. They are thus likely to be adaptive in this environment, even if they can be tripped up in the psychologist’s somewhat artificial experiments. Where do the norms of rationality come from, if they are not an idealization of the way humans actually reason in their ordinary lives? As a species, we can no more be pervasively biased in our judgments than we can be pervasively ungrammatical in our use of language — or so critics of research like Kahneman and Tversky’s contend.

Prediction comes true, NBA owners win

The owners came away with most of what they wanted.

David Stern and the owners came into these NBA labor talks saying they lost more than $300 million last season and $400 million the year before that. By getting the players to agree to what is in practice a 50/50 split of basketball related income (although the deal allows the players to get to 51 percent if revenue increases enough) the owners got the players to essentially accept a 12 percent salary cut that will cover those losses.

We predicted this outcome in an earlier post.

Remember, the alternatives to agreement determine the terms of agreement.

XKCD Money Poster

This is a wonderful visualization the price, cost, or value of many things. I will order the poster for my office ASAP. For a larger, more glorious view, click through at XKCD.

Data Driven Decision Making

According to the Atlantic, it is happening more and more:

According to Google economist Hal Varian, his company is running on the order of 100-200 experiments on any given day, as they test new products and services, new algorithms and alternative designs. An iterative review process aggregates findings and frequently leads to further rounds of more targeted experimentation.

Why monopolization cases are so difficult: AMD vs. Intel

Monopolization law (called "abuse of dominance" in Europe) is controversial (see the post below) and difficult, because there are no clear cut answers. The laws are brief, outlawing "monopolization" and "abuse" without defining exactly what they are. Typically rivals are injured, and can sue for damages, but the court has to decide if consumers (or the competitive process" is harmed as well. This typically involves weighing the evidence to determine whether it most favors the anti-competitive theory of the plaintiff, or the pro-competitive rationale of the defendant.

A variety of tests have been devised to help distinguish between the pro- and anti-competitive theories:

• Effects-Balancing 
• Profit-Sacrifice 
• No-economic-sense 
• Equally Efficient Competitor 
• Disproportionality 
• Complementary Market Monopolization

To illustrate how this process works, we use the recent case of Intel's loyalty payments to large customers (sympathetic view, skeptical view) in exchange for buying most of their chips from Intel instead of rival AMD.

AMD claimed that the loyalty payments made it prohibitively expensive for them to compete for large computer manufacturers who would lose large loyalty payments if they switched to AMD. This had the effect of reducing demand for AMD chips, which drove them up their average cost curve, and made it more costly for them to compete, which could harm the competitive process by driving AMD out of some markets.

However, the loyalty payments reduced price for the larger manufacturers which benefited their customers. The lower prices could be modeled as either a form of price discrimination or a discount justified by the lower cost of serving larger customers. They also could be justified as as eliminating the double mark-up problem, but plaintiffs argued that there were less anti-competitive ways of aligning the incentives of chip and computer manufacturers.

Intel eventually settled the case by paying AMD $1.25 Billion, and then faced investigations from US, Asian, and European antitrust agencies.

What if the Episcopal Church were subject to antitrust law?

Ever since Adam Smith, economists have recognized the role that competition between religious sects plays in aligning the incentives of the clergy with the goals of a congregation: if a church does not deliver what its customers want, the customers can vote with their feet, and find a church that does.

There are, in general, two ways to to respond to this kind of competition: (i) by offering customers more of what they want or (ii) by harming competitors. The former is good for consumers while the latter is not, and the antitrust laws try to distinguish between these cases with what is called the "no business sense" test. If an action by a firm with market power harms competitors in a way that doesn't make any business sense but for its anticompetitive effect, then it may face prosecution.

I was reminded of this principle when I saw (WSJ link) the leader of the Episcopal church respond to congregations that want to affiliate with a rival Anglican sect, by saying that she'd rather have these properties become Baptist churches or even saloons than continue as sanctuaries for fellow Anglicans.

When the Church of the Good Shepherd in Binghamton, N.Y., left the Episcopal Church ..., the congregation offered to pay for the building in which it worshiped. In return the Episcopal Church sued to seize the building, then sold it for a fraction of the price to someone who turned it into a mosque.

I include this under the heading of "Managing vertical relationships" because the buildings are an "upstream" input into the production of Church services. The Episcopal Church is trying to raise the cost of rivals for accessing this input.

The success of the strategy depends on how much rival costs go up without access to these particular land parcels. Using this criterion, the chances of success seem small.

UPDATE: In response to the very good comments to the post, here is a brief commentary on the "no economic sense" test taken from the short-lived Section 2 Report (since renounced) that described how the Department of Justice would enforce this part of the antitrust laws.

