Mike Hammock's Blog

SO2 Emissions: Stocks vs. Flows

2011-01-14T15:07:00.000-08:00

I saw Frank Stephenson's post on Division of Labour, referring to this post by Shawn Regan, which refers to this post by Stephen Hayward. To put it briefly, Hayward points out that SO2 has been falling for a long time, and the 1970 Clean Air Act (CAA) hasn't had a measurable effect on SO2 levels. I found this puzzling for two reasons. First, I was under the impression that the 1970 CAA, while identifying SO2 as a major pollutant, didn't actually do much about it. Second there is a strong consensus among environmental economists that the SO2 cap-and-trade program (a result of the 1990 amendment to the CAA) has been wildly successful, reducing emissions quickly at a much lower cost than expected. I did some digging, and I think I finally figured out why Hayward is saying the Clean Air Act hasn't mattered, while environmental economists think it has: they're looking at different things.

Hayward is looking at ambient concentrations of SO2. That is, he is looking at the stock of SO2 in the air, which is a result of past pollution. The stock of SO2 is important; the more there is, the larger the (negative) health effects and the more acid rain. Environmental economists, however, have been looking at the flow of SO2 into the air--that is, the emissions of SO2. This is also important. If we decrease the amount of SO2 we're adding into the air, the stock of SO2 will fall (or fall more quickly). What does the path of emissions look like?

You can get that data from the EPA here. Note that the data is in five-year increments until 1995. It's hard to say much, due to the lack of annual emissions data prior to 1995, but it looks to me like emissions fall more quickly after the 1990 Clean Air Act Emissions, if one were to draw a trend line for the data before and after 1990.

There are a few puzzles, such as the jump in emissions in 1995 (when the first stage of the cap-and-trade market started, and was focused on the 110 largest existing sources) and in 2003, but they're followed by even steeper declines. It turns out that the increases are due to sources that would be regulated under the second stage of the cap-and-trade program in 2000 (which applied to the other large existing sources and all new sources). It makes some economic sense: Squeezing the emissions of big polluters, without constraining the small ones, resulted in a shift of production, and therefore emissions, to those smaller sources. Why did emissions rise, then, and not just stay constant? This is just a conjecture, but I would guess that it is because those slightly smaller producers (of energy or whatever) were initially less efficient; for a given amount of output, they probably produce more SO2. I'm not sure why emissions stabilize from 2002 to 2005, rather than just falling. I could tell some more just-so stories, but they wouldn't be very satisfying.

My point is that environmental economists are, I think, right to view SO2 cap-and-trade as a success story, in terms of emissions. Emissions have fallen at a faster rate as a result of the program. Has this had an effect on ambient SO2? I can't really tell from Hayward's graph. It looks to me like ambient SO2 may have fallen faster after 1990, but to me, the interesting question is "what happened after 1995?"--and his chart only has three years of data there. Here are the EPA's charts of ambient SO2:

No matter which graph one looks at, it doesn't appear to me that there's a clear effect of the SO2 cap-and-trade program on ambient SO2. There's a pronounced drop from 1994 to 1995, but that's it. It looks like SO2 just keeps falling steadily. I don't know much about the physical science involved here, though. Is there a lag between the reduction in emissions and an effect on the stock of SO2? Is there something else going on that I don't understand?

Maybe, when I get some time (which could be some time from now), I'll look at some of the empirical papers on this. If I'm totally off-base, hopefully someone will correct me in the comments.

Sour Grapes--er, Milk

2010-12-22T07:22:00.000-08:00

When hearing a story about ethanol subsidies diverting corn from cattle feed and raising its price, angering dairy farmers, I confess my reaction was uncharitable. In fact, my reaction was something like "Oh, are the poor dairy farmers being forced to pay an artificially elevated price for something important to them? Poor babies. I know they would never support anything like that."

Of course, the ethanol subsidies are a terrible idea, too; it's just interesting to see such hypocrisy without any sense of self-awareness or irony.

Fun with Google Ngrams

2010-12-19T15:00:00.000-08:00

I saw a link on Marginal Revolution to the Google Ngram Viewer. It tells you how often a phrase occurred in the books contained in Google Books. My first thought was that Deirdre McCloskey should play around with it a bit, since her most recent work deals with the importance of language and other factors in allowing the industrial revolution and economic growth. For example, consider this ngram of bourgeoisie. Or maybe don't; it only shows how many times the word occurs. McCloskey would be interested in how the word is used--is it an epithet or used to praise?

So then I started wondering who's been mentioned more in recent years, and I decided to type in those two figures who towered over economics in the 20th century, Milton Friedman and John Maynard Keynes. Here's what you get. I recommend clicking the link; the graphs below are tiny by comparison.

I think it nicely reflects their roles over the last century, up until the last few years, when Keynes has made a resurgence. The graph doesn't seem to reflect that, at least, not in 2007 and 2008. Hyman Minsky is barely visible by comparison to both of them, so I won't even include that graph here.

I wondered how some other famous economists would compare. My expectation was that Adam Smith would be big, but I didn't realize how big:

Wow. He's surpassed by Marx in the 60s until the 90s (which fits with the times, I suppose, but is nonetheless frustrating), but otherwise Adam Smith seems to tower over the other big names. I was sad to see David Ricardo with so few mentions. For the sake of Austrians out there I threw Ludwig von Mises in, too. Sorry, Austrians; even Paul Krugman is getting more mentions than Mises nowadays (note that the frequency with which an economist is mentioned does not suggest that they are wiser or more correct).

Who are the other big names I should be putting in here? It would probably be best to drop Adam Smith and Karl Marx from any comparisons you do with any modern economists; they are mentioned so often that they make modern economists hard to see on the graph.

Airline Safety is Simple

2010-11-19T05:39:00.000-08:00

My god, I haven't updated since September. Life is kicking my ass lately.

The big story in the news lately is the TSA's increasingly invasive search procedures. My friend Art Carden has called for abolishing the TSA. This article points out that the TSA doesn't seem to actually catch any terrorists, and it's not clear why the mere existence of the TSA would deter terrorists more than the private contractors that provided security before the creation of the TSA.

Here's what I really don't understand: Why does it make sense to have a government agency providing security? As Art points out, airlines have an incentive to provide security, if only because they don't want to lose planes and pilots to terrorists. If you think that's not enough incentive, then make airlines legally liable for damage caused by their planes and for the deaths of passengers on their planes. Then step back and let the airlines provide security. They will search for and find the right balance between annoyance and safety--that is, they will provide safety up to the point where the marginal cost to passengers, in terms of annoying safety procedures, is equal to the marginal benefit to society (in risk of death and financial loss).

Contrast this with the TSA: What incentive do they have to worry about passenger convenience? They only face weak pressure filtered through the political process. Suppose something slips through, and someone gets hurt; the agency is not going to lose money as a result. It will face political pressure to do a better job, but it would likely get more funding as a result. The TSA faces perverse incentives.

This reminds me of Mixon's Law (named after Wilson Mixon): Government agencies can always justify funding increases. There are two reasons to increase funding for a government agency.

1) The agency is doing really well, and should be rewarded with more funding. That way it can do more great stuff.

2) The agency is doing a terrible job, and should be given more money so that it can do a better job.

Good Questions From My Students

2010-09-16T20:02:00.000-07:00

I've been teaching two introductory classes, and my students have asked me some really good questions, which is part of what makes teaching worthwhile. For example:

Why are there price supports for milk, but not for, say, steak? I don't know; the just-so story I suggested was that milk is sold primarily directly to consumers, who are a very dispersed interest group (so they find it difficult to organize to oppose the regulation). Steak is an important input for many restaurants, so perhaps they form an effective counter-lobby against ranchers. Bryan Caplan's answer to why such a clearly inefficient regulation would exist would be (in part) "voters are rationally irrational and support the policy", but I don't think that's true here. I don't think most voters are even aware milk price supports exist. It has to be some sort of classic lobbying battle.

Is there regional variation in minimum wage laws that correlates with homelessness rates? One student said that she had lived in Hawaii, where the minimum wage exceeded the federal wage and homelessness was rampant. I guessed that if one were to run the data, one would not find a relationship (although I don't think there'd be a causality problem--how would high rates of homelessness cause a higher minimum wage?), but it sure would be interesting to check.

Why do some cities have rent control, but not others? Why New York and Santa Monica, but not Atlanta? I don't really have any good answer here. Anyone have any ideas I could run by the students?

David Friedman On Macro

2010-09-03T07:03:00.000-07:00

I am teaching an introductory Macro class this semester, and it always makes me feel like a snake-oil salesman. David Friedman has a great new blog entry on Macro. I have two additional thoughts on the subject.

1) I have another objection to Macro: we cannot see the counterfactuals; there are no good natural experiments to test hypotheses. When some states do one thing, and others do a different thing, we end up with lots of different observations that can be used to test a hypothesis. We can see how two similar states that do two different things differ from each other, and this tells us something about the effects of policy. With the U.S., however, there are no other data points--different countries are too dissimilar to make direct comparisons. As a result we cannot know what would have happened if macro policy had been different. What would have happened without TARP, or the stimulus bill? We don't know. There's no way to know. Combine this with the poor predictive power of macro theory in its current state and you get something that is of dubious scientific value. Aside from "Inflation is always and everywhere a monetary phenomenon," there's not a lot of Macro that I would be willing to stand behind firmly.

2) Friedman suggests that insufficient attention has been paid to regime uncertainty--the reluctance of individuals and firms to make costly economic decisions when policy is uncertain. Bob Higgs has been writing about this topic for some time. I blogged about it once. Here's Jerry Jordan, former Fed bank president, making the same point. Here's Don Boudreaux reading James Madison on the subject. Here's Russ Roberts (after an interview with Higgs) on the subject, and again here. Here's Scott Sumnerdismissing the idea. Finally, here's Tyler Cowen on regime uncertainty (he calls it "policy uncertainty"), and not atypically, he takes a muddy position. My point here is that I'm not sure if insufficient attention has been paid to this topic. Lots of economists are aware of it. How much attention should the topic receive? I don't know. Given that it's so very difficult to test macro hypotheses, would paying attention to the topic of regime uncertainty make any difference at all?

Subsidies for Electric Cars Are Also a Bad Idea

2010-08-15T09:44:00.000-07:00

In June Art Carden and I argued that subsidies for nuclear power were a bad idea, not because there's anything wrong with nuclear power, but because we cannot know the best way to generate cleaner energy--it takes a market with prices to figure that out.

Daniel Gross argues in this piece in Slate that people who oppose subsidies for electric cars misunderstand "the process of innovation, economic history, and the current macroeconomic situation". For someone who is writing with such confidence, I would say Gross is the one displaying staggering misunderstanding. Yes, costs of building electric cars will probably come down with economies of scale, and yes, that process has repeated many times through history. None of that suggests that subsidies are a good idea, and Gross doesn't even begin to justify subsidies. How can the government know that electric cars are the best solution? What about small turbocharged clean diesels, or hydrogen, or some other technology? How can the government know which is the best one into which to sink billions of dollars? It can't. With a subsidy, however, it is making that very expensive bet.

If we want cleaner cars, a gasoline tax is the way to go. Car producers will experiment with a variety of techniques in an attempt to find the cheapest way to reduce gasoline usage. We'll also get responses from consumers, who move closer to work, carpool, and find other ways to reduce fuel usage (thereby reducing pollution). Government subsidies for new car technologies make as much sense as subsidies for, say, new MP3 players or new vacuum cleaners--that is to say, they make no sense at all. Markets are great at technological innovation; rather than ramming one form of innovation down our throats, why not give everyone the incentive to innovate in a variety of ways until we find the best solutions?

Nashville Bike Share--Will It Be Berry Bikes All Over Again?

2010-08-15T09:32:00.000-07:00

Personal stuff has kept me from blogging recently; I've just been too busy. I hope to slowly get back into things over the next few weeks.

Nashville has started a bicycle program called Nashville Bike Share to encourage people to ride bicycles rather than drive. My first thought upon hearing this was "This will be the Berry Bikes disaster all over again". In 1998 Berry College's student government placed bicycles around campus; anyone who wanted to use one could hop on and ride it to class for zero price. As detailed by Frank Stephenson and Daniel Alban in this Freeman article, it didn't turn out very well. Riders treated the bicycles poorly, and within weeks they were unusable. Why? They were common property; because everyone owned them, no one owned them, and because no one owned them, no one had an incentive to take care of them. No individual bore a significant portion of the costs of damage to a bicycle. This is the classic Tragedy of the Commons. The program was eventually abandoned.

I don't think the Nashville Bike Share will end up faring quite so poorly. Riders must check out the bicycles and return them to the checkout one hour before the checkout location closes, and hefty late fees are assessed if riders fail to do so. I don't see anything on the site about fees for damage to the bicycles, but with the riders being individually identifiable, simple legal remedies should work. It will ultimately come down to how diligent the bike share workers are in chasing down bicycle abusers. This is a huge improvement on the Berry Bikes.

Does this mean the program is a good idea? It's hard to say. On the one hand, if there is sufficient demand for bicycles for rent, then it should be profitable for someone to provide those bicycles. The fact that no one is doing so suggests that this is not a wise use of government funds (I'm guessing it's a government program--it doesn't actually say so on the site, so I'm not sure, and in any case, it could also be a poor use of private charitable funds). On the other hand, if there are unpriced negative externalities from non-bicycle transportation (air pollution and congestion from cars, for example) then more bicycle use could be efficient. If that is the case, however, then it makes more sense to raise the gasoline tax, since that allows individuals to find the lowest-cost ways of reducing externalities.

The Economics of Information Security

2010-06-16T10:02:00.000-07:00

I have uploaded a paper that I've just finished that surveys the literature on the economics of information. It discusses malware, botnets, and other attacks, and the defenses against them.

Frankly, I think it's pretty dry stuff. I initially thought it was going to be about encryption and online retail security, but it seems there's not a lot of economics there, and that particular problem is mostly solved.

Have Pity on Afghanistan

2010-06-14T08:13:00.000-07:00

As if their fate wasn't bad enough when they lacked any resources of value (with the exception of opium which, of course, they're not supposed to grow), now they've got one: Lithium. Given their high levels of government corruption, I would expect the natural resource curse to strike.

A New Machinery of Freedom!

2010-06-07T13:32:00.000-07:00

David Friedman is considering a third edition of his classic The Machinery of Freedom, and he's soliciting input regarding what to include and what to exclude. If you're familiar with the book and have an opinion, now's the time to express it!

This was the book that convinced me that I was a libertarian (and, for that matter, explained to me what a libertarian was). It's also the book that explained what kind of libertarian I was not. I think every libertarian should read the sections at the end on why most simple libertarian arguments about force don't make sense.

Some Reasons Why I'm Not a Big Fan of Ayn Rand

2010-06-04T06:56:00.000-07:00

A lot of libertarians were influenced by novelist Ayn Rand. It's important to keep in mind that she wrote her novels in a different time, when it was radical to suggest that profit and self-interest might not be bad. While I think it's possible to get some useful things out of her novels--a sense of outrage at the destructive capability of government intervention, for example--there's not a lot more to be learned from them. I read it in high school, and was briefly excited. It opened my mind to different ways of thinking about the world. I soured on the philosophy itself pretty quickly, however.

Charles Murray has a new review of two recent books about Rand, and it has some great criticism. When I look at the lives of the people who created and tried to live by the Objectivist philosophy, I don't really see anything that makes me want to jump on board. They seem miserable, hypocritical, self-deceptive, and prone to witch-hunts and purity tests that seem more like religion than rational philosophy.

There are plenty of knocks against the philosophy itself. David Friedman points out that her derivation of "ought" from "is" doesn't follow. Bryan Caplan suggests that her philosophy is at adds with evolutionary psychology (the same occurred to me after reading Nathaniel Brandon's biography a few years ago; they seemed to think human nature could be overcome by pure rational thought, or perhaps that human nature was pure rational thought--but evolution selects for reproductive success, not rationality. The results were affairs that ended badly.). Roy Childs pointed out years ago that the logical conclusion of her philosophy is Anarcho-Capitalism, not minarchy. A quick Google search will show you other critiques of Objectivism, although some of them are weak.

(SPOILERS for Atlas Shrugged below)
It has also always bothered me that Galt's Gulch is hidden by some kind of holographic screen, which is a pretty serious public good, yet we're also told that there's no taxation. So who pays for the screen? Surely it's not charity; that would be, in Rand's view, evil. The rest of the economics is pretty laughable, too--even with a motor that pulls static electricity from the air, they could not have a complex, wealthy modern society without heavy trade with the outside world, for natural resources at the very least. They'd be lucky to achieve subsistence. It reminds me of Art Carden's critique of the end of Wall-e: If they decide to try farming, 90% of the population will die within a year.

Miscellaneous Links

2010-06-03T09:24:00.000-07:00

Here are some things that are worth reading.

How can people miss the obvious parallels between alcohol prohibition and drug prohibition, and if they don't, how can they think drug prohibition is still a good idea?

This article on record teenage unemployment prompts Don Boudreaux to write one of his many letters to the editor pointing out that there was a recent record hike in the minimum wage, which the article's author doesn't even mention. Mark Perry provides a nifty graph and commentary. Here's the They Might Be Giants song, Minimum Wage.

