Tuesday, October 17, 2017

G-Eazy on opportunity cost

There is naturally a close affinity between economists and rappers, which is why it should be no surprise that G-Eazy's chart topping debut album, These Things Happen, includes his powerhouse economics-lecture-disguised-as-rap, Opportunity Cost.
Everything costs something bro
Winning somewhere, somewhere else you just lost something though
The cost of opportunities is always good to know
But if you know that then you're good to go

I could not have put it better myself.

You may watch the video but be warned that the G-Eazy also explores his feelings on non-economic issues with language some may find objectionable.

Gaming the ACA health exchanges

A recent headline proclaims that "Pennsylvania ObamaCare to see premiums spike amid Trump pay cuts." While premiums are in fact going up nationally (and are certainly exacerbated by the recent end to certain subsidies), the important part of the story is five paragraphs down.
While the increase is steep, in Pennsylvania it will only apply to the mid-level “silver” health plans that consumers can buy on the exchange.

Plans come in three tiers, bronze, silver, and gold. Government subsidies for purchasers are based on a state's price for the silver plans. The idea was that subsidies will reflect the "average" prices of a plan. It didn't take long, though, for state regulators and insurers to realize how to game this system, raising the price of silver plans to increase the subsidies that people can then use on bronze or gold plans.
If the price of a silver plan increases, tax credits that help customers purchase insurance will also increase, so the cost of the most comprehensive “gold” plan may be much cheaper than in previous years.

Friday, October 13, 2017

Perverse incentives in soccer

Presumably, the primary goal of any sport governing body is to provide adequate incentive for competitors to do battle on the field (court, pitch, etc.), each striving for victory. Things don't always turn out that way. 

My all time favorite example of the strangest (incentive-driven) spectacle in sport is from the 1994 Shell Caribbean Cup involving a match between Barbados and Grenada. 
A very poorly-conceived (though well-intentioned) tournament rule stipulated that any goals scored in overtime (and, by virtue of a sudden-death rule, there could only be one) would count double, as if the team scored two goals. The idea was to reward teams in close matches. This simple rule led to a very strange match.
Barbados needed to win the match by two goals to advance in the tournament. If they failed, either losing the match or winning by only one goal, their opponent Grenada would advance instead. With less than ten minutes left in the match, Barbados led by exactly two goals and began to play very defensively. In the 83rd minute, Grenada finally scored, making the score 2-1. Barbados tried to answer but, with only three minutes remaining, was unable to score. Members of the Barbados team contemplated their options. To advance, they needed either to score one more goal in the last three minutes (winning by two), or force the game to extra time where a goal would count as if they won by two. Barbados scored on their own net, tying the game at 2-2.
This is not yet the odd part of the match. The Grenada players, initial shock abating, developed their own strategy. If they could score on Barbados in the waning minutes, they would win the match and advance. But, if they could score a goal on themselves, they would lose by one goal which was still enough to advance. 
For two minutes, Grenada tried to score on either goal, with Barbados players split between defending their own goal and that of their opponents!
Normal time ended in a tie and the game did go to overtime, in which Barbados scored a game winner and advanced (though was eliminated from the tournament in the next round). No penalties for the players' actions in this game were handed down by soccer's governing body since both teams were earnestly trying to win their group, and the farce was the result of silly incentives.

Thursday, October 12, 2017

Pricing Political Risk - Catalunya

The recent referendum on Catalan independence injected some uncertainty into the Spanish bond market. Investors required a premium to own these bonds because they did not know how if the government was going to be able to pay them off. But prices have fallen since the vote, suggesting that investors think much of the uncertainty has been resolved.

Tuesday, October 10, 2017

Keeping Assets in Low Valued Uses - Jones Act Edition

If you wanted to truck oranges from Miami to New Orleans, it doesn't matter where the truck was made. If you wanted to fly them, it doesn't matter where the plane was made. But if you put them on a boat, the Jones Act says the ship must be American made or be subject to tariffs and fees. How much of a difference does this make?

Enough so that the administration temporarily waived the act so as to get shipments to Puerto Rico after hurricane Maria. Evidently, they believed this measure was restricting the free flow of emergency provisions. But, alas, the waiver will not be renewed. Some clever economist should measure how much this waiver lowered costs (and maybe saved lives). If so, we might have the ammunition needed to repeal this blatant protectionism.