The Department finds the no-economic-sense test useful, among other things, as a counseling device to focus businesspeople on the reasons for undertaking potentially exclusionary conduct. At the same time, the Department does not believe that a trivial benefit should protect conduct that is significantly harmful to consumers and the competitive process. Therefore, the Department does not believe that this test should serve as the general standard under section 2.

So even though it may have been the intent of the Episcopal church to monopolize, its ability to do so is unlikely.

The real meaning of Thanksgiving

John Stossel gives us another lesson that you won't learn in high school:

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.

Why? When people can get the same return with a small amount of effort as with a large amount, most people will make little effort. Plymouth settlers faked illness rather than working the common property. Some even stole, despite their Puritan convictions. Total production was too meager to support the population, and famine resulted. Some ate rats, dogs, horses and cats. This went on for two years.

"So as it well appeared that famine must still ensue the next year also, if not some way prevented," wrote Gov. William Bradford in his diary. The colonists, he said, "began to think how they might raise as much corn as they could, and obtain a better crop than they had done, that they might not still thus languish in misery. At length after much debate of things, [I] (with the advice of the chiefest among them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves. ... And so assigned to every family a parcel of land."

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. ... "

Peter Klein has some commentary, as does the revisionist NY Times:

Don't say the govt never did anything for you

See the cool graphs at FRED

How good is the government at "picking" new technologies?

Not very, if history is any guide:


"Breeder" reactor

Clinch River survived the first round of his spending cuts, in part out of deference to Senate Majority Leader Howard Baker (R-Tenn.), a strong supporter of the reactor, which was in his home state. But finally, in 1983, with the Congressional Budget Office saying the cost might exceed $4 billion, Congress terminated the program. Blueprints had been drawn up, modeling done, components ordered and some ground cleared, but the reactor was never built. The price tag for the federal government: $1.7 billion ($3.9 billion in today’s dollars).

"Clean" coal

After a carbon-capture project in Alaska burned through $117 million during the 1990s, Republican lawmakers tried to give the moribund project another $125 million in 2005. Just this year, the utility AEP, one of the nation’s largest emitters of carbon dioxide, abandoned a pilot project because it was too expensive — even though the Energy Department was willing to kick in $334 million, half the expected cost. A North Dakota project was shelved last December despite a $100 million federal grant.

 Synthetic Fuel

A handful of coal and auto companies tapped the new funds to build a facility that was intended to produce 50,000 barrels a day, the first of what was supposed to be a network of synfuel plants, many on federal lands. But after oil prices leveled off, then fell, in the early 1980s, the project was not economically sound, even with government help. The private partners pulled out.

Hydrogen car

... on the road to the showroom, the hydrogen car made a wrong turn. From 2004 through 2008, the federal government poured $1.2 billion into hydrogen vehicle projects; the Government Accountability Office noted that about a quarter of that money went to “congressionally directed projects” outside the initiative’s original research and development scope. Visitors to General Motors outside Detroit could drive a vehicle powered by hydrogen, but the technology was costly, and there was no infrastructure to support the vehicles. They died in development.

Hypocrisy is funny

HT:  Carpe Diem

Why Europe is different from the US

MBA Teaching tips

WARNING:  Be aware that successful teaching comes in many different forms, and that you have to develop a style that works for you.  Here are some tips that I have found useful.  

Build the course around the deliverables:  Because they are so busy, it is difficult to motivate students to do work that is not tied to deliverables.  So I design the course around the deliverables, and then figure out what I need to teach in order for students to successfully complete the deliverables.  

Put the particular ahead of the general:  I begin each topic with a real business puzzle that motivates the material for the students.  Then I get to the general principles, using as-simple-as-I-can make-them models.

If students are not asking question, they are not engaged:  and if they are not engaged, they are not learning.  Sometimes, I will say more and more outrageous things, just to get students to respond.  And once they do, the class always seems to flow better. 

Slow down:  the most common mistake that I make is to speed up in order to get through the material that I have on my slides or in my teaching outline for the day.  This is folly.  Students have enough trouble absorbing material without you trying to speed through it. Instead, slow down.  Students will absorb very little from fast teaching.

Cold call:  I find that this keeps students engaged in class (fear?), and I don’t accept “I don’t know” for an answer.  I stand there until the student comes up with an answer, and then turn to the student sitting next to him, and ask what they think of the previous answer and why.  I do make exceptions for foreign students who have obvious difficulty with the language. 

Anticipate lethargy:  when I feel that the class has slowed down, I show a video or make students do in-class problems to switch things up.  However, if you do an exercise, or show a video, always debrief it.  What seems obvious to you is not to the students.

Never answer a student’s question directly:  instead, get another student to answer it. 

Never add material to the syllabus:  It is OK to remove assignments from the syllabus, but never add, or shift assignments around.