After events like the bungled attack on the "freedom flotilla", I first think about the wonders of free trade, but then I turn to something else: Why are we sending any money to Israel? I don't mean to imply that they don't deserve aid because they're evil, or that I'm taking any particular stance on Middle East politics. Rather, I wonder why we send almost $3 billion in aid each year to a country with a per capita GDP of over $31,000. We're sending aid to a very wealthy country. Do they really need our help? Assuming that aid actually does anything (which isn't so clear, in terms of economic development, anyway), wouldn't those $3 billion do more good in a country that is poor? I can't help but think it would do more good in Haiti, even if half of it were squandered.

Ford to Kill Off Mercury (Probably)--But Why Did They Wait So Long?

2010-06-02T10:43:00.000-07:00

It looks like Ford is going to announce the demise of the Mercury Brand, which seems to me to be an obviously good idea. Mercury has offered slightly-modified versions of Ford cars for years, with the main difference being slightly higher equipment levels. The result was lots of unnecessary costs for producing slightly different sheet metal, emblems, and other cosmetic differences, with no clear benefit. GM did the same thing when it eliminated the Oldsmobile brand 2004, and the Pontiac, Hummer, and Saturn brands in 2009. Personally I think they should kill off Buick as well (in the U.S., anyway--it's still a big deal in China). All these brands lacked clear identities. Some of them had a clear identity at one time (Pontiac was a performance brand, Saturn produced small cars that were more reliable than the average GM car), but "badge engineering" diluted these brands. Ford also sold off the Land Rover, Aston Martin, Volvo, and Jaguar components of its Premier Automotive Group.

I think successful car companies like Toyota and Honda have shown that two or, at most, three brands is optimal. For example, Toyota has Scion for the youth segment, Toyota for the mainstream, and Lexus as its luxury brand. Honda gets by with just Honda and Acura. Ford is now down to Ford and Lincoln (with some technological cooperation from Mazda). GM has Chevrolet, Buick, GMC, and Cadillac.

Here's my question: Why did these companies wait so long to clean up their messy brand identities? These problems have been around for years. Did it have something to do with labor agreements and the revisions to them necessitated by the recession? Or was it simply reluctance to kill off old traditions? Why didn't the stockholders force the companies to take these steps earlier? Maybe it was a good idea before, but it's not now--but why? What changed to make badge engineering become a bad idea in the last few years?

UPDATE #1: Nathan Prey suggests it has something to do with dealership legalities (by which I assume he means contracts). Katie Francisco suggests that the thing that allows Ford to kill off dealerships now (as opposed to earlier) is a decline in Mercury sales. I think that's borne out by this graph. I pointed out that this suggests Buick should be killed off, too, but Nathan says that big sales in China will keep that from happening here. I still think it would be fine to kill off Buick here and let them continue in China, if only to avoid the costs of the tweaks to distinguish them from their Chevrolet versions (or the shipping costs, if they're shipped here), but maybe those costs are really low, or maybe the Chinese market success depends on them being sold here for marketing reasons.

UPDATE #2: Autoblog asks the same question, and comes to pretty much the same answer.

What's Under Your Gas Station

2010-06-01T17:59:00.000-07:00

The Kroger nearby put in a gas station. My wife took a picture of the enormous tank before they buried it. I thought it was pretty cool, so here it is.

Think about all the specialized labor and capital that goes into building this gas station.The workers know how to dig and build and hook everything up. There are tools for digging and moving things around, and there must be cool equipment used for building that big tank, and trucks and trailers for delivering it. The total operation must take hundreds of people, maybe thousands, most of them unaware of each others' existence, with no one coordinating the whole thing. Sure, there's probably a guy who oversees construction, but he doesn't oversee the production of the tank or the truck that delivered it. It's an incredible decentralized machine. Amazing, huh?

This American Life on Haiti and Development Economics

2010-05-25T06:55:00.000-07:00

If you're interested in development economics and/or Haiti, you absolutely have to listen to this This American Life podcast. It has almost everything: insecure property rights, infrastructure problems, education, health, incompetent NGOs, justifiably skeptical Haitians, and the hazards of central planning. The focus is on attempts to improve the mango industry, one of Haiti's few exports. What's missing is discussion of how markets can solve some of these problems, but it's lurking in the background.

You might also enjoy this Bob Murphy story about his experience in Haiti.

Do They Hate Everyone Who Breaks Dumb Laws, Or Just Some?

2010-05-24T08:58:00.000-07:00

It bothers me how many people get upset about illegal immigration simply on the grounds that the illegal immigrants are here illegally. They are upset that the immigrants didn't go through the (ridiculously convoluted, nearly impossible to penetrate) legal process to gain entry, permission to work, and citizenship. Laws that keep out peaceful people who just want to be productive are dumb. Shouldn't we be mad at the lawmakers, and not the people who break the dumb laws?

I wonder if the same people think the operators of speakeasies during alcohol prohibition were also moral monsters. Were they evil for allowing people in to drink? I think most people now agree that alcohol prohibition was a dumb policy. What about jaywalkers? What about someone who loses his temper and cuts off one of those "Do not remove under the penalty of law" labels on mattresses? Do illegal immigrant-haters hate those people, too?

Here are two seldom-heard reasons to want a lot more immigrants:

They tend to be young, and they pay payroll taxes, which means that they would postpone our problems with social security for many years.
They all need to live somewhere. We have a lot of excess housing. It's not "re-inflating the bubble" if increases in housing prices are the result of more people buying houses to live in!

Check out Art Carden's posts on Division of Labour regarding immigration here, here, and here.

UPDATE: Hat tip to Art Carden yet again for this great Jeff Miron piece on illegal immigration.

ANOTHER UPDATE: A friend who wants to remain anonymous says:

Another example of law-breaking relevant to the immigration debate is this: in the South before the war, you were BREAKING THE LAW by teaching slaves to read and write. Might this look familiar:

Now, I'm not a racist and I'm all for people learning how to read and write, but they need to do it LEGALLY and not BREAK THE LAW of our sovereign country.

New Article in the Freeman on Nuclear Energy Loan Guarantees

2010-05-21T06:48:00.000-07:00

Art Carden and I have a new piece in The Freeman on nuclear energy subsidies. Do we get to call ourselves prescient for our comments on removing limits on tort liability for the energy industry?

Guns in Nashville Bars: Opt-out Versus Opt-in

2010-05-18T18:23:00.000-07:00

Here in Nashville the legislature has tried to pass bills making it legal for individuals to carry handguns into a bar. On first hearing this sounds like a terrible idea; well-armed drunks are a recipe for trouble. I personally don't like guns; I'm sure if I owned one, I would end up shooting myself in the foot. I'm simply not comfortable around them.

In this case, however, I think the bill's supporters have actually managed to craft a reasonable bill. Gun carriers cannot drink in the bar, and bar owners can opt out, banning weapons from their bars as they see fit. If it really is such a terrible idea, then all the bars end up banning guns and the problem is solved. The bill ends up doing nothing.

Perhaps, one might argue, the law would still be inefficient because bars will have to spend money on signage announcing that guns are not allowed; prohibiting guns in bars would accomplish the same goal without any wasteful expenditure by bar owners.

There is a simple solution to this: Make the bill opt-in instead of opt-out. Make the default legal rule "guns are banned in bars", but allow a bar to post signage saying "guns are allowed here". Bar owners could even add stipulations, such as "gun carriers can't drink" or "guns must be checked at the door" or "only guns below .38 caliber allowed" (or whatever). The result would be that only bar owners that actually wanted guns in their bars would have to deal with them. Bar patrons who don't want to worry about guns at bars can simply avoid those that have chosen to opt in. I wonder, would any of the bill's current opponents accept this version? They can't think that bar owners would willingly place themselves at risk (physically and financially) and their patrons at risk (mostly physically, I guess) if guns in bars really are a bad idea. If they still don't support the bill, are they really worried about safety or do they simply not like the idea of people carrying guns?

That last question isn't rhetorical; I genuinely want to know. What are the remaining objections to my alternative version of the law?

XXX Isn't Really About YYY: Some Suggested Compromises That Won't Fly

2010-05-18T18:08:00.000-07:00

Robin Hanson famously argues that signaling drives much of behavior. Medicine isn't about health; it's about signaling to other people that we care, or that we're trying to be helpful--the real outcome isn't important (as suggested by evidence that health care expenditures don't contribute much to health).

Much (most?) policy discussion is driven by this signaling. So, for example, the BP oil platform accident drives one side to suggest banning offshore drilling, and the other side to remain steadfast or even increase its support for drilling. Surely neither side can really mean this--stopping all offshore drilling would be too costly, and no one can really think that oils spills are a reason to be more willing to support drilling. These positions are just posturing to keep the other from getting some advantage.

If they were really interested in the public welfare, they would support some kind of compromise. This is a pretty easy one: Get rid of the limits on liability for oil spills, which causes injurers to take into account the full scope of the damage they could cause. This causes them to take greater precautions against accidents. It doesn't cause them to reduce the probability of an accident to zero; that's impossible, and the closer we get to zero probability of an accident, the more costly it becomes. Given that there's little the injured can do to influence the damage from an oil spill (aside, I suppose, from living on or near the coast), simply making the injurer liable for the full scope of damage caused should give the injurer the incentive to take the efficient level of precaution.

This might upset some conservatives, as it means that some oil platforms might shut down or fail to start up in the first place, due to increased safety or liability costs. It might upset some liberals because it only reduces the amount of drilling and the probability of accidents, rather than eliminating them. But if both sides were really interested in increasing safety and allowing drilling, it seems to me a reasonable compromise. Of course, the limit on liability will not be removed. The two sides are interested in signaling to their constituencies, not in making society better off. Drilling regulation isn't about safety; it's about showing you care about the environment or people driving cars. The same goes for mine safety: tort and civil law won't simply be allowed to sort out who should bear the liability for accidents, because it's not really about safety or business.

Another example is Cap and Trade. Liberals want to limit CO2 emissions with regulation, conservatives do not, due to opposition to the taxation implied by Cap and Trade or carbon taxes. Here's another simple compromise: Replace payroll taxes with CO2 taxes (or CO2 allowance auctions for Cap and Trade). Tax burdens shift but do not go up overall--in fact, a tax that creates a deadweight loss is replaced by a tax that eliminates a deadweight loss. Yet neither side will even propose such a bill, because they're interested in heat, not light (some people outside of government, including Al Gore, have proposed such an arrangement). CO2 regulation isn't about reducing CO2; it's about showing you care about the environment or taxpayers.

Such compromises are not always possible, but the fact that they sometimes are available but unexplored should create some doubts in the minds of anyone with faith in the efficiency of democracy.

ADDENDUM: Robin Hanson talks sensibly about regulation and infrequent accidents. Hat tip to Bryan Caplan at Econlog.

People DO Respond to Gasoline Price Changes

2010-05-12T09:28:00.000-07:00

This is a terrible graph, layout-wise (if they're arguing that higher gasoline prices reduce miles driven, why is the dependent variable on the horizontal axis?), but it is interesting. The sections where the graph bends backwards are gas price spikes that lead to reductions in miles driven per capita. When gas prices go up, people do respond by driving less, and the bigger the price increase, the bigger the drop in miles driven.

The most interesting part of the graph is the section from 2008 to 2009, where the price falls while miles per capita continue to fall. I don't know what's causing this. If I had to guess, I would guess that, unlike the 1970s, we have a greater ability to adapt to gas price changes--by telecommuting, maybe--so once people started identifying such opportunities, they just kept on going. Also, the drop in housing prices may have allowed some people to move closer to work. Finally, the 2008-2009 price, while lower than 2007-2008, is still high by historical standards, so people may still be trying hard to find ways to reduce their high gasoline bills.

One more thing: If we want people to drive less, and use less gasoline, gas prices are the tool to use. Higher gasoline taxes will drive the price up and reduce gasoline usage. Whether or not that is a good idea is a separate question, but if the goal is to force people to use less gasoline, higher gasoline taxes are the most efficient tool to accomplish this.

Let's Play "Pat Robertson Channels God's Anger"

2010-05-04T11:21:00.000-07:00

We all remember how Pat Robertson let us in on why God smote New Orleans and Haiti. This raises the question, why does God hate Nashville? Or more accurately, what is the reason Pat Robertson would (will?) give for why God hates Nashville?

On Facebook, Eric Lease suggested "It's that demon country music!".

Also on Facebook, Art Carden suggested "They finally released Johnny Cash's American VI, so Nashville has apparently outlived its usefulness.

My own suggestions: Tennessee failed to make it illegal for gays to adopt last year (Nashville being the seat of the state government).

What do you think? What horrible sin has Nashville committed to deserve divine wrath?

More Pictures of Nashville from Metrocenter and Salemtown

2010-05-04T10:53:00.000-07:00

I went for a bike ride around Metrocenter with the crummy 2 megapixel camera in my cell phone and took some pictures and really low-quality videos. The area has experienced some flooding. It doesn't look like the buildings are in terrible shape. Last night my wife and I were part of a huge crowd that showed up to throw sandbags on a low spot in the levee that shields Metrocenter from the Cumberland River.

Some of the pictures below are panorama stitched together from several pictures. Combine the terrible quality of the camera with stitching and the result is a pretty bad image, but you can at least get an impression of the water levels. Be sure to click on the pictures to enlarge them.

Here's Morgan Park. That big body of water is supposed to be a big open grass area, with a baseball diamond in one corner. The auto stitching is particularly bad here. I had some images to the left, too, but the change in perspective made them unstitchable.

More pictures after the jump.

This picture was taken from the bike path atop the levee. The building across the river would normally be way above the water level; now it's in at least five feet of water.

This should give you a better idea of the change in water level. Some of these trees are probably forty feet tall normally; they're twenty to thirty feet underwater.

Here's the Titans practice inflatable thingy. I guess there's a field inside. The water goes all the way up to it; that would normally all be parking lots.

The Fountain Square mall at Metro Center has a large pond by it; now it's a huge pond.

Workers were pumping water back into the river from the parking lots. You can see the tubes at the other end of this tunnel. I'm not certain of the purpose of this "tunnel", but I think it's supposed to keep people away from water equipment on the right side of the trail (the tunnel is a permanent structure, not something put up during the flood).

I uploaded some videos from my phone. The quality is absolutely abysmal. They're something like 175 x 140 pixels. Yuck. The embed code doesn't seem to center them properly, so you may want to open them in another tab or window.

Pictures From the New Nashville Aquarium

2010-05-02T20:48:00.000-07:00

You might have heard that we got some record rainfall here in Nashville. In fact, it's been disastrous, with many homes destroyed and businesses damaged. Our house here is fine, although the dogs have been getting cabin fever from being cooped up all day.

We went for a walk to take some pictures this afternoon (all of the pictures below were taken by my wife). The Salemtown/Germantown neighborhood seems to have fared pretty well. Here's a view of Morgan Park from the river side, looking back to the west toward the community center (visible on the right). The park itself is flooded.

More pictures after the jump.

Here are a couple dogs frolicking in the water. You can see the sidewalk disappearing into the water. Over by the baseball diamond (not visible, but it's over to the right) the water was maybe seven to ten feet deep.

We walked down the greenway by the water treatment center. Normally there's a nice spot by the river with a bench and a trash can, where one can see the river. The entire area was underwater when we got there. You're looking at the Cumberland River, where there should be grass and trees.

That rail is part of a hill that goes down somewhat steeply, and the bench and trash can are at the bottom, under all that water. You normally can't really see the river at all from this spot.

We then headed over to the Bicentennial Mall and the Farmer's Market, where there was supposed to be some serious flood damage. Here's the auditorium at the south end of the mall (which you can see here on Google Maps):

The capital hill would be on the left. That must be twenty feet of water, maybe more.

Heading over to the Farmer's Market, the intersection of Harrison St. and Rosa Parks Blvd. was flooded.

That doesn't really convey the flooding that occurred, so here's a cell phone video to give you a better idea of the scale.

You can see the pink Nash Trash tour bus toward the end.

Heading over toward the Farmer's Market, we were saddened to see some pretty serious damage. The various plant sellers have suffered some serious damage to their inventory, the water was well up into the parking lot, trapping a couple vehicles.

Looks like the furniture store re-opening across the street from the Farmer's Market won't be so grand after all.

There are signs of damage inside the Farmer's Market, where some of our favorite restaurants reside. I hope Jamaicaway doesn't have to close down for long.

Sorry about the glare on the glass; there wasn't much to do about it. You can get a better idea of how high the water came from this picture.

It looks like something happened at the Dollar General--either this SUV crashed into the side (or perhaps floated into the side), or the side of the building buckled and the perspective is just making it look like the SUV was involved. Either way, they must have lost at least half their inventory.

We didn't see any flooded residences during our walk, but there are some areas around Nashville--Bellevue and Antioch, for example--which have apparently experienced damage severe enough for evacuations. The Red Cross is providing temporary shelter. Fortunately, there isn't supposed to be much rain for the next few days, so the water should recede fairly quickly.

UPDATE:

Here's a video of a temporary school building floating down I-24.

My Problem with Part of the Proposed Financial Reform

2010-04-30T05:56:00.000-07:00

I'm not sure if it's in the current version of the reform bill or not, but one proposal for financial reform was a sort of FDA for financial instruments. It would review new instruments and determine whether they were valuable innovations or excessively complex and unnecessary--possibly even fraudulent--tricks that will lead to further financial disaster. So, for example, if a company offers some fancy new kind of derivative, the review board would have to approve it before issuance.