Monday, October 9, 2017

Repost: Bargaining exam question

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 FroebUnilateral 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: http://ssrn.com/abstract=956400

Saturday, October 7, 2017

Friday, October 6, 2017

Rivals Horizontally - Cozy Vertically

With the latest releases of the Apple X and the Samsung Galaxy 8, we expected pretty intense rivalry. Maybe not so much seeing how Samsung is one of the major suppliers of components for the Apple X. The WSJ reports that Samsung "stands to make $110 from for each top-of-the-line, $1,000 iPhone X that Apple sells." For example, Samsung "is the only significant manufacturer of the organic light-emitting diode, or OLED, displays Apple has adopted to create the iPhone X screen." Furthermore,
An analysis conducted by Counterpoint Technology Market Research for The Wall Street Journal finds Samsung is likely to earn roughly $4 billion more in revenue from iPhone X parts than from components made for the Galaxy S8 in the 20 months after the new iPhones go on sale Nov. 3.

This suggests to me that Samsung's real comparative advantage is in the cutting edge technologies embedded in these components. Like most electronics, I suspect there are substantial scale economies  (and perhaps learning curve effects) in the production of these components. It can lower its unit costs be producing ever more units. It has vertically integrated into assembling them into phones so as to move down this cost curve. It hardly cares whether these components are in its own phones or are sold to downstream rivals to be included in the rival's phones.

Wednesday, October 4, 2017

Play the repeated prisoners' dilemma

By playing against one of five types you learn how to sustain cooperation:

  1. Be nice--no first strikes
  2. Be provokable--retailiate immediately if your rival cheats
  3. Be forgiving
  4. Be clear--make sure your rival can interpret your moves
  5. Dont be envious--focus only on your slice of the profit pie
HT: Jordan

Friday, September 29, 2017

Adapting to Changing Technology: Juiced Baseball Edition

NPR had a nice story about some economics of juiced baseballs. Yes NPR. 

There have been a record number of home runs this year, approaching 6,000. The evidence suggests that, due to changes in how the balls are being made, hits are going an average of seven extra feet. How do players and teams react to this?

More players now swing for the fences. Non-sluggers used to be content with just getting on base. Now they have a better shot at rounding the bases. We know this because there is also a record number of strikeouts.
SIEGEL: But given the number of strikeouts and given all the talk about the launch angle of the baseball as it leaves the bat, it seems that more baseball players are going up to the plate trying to hit a home run.
KERI: Well, that's certainly true. But it has to do with incentives. You know, if you hit a bunch of home runs and you strike out, there's nothing that's going to get you fired from your job for that. And Aaron Judge is a classic example of this. Aaron Judge has more than 50 home runs. He's going to win the AL Rookie of the Year, maybe MVP. He struck out more than 200 times this year. Only six players ever in the history of baseball, including Judge, have done that. And we don't say, Aaron Judge, tisk-tisk (ph), all those strikeouts. We say, Aaron Judge, what an exciting player.

Also, the premium teams pay for sluggers is likely to fall. Being able to hit 20 home runs a year used to be pretty rare. But the supply of pseudo-sluggers has just increased, causing the price to fall.
If you look at some other sluggers that have gone out on the open market and will this offseason, it's a supply and demand issue. If everybody's hitting home runs, why bother spending a lot for home runs?

Friday, September 22, 2017

Bundling video

What makes big tech firms so profitable?

McKinsey Report:
Increasingly the ranks of top players in TMT (technology, media, and telecommunications ) are populated by companies that have managed to create and scale successful platforms that benefit from network effects. These can be technology platforms (for example, Apple’s iOS), marketplaces (for example, Apple’s app store), or platforms of another type—but in each case these winning platforms increasingly exploit “network effects,” which means the value of the product, service, or the underlying technology increases when more people use it. The more you use Facebook, for instance, the more your friends will use it. There are also indirect network effects, which involve the creation of complementary products or services—the app markets that have grown up around smartphones and tablets, for example, or social gaming that is enabled by social networks.
Despite the network economies of size, success is short-lived:
Taking our data set as a whole, across all industries, nearly 60 percent of companies that were in the top quintile in terms of economic profit in 2000 were still in the top quintile 15 years later. In TMT industries, though, only 45 percent of top players from 2000 remained in the top quintile in 2015. The flip side is that over the same period 25 percent more companies that started at the bottom ended up in the top quintile (Exhibit 6).

Timeless words of Wisdom

I don't care who writes a nation's laws, or crafts its advanced treaties, if I can write its economics textbooks.
                            -- Paul A. Samuelson, the "father of modern economics."

HT:  MarginalRevolution.com

Thursday, September 14, 2017

Which jobs don't Millenials like?

This weekend, one of my executive students told me that she is able to hire college graduates in Chicago for only $30K/year if they get to work in a downtown office. However, these same graduates turn down sales jobs that pay $50K. She ascribes it to the “cool” factor of working in a downtown office, i.e., to get a graduate to work in the relatively uncool job of sales, you have to pay them a $20K compensating differential. HT: Megan

Monday, September 11, 2017

Excavating entrenched management

In the words of Weisbach (1988): "Managerial entrenchment occurs when managers gain so much power that they are able to use the firm to further their own interests rather than the interests of shareholders."