Incentive Compensation in the Academy

Even professors respond to incentives. The abstract for a new paper in Economic Letters states:

Using panel data, we demonstrate a 50% increase in research productivity following a dramatic increase in the piece rate paid for articles by a major Chinese University. The increased productivity comes exclusively from those who were already research active.

Hat tip E. Frank Stephenson at Division of Labor

John McMillan's "rational pigs" puzzle

To illustrate how game theory works, I sometimes pose this puzzle in class, taken from John McMillan's terrific book, Games, Strategies, and Managers.

 QUESTION: Two pigs, one dominant and the other subordinate, are put in a pen. There is a lever at one end of the pen which, when pressed, dispenses 6 units of food at the opposite end. It "costs" a pig 1 unit of food to travel from the food to the lever and back.

If only one pig presses the lever, the pig that presses the lever must run to the food; by the time it gets there, the other pig has eaten 4 of the 6 units. The dominant pig can push the subordinate pig away from the food, and cannot be moved away from the food by the subordinate pig.

If both pigs press the lever, the subordinate pig is faster, and eats 2 of the units before the dominant pig pushes it away.

QUESTION: If each pig plays rationally, optimally, and selfishly, which pig will press the lever?

To answer the question, construct a simultaneous game, where the "payoffs" to the pigs are the net amount of grain consumed.

 ANSWER:  The subordinate pig always does better by not pulling the lever, regardless of what the the other pig does.  This is called a "dominant strategy."  The dominant pig's best response to this strategy is to pull the lever.  The unique equilibrium is for the dominant pig to pull the lever and consume 1 net unit of food while the subordinate pig consumes four.

                                                 Subordinate pig
                                              Pull              Don't Pull
                                   Pull   (3,1)                  (1,4)
Dominate pig        
                           Don't Pull  (6,-1)                 (0,0)


Ironically, with these payoffs, the subordinate pig will soon become dominant.  Then the equilibrium will change.

Why didn't we hear about this when it was relevant?

Production as a by-product of government subsidies

Paper manufacturers can qualify for an "alternative fuels" subsidy by adding a little bit of diesel to black liquor soap, a by product of paper manufacturing, and then burn the mixture to make electricity. The subsidy is so valuable that paper has become a by-product of the subsidy:

“The problem for pulp producers is the tax credit encourages them to run at higher rates, which is putting pressure on already weak pulp prices,” said Mike Richmond, a paper and forest-products analyst at Salman Partners Inc., a Vancouver stock brokerage.

Should we "buy American" this holiday season?

From David Friedman via Steven Landsburg:

The Iowa Car Crop

....there are two technologies for producing automobiles in America.  One is to manufacture them in Detroit, and the other is to grow them in Iowa.  Everybody knows about the first technology; let me tell you about the second.  First, you plant seeds, which are the raw material from which automobiles are constructed.  You wait a few months until wheat appears.  Then you harvest the wheat, load it onto ships, and said the ships eastward into the Pacific Ocean.  After a few months, the ships reappear with Toyotas on them.

            International trade is nothing but a form of technology.  The fact that there is a place called Japan, with people and factories, is quite irrelevant to Americans’ well-being.  To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert wheat into cars.

            Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa.  A tax or a ban on “imported” automobiles is a tax or a ban on Iowa-grownautomobiles.  If you protect Detroit carmakers from competition, then you must damage Iowa farmers, because Iowa farmers are the competition.  ...

Steven E. Landsburg

The Armchair Economist:  Economics and Everyday Life

Make the rules or your rivals will: the economics of taxis in New York City

The NY taxi cartel, like a lot of other bad ideas, started during a crisis:

When the Great Depression hit New York and the city’s 30,000 taxi owners couldn’t pay their bills, the city’s impulse was not unlike that of the Roosevelt Administration in Washington: limit supply, so that demand would be adequate to support the suppliers left standing. FDR’s plans were (thankfully) declared unconstitutional, but New York City’s taxi cartel was there to stay. To operate a yellow cab and solicit passengers on the street you need a medallion. And the number of medallions is fixed at 13,237 – roughly 3,000 fewer than in the year (1937) the system was created.

A recent auction of a medallion was $1 million, which suggests the following break-even analysis:.

...let’s say the expected return on a $1 million medallion is seven percent annually (a low figure in light of the risks). To meet expectations, fare would have to be high enough to yield about $200 a day in profits. Yes, that’s right: $200 a day, after netting out the cost of drivers, fuel, maintenance and vehicle depreciation!

Is there any chance of reform? Sadly, the taxi cartel illustrates why it is so hard to undo these regulations:

If corporate medallions are worth $1 million each, the whole lot of them is worth something north of $10 billion (owner-operated medallions are presumably worth less than $1 million). And the owners are hardly likely to give up this unearned, government-defended surplus without a struggle. In any event, there’s no one around willing to give them a fight.