I have two problems with this (they're closely related to each other, but I think they're different enough to call them separate arguments). The first is well-summarized here with an example:

For example, before 1996, certain initial public offerings of stocks were subject to merit review in certain states, where the state decided if a security is a "bad" investment and thus not appropriate to be offered to its citizens. In fact, this is exactly what happened to Apple Computer when it first went public in 1980. Massachusetts prohibited the offering of Apple shares because they were "too risky," and Apple did not even bother to offer its shares in Illinois due to strict state laws on new issues. What if federal bureaucrats had had the power to impose their judgment on a "risky" financial product (such as an IPO) on a nationwide scale, or every state followed Massachusetts' lead?

That's taken directly from Marginal Revolution, which quoted it from Paul Atkins. This is a great example of my first problem with this kind of reform: Financial instruments are really just contracts, and every one is new and different. New financial instruments are created all the time, with new and different terms. Every new financial instrument is a new contract. Can a review board really review and approve all of them in anything resembling a timely fashion? The only way I can imagine that they could do so would be to restrict financial instruments to a set of standardized forms. Issuers are allowed to change a few things--the interest rate, the time period, etc.--without needing approval. Changing anything else would require approval.

Yet this would almost certainly leave some value-increasing exchanges foregone. There must be some value in allowing new and different financial instruments that don't follow strict forms; they can't all be schemes and frauds. Arnold Kling would probably argue that we can do without the complexity and do fine with simple forms, but I'm no more comfortable with that than I am with governments deciding if an innovator like Apple should be able to issue stock.

My second problem with this kind of reform has to do with the FDA. Economists (particularly Robert Higgs) have long suspected that the FDA tends to be too reluctant to approve new drugs. The reasons for this are straightforward: The incentive to approve new drugs is low, and the incentive to deny them is high. If a drug is approved, and someone gets sick as a result, the public and Congress are going to blame the FDA. If a drug is approved, and it works wonders without getting anyone sick, then no one is going to sing the praises of the FDA. Furthermore, the people who could have been saved by a drug that is not approved are usually not a vocal interest group (a notable exception being HIV/AIDS victims), and their suffering is not visible to most of the public. As a result, the FDA tends to require drugs be tested for a long time before approval.

I would expect the same problem to occur with financial instruments. The regulatory approval body would have an incentive to reject most instruments, or at least subject them to lengthy reviews that delay their implementation (leaving many potential users of these instruments without them for some time).

To add my usual caveat, I'm not an expert in finance or macro, and my opinion on this subject is not as valuable as the opinion of such an expert would be.

Why Do Soccer Players Fake Injuries So Frequently?

2010-04-28T11:22:00.000-07:00

I've often seen this question asked, and I don't think it's just an imaginary pattern. Here's my armchair economics-based analysis.

Real injuries in soccer are usually intensely painful, but brief (particularly shin and other lower-leg injuries--even with pads, they can still hurt). An injured player may briefly be in agony, but it ends quickly and the player can get back up.

This means that it can be difficult for a referee to tell a real injury from a fake one. If the referee is fooled, the penalty to the "offending" team is the same whether an injury is real or faked, so it pays to fake injuries. Furthermore, there's no disincentive to fake an injury--the referee is not going to penalize a team for trying to make the other team look guilty. Even if the referee wanted to do so, he'd have to use replays to reliably find the truth, and soccer fans cannot tolerate the delays that would be associated with replays. Maybe they could fine players after a game upon reviewing a recording of the game, but I suspect the fines would have to be really big to change player behavior.

So to sum up: In soccer, faking injuries is pretty much all benefit, no cost. Again, this is merely an armchair just-so story. I'd be interested in hearing other just-so stories, too!

Why Are Some Commercials Insulting to the Advertiser and Its Customers?

2010-04-23T21:05:00.000-07:00

For example, there's the GEICO gecko's clueless boss (and his dumb ringtone), or the two idiots that sit in their car at Sonic--two examples of effective commercials. Then there are those annoying Progressive commercials with the completely unfunny woman at the counter; again, they make their customers and employees look dumb, but the effect is annoying. I guess my question is, why are companies so willing to look stupid and insult their customers? I don't mind; in fact, I think self-deprecation is endearing, but it still seems counterintuitive.

ADDENDUM: Upon further reflection, the relationship is more interesting than that. Commercials are more likely to be insulting to employees and customers if they are for companies that have direct interfaces with consumers--restaurants, car insurers, etc. Advertisements that speak in vague, positive generalities about companies come from companies that don't have much direct interaction with the customer (such as commercials from ADM or GE). Again, this seems counterintuitive. Shouldn't companies that are closer to their customers be less willing to depict customers as idiots, and less willing to portray themselves as awkward and stupid? Perhaps companies with a close relationship with consumers have goodwill that allows them to be silly, while companies without such relationships cannot afford to insult anyone.

This is all anecdotal; perhaps I'm just imagining things.

Peel Back the Layers of the Marketplace Onion and it Still Stinks

2010-04-23T07:05:00.000-07:00

I really don't like American Public Media's public radio show Marketplace. It's rife with bad economics. I once heard a show in which a reporter explained that the Federal Reserve has two tools for influencing the economy: interest rates and money supply. That's like saying there are two ways to drive a nail into a board: you can use a hammer, or you can use a stick with a metal head on it.

Last night while driving I heard the host of the show explain that there is a law against futures trading for onions in the U.S. I was excited because I had actually learned something new from this show that so frequently annoys me. I was delighted when the host pointed out that prices in the onion spot market are more volatile than in other agricultural markets. It turns out that both statements are correct, too.

Then, of course, I was let down, as the host said (and I'm paraphrasing) "It just shows that you never know what to expect from a market". This is an indication of incredible ignorance of economics. Increased volatility is exactly what economics predicts should happen if futures markets are eliminated. Why? Because futures markets allow people to bet on future prices. If I look at weather data and conclude that onions are going to be in short supply in three months, I can sell a promise to deliver onions then (at what will be a high price) and buy a promise from someone else to give me onions (at today's low price). The result is an increase in the demand for onions now, and an increase in the supply onions later. What happens to the price? It goes up now, and down in three months. Prices are smoother over time because speculating in futures markets allows planning for the future. It's intertemporal arbitrage. (This does not mean that speculative bubbles cannot occur; it just means that we should generally expect prices to be smoother over time.)

This is not a surprising result. Econ 101 students should understand this intuitively. It's disappointing that the creators of a much-listened-to radio show do not seem to understand this.

Economic Freedom and Government Requests for Data

2010-04-20T16:09:00.000-07:00

Google has made available the number of requests for information and requests for removal of information that various governments made from July 1, 2009 to December 2009. I was curious what kinds of countries made various kinds of requests, so I plotted their Index of Economic Freedom score against their number of requests.

There are so few observations that's it's hard to say much. I had to throw out most of the removal request data because so many of them were classified as "less than 10" rather than specific number. It looks like there is a weak negative relationship, as one might expect--countries with lower rankings on the index of economic freedom made more requests. I suppose one could consider all sorts of variations on this, such as requests per capita. Maybe an industrious undergraduate could take a look at this. China is missing from this data, which leaves the U.S. with the most requests for data, and Brazil with the most requests for removal. Apparently Brazil's government requests lots of information from Orkut, which is a social networking site. Perhaps it's part of anti-drug investigations or some other criminal investigations.

What If

2010-04-16T20:19:00.000-07:00

I'm not a global warming denier; I accept the consensus view of climatologists that anthropogenic global warming is real. I am even willing to accept that it's worth doing something about.

It is my understanding, however, that the earth has been in a lengthy period of remarkably stable climate for some time, and that sometime "soon" (I'm not sure what that means in climatological terms--it could mean a thousand years from now as far as I know) we're due for some a cooling cycle. I can't find any nice summaries of the science on this, so let's just ignore my ignorance and suppose that we found out that global cooling was about to happen in the near future. Suppose also that this cooling would have serious implications for humans and for species around the world.

What would environmentalists want to do in this case? Would they be in favor of letting the world cool down, possibly leading to human suffering, and the extinction of many species? Would they be in favor of trying to warm the world somehow (not necessarily by increasing CO2 emissions--they might not like ocean acidification or some other side effect)? I don't know what their answer would be. Maybe different environmentalists would answer differently. I think the answer says something important about the opinions of the person answering, though.

I think economists would be in favor of doing whatever cost-benefit analysis supports, even if that means trying to manipulate global temperatures to avoid the costs of accommodating rapid climate change.

Art Carden and Others on The Myth of the Rational Voter

2010-04-14T10:00:00.000-07:00

There's video up of Mike Munger, Art Carden, Randall Holcombe, Geoff Brennan, and Bryan Caplan discussing The Myth of the Rational Voter at the 2008 Public Choice Society.

Part 1

Part 2

Part 3

Part 4

Part 5

Art Carden makes a lot of points from our forthcoming piece in Economic Affairs, The Truthiness Hurts. You can read a pre-print version of it here. I was disappointed to see that Art didn't mention that my wife came up with the name for "Stick-It-To-the-Man Bias", but then, his time was very limited. In fact, the editor seems to have cut out some of his remarks (which is a shame, as I thought he was more interesting than the other speakers).

A Research Project for an Industrious Undergrad: Discrimination in the Checkout Line

2010-04-11T14:42:00.000-07:00

There's an interesting literature that attempts to measure racial discrimination. For example, I once read a paper that tried to determine whether basketball referees are harsher on players who are not of the same race (as I recall, they were).

Here's something that an industrious undergrad might be able to pull off (although he or she might need a partner). Go to a local supermarket and sit near the checkout lines. Record the gender and race of each employee in the checkout line and each customer that goes through the line (you probably ought to ask a manager for approval first). Also record the number of people that go through each line in, say, an hour. Repeat this at some other grocery stores.

This data should allow one to determine:

Whether customers are more likely to go to an employee of the same race or gender than pure chance would predict.
How much customers are willing to pay, in time, to go through a checkout line operated by someone of the same race or gender (assuming a same-race or same-gender preference exists). That is, you can find out how much they are willing to pay to indulge their racism or sexism.

There may be some confounding factors--self-checkout or express checkout, and the relative attractiveness of the employee, but I think it should be a fairly straightforward project.

Markets in Everything: A Coffin for Your Dead Xbox 360

2010-03-17T13:02:00.000-07:00

If your Xbox 360 gives you the Red Ring of Death, at least give it a decent burial.

Okay, so this isn't actually for sale (yet).

An Inefficient Ruling: Severed Fingers are now the Manufacturer's Fault

2010-03-17T07:39:00.001-07:00

A man in Boston won $1.5 million in a lawsuit against the manufacturer of a table saw for failure to include technology that would detect the presence of fingers or other human flesh, which resulted in severe injury to his fingers.

The main problem with this ruling is that it assigns the burden of avoiding injury to the wrong party. The party that can avoid injury at the lowest cost is the person using the saw--he or she can simply be careful. It costs nothing more than going a little slower and paying more attention. By contrast, the inclusion of this technology would almost certainly be expensive, raising the price of a table saw significantly, and still would not eliminate the risk of injury (it would apparently result in small gouges rather than severed fingers).

Another problem is that it creates a disincentive for companies to develop these kinds of technologies. Flesh-sensing technology apparently does exist, and could be used on saws, but if failure to include it on all saws creates a large legal liability, then it might no longer be in anyone's interest to put it on any saws. Consider another example: The airbag was invented long before it was ever used in a car. Suppose that, one year after the airbag's invention, one could sue automobile manufacturers for failure to include them after being injured in an accident. This would give manufacturers two perverse incentives: to include airbags before they are fully tested (possibly causing more accidents), or to avoid developing airbags in the first place.

Depending on how the table saw case turns out in the end (I would not be surprised if the damages were reduced on appeal, or if the entire verdict were overturned), there are several possible outcomes that could occur:

1) Manufacturers stop selling inexpensive saws, and sell only high-end saws with flesh-sensing technology.

2) Manufacturers sell low-end and high-end saws with the flesh-sensing technology, resulting in more expensive saws for everyone.

3) Manufacturers continue to sell low-end saws without the flesh-sensing tech, but charge more for them to reflect the higher liability they represent to manufacturers.

Anyway you look at it, the consumers of low-end saws suffer from this decision (except, I suppose, for those who are unwilling to take care to avoid injury, and who would prefer to pay more to get a low-end saw with flesh-sensing technology--surely a very small portion of those who would buy table saws).

Why a Long-Term Business Model is Difficult for Some Games

2010-03-16T09:32:00.001-07:00

Consider multiplayer video games like Call of Duty or the Battlefield series, and pen-and-paper role-playing games such as Dungeons and Dragons. They both face a similar problem: After the initial publication of the basic game, which (if the game is successful, as these have been) sells a huge number of copies, there is little additional revenue.

Suppose all 400,000 people who want a copy of Battlefield: Bad Company 2 buy one. EA Games loves all the revenue this brings in, but now faces nothing but costs, possibly for years, as EA Games has to pay to maintain game servers (through which players connect, or on which players actually play the game together).

When Wizards of the Coast releases the fundamental Dungeons and Dragons rulebooks--the Players Handbook, the Dungeon Master's Guide, and the Monster Manual--the basic rules are now available to all players. The players and the game master/dungeon master/referee (or whatever you want to call him or her) can use their imagination to create adventures and characters to develop the rest of the game. Again, once the basic rules are released, the publisher brings in a lot of revenue, but after that it slows to a trickle.

In both cases, publishers try to find ways to sell more stuff to the players. Developers of video games release Downloadable Content (DLCs) or expansion packs. These are additional maps or new game modes that make gameplay more interesting and diverse. The danger of these for multiplayer games, however, is that they can splinter the player base. Only players who buy the game can play together; any individual player worries that if he or she buys the expansion pack or DLC, few other people will buy it, rendering the new content useless. Few people operating servers enable the additional content, because they do not want to limit the number of people that can play on the server. This coordination problem becomes a self-fulfilling prophecy: few people buy the expansion pack because of fear that few people will buy the expansion pack. Therefore multiplayer game publishers face a risk if they rely on DLCs and expansion packs to bring additional revenue. It is difficult for them to make additional profits from this content, so players may be stuck with stagnant gameplay.

Publishers of pen-and-paper role playing games also want additional revenue after the initial sales of rulebooks. This is usually done by selling "modules", or pre-written adventures (for those dungeon masters who don't have the time or imagination to create their own), as well as books detailing "campaign settings", the worlds in which the games take place (e.g., The Forgotten Realms, Dragon Lance, Eberron, Greyhawk, etc.). Again, these are only useful to gamers that cannot create their own settings. Publishers can also release additional rulebooks, which create new options for players (The Fighter's Handbook, The Bard's Handbook). Again, these are not necessary for players and dungeon masters with imagination, and they may not even fit the campaign setting being used.

In both cases, the result is lumpy income for the publishers: They get a big pile of revenue upon initial release, and then a small stream after that. Would it be possible to smooth this revenue over time? There are some possibilities, some of which are in use.

For multiplayer video games, the publisher can require that game servers be rented. This helps cover the ongoing costs of the game (developing patches and running any necessary central game servers), and allows the developer to more closely monitor and maintain the online game system. Another possibility is that the publisher could charge more for the initial game, but promise that the developer will release free DLC over time. Whether or not this works depends on the reputation of the developer. A developer like Valve Software could do this, as they have a long history of providing new free content long after a game's release. Publisher EA Games and the developer DICE, however, probably could not do this. They have a reputation for releasing buggy games which are slowly patched over time--sometimes there is free content, but often there is not (and sometimes gamers would prefer that the initial game be fully fixed instead). If this works, it does not smooth income over time, but it does avoid the coordination problem that comes with DLC and expansion packs for sale, allowing the developer to capture the revenue from their sale in the price of the initial game.

A final possibility for multiplayer games would be leasing, instead of sale. The publisher charges players a (probably low--maybe $5/month) monthly subscription fee for access to the game. The game gets upgrades over time. This makes the game much like a Massively Multiplayer Online Role-Playing Game, like World of Warcraft, except that this is a round-based action game, rather than a persistent-world role-playing game.

I think there are fewer solutions for pen-and-paper role-playing games. A leasing model would be difficult; leasing books is simply not practical. Leasing electronic versions of the rules is too susceptible to piracy. Charging a higher up-front fee and then providing free content isn't practical, either--the fee would have to be quite high to cover the costs of developing and then mailing out additional rulebooks, many of which would likely be of little interest to particular players and campaigns. Wizards of the Coast has instead revised the rules every few years, releasing D&D 3.0, 3.5, and 4.0. A danger with this, however, is that some players simply decide that the old rules were good enough, and therefore avoid the new books.

To summarize: Some multiplayer online games share lumpy revenue problems that are similar to those of pen-and-paper role-playing games. There are tools available to game developers to smooth this revenue over time, but pen-and-paper games do not have analogous tools available.

A Question About Regime Uncertainty

2010-02-15T20:09:00.000-08:00

An argument that is often advanced by free-market types (such as myself) is that regime uncertainty is responsible for sustained recession and slow recovery. The theory is that the unpredictability of policy causes businesses to be reluctant to invest and hire. The owner of a business doesn't want to commit to a costly course of action if government spending, taxation, and regulation could quickly render those decisions incorrect. Instead, the business owner prefers to sit and wait, and as a result, recovery takes longer.

Bob Higgs argued that this was the case during the Great Depression, and some argue that this is happening today--that the Federal Reserve is changing its role too unpredictably, that Obama's proposals for cap-and-trade and health care reform are costly and uncertain, and that Congress, too, can easily change policies in unpredictable ways.