Marc Fors told me this story of excavating entrenched management from American Business Products (ABP), a public company that was comprised of a variety of product groups; from food packaging to stationary and office products to book manufacture. BookCrafters was the book operation and was about $40M in sales and while historically profitable had now been losing money for several years. A new management group had been hired a few years before but the downward slide continued. All efforts to sell the company to other larger competitors had been fruitless. It had to be fixed or would have to be shuttered.

 I was hired as the turnaround CEO and moved to Ann Arbor with my wife and we rented a house in the community. This would be the smallest company I had attempted so far. It was the dominant company in the small town of Chelsea, and its largest employer. It had long been a family operation before being acquired by ABP and had been insulated from the changing realities of the print markets.

 Apart from the usual array of process control, a sales organization and equipment problems, there was a distinct morale issue. After a day or so at the plant HQ offices interviewing key players I began to understand the depth of the morale issue within the ranks. There was little respect or confidence in the new management team that had been hired by ABP. They had come across to the employees as aloof outsiders, more concerned with their own positions, and had not made any progress the 450 employees could see. Some key employees had been demoted or fired to make room for new managers aligned with the new management team, making matters worse as those hires brought a similar attitude and effected no positive change.

I had arrived a day earlier than planned and noticed that the entire management team was out at a “management meeting” at the local private golf club where the company maintained a membership. When they returned the next day I was struck by the lineup of leased company vehicles they all drove – all expensive luxury cars. These guys were out of touch and they had lost the respect of the hourly employees and were not likely to get it back. Morale was low and the rumor was out that I was here to reduce headcount and close the plant.

 After a series of one-on-one meetings with each department head where I was regaled with how much new capital they needed to improve operations I was scheduled to tour the plant with the three key manufacturing managers. A book printing operation is a complex operation of parts and assembly at that time. The skilled trades were on the printing presses, as large as a small house, and they were mostly men. The unskilled trades of assembling parts and operating the bindery were almost 70% women.

 Once out in the factory we walked through the Bindery with its loud clacking machines and all the handworkers gawking at the guys in suits, ostensibly to the center of the operation and to one of the newer printing presses that they wanted me to see and presumably be impressed by, they asked what I wanted to see first that day. I stopped the whole group in the aisle, by a small group packing boxes, and spoke loudly in order to be hard by all: “I want to see the women’s bathrooms.” Chuckles and odd smiles were the response all around and I said, “I’m serious. I want to see them all, one after the other – together as a group” Then I want to see any break room or employee changing area.” “After that, I will decide if we see anything else”

So that is what we did. I made them tour each bathroom and break area with me – making notes of cleanliness, broken faucets, paint problems, chipped and rusty porcelain and the like. It was intended to be obvious to the whole plant. I asked a female worker to take a break, leave her station and come with us – she entered before and made sure we were not disturbing anyone. I went in each bathroom over the course of a couple of hours (there were 12) and spent time in each and went I came out made a point of waving my arms, pointing and gesturing with the group around me.

After the tour, standing in the aisle we started in, I summed it up for the group: “So far, I am not impressed. You would not ask your own wife or daughter to spend time in those bathrooms and I am shocked you have let it go that far. I have to tell you I am not interested in touring anything else, or talking about any new capital for this plant until those bathrooms are fixed. That’s where we start. Productivity comes from people first and equipment second, not the other way around.”

The next day I fired one department head and hired back, as his replacement, a much beloved (and effective) manager that had been demoted. He began work on the refits. He had all the stalls dismantled and repainted by the local auto-body company in short order. Lighting was changed and upgraded. Paint and mirrors replaced and new seating and lockers installed in the break rooms. Fresh food options replaced broken vending machines.

 Over the next two years more progress was made and the sales organization was rebuilt. The plant never experienced the feared reduction in hourly manning – in fact the reverse. Sales grew, new product lines added, and morale and productivity recovered. I then led the sale of BookCrafters to a larger company that had two similar book plants that we merged with and integrated, led by the BookCrafters management team, bringing our management style and priorities with us. BookCrafters grew to become the Book Division of the Sheridan Group, a $500M print company, and is still in operation today in Chelsea Michigan.

Tesla "Crimping?"

Alex Tabarrok over at Marginal Revolution thinks Tesla may have unwittingly committed a marketing faux pas. As Hurricane Irma bears down, they expedited an over-the-update to the cars to extended battery life.
Tesla owners in Florida may be grateful for this mileage boost as they escape the ravages of Irma but I suspect that some of them will be upset when they have more time to reflect. How could Tesla increase the mileage at the flick of a switch? The answer is that owners of the Tesla 60kWh version of its Model S and Model X actually have the same battery as the 75kWh vehicles but the battery has been purposely limited or “damaged” to provide only 60KWh of mileage. But why would Tesla damage its own vehicles?