Who will "win" the basketball bargaining standoff?

The axiomatic or "simple" view of bargaining suggests that the alternatives to agreement determine the terms of agreement.  For the following reasons, players have a lot more to lose than owners:

First, the owners are losing net revenues, the players their gross revenues. 

Second and most important, owners are sacrificing SR (short run) net revenues for LR (long run) increases in franchise values from cost control. Players have no LR gains to motivate SR pain. 

Owners have a LR view, players SR, so it makes much less sense for players to take a SR hit without a big offsetting gain.

For these reasons, one would predict that the owners would capture a bigger share of the gains from trade.  

Does the worn-out welfare state induce "sloth?"

The chairman of China's sovereign wealth fund thinks so:

If you look at the troubles which happened in European countries, this is purely because of the accumulated troubles of the worn out welfare society. I think the labour laws are outdated. The labour laws induce sloth, indolence, rather than hardworking. The incentive system, is totally out of whack.

What does "Margin Call" teach us about the morality of markets?

Review of Margin Call, starring Kevin Spacey.

An analyst at an investment bank (think Goldman Sachs) builds a model suggesting that their portfolio of securities is essentially worthless. The firm ends up selling the assets to other sophisticated firms whose models place different valuations on them.

For some reason, however, the protagonist wrestles with his conscience before deciding to fulfill his fiduciary responsibility to shareholders.  And this takes up the bulk of the movie.

When they sell the assets, price drops by about 35% as other firms realize that their models must be wrong.

The happy ending is predictable: price adjusts to reflect the real value of the assets.  Future investors are protected from losses that would have been incurred had they purchased over-priced securities. And the firm survives because they were the first to realize that their securities were mis-priced. Other firms presumably failed.  Performance is rewarded:  the analyst who built the model makes a lot of money, while the other analysts are fired.

All my friends who voted for President Obama are raving about the movie. I suspect they see it as an expose of the inherent corruption of Wall Street and a cause for the rebels who are occupying it.

Here is a question for my economically challenged friends. Would the ethical issues raised by the movie have been any different if the firm had been buying rather than selling securities, i.e., how is searching for under-valued securities to buy any different from searching for over-valued securities to sell?

The movie is playing at the Belcourt in Nashville and On-Demand on Comcast.

REPOST: Lincoln Electric succeeds by organizing as a sweat shop

Nice example of a company that has learned to align the incentives of employees with the goals of management. My favorite quote "only 1/3 of the people out there could survive doing piecework." Think "adverse selection."

Why seat belts kill (Sam Peltzman explains).

Make the cost of a collision fall and you get more of them.

Hat tip: Mungowitz

This post has nothing to do with economics

but I like to watch my brother wipeout (red sails)

Untitled from Daniel DeLave on Vimeo.

Auctions in Lost(Stolen?) Goods

Why small changes in the Italian bond market have such big effects

In August, when the European Central Bank began buying Spanish and Italian government bonds , the two nations’ 10-year bond yields fell to 5% from 6.4%. What happens when the Bank stops buying? Some simple calculations from Leeds on Finance tell us why a small change in Italian yields has such significant effects on all of Europe:

You don’t need to know anything about economics to do some basic math. Here it is…lets imagine a country with debt-to-GDP of 120%. Lets also imagine that the country pays interest of 6% (that’s what Italy is currently paying; Greece is paying much more). If that’s the case, you’re paying interest that is equivalent to 7.2% of GDP. (That’s 120% x 6%.) Italy’s tax revenue is around 22% of GDP. If one-third of their tax revenue is needed to pay interest, the numbers don’t work out.

The US is different from Italy only in that our debt is a little lower, and our interest rates are a lot lower. But as soon as the markets figure out that we cannot or will not reduce our spending, then our situation looks very much like Italy's. What happens when we have to pay 1/3 of our federal budget to bondholders?

 So what are the long run prospects for Italy?

At a press conference after the first summit, Angela Merkel and Nicolas Sarkozy were asked whether they were reassured by Mr Berlusconi’s promises. The German and French leaders hesitated, stole a glance and smirked. The room burst into laughter. Rarely has a leader—from a founding member of the European Union, no less—been treated so disdainfully by his peers.

Why Pay?

When negotiating for a the ticket fee, evidently these fans have too high of a disagreement value.

Who celebrates inequality?

Watch Does U.S. Economic Inequality Have a Good Side? on PBS. See more from PBS NewsHour.

How long before the rest of the PIIGS ask for debt relief?