My question is, how would one test to see if this hypothesis were correct today? How would one find evidence to support this view and reject, say, the Krugman view, which is that the stimulus just hasn't been big enough? There's always uncertainty about future policy. How do we know it matters more now than it did in the past?

Bad Economics: Revenue vs. Profit

2010-02-04T11:20:00.000-08:00

I was reading The City Paper, one of Nashville's free news magazines, and came across this article on music sales. The following caught my attention:

Now for some basic math, using a revenue formula (for record labels) of 70 cents per digital track and an average of $9.25 per album. The results: 2009 digital track revenue grew about $62.3 million while album sales revenue fell about $503 million. That’s a net revenue loss of more than $440 million.
So clearly digital track sales are not fully replacing lost album sales revenue. In fact, during 2009, digital track increases offset less than 15 percent of the revenue lost from shrinking album purchases.

There are two things that bother me about these paragraphs. The first is the comparison of digital tracks versus album sales, which includes both physical (CD) and digital albums. It's not clear to me why one wouldn't just treat albums as bundles of tracks, rather than different things. In any case, while sellers might not be happy with decreasing album sales, buyers are presumably happier because they don't have to buy as many unwanted songs as they did when albums could not be broken up.

The more serious objection is that the real issue is not revenue but profit. What if digital tracks (and albums) are significantly cheaper than physical albums to produce and distribute? It might not be the case--bandwidth, storage, and management of these files are not free--but then again, it might. If the profit margin on a digital track is high enough, and if the profit margin on physical media is low enough, total profit might still be rising despite the drop in album sales revenue. Yet the word "profit" does not even appear in the article. We simply cannot tell whether the decrease in album sales and increase in digital track sales is, on net, good or bad for sellers, based on the information in this article.

Identifying Crazy, Stupid, or Just Plain Wrong Beliefs

2010-02-03T08:02:00.000-08:00

Bruce Bartlett links to and presents results of a poll of Republicans. If the results are to be believed, a significant portion hold beliefs that I think could be fairly described as stupid or crazy. For example, on the fact side, fifty-eight percent either believe Barack Obama was not born in the United States, or are not sure. Fifty-seven percent either are not sure whether Obama wants the terrorists to win, or think that he does want them to win. One third think Barack Obama hates white people. On the opinion side, seventy-three percent believe openly gay men and women should not be allowed to teach in public schools, and a third believe that contraceptives should be illegal and that the birth control pill is an abortion method.

I don't think that belief in conspiracy theories runs quite as deeply through Democrats, although they surely do have some mistaken beliefs of their own. I would like to see a poll of Democrats with Yes/No/Not Sure questions such as:

Do you think Republicans hate poor people?
Do you think Republicans want to harm poor people?
Do you think it is wrong for a business to make a profit?
Are prices of goods and services set by agreements between businesses? (This question needs work--there ought to be a way to get at the question of whether prices are determined centrally by colluding firms or by decentralized market processes).
Does an increase in the minimum wage raise cause some workers to loser their jobs?
Can we clean up the environment at no cost to consumers by forcing stricter emissions standards on car producers?
Do you believe Freedom of Speech should protect racist speech, too?

What other questions could one ask? For that matter, what questions could one ask of libertarians? There would probably have to be questions about the Federal Reserve and fiat money, a source of much libertarian paranoia that I have never quite understood. I would like to see a question about the Non-Initiation of Force Principle, which is important to many libertarians but which has, I think, been demonstrated to be full of holes.

You Can Save Money On Your Car Insurance!

2010-01-20T09:07:00.000-08:00

There are a lot of commercials for car insurance on television. Many of them claim that people who switch to their insurance company save a certain percent, or a certain amount of dollars, compared to their old car insurance. Yet it can't be possible that every car insurance company has cheaper rates. Can the average person who switches saves 15% or more, or $150, or whatever?

Yes. The reason that it's possible is that the people who wouldn't save money by switching don't switch. As a result, the average person who switches saves money. This is similar to a point Steven Landsburg makes in The Armchair Economist. He argues that grocery stores can truthfully claim that shoppers buying there can save money, because they are each touting the sale prices of their cheapest goods--and these goods are different from store to store.

A remaining question is why there might be enough price dispersion to allow such different policy prices for different consumers; I don't know the answer to that. Perhaps different sellers specialize in different kinds of customers, resulting in specific knowledge and human capital that allows them to charge lower prices to those customers. That is, Safe Auto and GEICO probably attract different customers.

O'Brien, Leno, and Coase

2010-01-19T10:25:00.000-08:00

In 1960 Ronald Coase's paper "The Problem of Social Cost" was published. In it Coase laid out what has come to be known as the Coase Theorem. There are at least two versions of the theorem, and they can be stated many ways. The version I'll discuss here goes something like this: "In the absence of prohibitively high transactions costs, the same efficient allocation of rights will occur regardless of the initial allocation of rights."

"Efficient" means "the difference between benefits and costs is maximized". "Transactions costs" are the costs of transacting--the costs of bargaining to reach agreements. They could be language barriers, regulatory differences, excessive arrogance or mistaken beliefs of the parties to the agreement, or even coordination failure due to a large number of participants on one or both sides of the negotiation. "Rights" could mean any right to anything--the right to graze one's sheep in a particular area, the right to be free from pollution, the right to pollute, or even the right to host a television show at a particular time.

The recent mess over at NBC over late night television is, I think, a simple example. NBC and Conan O'Brien signed an agreement years ago, in which NBC promised that Conan O'Brien would host the Tonight Show. It is not clear whether the contract guaranteed O'Brien the 11:35 time slot, but let us assume for the sake of argument that it did (even if it doesn't, The Tonight Show is closely associated with that time slot, so that O'Brien might be able to argue that it isn't the same show if it airs at a different time).

Eventually O'Brien took over The Tonight Show from Jay Leno, who got a new show at 10:00. Leno's new show performed poorly. O'Brien's Tonight Show also did not perform as well as NBC had hoped (in particular, NBC's affiliates were especially upset).

Now NBC has a problem. They have promised O'Brien The Tonight Show and (perhaps) its time slot. Leno also wants his old show back, as his new show is about to be canceled. What efficient new bargain can they strike?

It is pretty straightforward, and it is the result that the network and O'Brien are rumored to have struck. NBC buys O'Brien's right to The Tonight show, and lets Leno return to the show. Everyone is better off: The viewers and the NBC affiliates get the show they want (bizarrely--I can't imagine preferring Leno to O'Brien). NBC should expect an increase in profits as a result. Leno gets his old show back, and O'Brien gets a large amount of money, and the opportunity to go to a network that will appreciate him. (If you must have some numbers, suppose the network values having Leno back on The Tonight Show at $60 million, and suppose O'Brien values staying on the show at $20 million. There is a range of offers that would make both parties better off.)

Similarly, if NBC had never promised the show to O'Brien, this same outcome would have occurred--Leno would have the show, and O'Brien would not. The parties end up at the same efficient outcome, regardless of the starting allocation of rights.

What about transactions costs? There could be transactions costs that prevent a bargain from occurring. O'Brien might be offended and stubborn, or he might overestimate how much NBC would be willing to pay for the rights to host The Tonight Show. If he asks too much, NBC declines to pay. Similarly, NBC might underestimate how much O'Brien loves the show, and might try to offer too little. Still, both these problems should be addressable with repeated negotiation. The more serious impediments to bargaining don't seem to exist here.

A side note: I am leaving out wealth effects; I think this is reasonable in this case, given the wealth of the parties involved.

Another side note: I suppose this is also an example of efficient breach.

UPDATE: John Lentz points out that it appears transactions costs were low enough for an efficient bargain to be struck.

The Opportunity Costs of Foregone Economic Growth

2010-01-14T09:51:00.000-08:00

Economic growth is great; it brings people out of poverty, so they can have cleaner water, sufficient food, better medicine, and safer cars, as well as less important things, like bigger houses, cool gadgets, and hundreds of channels of television.

The earthquake disaster and its aftermath in Haiti has reminded me of another benefit of growth: it creates resources that can be used to prevent and deal with crises. A wealthier country would have safer, stronger buildings, fewer of which would have collapsed. A wealthier country would have more and better hospitals that could deal with the wounded. A wealthier country would have an airport that could handle the influx of foreign aide without running out of fuel to get the planes back out again. A wealthy country has accumulated physical and human capital that allows it to deal with emergencies, and to better receive help from other countries during emergencies. Haiti's poverty makes disasters more disastrous, makes internal efforts at recovery impotent, and makes foreign aid less effective.

Wealthy countries aren't immune to disasters, of course--thousands died in the U.S. in Hurricane Katrina, and nearly 15,000 died in France in 2003 during a heat wave. These pale compared to the death toll in Haiti, however. Even if an earthquake occurred in, say, San Francisco, I would expect the death toll to be a much smaller fraction of the population than has occurred in Port au Prince.

It's hard to come up with a silver lining for this, but I'll stretch and try. Tyler Cowen suggests that Haiti as we know it is gone. This is a chance to replace its government and other institutions with new institutions that work better, allowing economic growth and a brighter future. It's hard to be optimistic, however. The old government (or what is left of it) surely won't give up power, and it will try to steer any changes in ways that benefit it at the expense of others. Other countries may try to steer the direction of change to their own advantage. Gangs and criminal organizations may try to carve out their own pieces of the country.

Maybe these problems can be overcome, but it's not clear to me what process would lead to better institutions. One possibility is for a country with relatively health institutions to just take over, copying and pasting its legal system and eventually its traditions. Here the problem is how to figure out which country does this. I wouldn't want, say, Venezuela to take over. I'm not even sure I would want the U.S. to try to run things.

Another possibility is for the U.N. or some other international entity to try to redesign their legal and political systems. I can't see this top-down approach working out well. This sort of central planning problem is just too difficult to solve. No, if beneficial change is going to take place, it will have to be from the bottom-up, and gradual. I'm not sure if the political entities involved will allow this.

(Please note that I'm not repeating the stupid claim sometimes made about the success of Japan after World War II. That is, some said that Japan grew so quickly after the war because they were able to replace their old factories and equipment with new ones. This is ridiculous; absent the war and its destruction of capital, they could have had the old factories and the new ones, or they could have torn down the old stuff if necessary. Destruction of capital is not a path to growth. Rather, I am arguing that destroying old and harmful institutions can be beneficial.)

You Know Medical Marijuana is Here to Stay When the Sellers Begin Rent-Seeking

2009-12-14T19:56:00.000-08:00

My wife pointed me to this NPR story. Some in Los Angeles think there are too many marijuana dispensaries. The City Council is considering restricting the number of dispensaries to seventy.

The obvious question would be "why should there be a limit?" The story doesn't answer that question. In fact, it doesn't even ask it. The closest they get is to suggest that dispensaries are too close to homes. I wonder if they feel the same way about alcohol sales. It is also suggested that many of the dispensaries are operating illegally, selling over-the-counter instead of by prescription only. I think marijuana should be available over-the-counter, but even if one believes that it shouldn't, the solution is to enforce the existing law, not arbitrarily limit the number of dispensaries.

As an advocate of medical marijuana points out in the story, driving sellers out of business is going to increase the black market in marijuana, with all its unpleasant effects. So given all this, why would one want to eliminate sellers of medical marijuana? Who are the "some" people that I mentioned in the second sentence of this entry? Here's a possibility: The first person interviewed in the story is the owner of a medical marijuana dispensary. Is this a classic case of the baptists and the bootleggers?

An Important Public Service Announcment: MST3K on Hulu

2009-12-09T12:43:00.001-08:00

HT to Bret Butgereit for pointing this out: five episodes of Mystery Science Theater 3000 are available on Hulu (for free, of course). So far it's only episodes from seasons four, five, and six. Secret Agent Super Dragon is, I think, particularly good (and weird).

Of course, if you're really keen to watch more MST3K, they're all available free on Youtube and Google Video, and you can buy most episodes on DVD. The downside of Youtube is that quality is often poor, and one sometimes has to hunt down the different pieces of each episode. I recommend starting with shorts, like "Mr. B Natural", "Snow Thrills" and "X Marks the Spot".

An economics tie-in: When does recycling make economic sense? It makes sense when the value of the recycled product exceeds the costs of recycling. In the case of MST3K, we know that recycling these terrible old movies is worth it because people are willing to pay enough to cover the costs of doing so. With other forms of recycling, this may not be so clear--it depends on the value of the resource consumed in the recycling process, and whether or not the process itself produces pollution that harms others.

Another Question I Should Have Asked in Econ 307: Optimal Firm Size

2009-12-09T10:40:00.000-08:00

Firms with ten or more employees are subject to regulation by the Occupational Safety and Health Administration. Firms with employee hours worked in a year exceeding 20,000 hours must report emissions of a long list of chemicals to the EPA's Toxic Release Inventory. Other regulations and taxes, such as Unemployment Compensation, begin with the first employee. In an interview I just heard on NPR, the interviewee said that firms with ten or more employees must buy workers' compensation insurance.

What effects should we expect these regulations to have on firm size, and (leaving aside the value or harm of the regulation's direct effect) is this change in firm size efficient? You might think about Coase's 1937 paper, The Nature of the Firm.

Bonus question 1: What are some other regulations that have similar effects? (I don't know the answer to this one.)

Bonus question 2: Is there any empirical work that tries to estimate the effect of such regulations on firm size? (I don't know the answer to this one, either).

Bonus question 3 (for econometrics students): Where would you ideally look to test this, and how would you do it? (I think there is a clear "best answer" to this.)

If you have responses, feel free to post them in the comments.

Evil Profit Maximizers Being Nice

2009-12-02T19:22:00.001-08:00

It is common to view profit-seeking firms as evil--they do not care about consumers, or worse, they conspire to harm consumers. Many people would agree that it is wrong for firms to raise the prices of goods and services, and that doing so makes them evil.

So I wonder, when confronted with this, would one conclude that these are, in fact, virtuous firms, employing kind, sweet people who love consumers? The research firm iSuppli found that television prices fell 22 percent for Black Friday sales. Why would they do this?

Of course, they are forced to do this by competition. The intense competition for sales on Black Friday forces firms to lower their prices. It's an interesting case in which a simple supply-and-demand model can't quite describe what's going on; we need to think more carefully about expectations, economies of scale, and decreasing cost industries, and how those can affect prices.

A related question: Why doesn't this happen in health care? Again, one could say that maybe health care providers are evil and greedy, whereas providers of consumer electronics are generous and selfless, but that doesn't make much sense. If you're interested in a good overview of the problems with the U.S. system, and why it doesn't behave like the consumer electronics industry, you could do worse than to listen to these This American Life podcasts, here and here.

UPDATE:

I linked to this post in my facebook profile, and Justin Coffey had some comments. I think his argument can be summarized as the following question:

If consumers are the people firms really care about, why do managers have a legal duty to shareholders instead?

I think I may have been too subtle in the original post. I was, in fact, not arguing that firms are virtuous and care about consumers for their own sakes. Clearly firms do not care about consumers per se; the goal of the managers of the firm is to make shareholders happy. The original post was intended to point out a contradiction. When firms raise prices, they are denounced as evil. When they lower prices, no one praises them for being virtuous. Why is that? It is because people are inconsistent in how they think about firms.

It turns out that both ways of looking at the behavior of firms are wrong. Firms are not being evil when they raise prices, and they're not being virtuous when they lower them. They are responding to the changing signals of the marketplace in an attempt to maximize profits and please shareholders. That is to say, they're just being self-interested.

To reiterate an argument I've made before, self-interest is neither good nor evil. It can have good or evil effects, depending on the institutional arrangement within which people act. So, for example, if people can pollute without paying any costs for doing so, then they drive their cars too much, operate their power plants too much, and so on. I'd be reluctant to call all drivers and power plant operators (and customers of power plants) evil, though. I'd just say they're responding to incentives. Similarly, when a company lowers prices, I would not call it virtuous. Nor would I call it evil if it raises prices. It is responding to the incentives it faces. In competitive markets, firms are forced to please consumers, for fear of losing profits. The institutional arrangement dictates their behavior. In a non-competitive market--perhaps market dominated by a government-protected monopoly--firms do not work as hard to please consumers, because they do not fear loss of profit to competitors. It's not because they're evil; they're ordinary people like everyone else. It's simply a response to the incentives they face. Expecting people not to respond to incentives is naive and dangerous, as it can create bad policy.

One final point: Higher prices can be a good thing in some circumstances. They may communicate to consumers a reduction in the availability of inputs, or higher prices may tell producers that consumers really like the product and want more of it. It is important to disconnect price changes from notions of good and evil, and instead think about the information conveyed by price changes.

More on Consumer Protection from Costco Connection

2009-11-19T07:25:00.000-08:00

Every month Costco publishes a magazine called Costco Connection. Each issue contains a debate between to experts on some topic of general interest. Most are dull--should kids be spanked, do timesaving devices really save time, etc. Some topics are interesting, however. For example, I commented on an illuminating debate over farm subsidies (it was illuminating primarily because it made it crystal clear how disingenuous the agricultural lobby is).

This month the topic is "Should We Have a Consumer Financial Protection Agency?" The supporter of such an agency makes a bizarre argument: Regulation failed to protect consumers from predatory lending, so we should use regulation to protect consumers from future predatory lending. Why does Ira Rheingold think that future regulatory agencies will be free from the political pressures that caused them to fail last time? He doesn't say. If consumers were genuinely defrauded by lenders, perhaps we should look at their civil law alternatives. Is there something wrong with tort or contract law that has prevented them from suing? Lawyers can take cases on contingency; it can't be a matter of consumer budget constraints. The guy on the other side of the debate, Chris Stinebert, doesn't really make any impressive counterarguments, but he does point out that better-educated and better-informed consumers might help. If there is a role for regulation here, I would say that it is at most that of mandating and standardizing information disclosure.