The idea of offering both premium and discount versions is common, as is purposely 'damaging' the product one so as to make the discount version perform more poorly than the premium version (i.e. "Crimping").

In this case though, there may have been no deception. There is a report that owners may have opted not to pay for the better battery life.

Saturday, September 9, 2017

REPOST: Risk-on, risk-off trading

Thursday, October 31, 2013

Risk-on, Risk-off trading

In our chapter 9 video, we illustrate how Vanderbilt Treasurer made money by selling risky assets and buying less risky ones when risk premia (the extra return investors receive for investing in risky assets) moved to historic lows.  He correctly reasoned that investors were ignoring risk in search of higher return, so when risk premia widened, in 2008, the price of risky assets fell relative to their less risky counterparts.  In the jargon of finance, this is known as a "risk off" trade.

We can illustrate risk-off trading, uusing Don Marron's "history of the European Union in one simple chart" below. It shows the premia that the Southern European PIIGS (Greece is in orange) had to pay to borrow money.

In 1995, for example, Greece (in orange) had to pay 18% to borrow money, representing an 11% premium over Germany's (in red) 7% rate.  The risk premium disappeared in 2002 when Greece joined the EU.  In 2008, the risk premia re-appeared, as the interest rate on Greek debt rose to 16%, a 12% premium over Germany's 4%. 

From investopedia:

...During periods when risk is perceived as low, risk-on risk-off theory states that investors tend to engage in higher-risk investments. When risk is perceived as high, investors have the tendency to gravitate toward lower-risk investments.  ... The 2008 financial crisis was considered a "risk off" year, in which investors attempted to reduce risk by selling existing risky positions and moving money to either cash positions or low/no-risk positions, such as U.S. Treasury bonds.

If you can anticipate changes in risk premia, you can make money:

  • A prescient "risk-off" trade would have been to short Greek debt and buy German debt in 2007, and sell in 2011.  
  • Conversely, a prescient "risk-on" trade would have been to buy Greek debt and short German debt in 1995, and sell in 2001.

Friday, September 8, 2017

REPOST: Trump was right: China ate America's manufacturing jobs.

Monday, February 27, 2017

Trump was right: China ate America's manufacturing jobs.

Freakonomics podcast featuring labor economist David Autor:
  • Between 1991 and 2013, Chinese exports grew from roughly 2 percent of the world’s total to nearly 20 percent.

  • ...There are two big differences of the last two decades relative to earlier periods. One is that a lot of our trade prior to China’s rise, a lot of it was North-North trade. You know, trading between wealthy nations. So you know, we sell aircraft engines to France and we buy cheese and wine and Renaults or maybe we buy Mercedes from Germany. And so it’s a lot of high-skill people trading high-skill goods and we’re trading on the basis of taste. Like, “I like your vehicles. You like my aircraft.” It’s not trying to see who can make the cheapest version of X, Y, or Z. We’re often focusing on a set of expensive goods in which we all are differently good at different subsets.
  • So when the United States trades with the developing world, we’re going to typically export skill-intensive products: aircraft engines, electronics, movies, and TV programs and things that use a lot of highly educated labor. And we’re going to tend to import low-skilled or what we call labor-intensive products like you know footwear and textiles, leather goods, things that require a lot of hand assembly. 
  • TRADE BENEFITS US SKILLED WORKERS AND CONSUMERS:  And so what does that do? Well, when we export those high skill-intensive goods we’re basically raising demand for skilled or educated workers in the United States. When we import those labor-intensive goods, we’re going to reduce demand for blue-collar workers, who are not doing skill-intensive production. Now we benefit because we get lower prices on the goods we consume and we sell the things that we’re good at making at a higher price to the world. So that raises GDP but simultaneously it tends to make high-skilled and highly educated labor better off, raise their wages, and it tends to make low-skilled manually intensive laborers worse off because there is less demand for their services – so there’s going to be fewer of them employed or they’re going to be employed at lower wages. So the net effect you can show analytically is going to be positive. 
  • BUT HARMS U.S. UNSKILLED LABOR: But the redistributional consequences are, many of us would view that as adverse because we would rather redistribute from rich to poor than poor to rich. And trade is kind of working in the redistributing from poor to rich direction in the United States. The scale of benefits and harms are rather incommensurate. So for individuals, you know, I have less expensive consumer items because of imports from China. But it hasn’t affected my employment or my wages. For many others – on the order of at least a million U.S. manufacturing workers – it meant the end of their jobs and in many cases the end of their industries.
BOTTOM LINE:  Trade helped U.S. skilled workers (by increasing demand for their services) and consumers (by giving consumers cheaper goods), but hurt U.S. unskilled workers (by reducing demand for their services).  In a frictionless world, they would move to their next best alternative (e.g., Texas or Tennessee), but instead they are moved out of the labor force and into the safety net (e.g., medicare, medicaid, early retirement, disability insurance, food stamps, and TANF).

