When does introduction of a new brand cause higher prices on the old one?

P&G just raised prices on its high end Tide detergent:

To compensate for the introduction of a lower-end version of its big-selling Tide detergent, P&G is raising prices on some fancier Tide varieties by as much as 25%.

Two possible explanations:

1.  Pricing changes with commonly owned substitutes.  Before introduction of the new brand, Tide did not care where from where it drew customers.  After introduction of the new brand, marginal revenue on sales of old Tide goes down (because some of the additional sales come from new Tide).  When MR falls below MC, P&G responds by selling less (and raising price).

2.  Suppose there are two types of consumers:  higher elasticity consumers who prefer the new cheaper Tide, and lower elasticity consumers who prefer the older more expensive Tide.  The introduction of new Tide attracts more of the price elastic consumers, making demand for old Tide less elastic.  P&G responds with a higher price on old Tide.

The explanations are not mutually exclusive.  The second depends on two different consumer types.  The first does not. 

HT:  Brian

Hitler on bubbles (humor)

Put your money where your mouth is

Planet money has another show that is making me re-think my opposition to subsidies for public radio, The Bet 

Paul Ehrlich, biologist, author of the population bomb, predicted that prices would go up as population grew.  He reasoned that predicted population increases would increase demand for minerals which would drive up their price.

Julian Simon, economist, predicted that technological advances would lower the cost of extraction, and that price increases would cause people to find substitutes.  In other words, supply would shift out and become more elastic as price went up.  If supply shifts faster than demand, then price goes down.

Simon won on all counts.

What is interesting about the interview is how anti-science Ehrlich seems in retrospect.  He is unwilling to subject his theory to empirical testing. 

President Obama's sex problem

President Obama's policies have given me a wealth of examples that illustrate adverse selection, moral hazard, and the unintended effects of various policies like price control.  And while this makes it easier to teach these ideas in class, I do fear for the country.

Just as more disabled and old people are signing up for Obamacare, so too are more women (who have higher expected medical costs than men) signing up.  What this means is that premiums will have to go up to finance the higher expected costs, which makes it even less likely that younger, healthier, and men will sign up.

What it means, in Grady’s words, is that “the new health care law forbids sex discrimination in health insurance.” Just as no one can be denied insurance or charged more because of a pre-existing condition, a woman and a man of the same age must be charged the same premium, and their policies must cover the same conditions–including maternity care for unmarried men (and women past childbearing age).

What it also means, however, is that women, like persons with pre-existing conditions, are more expensive to insure. The ban on what is called “gender rating” drives men’s premiums up as well as women’s down. (That doesn’t mean, by the way, that women pay less under ObamaCare than before. It may be that premiums rise for both sexes but the increase is steeper for men.) It means, further, that if ObamaCare enrollees are disproportionately female–just as if they are disproportionately older–premiums will tend to go up for everybody. And lo and behold, they are: The Department of Health and Human Services reports that of the 2.2 million people who have “selected a Marketplace plan,” 54% are female.

HT:  Kevin

Price controls destroy wealth: NY Living Wage version

Old theory, new application, via Richard Epstein. 

The first of these stories carries the headline “After Winning a Raise, 175 Workers At a Queens Casino Lose Their Jobs.” That result would never have happened if the workers had won their raises by demonstrating higher levels of productivity to their employer, The Resorts World Casino. Instead, these wage increases were dictated by a labor arbitrator who doubled the base wages for workers in the casino under the living wage arrangement that he imposed on the firm.

No one should be thrilled that restaurant workers have to settle for wages of $5 per hour plus tips. But a steady job at that level is better than no job at the $12 base pay ordered by the arbitrator. The casino sought to raise food prices to compensate for the increased costs, but the law of demand applies to consumers as well. In hard times, they won’t stand for the increased prices, so the casino closed a food operation that could only operate at a loss, leaving 175 union members to scramble for jobs.

When will they learn?

Why does Medicare pay twice as much for VES?

Medicare currently pays suppliers more than twice as much for VES's (Vacuum Erection Systems) as private consumers who buy over the Internet.  The reason is simple:  other people's money. 

When the government spends our money, they don't care as much about the price. 

What will happen to housing in 2014?

WSJ Blog uses supply/demand analysis to forecast the housing market in 2014.  On the supply side,

Lenders could begin to ease certain “overlays”—or additional credit and documentation checks—that have been imposed over the past few years. Mortgage insurance companies are getting more comfortable insuring loans with down payments of just 5%. So don’t be surprised if, at the margins, it gets a little easier to get a mortgage—especially if you have lots of money in the bank.

Even if it gets easier to get a loan—by no means a given—borrowing costs and fees could rise. Banks also face new mortgage regulations that could keep most of them cautious. Borrowers with more volatile or harder-to-document incomes, including the self-employed or those who make a lot of money on commissions, bonuses, or tips, could continue to face tough sledding.

Uber and surge pricing

Uber and Economics versus Business

In another insightful piece, Megan McArdle describes one way that business pricing models differ from pricing from naive economic models. Uber's pricing mechanism matches supply and demand at a time and place in real-time. So, when supply is limited, e.g., a cold New Year's eve, the suppliers are accused of "gouging." Echoing long understood economic principles, she writes:

When demand is very high, and supply is very limited, the right thing to do is let prices rise. This performs two functions: It ensures that available supply is distributed to people who want it pretty badly, and it can attract more supply into the market.

But the she adds the insight:

We do not like market transactions made under duress, even if the seller is not responsible for the duress. Merchants in disaster areas often charge less than they could because they know that the goodwill costs will exceed the profits from maximizing their markup.

Sometimes the actors in real life stubbornly refuse to behave the way our models assume.

Now that we have learned something, isn't it time to act?

Anyone who reads this blog, or the textbook, knows that we encourage companies--and governments--to test the effects of various programs.  The Oregon Medicaid expansion gave us a nice natural experiment, about which we have blogged before, to understand the effects of increasing health insurance coverage on costs.  In addition to encouraging hospital visits--with no discernible effect on health--now we learn that it encourages emergency room visits. 

Conventional wisdom holds that it should, by diverting them from expensive emergency room use to less-expensive visits to doctors and nurse practitioners. This argument was very popular with advocates for health reform in 2009, and it remains a sort of folk wisdom among educated people; I’ve heard some version of this argument in virtually every discussion I’ve had about health care in the last decade.

To health-care economists, though, the question is more complicated. Health insurance does theoretically let you go to a primary care physician rather than relying on ER docs who are legally required to treat you. On the other hand, it also reduces the cost of going to the ER. And as the basic laws of economics tell us, when you reduce the price of something, people usually want to consume more of it.

Just once, I would like one of these advocates to apologize and admit that they were wrong.   And now that we have learned something about how the act works, shouldn't we go back and change it so that it works better?