I'll give quick answers to some other Costco Connection questions. Last month the topic in Costco Connection was "Should We Rely More on Wind Energy?" The entire debate was silly; the answer is quite simple: We can't know until we get the prices right. That means taxing polluting forms of energy, and letting the various forms of alternative energy sink or swim. A policy that consists of picking winners according to political influence, and then subsidizing them, is sure to get the answer wrong.

The topic in August was "Should Mail Delivery Be Cut to Five Days a Week?" Let's end the postal monopoly on first-class letter mail and see what happens. If people had a choice of who they wanted to deliver their mail--much like their email--maybe they would choose a company that delivers five days a week. Maybe they would choose one that delivers six days a week. Maybe some people would choose one, and some would choose the other. Maybe the post office would go out of business. Let competition work and we'll see what happens.

In July it was "Should the U.S. Develop High-Speed Rail Lines?" We've massively subsidized the car with (mostly) zero-price roads. Should we subsidize high-speed trains, too? Why not just stop subsidizing the car instead, and see if trains can compete? We used to have a vigorous private passenger rail system in the U.S. prior to the highway system. Seizing private land for train tracks is one of the least-upsetting uses of eminent domain, since that's the sort of thing for which it was originally intended (not railroads specifically, but canals, roads, and transportation in general). I can imagine a future U.S. in which train travel makes sense, if we give it a chance. The key here is to let different forms of transportation compete on even footing, without encouraging or discouraging them, rather than subsidizing some or all of them.

Consumer Reports Lectures Me on Credit Card Regulation

2009-11-19T06:51:00.000-08:00

I have a subscription to the Consumer Reports website because of the wealth of product information it contains. Occasionally, however, Consumer Reports takes positions on policies, and I nearly always disagree with them (another example: Consumers Union supports higher CAFE standards; I do not, as a higher gasoline tax would be far more effective). I received an email from Consumer Reports today regarding credit card legislation. I was encouraged to go here and support immediate regulation of credit card fees by Congress. I responded with the following.

Dear Consumer Reports,

I have a better idea. Rather than relying on government regulation to set prices, interest rates, and fees, let's lower barriers to entry into the credit card market to encourage competition. I trust a competitive market process to protect consumers much more than I trust a government to do so.

Consumer Reports's naive view of regulation and wrongheaded policy advocacy is almost annoying enough to make me want to cancel my subscription, but your valuable product information is sufficient to change my mind. If only I could get one without supporting the other.

Mike Hammock

Two things may deserve more explanation.

1) Why does competition protect consumers?

Because firms that are afraid of losing customers to competitors have an incentive to keep those customers happy. If that means keeping fees low, that's what they'll do. DVD players didn't go from $200 to $30 because Sony and Philips and Samsung like their customers; they got cheaper because these companies are trying to beat the hell out of each other in a competitive market. There are only five credit cards in common use: Mastercard, Visa, American Express, Discover, and Visa. Discover was the last new major card, and it was introduced back in 1985! Before the government starts trying to set prices and fees, it would make more sense to eliminate whatever barriers to entry exist in this market. I'm guessing they are primarily regulatory. There are probably some network effect problems (getting retailers to accept a new card may be difficult), but those shouldn't be insurmountable--especially if the new card charges lower fees to retailers than existing cards.

2) Why not just let government set all fees and prices?

Because it won't get them right. Prices can be too high, in the case of insufficient competition, but they can also be too low, resulting in shortages. In the credit card market, this would mean denial of credit to some consumers.

This has implications for other policy debates, too. If we want to make something cheaper--like, say, health care--we should look first to the way the market is structured, and look for a market mechanism that can push prices down.

Does This Seem Familiar to Anyone?

2009-11-02T19:26:00.000-08:00

HT to Marginal Revolution for this:

Art Carden and I did basically this exact same thing at Rhodes College for the last three years, making the exact same point regarding lobbying. I'm sure Art's still doing it there now.

To Stimulate or Not to Stimulate

2009-10-14T10:22:00.000-07:00

In this article, Daniel Gross argues that complaints about the failure of the stimulus package are wrong because most of the money hasn't been spent. Yet there are signs of a possible recovery. Here is Brad Delong quoting the data suggesting a 4% GDP growth rate for the quarter. I keep hearing on the radio that economists suspect the recession may be over, or will be over soon.

If the stimulus hasn't done much yet because not much of it has been implemented, and if we are nonetheless headed for recovery, doesn't this suggest that there exists a self-correcting mechanism for the macroeconomy, and that it seems to be working? Daniel Gross argues that this is all going exactly according to plan--things are starting to recover right now because of the $200 billion or so that have already been spent. $200 billion is not chump change, but if it really is responsible for the uptick in economic growth, the multiplier must be bigger than previous estimates. Once again, the inability to do the counterfactual experiment hinders macroeconomics: we will never know how long it would have taken the economy to recover had we not spent $787 billion on stimulus. If Arnold Kling's macroeconomic readjustment story is correct, we could find ourselves spending a lot of money to just postpone the pain for a little while.

Discomfort with Unplanned Systems

2009-10-03T13:59:00.001-07:00

My former colleague Art Carden has a great post over at Division of Labour. He points out that many people are uncomfortable with markets because markets do not have any goal or point or direction in mind (because they do not have a mind to begin with). Markets are unplanned systems that nonetheless produce results, and usually (but not always) pretty good ones--more and better stuff at lower prices. More amazingly, markets work because no one is in charge of them; the profit motive, plus a few simple rules (private property, enforcement of contracts, etc.) gets people who will never know of each others' existence to unknowingly cooperate. This is counterintuitive and even undesirable for many people--how can we let all these resources go around willy-nilly without anyone thinking about whether it all makes sense?

I think this is interesting because this discomfort is very similar to that felt by those skeptical of evolution. Evolution is an unplanned system that nonetheless proceeds toward increasing complexity. There's no one in charge of it; the outcomes are determined by random copying errors and the environment in which these mutations occur. Life doesn't have a point (certainly not a grand cosmological or moral point) in evolutionary biology. It just is, and humans aren't any more important to the universe than any other creature. There is no central planner. Many people--almost entirely religious conservatives--are uncomfortable with this view. They see it as nihilistic and morally troubling.

Furthermore, I think it is fair to say that the skepticism of unplanned market systems tends to exist mainly on the left, while the skepticism of unplanned biological systems exists mostly on the right. This makes me wonder why that would be. Why aren't people on the left skeptical of evolution, too? Why is the right more comfortable with less regulation of markets? Granted, conservatives in the U.S. tend not to be very market friendly, especially in regards to drugs and prostitution, but I still think it is fair to say that conservatives are more friendly towards markets than those on the left.

Maybe I need to reread Rubin's Darwinian Politics.

One more point: Government--that institution that many would like to use to direct markets and reorder society--is also an unplanned system. It has no single mind coordinating it, and the outcomes it produces are not always what one would expect, and (in my opinion) they are seldom what one should find desirable. Government is a maze of competing interest groups, using votes, campaign contributions, promises of post-politics employment, lobbying, and even threats to push for their goals.

That's not to say that there are not market failures that a government could conceivably address; there certainly are. Rather, the question is whether a real-world government could reliably fix them without creating new problems. I'm much more skeptical about that. I would love to see payroll taxes replaced with pollution taxes; the potential welfare gains are enormous. I simply doubt that such a policy could make its way through Congress without becoming something terrible in the process.

Wallace and Gromit: The Greatest Fictional Entrepreneurs

2009-10-03T06:35:00.001-07:00

My wife and I have had some foster kids staying with us recently. We've used this as an excuse to rewatch the Wallace and Gromit shorts and movie (the shorts are better--I think The Wrong Trousers is the best).

It occurred to me after watching them that Wallace and Gromit are underappreciated for their entrepreneurial spirit. In three of their five outings, they start up and succeed in new businesses due to the application (or perhaps over-application) of new technology. In A Close Shave they run a window-washing businesses and Wallace has invented an automatic sweater-knitting machine. In A Matter of Loaf and Death they're running a bread delivery company. In the movie, The Curse of the Were-Rabbit, they have a successful no-kill pest control company (called "Anti Pesto").

There are also four video games based on the characters. I've only tried a tiny bit of the first one, but Wallace and Gromit have already started up a successful honey delivery system--fresh honey, piped directly to one's home. Do they start up more new businesses in the other episodes?

I suppose they have a bit of advantage in that they're made out of clay and live in an unrealistic world in which ridiculous inventions actually work. Still, for sheer entrepreneurial spirit, I can't think of anyone else in fiction who comes close. I mean, these guys run a successful business and then quit, just for the joy of starting and succeeding in a new business! Not even Tony Stark or Archibald "Harry" Tuttle can compare.

Are there any other entrepreneurs in fiction who stack up?

Soft Drink Substitution

2009-09-18T13:25:00.001-07:00

One of the great things about a pollution tax is that it causes people to shift toward doing things that produce less pollution. That is, it's difficult to substitute something in place of polluting production processes (although it is possible to move production overseas in some cases, although not in the case of power generation). The pollution tax revenue can then be used to get rid of taxes on work, like the payroll tax.

There is a some discussion of a soft drink tax. The argument is a bit different from a pollution tax, in that a pollution tax addresses a negative externality, whereas a soft drink tax is more like a sin tax--taxing people who do things to themselves that we don't like. There isn't much of an economic justification for this (unless overweight people impose a tax externality on others due to using state-funded health care for their expensive health care--only they don't seem to have higher lifetime health expenses because they die earlier), but even if there were, it seems to me there is a significant problem: substitution. There are plenty of ways to satisfy a sugary craving for calories, aside from a soft drink, and although they may not be perfect substitutes, I doubt a soft drink tax would be sufficient to make much of a dent in obesity.

A general calorie tax might work, although that, too has problems--it would be very costly for small-scale food producers that otherwise don't have to provide nutrition information, as they'd have to calculate the calories in their food in order to figure out the tax (and exempting them from the tax seems to be to be unfair--it penalizes large producers for being successful). Such a tax would also make it more difficult for the poor to afford food of all kinds (currently the poor a re more likely to consume unhealthy food and suffer obesity). We would have to create an algorithm for determining what food is healthy or unhealthy, and therefore how much to tax it, rather than a simple calorie or soft drink tax--but that is even more elaborate and difficult to get right, and even worse, it's going to be subject to lobbying that could give us even less healthy relative food prices.

A safer start would be to eliminate agricultural subsidies and protective tariffs and see what happens. I suspect that so long as America remains relatively rural and suburban (compared to Europe), obesity will remain a problem.

Some Thoughts on the Health Care Debate

2009-08-19T13:54:00.000-07:00

It’s been painful watching the ridiculous arguments and accusations in the current U.S. debate over health care. This issue in particular seems to have brought out the worst of democracy, with a rationally irrational public shouting about death panels and calling names. Health Economics is not one of my fields, but some things can be said without being a specialist in the field.

First of all, many people are comparing health systems around the world and making unjustifiably strong claims, sometimes using questionable data or results. For example, the oft-cited WHO study ranking countries’ health care systems focuses almost entirely on the distribution of health care, rather than the level, and has error bars so large that the results are almost worthless. Rankings of life expectancy are also of questionable use when comparing countries’ health care systems, as life expectancy can vary for reasons unrelated to health care systems. For example, Americans tend to be more obese, get in more care accidents, and experience violent crime more often than people in other countries. These may be serious problems with American society, but they are not problems with the health care system. Another measure that has been used recently is a comparison of preventable deaths for people under 75 years of age. This suffers from a problem similar to life expectancy—Americans may be more prone toward particular kinds of health problems, and treatment of them may be less successful, for reasons unrelated to the health care system. A real study of the subject would need to control for more variables.

Similarly, one hears that around 50 million Americans do not have health insurance. While technically correct, this number is of dubious value. What fraction of those 50 million people qualify for government aid but have not used it? What fraction are wealthy but have opted not to buy health insurance? How many actually went for an extended period without health insurance, and how many went without for a short period only?

There are also questionable statements about health care in other countries. They are sometimes presented as utopian, and at other times as hellish, depending on the position taken by the discussant. Conservatives like to claim that wait times in Canada for medical tests and procedures are outrageously long; others claim that waits lists in Canada are reasonable.

Do other countries do a better job controlling costs? David Goldhill argues that if they do, it’s not by much:

From 2000 to 2005, per capita health-care spending in Canada grew by 33 percent, in France by 37 percent, in the U.K. by 47 percent—all comparable to the 40 percent growth experienced by the U.S. in that period. Cost control by way of bureaucratic price controls has its limits.

Perhaps other systems get the level of costs down, but cannot control growth, meaning they will end up where the U.S. is eventually.

None of this is to say that the U.S. health care system could not use some dramatic changes. To explain what kinds of changes might work—and by “work”, I mean provide the same or better care at a lower cost to more people—I need to talk about some basic economics, and then some particular economics of health care.

Students in any economics class learn that resources are limited, or scarce. We cannot all have as much of anything as we want. This is true of cars, gasoline, televisions, computers, clothing, leisure, and everything else people enjoy consuming. One can have more of something, but only at the cost of giving up something else. Over time, economic growth allows us to produce more goods and services with fewer resources going into each of them, but this is a slow process. Even with growth, getting more of something is not free.

This applies to health care just as much as it applies to everything else. From society’s point of view, providing more health care means providing less of something else. When people become doctors, nurses, medical device engineers, or other medical specialists, they cannot also be computer programmers, chefs, or produce other non-medical goods and services. No health care system—government run, purely free-market, or anywhere in between—can produce as much free health care as everyone wants. They can be more or less efficient, depending on the incentives of the system (which I will discuss later), but unlimited free health care is not an option, and anyone that tells you it is possible is lying to you.

Economists call the process by which things get allocated to people “rationing”. In a purely market-based system, economists say that the price acts as a “rationing mechanism”—people who are willing and able to pay enough for something get it, and people who are not willing or able to pay enough for something do not get it. In a purely government-run system (say, Soviet-style central planning) bureaucrats decide who gets what, and base it on a calculation of needs, political influence, or some other measure. There are possibilities in between the two extremes.

In any health care system (as in every part of an economic system), someone ultimately says “no”. There are entities that decide who will get care, and who will not. In the U.S. those entities are insurance companies (who decide what to cover and what not to cover, as well as to whom policies are sold), governments (state and federal, which administer programs for government employees, the poor, and the elderly), and individual consumers, whose incomes limit the amount of health care they can afford. All these people—insurance companies, governments, consumers—can say “no” to getting a particular kind of care. Obviously a consumer would prefer never to hear “no” from the other two groups of decision makers.

One might object that doctors get to decide who gets what kind of care, if any, and to an extent that’s true—they (hopefully) will not treat a torn ACL with chemotherapy. Yet doctors are ultimately paid by someone, and if that someone (consumers, the government, insurance companies, charities, whoever) stops paying, they will eventually reduce the amount of care they provide.

In other countries the decision makers may be government officials. The NHS in the U.K. decides which treatments are acceptable for what health problems, and which ones are not acceptable (and therefore will not be funded). When controversies arise in such systems, they are often over whether the government should pay for one treatment or another (one would expect such controversies to arise most often when new treatments become available). Governments can also ration care using queues—care is given out first-come, first-serve. The waiting time for a service depends on what kind of resources a government allocates to it, and how efficiently those resources are used.

Whether government decision makers do a better or worse job than private decision makers is an interesting question, and you might have gathered from the discussion of international comparisons above, it is a difficult question to answer. Nonetheless there is a consensus that the U.S. system is not working as well as it ought to. Health care is getting more expensive rather than less (contrast health care costs with, say, the cost of DVD players). Why is this so?

There are two economic primary theories to explain why this would be the case: adverse selection and moral hazard (both having to do with the economics of insurance). Both can be expected to drive up the costs of health care, pricing many consumers out of the market.

The adverse selection argument goes like this: Suppose that there are two types of consumers, those who will get sick (the unhealthy) and those who won’t (the healthy). Suppose consumers know which type they are, but insurers do not. Then the healthy types, knowing that they do not get sick, will not buy health insurance. The unhealthy types, knowing that they will get sick, will try to buy health insurance. Should insurers sell to them?

They should not. If only the unhealthy types buy, then selling health insurance is a sure way to lose money. Each consumer is going to incur, say, $10,000 in average medical costs, which the insurer will have to pay, and then pay his workers and stockholders. But the consumer isn’t willing to pay more than $10,000 for the insurance policy, so there’s no way for the insurer to make a profit.

This is an extreme version of the adverse selection story, in which the insurance market completely disappears. A more realistic version would involve probabilities, rather than certainties, and when one creates such a model, an interesting result can emerge: If enough healthy consumers drop out of the market, health care can get sufficiently expensive that only the most risk-averse, wealthy consumers (of either healthy or unhealthy type) can afford to buy. That is, even if I am a healthy consumer, I might still want to buy insurance because I am particularly risk-averse—but I can’t, because it’s too expensive, because of adverse selection. If everyone could be forced to buy insurance, it would be cheaper for all. (Here is a clever related argument regarding car insurance, suggesting that cities that require all drivers have car insurance should experience lower rates.) Adverse selection is why health insurance companies try so hard to screen for preexisting conditions, smoking, and other factors that can increase the risk that a consumer will become ill; they are trying to sort out the good risks from the bad.