Interesting closing thoughts by David Autor, which seems to echo President Trump's campaign:
I think the other thing that we have to recognize, and that economists have tended not to emphasize is that jobs aren’t purely income. They are part of identity. They structure people’s lives. They give them a purpose and a social community and a sense of relevance in the world. And I think that is a lot of the frustration that we see in manufacturing-intensive areas. We saw a lot of that actually in the recent election. People feel like their place in the universe, or at least in the economy, has really been kind of reduced, made less valuable. And I think that that’s costly even beyond the direct financial costs.

Tuesday, September 5, 2017

Equilibrium in the Tinder Market?

When demand shifts up we expect price to rise, ..., or quality to fall. Worst-online-dater over at Medium.com has done some analysis of activity on Tinder. The nice thing about heterosexual matching markets is that there is are almost equal numbers of males as females. With a few exceptions, matches tend to be one-to-one. But, before settling down (and perhaps after), there appears to be much more interest by men in dating women than women in dating men. Normally this would lead to side payments but that has traditionally been frowned upon. So what other mechanism allocates scarce women to the surplus of men?

Quality, or at least attractiveness, sorts these scarce women to all these men. The curve between the pink and the blue represents equal numbers of Tinder "likes" by attractiveness percentile of men and women.

Men must be quite attractive to be "liked" on Tinder while women need not be.
In reality, the bottom 80% of men are fighting over the bottom 22% of women and the top 78% of women are fighting over the top 20% of men.

An Honest Pension Manager

Zero Hedge Fund has a nice story demonstrating the power of compounding. One way to make your pension look solvent is to assume exceptionally high expected rates of return. Minnesota made more realistic assumptions and found that their unfunded obligations ballooned from $16 billion to $50 billion. But Minnesota is only noteworthy because their revised assumptions are now more honest. Most other states are in pretty bad shape too.

Friday, September 1, 2017

Reduce Prices When you Acquire a Complementary Good: Amazon/Whole Foods

The WSJ is reporting that Amazon will begin steep price cuts at its newly acquired Whole Foods affiliate. One way to think of the merger is that it couples Whole Foods's retailing niche with Amazon's logistics expertise. These are complementary assets. Lowering the margin on one increases the demand for the other. This is likely to be profitable for Amazon. Some evidence that this will benefit consumers can be gleaned from the effect of the announcement on traditional retailers.
The announcement Thursday, which sent stocks of traditional grocers into a fresh tailspin, said price changes for both staples and more high-end foods would go into effect as soon as Amazon closes the Whole Foods deal on Monday. 

Monday, August 28, 2017

Anti-Price Gouging Laws: Keeping Assets in Low Valued Uses

The gulf coast of Texas needs critical supplies. It is wonderful that many are contributing out of the goodness of their hearts. But the Attorney General seems to not want to marshal the power of the profit motive.
“During declared disasters, state law prohibits businesses from charging exorbitant prices for necessities such as gas, food, drinking water, clothing and lodging,” Attorney General Paxton said. “Texans affected by Hurricane Harvey should take steps to protect themselves and report any alleged price gouging or scam contractors to the Office of the Attorney General.”

Keeping prices artificially low: 1) means critical goods flow to those who 'know a guy' rather than those who have the greatest need (as expressed by their willingness-to-pay), 2) creates an inefficient black market, and, most importantly, 3) blunts incentives for entrepreneurs to supply these goods.

Saturday, August 26, 2017

REPOST: Truckers are stockpiling dirty diesel engines

In 2007, new EPA regulations that mandate cleaner diesel enginestook effect. The new engines reduce particle emissions by up to 98% over the previous generation and cut Nitrogen-oxide emissions in half.

But they increase the cost of trucks by $12,000, or about 10%. In addition, truckers (consumers of the new engines) expect higher maintenance costs and worse fuel mileage.