Any economist would look at the news coming out of the EU this morning with a healthy dose of skepticism: by granting Greece a reprieve, they reduce their incentive to "fix" their fiscal mess; and by granting banks a reprieve, they increase the incentive to take on further risk. Zerohedge explains:

the European joke has come full circle. Indebted nations borrow more money to bail out other indebted nations who ask insolvent banks to cut a 50% off deal on the loans that were given to them, but the insolvent banks will then have to raise capital which the will of course borrow from the over-indebted nations whom they just gave money to. Get it? Problem solved - BTMFD!!!.

Irony

The Occupy Wall Street demonstrators are learning what Wall Street already knows, that people respond to incentives:

The Occupy Wall Street volunteer kitchen staff launched a “counter” revolution yesterday -- because they’re angry about working 18-hour days to provide food for “professional homeless” people and ex-cons masquerading as protesters.

So, lets get this straight: the Occupy Wall Street crowd want to re-distribute income from those who have it to those who don't. Like many deontologists, they ignore the trade-offs created by their principles.

Is there a parking space "shortage"...

...or just prices that don't adjust?

In the Metro-North parking lots along Connecticut's Gold Coast, the haves and the have-nots aren't defined by their clothes, car or even their net worth. Here, it's about whether they have a flimsy green piece of paper visible on their dashboards. 

A public parking pass in this and other towns along the Long Island Sound has become a precious asset. The waiting list for a Fairfield Parking Authority permit has 4,200 people and stretches past six years. In another town, Rowayton, the annual permit sale is an epic frenzy similar to that surrounding the release of a new iPhone, with residents camping out overnight to ensure they get a $325 pass.

Did Netflix Raise Price Enough?

Netflix has been getting hammered in the press for its missteps from raising prices, starting Qwikster and then killing Qwikster, and now for raising price (see earnings report).  But lets look a little closer at the effects of the price change. Its $9.99 monthly plan went to $15.98 (an increase of 60%) and the earnings report indicates that they lost 800,000 subscribers during the quarter (from 24.6 million to 23.8 million, a loss of 3%). This would imply an elasticity of 0.05, pretty inelastic.

When you increase price with an inelastic demand, revenue goes up.  Indeed, Netflix earned $62.5 million in the quarter compared to $38 million the same quarter last year. On this news, the stock price plummeted 37%, wiping out $2.3 billion in market capitalization. Stock market analysts claim that the stock price is warranted despite the good earnings news because they expect much lower future earnings.  

Stossel on city pensions

This is a little long (7 minutes) for my taste, but it dramatically illustrates the problem of unfunded pension liabilities.

 QUESTION: Most city pension funds use an 8.25% to discount the future pension liability. What are the consequences of this high discount rates?

ANSWER: (from earlier blog post)  A recent paper blamed some of the under-funding on the use of discount rates based on the characteristics of the invested assets:

•  the use of higher-than-appropriate discount rates reduces the value of the pension obligations that is reported to the public, and thus likely reduces the contributions that sponsors feel they must make to pre-fund their pension obligations. 
•  the link between the discount rate and the expected return on plan assets may encourage sponsors to invest in riskier portfolios than they would otherwise choose in order to justify a higher discount rate, and thus a lower contribution into the pension trust. 
•  these rules may encourage fiscal gaming in the form of “Pension Obligation Bonds.” These devices allow governments to borrow, invest in risky assets through the pension trust, and treat the difference between the expected asset return and the bond interest rate as “found money.”

Where were you when...

our debt surpassed our income?

Your kids will want to know.

Merle Hazard on moral hazard

Paul Solman, of the PBS NewsHour, speaks with with former IMF chief economist, Prof. Simon Johnson of MIT, about what it all means; and, the same interview via YouTube

How do you align the incentives of providers with the goals of payers?

Massachusetts Democrats are...

...working toward a plan that would encourage flat “global payments” to networks of providers for keeping patients well, replacing the fee-for-service system that creates incentives for excessive care by paying for each visit and procedure.

How long before the patients revolt?

How Chinese inflation helps US beer tap industry

Because China pegs its exchange rate to the US dollar, it loses control of its money supply because the Chinese central bank has to print yuan to give to exporters who are paid in dollars (and whose costs are incurred in yuan).  Printing yuan results in domestic inflation, which has the effect of appreciating the Chinese yuan (the "real" exchange rate depreciates).  This makes US goods look cheaper, and Chinese goods more expensive.  Carpe Diem tracks the effect.

Manufacturing wages in China continue to increase at 15-20% per year on average, and have actually increased by a whopping 300% for Taphandles since it opened a Chinese factory in 2006. In contrast, manufacturing wages in the U.S. have remained relatively flat, or have even decreased in some industries that have adopted a two-tier wage structure.

Can a billionaire Democrat teach us anything about leadership?

When I hear someone talk about "leadership," I cringe because what usually follows is vague, opinionated rhetoric.  This article seemed different, in that it specifically laid out directions that President Obama could have taken to address the current economic malaise.