Does this argument help explain why health care is so expensive in the U.S.? I don’t think so. Recent reforms in Massachusetts have succeeded in getting almost everyone in the state (97% of the population) insured, yet health care costs have risen dramatically, and the state is having trouble with its budget. Adverse selection is really an argument about health insurance costs, not necessarily health care costs.

Moral hazard is a simple response to incentives: Once insured, people have fewer incentives to take precautions to prevent future illness, because the medical costs will be paid for by a third party (the insurer or the government). This makes small medical problems into big medical problems, driving up the cost of treatment (and the cost of insurance). In fact, in the U.S., around eighty to ninety percent of all health care expenditures are paid for by third parties (again, insurers or governments, rather than the patients). This has additional incentive effects beyond simply failing to take precaution. People stop shopping around when someone else is paying. They also request additional procedures or tests, or go to the emergency room instead of a less-costly physician. Doctors, who are paid for procedures and tests performed, have little incentive to resist, leaving it up to insurance companies or the government to say “no”—which, naturally, makes consumers angry, and they exert pressure to make “no” a difficult thing to say.

When a large portion of consumers are no longer paying attention to costs, and no longer shopping around, competition stops functioning. Competition—the process that gave us the $20 DVD player, instead of the $900 DVD player we started with—is an important mechanism for disciplining producers, whether they are producing cars, newspapers, computers, or cancer treatments. Competition keeps producers on their toes, forcing them to find better, more efficient ways to do things. I find the moral hazard/lack of competition argument compelling. In health care, competition seems broken.

Robin Hanson has argued that overconsumption of medical services means we could cut health care spending in the U.S. in half (by simply denying care or refusing to undertake procedures or tests) with almost no effect on health care outcomes. If correct, is a pretty stunning result—if we can get people to consume more carefully, we can dramatically reduce costs.

What reforms should be enacted? It is possible that moving to something like Canada’s system might be an improvement; I don’t know. I am skeptical because our government has budgetary problems with the current large medical program, Medicare. Taking on additional large expenses will be problematic. Furthermore, I do not think our federal government is good at running technocratic programs. Remember, there are more than 300 million people in the U.S. (compared to 33 million in Canada); I am not convinced that the federal government can run a health care program that serves them all. That is, I do not think the U.S. government would run Canada’s health care system as well as Canada has. The more government involvement in the system, the less competently I think the U.S. government performs. I shudder to think how badly the U.S. government would run a system like the U.K.’s NHS.

This brings me to a reform that I think would work. Bryan Caplan, Tim Harford, and others have praised Singapore’s health care system. It seems designed to address all the problems people have with the U.S system, without requiring a large amount of government management or intervention in health care markets. It is certainly not laissez-faire, but it is not single-payer or nationalization, either.

You can read Caplan’s account of Singapore’s system here. I think the most important features of Singapore’s health care system are:

1) Mandatory medical savings accounts: Every person pays into a savings account that accumulates over time, and can even be passed on to one’s children. The money in the account can only be used for medical care. This gives consumers an incentive to shop around—they are spending their own money, after all. It may also give them an incentive to undertake preventative care, as doing so increases the amount in their account in the long run. This policy puts competition back in health care markets.

2) Mandatory published price lists: All hospitals and medical facilities must say what their procedures and tests cost. This allows consumers to shop around, and even establish reputations for low prices. Try calling a local hospital in the U.S. and ask them what a procedure costs; they usually won’t be able to tell you. Your insurer might be able to tell you what they pay a particular hospital, but they might not. This policy, like the first, encourages competition.

3) Optional low-cost catastrophic coverage: When health care expenses go over a certain threshold, the government steps in and pays. Because catastrophic illness is uncommon, this coverage is relatively cheap to provide. Private insurance can also be purchased. This is sort of like the “public option” of the current health care reform proposal in the U.S., but it is far less generous, covering extreme situations rather than routine medical expenses.

There is one aspect of Singapore’s policy that I’m not so sure about: supposedly the government pays for“80% of basic health care services”. I’m not sure what that means. I’m guessing checkups and other services that catch disease early. It surely can’t mean a much broader swath of health care services, or the “buffet mentality” (as they call it) would emerge, with some people overconsuming care, driving costs up. So far, Singapore has managed to provide a high quality of care with low costs (that rise slowly!).

I think such a system might be manageable in the U.S. because the government’s role in it is simple; competitive markets do most of the hard work. There are other reforms that should also be enacted in the U.S., such as removing (or at least equalizing) the tax advantage of getting insurance through an employer, and making interstate health insurance sales legal. There may be other ways to get similar results to that of Singapore, perhaps with health care vouchers (much like education vouchers).

Realistically, however, I do not think we will get reforms that will make a significant difference, for better or worse.

Thinking Out Loud: An Idea for Stimulus

2009-08-10T11:10:00.000-07:00

I've already talked about why I don't like the Cash for Clunkers program. In short, it is not likely to be environmentally friendly, since the process of producing new cars creates pollution, and because old cars must be disposed of. It also has a bit of a broken window fallacy aspect to it, destroying something old just so we can have the "pleasure" of replacing it.

Another reason to disapprove of this program is that the government has chosen to pick winners and losers. Car purchases get stimulated, but other purchases do not. The government is altering relative prices, encouraging them to buy cars when, absent the reduced relative price of cars, people might benefit more from buying new clothes, or a computer, or bus passes, or whatever. Resources are not being put to their highest-valued use; rather, they are going to the use the government favors.

On the other hand, the program has been hailed as one of the few pieces of clearly successful stimulus spending. Tax cuts handed out last summer were mostly saved rather than spent, for example, yet people are scrambling to take advantage of Cash for Clunkers. My in-laws were considering buying new cars at some point, but they have moved their purchasing decision up to right now, rather than later. In terms of economic stimulus, one could argue that this is a good thing--sure, people are just transferring their car purchases through time, from the future to right now, but on the other hand, we presumably need stimulus now, rather than at some point in the future when the economy has recovered.

Why is Cash for Clunkers different? Why are my in-laws running out to buy cars now, whereas everyone just saved the tax cuts? Because this program is temporary. There has been a total of $3 billion allocated to this program, and once it runs out, the program is over. Apparently the temporary nature is enough to get people to run out and buy now.

So why not apply this more generally? Instead of having the government pick this or that place to spend money--on roads here, on a solar power plant there, and on some representative's pork barrel project some other place, why not just give people time-limited cash, which must be spent at retail?

That is, the government could take, say, $200 billion of the stimulus package, and say "Every American may receive up to $1,000 in federal spending for any purchase of their choice. However, once the money is gone, the program is over. If you do not use up your $1,000 before the money is gone, it disappears."

There is no change in relative prices (except for that between consumption and saving, which is part of the point). Retailers would have a form to fill out, similar to that of Cash for Clunkers, which would allow them to receive payment from the government.

One problem is that people might have a hard time tracking their spending. For example, if I buy $800 worth of stuff at Wal-Mart, I have $200 left over for other uses. Costco doesn't know this, so when I go to Costco and try to charge $300 to the government, there will be paperwork and bureaucracy as the government tries to figure out what to do with the $100 overcharge. Cash for Clunkers doesn't run into this problem, since every new car far exceeds the $4,500 maximum subsidy. One solution may be for the government to issue everyone a debit card with up to $1,000 on it, and then when a total of $200 billion is spent, all the cards get cancelled.

There are potential public choice problems, too. This sounds like something politicians would love to abuse. They would probably love to hand these out during booms, too, defeating the counter-cyclical purpose for which I proposed them. I suppose there could also be problems with fraud.

Still, it could be an improvement over the mess that is current stimulus spending, couldn't it? I'd love to hear additional criticism in the comments.

An Answer to the Exam Question I Should Have Asked

2009-08-07T11:10:00.000-07:00

Former student Michael Duch provides the following answer to the question I posed:

The demand for water is inelastic! The fact that total revenue rose after the price increase implies that the percent change in price > percent change in demand, which gives us an elasticity ratio less than 1.

And the price increases should have been enacted first because they would have reduced the amount of water used while allowing people to maximize their utility. If this failed, which, it probably would have (assuming I'm right about the inelasticity of water) restrictions should have been imposed. I think the conservation of water in a drought takes precedence over allowing someone to maximize utility. But that's just me.

Some comments: Michael is correct in his conclusion that the own-price elasticity of demand for water must be less than one, and his reasoning is correct, too. Own-price elasticity of demand is:

Absolute value ( (percent change in quantity demanded)/(percent change in price) )

...and total revenue is simply Price * Quantity. If price goes up, quantity must go down (that's the Law of Demand), but what if revenue still rises? Then the increase in the price outweighs the decrease in quantity. In terms of elasticity, the denominator must be larger than the numerator, meaning own-price elasticity of demand is between zero and one--which we call inelastic. Good job, Michael!

Regarding the second paragraph, I agree that it would be better to raise the price first, but I would like to elaborate on why that is a good idea. Raising the price allows people to adjust in a variety of ways. For example, someone who has fruit trees in their yard might be willing to pay extra in order to make sure that the trees bear fruit, whereas a simple watering ban doesn't allow that option. Other people might decide it's better to just forgo watering altogether, or to collect rainwater, or take other actions. A price increase allows this variety of responses, while still achieving a given reduction in use.

Watering bans are usually riddled with exceptions for car washes and golf courses; there is no economic justification for this. If the water to be used at a car wash is too valuable for that use, then it shouldn't be used. The car wash, faced with an increase in water costs, will try to pass that cost increase to customers in the form of higher prices. If customers are unwilling to pay it, they won't, and the car wash will shut down. This is exactly what we should want to happen. We should want low-valued uses of water to stop, and allow only high-value uses of water to persist. Simple restrictions on use can't achieve this, but a price increase can.

More on Cash for Clunkers

2009-08-05T06:14:00.001-07:00

Here's some more on the environmental effectiveness of Cash for Clunkers. Nina Shen Rastogi argues that it was too costly. This AP piece makes the same point, claiming that the program will save the equivalent of shutting down all cars and power plants in the country for one hour--a miniscule fraction of our annual pollution production. Jeffrey Miron, one of my favorite economists (if you haven't read his 1995 Journal of Economic Perspectives article on the economics of drug prohibition, you should do so immediately), argues against the program here.

It has surely stimulated auto sales, although with a $3,500 or $4,500 subsidy, you can stimulate lots of things. It would make more sense to give people a payroll tax cut or even a direct payment, so they can spend the money on what is important to them, rather than trying to decide what specific products people should be buying.

Cash for Clunkers is for Chumps

2009-07-31T13:14:00.001-07:00

The federal government is currently running a program popularly known as "cash for clunkers". It pays consumers (actually, it pays dealers, who pass the savings on to consumers) for giving up their older cars for newer, more fuel-efficient cars.

There are at least two problems with this. One is that it's not clear that it actually does anything for the environment. The process of building a new car creates pollution and uses energy and scarce resources; continuing to drive an old car does not. It may take years for the reduced emissions from a newer car to counteract the environmental cost of building a new car.

My second objective is that there is a better way--a way to get people to get rid their older cars when appropriate, that is, when the reduced emissions from the newer car are actually worth it: raise the price of gasoline via a tax. This will cause some people--those who drive the most--to switch to newer cars with improved fuel efficiency. Because these are the people who drive the most, the environmental payoff is likely to occur sooner (because the older, dirtier car would create more emissions over a given time period). This differs from the current cash for clunkers program, which encourages everyone with a vehicle meeting the requirements to buy a new car. A higher gasoline tax will also have other affects: It will encourage people to drive less by carpooling, combining trips, or taking alternative forms of transportation. It will encourage people to move out of rural areas, where a great deal of driving is necessary, to urban areas, where distances are shorter and alternatives to driving are more attractive.

It would be possible, with appropriate policies, to get these results in other ways than a gasoline tax. The government could mandate carpooling on certain days, issue limited licenses for cars in rural areas, or just force people to move. What if, however, some people have a lower cost of taking these actions than others? Don't we want the guy who lives in the country but has a lot of friends and contacts in the city to move their first, rather than the guy whose entire lifestyle is structured around country living? Don't we want to have the guy who drives a large SUV by himself to work every day to carpool, rather than the guy in his two-seat roadster?

In other words, it makes a lot more sense to use the price system and its system of incentives than to try to micromanage the various ways to get around, because people will tend to choose the optimal outcomes--it is in their interest to do so. Raising the gasoline tax causes people to find the low-hanging fruit on their own, rather than requiring the government to be clever and honest enough to catalogue all the fruit in the country and then send out bureaucrats to pick the low-hanging ones.

A Question I Should Have Asked on an Exam

2009-07-31T06:59:00.000-07:00

Here's a question I should have asked on an exam, but didn't.

During a prolonged drought, Georgia (the state, not the country) implemented water use restrictions, which limited when people could water their lawns, wash their cars, and use water for other outdoor uses. The eventual result was a reduction in water usage. This reduction in water usage resulted in a decrease in revenue collected by the government-operated water utilities. In order to compensate for this, and to encourage more conservation, the state increased water prices (the rate structure was also changed, but ignore that).

Suppose that after the price increase, the amount of revenue collected by water utilities increases. If price rises, and total revenue collected rises, what can we say about the own-price elasticity of demand for water?

Extra Credit: Why would most economists say that these policy decisions were taken in the reverse order of what should have been done? That is, why would economists say that the price should have been increased first (and perhaps more than once), and only if that failed to reduce usage should other restrictions have been imposed?

More on School Choice

2009-07-16T09:43:00.000-07:00

Art Carden and I have another op-ed on school choice, this time in the Memphis Commercial Appeal. Our previous one was in The Tennessean. This time we are responding to comments by a school superintendent, who dismissed charters schools as unnecessary, because Memphis schools are already very good. If this were the case, however, then Memphis schools would have nothing to fear from charter schools (or vouchers or any other choice-based reform).

Who's Oppressing Whom?

2009-07-02T04:45:00.000-07:00

This story (update: link corrected) on PRI's "The World" says that Spanish police have found sweatshops in Barcelona and "freed" more than 300 Chinese immigrants working in them. The immigrants, however, are now protesting the loss of their jobs.

The reporter somewhat incredulously explains that the workers are apparently comparing their conditions in Barcelona to those back home, and finding the new conditions better, voluntarily accepting them. As with any voluntary exchange, both sides are made better off.

Clearly, then, preventing this workers from working at the agreed-upon wage is making them worse off. Why wouldn't they just take jobs at the legal minimum wage rate? Spains unemployment rate is around 17%, and expected to go higher. Chances are good that they would not be able to find jobs at the legal minum rate, because they are not productive enough to justify such a wage rate.

We do not get such protests over the minimum wage in the U.S.; partly this is because it is increased by relatively small increments, so that the unemployment increases that result are small. If we went to a $40/hour minimum wage, I suspect there would be a large number of people laid off, and protests as well.

I take slight issue with the arguments advanced by the Spanish economist in the piece; he suggests that Spain will have to move to a twelve-hour work day, and take other actions to "remain competitive". Countries don't actually compete like that, though, as Paul Krugman has argued in his better works, like Pop Internationalism. A simpler policy would be to simply let people work as much or as little as they like, rather than imposing some official number of hours. If they really want to work less, then companies will find it too expensive to ask them to work more. If they want to work more, let them! A competitive labor market can deal with these matters pretty easily. Different people may well end up working different amounts.

So who is doing the oppressing here? Is it the sweatshop operators, whose employees want to go back to work, or the Spanish government, which wants to prevent workers from working on terms they find acceptable? Is it right for some people to dictate the terms at which others may work, even if it throws these others out of work?

Confusion and Misinformation on Cap-and-Trade

2009-06-28T05:06:00.000-07:00

Republicans in Congress have been reciting a set of talking points regarding the recent cap-and-trade legislation that are misleading. In this entry I'm going to explain a bit about how cap-and-trade works, and why "it will drive up energy prices" is a dumb complaint to make.

First a bit about pollution. The problem with pollution is that the person making it doesn't pay the full costs of it, so he or she does too much of it. That is, the owners of the power plant emitting carbon dioxide will not bear much of the costs of global warming, so they emit whatever amount they find convenient, unless forced to do otherwise. This is called a negative externality--the costs are external to the person creating them. Economists generally prefer two tools to control pollution (whether CO2 is a pollutant or not isn't really important; if we want to reduce it, all the economics in this post applies): pollution taxes or tradeable emission permits, the latter of which is also known as "cap-and-trade". If done correctly, these programs will internalize the externality--that is, they will cause the people producing and consuming the polluting goods and services to recognize the costs they are imposing on others.

I've talked a bit about pollution (or "pigouvian") taxes and cap-and-trade before. Both tools are known as market-based regulatory devices because they attempt to alter incentives and let the market do the rest. For example, a pollution tax raises the cost of emitting pollution. If a firm is charged, say, $5 by the government for each ton of pollution emitted, then if a firm can clean up that pollution at a cost of less than $5, it will do so and avoid the tax. It is in the firm's interest to find the cheapest way to clean up, because it will save money by doing so. If it costs more than $5 to eliminate that ton of pollution, then the firm will go ahead and pollute.