Predictably, the new regulations caused a big increase in demand for 2006 engines and trucks,
Truckers seeking to beat the price increases made 2006 a record year for truck makers. More than 373,000 big-rig trucks were built in North America, says Ken Vieth of A.C.T. Research, which follows truck sales trends. The tally easily topped the previous record of 330,000 trucks in 1999.
But next year, Vieth predicts "a production drought," with sales falling by more than 40% to 220,000 as trucking firms hold off buying to see how the new clean-diesel trucks perform. ...
The cost to truckers goes beyond new big-rig purchases, according to Moskowitz. The new fuel costs 5 cents to 10 cents more per gallon to refine and may produce lower fuel mileage. The new engines weigh more, further cutting mileage. "Over the long run, their increased costs will be passed on to the shippers and ultimately, the consumers," Moskowitz says.
Both the 2006 boom, and the 2007 bust were predictable with simple supply-demand analysis, especially since a similar regulatory change occurred in 2002.

For policy makers, this points out yet another disadvantage of a command-and-control approach to clean air. Mandates from Washington have to be phased in, and this gives consumers an incentive to stockpile old, cheap, but dirty engines so they can use them in the future. Instead of telling producers what to produce, or consumers what to consume (by picking technologies, like ethanol, to subsidize), tax what you don't want (pollution) and let the market decide how best to reduce it.

Bottom line: How many economists does it take to screw in a light bulb? None--the market will do it.

REPOST: Uber's surge pricing is efficient, but deeply unpopular

So much so that places like Dehli has banned the practice.  In response to these political threats Uber has started trying to educate the public about the benefits of surge pricing.  Here is a "natural experiment" in Manhattan.

In the left panel, on New Year's eve 2014, there was no surge pricing (the algorithm broke down), and wait times tripled while the completion rate was cut to 25%.  The right panel shows the same area of Manhattan following a Ariana Grande concert in 2015.  After the concert let out, fares increased, but there was no change in wait times nor completion rates.

BOTTOM LINE:  surge pricing is needed to bring in supply and allocate rides to those who want them the most.  Without it, supply is too small, and rides are not allocated to their highest valued use.
(Economist article)

Friday, August 25, 2017

Heckman on Empirical Economics

Jim Heckman was awarded the Nobel Memorial Prize in Economics mainly for his contributions to the development of empirical methods. He applied these to social policy issues but they are also being applied to managerial decisions. Here he is talking about the value of empirical economics to go beyond ideology.

Wednesday, August 23, 2017

Markets Reveal Value

A recent article in the WSJ reports that:
Four mutual-fund companies have marked down their investments in Uber Technologies Inc. by as much as 15%, the first such price cuts that suggest these investors are souring on the ride-hailing giant following a scandal-ridden year.

A 15% swing in price in one day is huge. This happens because Uber is privately held and there isn't an organized market for the shares. They do not have to announce write downs of their shares in, say, GM or Merck. They simply check their favorite financial news site. But they likely had a team gathering information and poring over the numbers in order to come up with the new Uber price point. This is costly. One of the great virtues of markets (described beautifully by Hayek) is that they reveal value to the uninformed nearly costlessly. Yet another reason economists are so infatuated with markets.

Tuesday, August 22, 2017

Reduce Prices When you Acquire a Complementary Good

Minjae Song, Sean Nicholson, and Claudio Lucarelli examine the pricing of drug "cocktails" in their new paper in the RAND Journal of Economics. Sometimes the preferred treatment regimen is a combination of drugs made by competing firms. Each drugs might deal with issues not treated by the other, or that are exasperated by the other, and so are complement each other. In these cases, there would be two effects from a merger between firms:

  • higher prices from increased market power when the drugs are sold stand alone and 
  • lower prices from internalizing the complementarity when the drugs are sold in combination. 

In their simulations of hypothetical mergers, Song et al. find that the two effects are practically a wash and often consumers are better off.
The net impact of a merger is a modest price increase, or even a price decrease.

Sunday, August 20, 2017

Germany's North-South divide

The latest evidence about the superiority of markets (over government planning) seems to come from Germany, people go to better schools, get jobs more easily, earn more and live longer to enjoy it. Crime is also lower. I say "seems to" because inferring causality from correlation is notoriously difficult.
In 1960 Bavaria was the poorest part of West Germany. Like its neighbours, it lacked natural resources and had to find work for millions of Germans who had fled central Europe from 1945 and settled in rural areas. So successive governments limited bureaucracy and offered incentives for investment not just in big cities but also in smaller-scale production in towns and villages. This suited economic traditions: the hilly south had generally been farmed in small patches by self-sufficient families, while the flatter north lent itself to larger, more class-stratified agri-businesses. ... Bruno Hildenbrand, a sociologist, even suggests that the relative autonomy of the southern farming families gave the region a more entrepreneurial and pragmatic mentality.
HT: MarginalRevolution.com