 [Shortly after the inauguration], he supported Mr. Obama's call for heavy spending on infrastructure. "But if you look at the make-up of the stimulus program," says Mr. Zuckerman, "roughly half of it went to state and local municipalities, which is in effect to the municipal unions which are at the core of the Democratic Party." He adds that "the Republicans understood this" [which now makes it hard to reach agreement on current legislation]. 

 Then there was health-care reform: "Eighty percent of the country wanted them to get costs under control, not to extend the coverage. They used all their political capital to extend the coverage. I always had the feeling the country looked at that bill and said, 'Well, he may be doing it because he wants to be a transformational president, but I want to get my costs down!'" 

 "...To fan that flame of populist anger I think is very divisive and very dangerous for this country." ...  The U.S. "has fundamentally great qualities," he says. "It's a society that welcomes talent, nourishes talent, admires talent . . . and rewards talent." [Note that inequality is a consequence of rewarding talent.]

[Bottom line for Mr. Zuckerman]: "I don't want my daughter telling me, 'Dad, I want to move back to Canada because that's the land of opportunity.'"  [see our earlier post on migration to Canada].

So what does this teach us about leadership?  My take is that a great leader is one who sacrifices his own interests in favor of those of the organization he leads.   

How does a city go bankrupt?

All it takes is a series of bad investment decisions:

• The city invested in new technology,
• at a too-good-to-be-true price,
• unproven at the scale they wanted,
• from an entrepreneur who was uncertain that he could deliver, and
• despite being unable to find insurance to cover the city in case the project didn't work. 
• To top it off, the one council member who voted against the project was not re-elected.

Next time you hear the words "investment" uttered by someone trying to justify increased government spending, think of Harrisburg.

Remy's Occupy Wall Street Protest Song

Also, not quite on topic for this book, but still fun. The main message: "Yes, income is unequal, but we are unequally rich - thanks to capitalism."

Roll with the Flow

This is more of a Macroeconomics Video, but it also has some stuff on Opportunity Costs.

Is Canada a viable plan B?

In past years we have run "Plan B" contests, to find a country to await the decline and fall of the US empire. It looks like a lot of people are voting with their feet for Canada:

"Windsor, Ont.-based immigration lawyer Drew Porter is also seeing history reverse itself. He is fielding more calls from high-net-worth Americans who are worried their taxes are set to rise. “I’ve been doing this for 20 years now, and always the calls were from people that did well in Canada and wanted to move to the U.S. to increase their standard of living and minimize their income taxes,” he says. “It’s quite noteworthy to me that now I’m getting calls from the U.S. interested in Canada for the same reasons."

HT: Carpe Diem

Make the rules or your rivals will: hair braiding in Utah

If competition gets too intense, call in the state government:

Making hairbraiders get an expensive and irrelevant cosmetology license serves only one purpose: to protect the cosmetology industry from competition and stifle Jestina’s right to pursue her occupation of choice. African hairbraiding is a centuries-old natural hair care technique that uses no dyes or chemicals; it is safe for the braider to perform and does not hurt the person getting their hair braided. And with Utah’s increasingly diverse population growing through adoption and migration, the need for African hairbraiders in the state is growing

Education bubble: WOW

One indication of a bubble is a big increase in debt financing. Using this metric, we are in a huge education bubble. This infographic takes time to go through, but I was shocked at the amount of debt students take on, the default rates on student loans, and students' inability to use bankruptcy to get out of debt.
Via: HealthcareAdministration.com

Defending the undefendable

One of the books that piqued my interest in becoming an economist is now available free, online.

What do you look for in a mate?

An economist has the answer:

...for every 10% increase in a man's Body Mass Index, his salary must increase by 2% in order to [compensate women]. However, women who weigh more by two BMI units compensate [men] with a year of extra education, rather than money.

In other words, women have to be compensated with income for marrying a heavier man; while men must be compensated with education for marrying a heavier woman. HT: Larry

It Ain't Fair

I saw Moneyball this weekend and liked it. But of course I would. It is about how economics and data driven decision making was used to revolutionize how baseball has been managed. The main characters are based on real people - Billy Beane and Paul DePodesta. Click on the links and you will see two relatively handsome men. But the baseball guy is played by this guy















And the economist is played by this guy.















It ain't fair.

Maybe I have a little mind

Ralph Waldo Emerson wrote that "a foolish consistency is the hobgoblin of little minds."

Jobs' biggest mistake: he forgot about complements

Although Steve Jobs is rightly remembered for the innovative products he brought to market, he is also responsible for one of the biggest business blunders, ever.  Like Michael Porter, he forgot about the importance of complementary products and the Macintosh platform almost died on his watch.