How does cap-and-trade work? In the economist's preferred setup, the government would auction off permits, selling for whatever price emerged from the auction. Each permit allows a firm to emit one ton of pollution. Suppose a firm buys a permit for $5, then finds out that it can actually reduce that ton of pollution for a cost of only $3. Now the firm can sell that unnecessary permit to another firm, which can avoid eliminating its pollution.

At this point some environmentalists get confused, suggesting that this means firms can simply buy their way out of polluting. For a particular firm this is true, but it is not true in the aggregate. A particular firm could buy a bunch of permits, which would allow it to pollute as much as it wants. This means that some other firm must be selling permits, however, which means that it must be reducing its pollution. The total number of permits is limited. That is, the government might issue permits for, say, 5 billion metric tons of CO2. Any increase in emissions by one firm must be matched by an equal decrease from another firm. This regulatory method is currently used for Sulfur Dioxide (which causes acid rain as well as health problems) and has been wildly successful, reducing pollution significantly and at a much lower cost than expected.

Both the programs I have described raise revenue. In the first case it is tax revenue, and in the second it is auction revenue. In both these cases firms will have to reduce their pollution, which is costly to them. Higher costs will mean higher prices for pollution-intensive goods and services, such as electrical power from coal plants. The Republicans have been repeating this point over and over, saying that for this reason (higher energy costs for consumers), the cap-and-trade program is a terrible idea.

They have it precisely backwards. Higher energy costs is the primary point of the program. It is supposed to raise energy costs. The reason why this is a feature, and not a bug, is that it communicates to consumers the harm that is done by their purchase of energy that creates CO2. That is, by raising the cost of energy, consumers are induced to buy less of it. If CO2 is harmful--and the strong consensus is global warming is real, and will probably be harmful--then we want consumers to consume less energy. It is as though the Democrats passed a bill to reduce pollution, and the Republicans objected that it would reduce pollution.

Another objection is that reducing pollution may be too costly for some firms, which may shut down. Again, this is a feature, not a bug. Firms which produce goods of such low value that they cannot justify the harm produced by their pollution should shut down.

Finally, another advantage of pollution taxes and cap-and-trade is that they encourage development of cleaner alternatives. Cleaner sources of energy pay less tax or buy fewer permits. This gives them an advantage, and causes dirty energy producers to switch to cleaner technologies. It also causes firms to research new technologies which might be even cleaner still. Best of all, it gives firms a strong incentive to find the best new clean technologies. By contrast, the government has in the past tried to subsidize research into clean technologies, with mixed results. Why have these results been poor? Because the government has little incentive to find the best, lowest-cost ways to reduce pollution, because it has little at stake. By contrast, firms that find fantastic new technologies stand to profit substantially.

One way to make higher energy costs less painful for consumers is to give the revenue collected to them. A simple way to do this would be to use the revenue collected to simply eliminate a tax, such as the payroll tax. This could result in efficiency gains (known as the double dividend), although for complex general equilibrium reasons (having to do with the form of taxation eliminated and the response by consumers to the tax cut), it might not happen. Still, for distributional or for efficiency reasons, it may be desirable to give the money back to consumers.

Here's where a legitimate complaint about the current bill might be made. The proposed cap-and-trade program does not auction off the permits. It simply hands them out for free. It still reduces pollution, and firms can still buy and sell them, and energy prices will still go up, but there is no revenue collected by the government. This is equivalent to taxing the firms for polluting, and then giving them all the tax revenue back. Most economists would prefer that the money be used to eliminate distortionary taxes, or at least to reduce the level of government borrowing. Republicans are not making this complaint. They could also complain that there are inefficiently few permits being issued, but they're not doing that either. They are instead complaining that the regulation might do exactly what it is designed to do. That is confusing and misleading, but I suppose that's politics.

Update: From Greg Mankiw's blog, here are two articles describing legitimate problems with the current cap-and-trade bill. One of the problems discussed is the free distribution of permits (as opposed to an auction) that I mentioned before.

Boudreaux on Globalization and Local production

2009-06-26T07:02:00.000-07:00

Don Boudreaux has a great "ask the professor" post on globalization and, even better, the current fad for local production. As far as I'm concerned, there's only one reason to buy locally produced anything, and that's to get fresher fruits and vegetables. The question-and-answer section after the main article is great, too.

Hat tip to Arnold Kling.

Future Imperfect and the Disputed Iranian Election

2009-06-26T06:32:00.000-07:00

One of the arguments David Friedman makes in Future Imperfect (which I sort of review here) is that it is hard to know which way information technology will take us--to a panopticon in which the government can watch everyone, or a world in which everyone can easily monitor the government, or both. Would a world in which everyone can watch everyone result in more happiness or less?

The press has been talking a great deal about the use of information technology, particularly twitter, by the protestors in Iran. It has been used to get information to the outside world, and it has probably been used to organize protests. Here is an article, however, which argues that the government can just as easily use this technology to sow confusion and misinformation, or to stifle discussion.

Hot Town, Summer in the City

2009-06-22T15:34:00.001-07:00

Finally, the hydrant has been opened! It took them much longer to get around to it this summer.

It's so hot that Charlie is (misguidedly) hanging out on top of the air conditioner.

More on Schooling

2009-06-15T15:11:00.000-07:00

Art Carden and I have an op-ed in The Tennessean that was originally based on this blog post. It changed quite a bit, in large part because of space constraints (550 words or less), and also because Art's take on the subject is slightly different--perhaps only in style--from mine. Art's focus is more on getting government out of education completely. The original blog entry focused primarily on vouchers, and on the lack of a compelling argument for having schools operated by the government. I'd like to use this entry to add nuance to the arguments in the newspaper op-ed.

To reiterate the initial thrust of both pieces, there is little reason to think that having the mayor run the schools will result in an improvement in the quality of education. This is not because the mayor is evil or stupid or anything nefarious; it is simply because he is trying to solve a very difficult central planning problem, while facing pressures from various lobbies. Just as when production of cars or food is centralized, the result of centralizing education tends to be a one-size-fits-all, bureaucratic, poorly-run mess. There simply aren't incentives in place that would encourage or even allow the mayor to find the right ways to run a school system. Competition, on the other hand, should help with this problem. We don't need to find the "right way" to build a car; we let many companies build cars, and let consumers decide which ones are right. Firms compete over consumers' dollars, and in so doing try to find new and better ways to make those consumers happy.

Markets are not perfect, but perfection should not be enemy of the good. We're simply not likely to get persistent improvement in schools so long as schools are in the hands of a government-enforced monopoly. The piece in The Tennessean contains the following:

When markets are left alone, people are usually compelled by competition to serve one another in spite of our natural disinclination to do so...

This is simply Adam Smith's invisible hand argument. The idea is that individual self-interest can lead to cooperation and service of others, even if that is not one's intent.

The word "usually" is in there for good reason. There are particular ways that markets can go wrong--negative externalities, such as pollution, or public goods that might be underprovided by the market, such as national defense, as well as other "market failures" that I won't go into here. There may very well be positive externalities from education. That is, there may be external benefits from having everyone able to read--you benefit from being in a society in which I can read, but I don't take that into account when I decide whether or not to learn to read. As a result I may underinvest in education. It seems to be the case, according to Kerry King, that even if these external benefits exist, people would choose to buy enough education to create them anyway. That is, those very basic skills that make for a better society--literacy and numeracy--are likely to be almost universally obtained out of self-interest.

Even if King is wrong, however--even if people, left to their own choices, would not choose enough education--that is not an argument for schools run by the government. It is an argument for subsidizing privately run schools. That is what vouchers do--they are a government payment that can only be used to purchase schooling (the G.I. Bill and Pell Grants were really vouchers for higher education). These vouchers could be restricted by income, although I see little reason to do so. The D.C. voucher program was targeted at low-income families. The result was that a lot of poor, mostly black families were able to send their children to schools of their choice, rather than being locked into their local monopoly. Right now, only the wealthy have that option, since only they can afford to move based on school district quality, or to send their children to private schools.

A concerned neighbor commented via email on my original blog entry, suggesting that the result of vouchers might be that people end up sending their children only to schools with people who are just like them. I agree that this is possible; bigots might choose to keep their children out of schools with black students, for example, or Christians might not want their children associating with heathens. I have several responses to this, however:

1) I don't think this would happen today to the same extent that it would have, say, thirty years ago. It would surely still happen, though.

2) The wealthy already have this option. We currently have a system that allows the wealthy to be bigots, but does not allow the poor to be bigots. The only way to prevent this is to make it illegal for parents to send their children to private schools, make it illegal to home school them, and to somehow prevent them from taking advantage of majority-white school districts, perhaps with busing.

3) I see this kind of voluntary bigotry as offensive, but I think it should not be equated with the government mandated segregation of the past. That is, it is one thing for people to choose to send their children to schools with a particular makeup. It is another thing for the government to force black children to go to black schools. Rememember the children in D.C.: They were poor and mostly black, and they were able to choose to go to private religious and secular schools of varying racial makeups. If it came down to it, I would prefer a voucher system targeted at poor families to no voucher system at all.

4) I would prefer to have students--particularly poor students currently worst served by the system--getting high quality education on a competitive market, even if that leads to some self-segregation, to having students forced into more diverse schools that provide poor education. I admit that this is a value judgement.

A related argument was that some schools might try to keep out black or poor students, perhaps by raising tuition above the amount of the voucher. This is possible, but I think it is unlikely unless parents have a very strong preference for bigotry or classism. Schools do not want to turn down money; I do not think they will turn away the students that go with the money. It is possible that some schools will offer some sort of very expensive education, and may therefore charge tuition that exceeds the amount of the voucher but that would be because of higher costs, not because of racism. Again, I am not saying that such bigoted influence on tuition is impossible; merely that it is unlikely. I am not familiar with such a thing happening with past voucher experiments. If anyone has evidence on the subject, please pass it along.

Finally, the article says that I am a "free-spirited economist"; that was intended to be a humorous euphemism for "unemployed economist". I am currently looking for teaching work in Nashville. I was curious to see if The Tennesseean would keep that in there, and surprised to find that they did.

I have always wondered why op-eds seem so simplistic and one-sided. Now I know: space constraints. Unfortunately, the freedom afforded by a blog probably causes me to go too far in the verbose direction.

A Question About Happiness

2009-06-11T15:18:00.001-07:00

This entry (and the more detailed explanations linked therein) by Justin Wolfers on happiness research and the Easterlin Paradox is interesting. In short, they find that, contrary to previous research, being wealthier does in fact make an individual happier, and wealthier countries are, on average, happier.

This is a study of the relationship between levels--the level of wealth and the level of happiness. I wonder, is there a relationship between the growth of wealth and the level of happiness? A long time ago I read Brad Delong's review of a book by Ben Friedman, in which Delong wrote:

...modern society is a bicycle, with economic growth being the forward momentum that keeps the wheels spinning. As long as the wheels of a bicycle are spinning rapidly, it is a very stable vehicle indeed. But, he argues, when the wheels stop—even as the result of economic stagnation, rather than a downturn or a depression—political democracy, individual liberty, and social tolerance are then greatly at risk even in countries where the absolute level of material prosperity remains high

I wonder if this would show up in happiness data. Has anyone done the simple panel data regression of happiness on growth rates of GDP, rather than per capita GDP?

Update: Thanks to Jonathan nation for a correction.

Trading One Monopoly for Another

2009-06-07T11:41:00.000-07:00

An article in The Tennessean today explains that the mayor of Nashville may be taking over the schools in the district (rather than having them run by elected school board officials). The argument in favor is that it streamlines the system, making it easier for changes to be implemented. Working with a board can be difficult, as competing interests battle for control of the system.

I don't really see why handing over control to the mayor would be an improvement, however. Sure, it eliminates bickering between board members and the interest groups (parents, teachers' unions, and the government school bureaucracy), but without some sort of competitive pressure on the mayor's administration, why would he be able to do any better? All he can do is decisively favor one group, or no group--I see no reason why he would be better able to get things done, and I see no strong incentives for improvement.

Suppose we built our cars like we provide education. We would have local factories, run by the government and paid for with property taxes. What car you would get would depend on where you lived. If you didn't like the car you got, you could move to another area, or go to local car factory meetings (where you must battle the workers' union, which wants maximum wages for minimum effort, and does not want their quality scrutinized, and the government bureaucracy, which cares little about the outcome). You could also buy a privately produced car, but that would mean that you would forego all that money you paid into the property tax system, and you'd have to pay the full price of a private car on top of that. Does anyone think this system would give us better cars? Surely not. It provides choice of cars only for the wealthiest buyers; the rest must consume the cars produced by the local monopoly.

Education is a very complicated good (or if you prefer, a very complicated investment), but I don't think the comparison to cars is unfair. Cars are also complicated bundles of characteristics--fuel economy, acceleration, comfort, appearance, reliability, safety, convenience features--that must be bought together. Some characteristics, such as reliability, cannot be immediately observed. Organizations, such as Consumer Reports, exist which try to collect data on reliability, so that consumers can make informed judgements about the long-term wisdom of buying a particular car. Is education really so different? Surely it makes a great deal more sense to set up a system of incentives that encourages schools to compete to improve quality, in order to attract students, rather than debate which whether we should place the government monopoly under a board's control or a mayor's control. Sure, we might get lucky and elect a particularly motivated, competent school-board director, but what about when he is gone? A system that relies on the public electing brilliant, motivated officials, rather than relentless competition, does not inspire my confidence. A system of incentives is more powerful and reliable in the long-run than a system of "big men".

A voucher system is one such method; give each student a voucher good for some amount of money, and let the student (and his or her parents) spend it on whatever school the student wants. Schools must lure students, and their money, to their doors, by providing education that people want. A common objection to this system is that, because students could choose private schools, this removes resources from the public school system. This is true, but it is also true that this system removes students from the public school system; with fewer students, the public school system does not need as many resources. The evidence on voucher systems that have been tried in the U.S. so far is mixed; the experiments are sometimes short-lived (teachers' unions strongly oppose them), and the lag times involved from input to output may mean we haven't given them enough time. Other countries, particularly some European countries that do better than the U.S. on standardized test scores, use a voucher-like system. (There are other reasons why they may do better on standardized tests, including the possibility that they test fewer of their students.)

Even if vouchers are not a panacea, I nonetheless see no good reason why education must be produced by government schools. Why should we expect the government to be better at producing education than a private institution? If equity or access are concerns, vouchers address them. I can think of a bad reason why government would want to provide education: to indoctrinate. Looking back on my own education, I find it bizarre that I was required to stand up and salute the flag, and in elementary school, we even had to sing The Star Spangled Banner every morning.

Learning by Doing

2009-06-04T05:57:00.001-07:00

Tesla Motors, producer of the Tesla Roadster all-electric sports car (0 to 60 in 4 seconds with a 240 mile range!) has produced their 500th car. Their next product will be an electric luxury sedan at a significantly lower price than the $100,000 Roadster.

Aside from being an interesting example of technological change, this story is interesting because it's an example of what economists call learning effects, or learning by doing. It took Tesla Motors eight months to produce the first 100 Roadsters. The next 400 roadsters took only another eight months. Some of that is probably due to increased capital, but a lot of it surely has to do with simply getting better at what they're doing through practice. The most famous example of this is the production of weapons and vehicles during World War II, during which factories found that they could rapidly expand their production, producing more planes, faster, and at lower cost, simply because workers learned more efficient ways to do their jobs.

These sorts of gains are one reason why we should be optimistic regarding the production of alternative energy vehicles. They may be expensive now, but they will get cheaper with time. It is true that some inputs--such as lithium for lithium-ion batteries--are very scarce. They may even get more expensive. This isn't an insurmountable problem, however. Julian Simon pointed out that there is more than one way to make wire for communications when copper becomes scarce. One way is to find more copper. Another is to come up with a substitute, such as fibers that transmit light. The substitute may even be better than the original. The more scarce the original resource becomes, the more pressure there is to find an alternative, and the more profitable such a discovery becomes. Recycling old resources may also be an option, if the recycling process is not itself too resource-intensive.

The Unpredictable Future

2009-05-31T08:45:00.000-07:00

I've finished reading two interesting books, David Friedman's Future Imperfect, and Edward Castronova's Exodus to the Virtual World. Both are attempts to forecast what the future looks like, and I would say that both have a time horizon of about ~~fifty~~ thirty years into the future, although Friedman is explicit in that estimate, whereas Castronova is vague about the amount of time involved.

Future Imperfect tries to work out the implications of a variety of technological changes that will occur, starting with changes in privacy related technology online--encryption, electronic snooping, etc. I found this part of the book somewhat dull. The implications are sometimes interesting: Will the world become a place of zero privacy, where everyone knows whateveryone else is doing? Will this be an oppressive place where the state can easily control everyone (as in 1984), or will the ability to spy on the police, too, make it a better place? The second part of the book is much more interesting, and deals with changes in nanotechnology and biotechnology. What happens if we can build tiny machines that eat and sequester carbon? Could this eliminate global warming? Could we make machines to go into the body and repair it? What are the implications of medical innovations that allow immortality, or the uploading of the content of our brains into computers or new bodies? It could lead to a wonderful paradise. On the other hand, self-replicating nanomachines could mutate, consuming everything they encounter, converting the world into inanimate, lifeless matter--the "grey goo scenario".