Friday, August 18, 2017

Fake Eclipse Sunglasses

Like many, I will stop my day to experience the solar eclipse on Monday. Many will regret it. As the WSJ reports, they will have stared up at the sun thinking their eyes were protected by special sunglasses that "can filter out tens of thousands of times as much light from the sun as sunglasses." Instead, they will be exposing their eyes to potential harm from counterfeits.
Mr. Jerit said some dealers on Amazon have created copycat versions of his company's Soluna brand of eclipse glasses, sold by GSM Sales LLC. He says the knockoff Solunas are replicas down to the logo, design and product information printed on the frames, and often are sold at much lower prices. A pack of 10 legitimate Soluna eclipse viewers cost $39.95 on Amazon as of Aug. 4

This is a case of a very large and very temporary expansion in demand. Supply cannot increase fast enough making price rise temporarily. But even more, the new temporary demanders are not as discerning about quality as the traditional customers. These are the characteristics that permit moral hazard. With a higher price, there is room low cost producers to enter temporarily with sub-standard products.

I am predicting that ophthalmologists will be busy over the next few months.

Thursday, August 17, 2017

Sheldon Chooses a Console

I use this youtube video in class to get a discussion going of all the instances of opportunity costs. The writers did a good job making it accessible even to non-gamers and in carrying a gag as far as they could.

Tuesday, August 15, 2017

Game theory applied to extreme view protests

In light of events in Charlottesville over the weekend, I am reposting from a story in the WSJ. Germans pledged money to an anti-nazi group for every meter that nazis marched. You cannot help but smirk when watching the video.

I suggest that the next time an alt-right, nazi, or KKK rally is planned, a similar campaign is launched. I know many would pledge money for every hour that the speeches are made and their protest lasts if donations went to a suitable organization that peacefully counsels these folks back into the mainstream. Then hand out lozenges so they could continue as long as possible. Have a signboard with a running total so they could see how much they have raised.The media would eat it up.

Monday, August 14, 2017

The Dark Side of Incentive Pay?

The Financial Times recently published a thoughtful commentary by Jonathan Ford arguing that performance pay in the financial sector has been bad for financial market consumers. He extolls the virtues of the post-war, pre-liberalization banking system where a particularly industrious bank manager might get rewarded with a letter of commendation from the bank president. Ford notes that there were flaws.
The system was not perfect: it could entrench snooty managers and make credit hard to come by.

In contrast to these halcyon days, today's financial managers face constant competitive pressure and are constantly rewarded for increasing profits. We hope that profits are generated by delivering ever increasing value to customers. But, especially during the financial crisis, there were many examples of bankers fleecing customers. He notes that the bad acts are a result of bad incentives and suggests a remedy for these bad acts.
But there is of course a simpler way to avoid offering bad incentives. That is simply to pay employees a salary based on what the job is worth.

On net, was the move to market liberalization, and incentive pay as a consequence, worth it?

I will note that, over the past four decades, the financial sector has seen nearly as much innovation as the IT sector. Spreads between interest rates to borrowers and savers and in stock market transactions have shrunk dramatically. More consumers have access to more financial instruments than ever before in part because more financial instruments are available at cheaper rates than ever before. Ask your grandparents if they diversified their retirement fund into international equity funds when they were your age and you will probably get a blank stare. This innovation is also a result of market liberalization. Would de-liberalization and a reduction in banker incentive pay also put a halt to further financial market innovation?

Thursday, August 10, 2017

Non-Standard Real Estate Commissions

The relationship between home sellers and their realtors represents a classic principal/agent problem. Realtors are engaged in many activities related to selling the property such as photographing it, listing it, coordinating with home buyers' agents, holding open houses, and so on. Since realtors have traditionally earned a 6% commission on sales they have an incentive to engage in these costly activities. But realtors know much more about how the market is likely to shake out than do their clients. All else equal, they would recommend dropping the price so that the house will sell faster and without all that effort since 94% of the lower sales price is born by their clients. What happens when they bear the full 100%? Levitt and Syverson showed that when realtors sell their own homes, on average, they keep them on the market longer and sell them for higher prices.

So maybe a 6% commission is not enough to eliminate shirking. How do you provide stronger incentives without giving away too much? Alina Dizik at the WSJ reports that owners of high priced houses are getting creative.
[Mr. Mahller's] agent would earn a 2% commission, and the buyer's agent would get a 2.5% commission on the home's sale price. The sweetener: Mr. Mahller's agent also pocketed an extra 5% commission on the difference between the asking price of $2.7 million and the final sale price, which was $2.85 million.

Micro econ videos from Marginal Revolution University

Course Outline

2 Supply, Demand, and Equilibrium
3 Elasticity and Its Applications
4 Taxes and Subsidies
5 The Price System
6 Price Ceilings and Price Floors
7 Trade
8 Externalities
9 Costs and Profit Maximization Under Competition
10 Competition and the Invisible Hand
11 Monopoly
12 Price Discrimination
13 Labor Markets
14 Public Goods and the Tragedy of the Commons
15 Asymmetric Information
16 Consumer Choice
17 Exam

Tuesday, August 8, 2017

Why I can't buy a Tesla

Well, besides not being able to afford one.