In 1984, the graphical user interface on the Macintosh computer gave it a huge advantage over its rivals who had command line interfaces.  Mr. Jobs exploited this advantage by charging a high price to buy the computer, but also to develop software for it.  Meanwhile, Bill Gates, with his inferior product, was doing everything he could to encourage developers to make software that ran on his operating system.

Gates' strategy was the right one because the demand for an operating system increases with the availability of programs that run on it.

Steve Jobs learned from his mistake however, and when he developed the iPhone and iPad, it was an open system, designed to make it easy for App developers to design and make software for it.   

Hurry up and wait

Planes frequently push back from the gate on time, but then wait 2 feet away from the gate until it is time to queue up for take-off. This increases fuel consumption, and increases the time that passengers must sit in a cramped plane awaiting take-off.

One look at the wage scale for flight crews tells you why this occurs:

The first row (per diem) indicates how much the flight crew earns once it checks into the airport, the second (holding pay) after it loads the plane, and the third (hourly wage) after it pushes back from the gate and turns on the beacon.    By rushing to load the plane, and push back from the gate, the captain earns $164/hour more than he or she does by waiting to load the plane.

It would be relatively easy to solve this problem by taking the decision on when to push back from the gate away from the flight crew and give it to the airline instead.  

The best commencement address--Steve Jobs, RIP

I bought my first Mac in 1984, and I will have one until they pry my cold dead fingers off the mouse.

Milestones in regulatory myopia

In Europe under Basel II banking regulation (the current regime), a bank can hold any amount of the debt of the country it is in, with a risk weighting of zero. In other words, no capital at all is required for a bank to hold gov't bonds of its home country.

This may be the reason that Dexia, the Belgian bank, which recently passed regulatory "stress tests" with flying colors, is now in talks with the Belgium government for another bailout, just three years after their last bailout.

Is this so hard to understand: if you bail out banks that make risky loans, you get more risky loans.

What happens when we bail out banks who take on too much risk?

New paper by Ran Duchin and Denis Sosyura finds that we get more risk:

after the bailout, bailed banks approve riskier loans and shift investment portfolios toward riskier securities.

As if this weren't bad enough, the shift to risk occurs within the same asset class so has little effect on the capitalization ratios watched by regulators to make sure that banks aren't taking on more risk. We are left with a most unhappy conclusion:

...the net effect is a significant increase in systemic risk and the probability of distress due to the higher risk of bank assets.

Amazon versus Apple Tablets

Marketplace has an interesting story about Amazon's new Kindle Fire. Amazon might succeed where others have be able failed because it might to exploit complementarities. Here's part of the transcript:

And something else is smaller too: the price.

Bezos: It's $199.

Sarah Rotman Epps: You could buy four Kindle Fires for the price of one souped-up iPad.

That's Sarah Rotman Epps, a tech analyst with Forrester Research. Epps says Amazon may be selling the Fire at a loss. That's because the online retailer wants the Fire is to function mainly as a virtual shopping cart.

Epps: Putting this device in consumer's hands pretty much guarantees that they will be a serious Amazon spender.

Loading up on digital content like music and books, and maybe some pots and pans too.

Analysts predict sales of the Fire could top three million this year. The tablet ships on November 15th -- in plenty of time for you know what.

Hedging One's Beliefs

This XKCD cartoon has a different message for social scientists. Why don't more college football fans bet against their alma maters? Wouldn't that make them happy no matter the outcome?

Why is this so shocking?

How does the current crisis compare to others?

Compared to post-war US recessions, it looks worse:

But compared to world financial crises, it doesn't look as bad.

Monitoring Through GPS Shoes

The GTX Corp has developed GPS enabled shoes so that loved ones can better monitor Alzheimers patients. I, of course, immediately though of the application in which jealous wives give them to their husbands.

It's Damned Hard Bein' Green

I'm not sure a solar powered trash compactor is ever efficient. But, when you place it indoors it becomes much less efficient.

What was Netflix Thinking II?

Reed Hastings, Co-Founder and CEO, Netflix fesses up about their pricing blunder. The best part has to do with overall business strategy.

Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us) because they are afraid to hurt their initial business. Eventually these companies realize their error of not focusing enough on the new thing, and then the company fights desperately and hopelessly to recover. Companies rarely die from moving too fast, and they frequently die from moving too slowly.

amen brother

Committing to Deficit Reduction Strategies

The Congressional Super Committee was charged with negotiating for deficit reduction and it membership is split evenly between the blue and red teams. It has been clear that, as part of the package, the blue team wants to raise taxes and the red team does not. No one doubts that the leaders of these two teams, President Obama and Speaker Boehner, are giving private instructions to the committee members from their team. So why should these two make public announcements here and here?