Because the state of Texas does not allow Tesla to sell me one. Reason TV documents this form of auto dealer protectionism. Tesla has chosen to only sell direct to consumer, or has vertically integrated into retailing. The state of Texas prohibits automobile sales that do not go through a dealer, or they require manufacturers to outsource the retailing function. It is hard to imagine how this regulation benefits consumers. Don't let Bubba tell you that Texas is a bastion of free markets.

Monday, August 7, 2017

Nukes as Sunk Costs

Two South Carolina utilities have plans to abandon two nuclear reactors that are still under construction. The two reactors have cost the utilities roughly $9 billion and are less than 40 percent completed. They were expected to begin generating electricity after 2021 at cost of $25 billion — more than twice the initial $11.5 billion estimate. At the same time, demand growth has not materialized and the costs of alternative energies, such as natural gas and wind, have fallen substantially.

Scana Corporation, the project's owner, said in a statement,“Ceasing work on the project was our least desired option, but this is the right thing to do at this time.” This beats throwing more money at an increasingly unviable project.

Splitting the check? There's an app for that

Do you have to pay for other people's drinks if you didn't order any? Do you chip in for an appetizer you didn't eat? How do you split tax and tip?

So starts the CNN story about splitting the check (without losing friends). The social etiquette of group dinning may be evolving due to  the advent of smartphone payment apps like Venmo and Square Cash that allow funds transfers among friends. Moreover, apps such as Tab or Plates are specifically designed to split the check using these funds transfer apps.

It used to be that when I initiated the invitation, I expected to pick up the tab. Often, there was an expectation of later reciprocal invitations which helped facilitate the development of longer term relationships. Sometimes though, it encouraged free-riding as they ordered from the top-shelf. But if it is easy settle-up after each shared meal, both reciprocation and free-riding are reduced.
Paying only for what you ordered -- particularly down to the cent -- used to feel stingy. But the apps help reduce the pressure to round up or kick in a little extra.

Friday, August 4, 2017

Set prices to reflect costs AND demand

Andy Kessler at the WSJ documents multiple instances of inappropriate use of break-even analysis.
  • The USPS saw the volume of first class mail "fall from 103.7 billion letters in 2001 to 61.2 billion last year." More substitution with email and online bill pay makes demand more elastic implying margins should fall. Instead, the USPS raised prices 50% to make up for the shortfall.
  • ESPN's subscribers have dropped from 100 million in 2011 to 89 million today. To 'make up the difference' it raised prices from $4.69 per sub a month to $7.21 today.
  • Microsoft kept raising the price of its Windows operating system to computer manufacturers at the same time Android based computing came to dominate the market.
  • Booksellers have raised effective prices on digital books "to offset the decline of physical copies."
The article documents many more examples. These examples share some commonalities. Firms had enjoyed substantial market power but now face unexpected competition. Managers feel pressure to meet investor expectations. And then they forget their marginal analysis. The lesson is:
Increasing prices attracts others to attack your market. Amazon's Jeff Bezos warns: "Your margin is my opportunity." 

Thursday, August 3, 2017

Fantasy Football Draft or Auction?

Tristan H. Cockcroft at ESPN has seen the beauty in auctions.With football season just around the corner, many a fan is looking to put together the ultimate fantasy football roster. And the first step is drafting players among your league members. What is wrong with a draft?
I'm tired of the annual charade of one of my longest-standing home leagues, in which the owner who draws the dreaded 10-spot -- it's a 10-team league -- reacts as if it's some sort of death sentence.

He proposes an English auction perhaps, as our favorite textbook shows, because it is essentially equivalent to a second price auction in which the bidding strategy is simple. Simplicity is important when you are bidding on multiple players and not just buying a single item. Still, he provides lots of advice on strategy: don't fall in love with players, avoid bidding wars, don't bid for players you won't use, don't get rattled, etc.

Tuesday, August 1, 2017

Bargaining as a Group

Last month, FTC alumni Dan O’Brien and Jon Leibowitz along with Russell Anello, completed a study extolling the virtues of Healthcare Group Purchasing Organizations (GPOs). GPOs bring together multiple firms to buy of common products jointly rather than separately. Among the ways this lowers costs is by lowering their counter-party's disagreement value.
A healthcare provider’s bargaining strength depends in part on the size of the loss it can impose on a vendor by refusing agreement. If a vendor has little to lose from failing to reach an agreement with the provider, then the provider’s bargaining position is weak, while if the vendor has a lot to lose, then the provider’s position is strong.