Perhaps these are commitment devices. Speaker Boehner can easily go back on a private "line in the sand" spoken to committee members. It is harder for him to repudiate a public statement (though it has been done). So President Obama has to stake out his territory and commit to his version of the deal in which one-third of the amount is from tax increases. Negotiations when both sides commit to intractable positions usually do not end well.

Sure to make booms higher and busts lower. Wow.

A bank's capital ratio is designed to measure a bank’s capital relative to its risk exposure and is one of the ratios that regulators like the FDIC and the Bank of International Settlements uses to measure the "health" of a bank.  Here is how a banker sees the new regulations:

When I returned to my office this morning I received a call from a trade group person who told me that the new Tier 1 Leverage ratio for banks is now unofficially 9%, up from 5% that has been in place for years.

The combined shock to the system of capping debit card fees, doubling the capital requirement, significantly restricting OD charges plus the impact of 263 new regs from Dodd-Frank and all within 3 years is severe.

The higher capital requirements (almost double) cut the returns to capital almost in half. This is part of the reason that Bank of America's is raising capital from Warren Buffet:

Under the terms of the deal, Berkshire will buy $5 billion of preferred stock that pay a 6 percent annual dividend, and receive warrants for 700 million shares that it can exercise over the next 10 years. Bank of America has the option to buy back the preferred shares at any time for a 5 percent premium.

If you take a step back, we see that the regulators are running a procyclical policy: reducing capital requirements in boom years (before 2008); and raising them in bust years (today).

What makes Germany so different?

ten years ago, German unemployment was just as bad as the rest of Europe's.  But now it has a 6% and falling .  What is their Secret?  Planet Money has a 16 minute podcast that gives you the answer:

1. make it easy for firms to fire workers, and 
2. reduce the benefits from being unemployed.    

Search and Pricing Power Even in the Longrun

I sometimes teach search theory. And XKCD gets it in one picture.


An important implication is that, often, it is not worth it for a customer to find a better price. It depends on the costs of obtaining the new price quote and the variation in prices. From the seller's perspective, this means it can set prices above marginal cost and still retain some customers. Customers' different search costs can be the source for a firm having a downward sloping demand curve. So, even in the long-run with free entry, firms' prices need not equal marginal cost.

Brazil's economy adapts to a 12% interest rate

The success of the Brazilian economy has lead to opportunities for investors which increases demand for loans, leading to high interest rates.  In turn, the high interest rates in Brazil are attracting foreign investors, who sell dollars to buy real.  This can be modeled as an increase in demand for real (or an increase in supply of dollars) which results in real appreciation or dollar depreciation.

This hurts Brazilian firms:

The strong real is an even bigger problem for manufacturers. Humberto Barbato owns a company that makes parts for high-power transmission lines. Decades ago, he benefited from government policies that helped manufacturers set up export businesses. Now the currency is pricing him out of hard-won overseas markets. At home, he's losing clients to cheap Chinese imports.

And helps Brazilian consumers:

He does get some comfort. While visiting his son in Florida recently, he went on a strong-real shopping binge with the other Brazilians at the local mall. "That's my revenge," Mr. Barbato said.

In case you hadn't noticed, ...

Volatility in the stock market is way up.  And as you know from chapter 9, investors have to be compensated for bearing this extra risk with a higher expected return (in long-run equilibrium).  Higher expected return implies lower current prices.

How can the government create jobs?

Doug Holtz Eakin has the answer

Crony capitalism makes me sick

But don't we have an obligation to teach our students how to do it?  

What do Switzerland (top) and Norway have in common?

ANSWER: They are both "safe havens."

Norway’s krone will gain further as investors “desperate” for protection against a deepening European debt crisis turn to one of the few haven markets that isn’t overvalued, said Deutsche Bank AG, the world’s biggest currency trader.

The krone rose more than any other major currency against the franc on Sept. 6, when the Swiss National Bank said it will defend a target of 1.2 against the euro with “utmost determination.” As Swiss efforts to shut the door on franc appreciation force investors to turn elsewhere, the krone will be one of the currencies to fill the vacuum, said Henrik Gullberg, a London-based strategist at Deutsche Bank.

“There is a desperate need for safe havens and the krone is an obvious candidate,” Gullberg said in a phone interview yesterday. “The krone is not significantly overvalued, which is another thing that is attractive.”

Investor's are selling euros (and dollars) and buying Norwegian krona and Swiss francs, which can be thought of as an increase supply of dollars, which reduces its price (measured in francs or krona) in the foreign exchange market.

Footnote:  the resulting appreciation has hurt exporters in Switzerland, and induced the Swiss central bank to print money to buy foreign currency.  This selling francs to buy dollars has brought down the value of the franc a little, it has also caused the bank to suffer huge losses on its foreign currency holdings (about 5% of Swiss GDP).  

Price discrimination in photos

Link to Carpe Diem for more photos.