Castranova's book looks at the burgeoning world of Massively Multiplayer Online Role-Playing Games, such as World of Warcraft and Everquest (the latter now being a dated reference). His view of the future is almost completely positive. Only at the very end of the book does he consider the possibility that the use of artificial worlds could be pathological--that plugging into an experience machine could be unhealthy. Friedman discusses this possibility as well, and comes to the conclusion that given Nozick's choice between existing in the real world or a slightly better imaginary world, he would choose the real world. He notes that he plays a good deal of World of Warcraft himself, though--I wonder at what price would he be willing to switch to the imaginary world? What if it were not just slightly better, but a great deal better, more fun, and more rewarding?

What I take away most from these books, though, can be summarized in the following graph (for which I am to blame; it's not in Friedman or Castronova):

The vertical axis measures well-being, perhaps measured in per-capita GDP or a happiness index or some other measure. "Business as usual" means continued economic growth around two percent per year over the next ~~fifty~~ thirty years. This is the view most economists take, and radical technological change aside, it's pretty nice. Two percent growth per year for the next ~~fifty~~ thirty years means that the average American will be making a salary well over ~~$100,000~~ $80,000 in real terms (i.e., adjusted for inflation). That's a pretty amazing standard of living.

What's really striking, though, is how much better or worse things could be, and how uncertain that is. These technological changes could push things strongly in one direction or another. Medical advances that eliminate disease could push our well-being far above what ordinary economic growth would suggest. On the other hand, if these advances are based on a technology that ultimately wipes out all life, that's pretty much the worst outcome possible. Seen in this light, global warming seems like a pretty small problem. Even the worst case scenario of twenty-foot sea level rise pales compared to the extinction of all life. Furthermore, if nanomachines really do pay off (and don't kill us), they could eliminate the problem of global warming altogether, either by eating the stuff that causes it, or by addressing the effects of global warming (imagine an army of nanomachines that reduce ocean acidification, for example). We really don't have any idea how this will work out, and the range of possiblities, from disastrous to heavenly, is staggering.

It's not clear that policy can allow us to avoid the undesirable outcomes. Even if the U.S. government were to strictly regulate nanotechnology, they would be unlikely to be even as (un)successful at that as they have been at preventing the development of nuclear weapons. The U.S. government can't regulate everyone everywhere. Whatever is going to happen is going to happen, and there's not a lot "we" can do about it through government.

Personally my view is optimistic, but I'm not sure that there is good reason for that. My optimism is heavily based on the last two hundred years of technological change, which has mostly made people better off (granted it has also killed millions of people along the way due to improved military technology, but that must be weighed against the lives saved and made better). If Friedman is to be believed, the next ~~fifty~~ thirty years are going to result in changes so radical that the last two hundred years will pale by comparison.

Update: Thanks to David Friedman for a correction in the comments, and for linking to the online version of the book.

Armchair Predictions

2009-05-11T08:09:00.001-07:00

My colleague Art Carden has a post up at Division of Labour in which he mentions how increased diversity of food is a hidden benefit of immigration. It's a benefit of immigration because more people from more places means that there is a large enough mass of people with different tastes to support new kinds of ethnic restaurants, and that means new food for people to try. It's a hidden benefit because increased product diversity doesn't show up in GDP numbers. If I spend $10 on ten different kinds of food, I am probably happier than if I had little choice but to spend $100 on one kind of food.

This reminds me of another related prediction that I have made: The increased availability of online information about restaurants online should lead to a reduction in the popularity of chains and an increase in the number and diversity of independent restaurants, ceteris paribus. The reason that chains became popular was that they provided reliable, consistent quality of food regardless of where you were. When car travel became affordable and easy for most Americans, they travelled all over, but finding good food can be difficult if one is in a strange place. A place like McDonalds becomes valuable because everyone knows what to expect there. A Big Mac is the same everywhere; McDonalds relies on reputation to attract customers who want something safe.

The internet changes this. Now travelers can simply hop on Google and check to see how the locals rate restaurants nearby (they could do this before by polling locals, I suppose, but that is time consuming and therefore costly). This should result in an increase in the number and diversity of independent restaurants. Chains will have to step up their quality and diversify their menus to compete, and I think that is exactly what they are doing. And finally, a third effect that reinforces these other two is that we are getting wealthier, which probably means that we begin to value quality and diversity of calories more and more; food quality and food diversity are normal goods.

Art has another prediction about which I do not think he has blogged. He thinks that the availability of DVDs as a convenient way to buy entire seasons of television shows should lead to an improvement in the quality of television, particularly in regard to well-structured story arcs. This is because networks need not rely on advertising alone to pay for shows; a show can have a long life after it is off the air in DVD sales. The old model was that a network would push the creators of a successful show to keep making new episodes until their creative juices ran dry and the show descended into crap (e.g., Fonzie jumping the shark), in order to extract the maximum possible advertising revenue.

Now, however, a show that descends into crap will suffer reduced DVD sales. It makes more sense to let the show's creators create a story arc with a clear ending, because these are more satisfying, and lead to increased DVD sales. LOST is a great example of this. Battlestar Galactica is a not-quite-as-good example, as (in my opinion) the end of the show was a disaster of incredibly poor planning and writing. Still, it would have been worse if they'd just kept making new episodes until the network lost interest. DVD sales of Battlestar Galactica are likely quite good. The availability of online sales of TV shows through iTunes should have a similar effect.

Counter-Strike Economics

2009-04-27T14:25:00.000-07:00

I keep forgetting to post something about this. My paper on Valve Software's attempt to incorporate a simulated market into Counter-Strike: Source is up on SSRN. From the abstract:

Valve Software's popular game Counter-Strike: Source uses prices to balance more and less desirable pieces of equipment purchased by players. Because scarcity in the game is only an illusion, a price adjustment algorithm was implemented to simulate a global weapons market. This simulated market mechanism, its operation, history, and results are examined. In an attempt to better understand what is going on, particularly in regards to how the mechanism produces undesirable results, simple simulations are conducted. Some changes are proposed that may improve the behavior of prices over time.

It's currently a working paper. If anyone has an idea for a journal to which it could be submitted, let me know. It's a strange paper; I'm not sure where it would fit in.

Updated: The first time I tried to post this Chrome froze up. The second time I forgot to link to the paper! A link is now available above.

Exodus to the Virtual World, or Imprisonment in the Virtual World?

2009-04-24T17:46:00.001-07:00

I've been reading Edward Castranova's book Exodus to the Virtual World: How Online Fun is Changing Reality. It's a fascinating look at MMORPGs, such as World of Warcraft, and how we should expect them to impact the real world in the future. You can listen to Russell Roberts' Econtalk podcast discussion with Castronova here.

Castranova quite reasonably predicts that we should expect these games to become more fun over time, and that we should therefore also expect people to want to spend more and more time in them. He sees this as a desirable outcome--people get to pretend to be and do whatever they want, and it might even force the real-world to be a bit more fun, too (insofar as the real world will be competing for the attentions of people, and will have to step it up!).

What's interesting to me is how precisely opposite this to most previous predictions of how such an exodus would turn out. In the original Star Trek pilot (for the original series), "The Cage" (later edited and released later in the show's run as "The Menagerie"), Captain Pike (who preceded Kirk as the captain of the Enterprise) discovers a planet inhabited by aliens who can use powers of illusion to make things appear as they wish. It is suggested that the populace became so interested in illusions that they lost interest in everything else, and the population declined. Eventually Pike and a human survivor of a crashed ship decide to stay on the planet, where horrible injuries they have sustained can be imagined away. In this sense the episode's message is mixed: the humans choose the illusion over reality, and are happy, whereas it resulted in the downfall of the aliens. You can watch the remastered "Menagerie" version of the episode in HD at CBS's site.

In The Matrix (the original film, of course--as far as I'm concerned, the sequels do not exist), a character betrays his friends so that he can be put back into the imaginary, simulated world, where his memories of the real world will be erased, and he will be put in a position of power. He wants to live an illusion, although interestingly, he doesn't want to remember that it is an illusion. We are meant by the filmmakers to think poorly of this decision, and not just because he betrays his friends. They also suggest that the human brain would not accept an illusion that was too happy, as we would consider it unrealistic.

In Anarchy, State, and Utopia, Robert Nozick proposes a thought experiment, with the goal of determining whether or not pleasure is the most important thing to humans. Suppose you had a machine that could reproduce whatever experience you wanted. You could live in it for the rest of your life, having everything just as you wished. The machine could even directly stimulate your brain to make you happy. Would you choose it? It seems obvious to Nozick that no one would choose it--that the experience would be hollow or meaningless in some sense. We want to do things, not pretend to do them.

Castranova might disagree. MMORPGs (and some other video games) are the closest thing we have to such an experience machine, and people are moving to these imaginary worlds in droves. Will such experience machines lead to the downfall of humanity? I would guess no--our lives will just get a lot more enjoyable. Unfortunately, living happy lives of our choosing inside machines designed to please us probably doesn't make for good stories, so don't expect to see any movies based on that any time soon.

Guest Blog: Lessons from the Economist’s Table

2009-04-23T19:10:00.001-07:00

This blog entry is an article written by one of my best students, Brent Butgereit, who wanted to get it into the school paper, but it seems not to have been accepted. It's a clever solution to persistent housing problems on campus. I hope current students will think about this and consider implementing some version of this. If you're interested, contact Brent, or contact me and I'll put you in contact with Brent.

-Mike Hammock

_________________________________________

A couple of weeks ago, roughly three-fourths of the current student body went through “Housing Registration” which has all of the anxiety of uncertain living conditions combined with the tedium of waiting in long lines. This system is theoretically designed to maintain ‘fairness’ in room acquisition and yet in practices proves to be inefficient and largely non-negotiable.

Each student is randomly assigned a number within differently ranked class brackets. Upcoming seniors have priority above all other grades in housing registration because they have, in some sense, “earned it” by going to Rhodes longer (upcoming juniors are ranked below them and so on). The random numbers are meant to take the responsibility of ‘who gets to pick what room first’ out of the administration’s hands. Favoritism can be considered less of an influence with merciless Chance at the wheel.

But because Housing Registration is a lottery, it is unable to allocate the rooms to the people who would value them the most. As well, it may prevent the allocation of rooms to people who have no other housing options. The limited number of rooms and obligation for all first-year students to live on campus can result in upperclassmen – who because of their poor lottery numbers are unable to obtain on-campus housing – to have to transfer. Rhodes may be losing excellent students at the roll of a die (albeit a very large one).

At least once a week I have lunch with a table of economists (professors and classmates) to discuss the economics left out of the 101 and 102 models – or the economics of everyday life. The answer to the housing dilemma was simple (but not simplistic): establish a market for housing. One possibility could be that we randomly assign rooms to students and allow them to trade until they settle with a room they like. Students would at least have the opportunity to trade up to a room they value more. And while this could produce a slightly better outcome than the status quo, it faces the same problem of a random ‘number’ generator deciding who is going to stay on campus.

There might be a better way through the use of an auction; we could just bid for rooms. The person with the highest valuation of a room will be the one to get it. Of course, financial means are not equally distributed throughout the Rhodes student body – so bidding with actual dollars will not work (the students with more money have a clear bidding advantage over the students with less money). So what if we started using academic points instead? Simply put: the better you do in your classes (and the higher level the classes are), the more points you get. (For example, an ‘A’ in a 400-level class would give you 440 points while an ‘A’ in a 300-level would give you 340 points.) Students who are more successful in more rigorous classes would be rewarded by being able to use the points they earned to bid for better rooms. Moreover, this would still grant some degree of seniority to upperclassmen (who are more likely to take upper-level classes anyways). Rhodes could effectively establish a market for academic points where students could buy and sell each other’s points or simply use their own in the housing bidding process. Of course, this does not mean students have to sell their points.

Under the point-bidding system, students who are excelling academically are rewarded for their work while more-passive students will have an incentive to work harder. It is possible that the well-to-do students just buy a large number of points from the good-grade students and outbid everyone for the best rooms easily. But bear in mind that the good-grade students are able to decide whether they would rather have a monetary bonus or better housing arrangements – and that because they face this set of trade-offs, there will not be the flow of points from the hands of the many to the hands of a few. And regardless of whether or not the points accrue in the hands of the well-to-do, it will not be easy for any bidders to know the valuation others place on a room until the actual auction. Not knowing how many points it takes to win an auction means that attempts to amass large quantities of points could have the same outcome as if moderate amounts of points are amassed. However, it would be prudent to post the previous year’s bids for each room so that students can have an approximation of its price.

The most effective way to operate this auction would be via computers (leading to what I see as the biggest hurdle in changing systems – designing the software for bidding). But I don’t see this as being too much of a problem. Each student could place a bid for multiple rooms and the highest bidder would get the room. Should one student win multiple rooms, they select the room they want and the other rooms go to the next highest bidder. It should be made clear that this system would not fix the housing shortage; but it would make it less likely that the better students would have to leave because of a poor housing structure.

The current registration system does not work anywhere near as well as it should. And while the system suggested by the Economist’s Table is not perfect, it provides a way to allocate resources more efficiently. When trying to improve policy anywhere, our goal should be to minimize the inefficiencies knowing that we will never be able to completely eliminate them. With the relatively low cost of switching systems, I don’t see any reason why we shouldn’t try this out; the ability to improve efficiency and experiment with policy design should be welcome – especially in a small, liberal arts college where the objective is to expand learning beyond one’s major. I would be more than happy to talk with anyone who knows how to get this proposal implemented.

-Brent Butgereit

Suppose There Exists a Country Producing Two Goods...

2009-04-02T19:37:00.001-07:00

The other day I was teaching the Law of Comparative Advantage to my Econ 102 class. Part of teaching this requires using a Production Possibility Frontier, which displays the production choices available to an imaginary country. This country can produce two goods, and only two goods. The classical example is guns and butter. The point is to demonstrate that societies face choices about what to produce; producing more of one thing requires giving up something else.

When I teach this, I always let my students decide what two goods the country produces. When I asked my students the other day, they sat around looking bored for a few moments (the class is at 8:00 A.M., so I suppose that's to be expected). Eventually one of them suggested "Olympic athletes". I altered that slightly to be "Olympic Athletic Entertainment", since it's a bit unclear if athletes are an input or an output.

They had a great deal of trouble coming up with the second good. I mentioned that when I first taught at this college, the students in my first class suggested that the goods be Prostitutes and Crack Cocaine. My current students thought this was funny. What did they therefore choose as the second good to be produced?

Cracked-out prostitutes.

Classy, eh? I guess they felt they had to one-up the previous class. It didn't occur to me at the time, but prostitutes, like athletes, are probably an input, not an output (the output being "prostitution services").

Of the things I will miss most about teaching here, I would include the following, from least missed to most:

3) Playing soccer with a great group of students, alumni, and other folks from nearby.

2) Teaching these fantastic students. They make class interesting, and they are able to maintain a sense of humor, even at 8:00 in the morning.

1) Hanging out with faculty and students and talking about economics. You know you're at a good school when students choose to sit next to you in the dining hall so that they can talk about economics outside the classroom.

A Farewell to Lynx

2009-04-02T07:56:00.000-07:00

To my current and former students:

This will be my last semester teaching at the college. The department has finally managed to fill the chaired position, and they've done it with a fantastic econometrician and teacher. I'm very excited for the opportunities that you'll have as a result. Since the chair is an expensive position to fill, and money is tight everywhere, the department will be satisfying any teaching shortfalls with local and less costly adjuncts (and I think it is a good and prudent decision). There's no drama or tension or anything like that.

Teaching here has been the greatest job I've ever had. Partly that's been because of my fantastic colleagues, especially Art Carden, who goes to lunch with me and talks about economics almost every day, but it's also because of the amazing students. You've made teaching a joy, and I hope I'll continue to hear from you about your success in school, and your accomplishments after you graduate. I've never before taught students so eager to learn, and so capable of handling all the difficult material I gave you. You've made me a better teacher, and probably taught me more than I taught you.

I'm not sure what I'm going to be doing next year. In any case, I'll finally be in Nashville, which will be nice since my wife lives there. I'm looking for teaching positions there. If you know anyone who needs an economist who specializes in Environmental, Online, and General Microeconomics (with a bit of Law and Econ and Public Choice on the side), let me know!

If you need to get in touch with me, use my gmail account. My school/work account will eventually be shut down. You can also use Facebook.

Good luck to all of you!

(If you recognized the title of this entry as a play on the title of a Rush album, give yourself extra credit.)

Thoughts on the Recession and Stimulus

2009-04-02T07:39:00.000-07:00

This is an expanded version of a short article I was asked to write for the college newspaper.

We are currently in a recession. Why? How do we make it end sooner? The causes are complicated, and there is some disagreement over them. A bubble appeared in housing. A bubble occurs when people wrongly believe that the price of an asset will keep going up, so they buy now in order to sell later and make a profit. Eventually bubbles pop—everyone realizes that housing can’t go up at such a rapid rate forever, so they scramble to sell before everyone else does (According to Larry Lindsey, there are about 3 million surplus empty housing units on the market, for a total of around 18.5 million--and that was as of last June. The numbers have surely climbed since then). As the supply of houses on the market increases, prices drop rapidly. People who own these assets (some of whom did so in lieu of saving) experience a decline in their real wealth. When this happens, they are poorer, so they spend less and save more. In some macroeconomic models, this reduced spending results in recession due to the inability of prices to fully adjust downward in the short run.

When businesses begin to close down on a large scale (for example, many financial businesses closing down, or many homebuilding companies closing down), many people lose their jobs. If wages were fully flexible, employers could just offer these workers a pay cut to stay on, but this doesn’t seem to be the case. As a result, unemployed workers are poorer, so they reduce their consumption, which affects other people who depend on that expenditure for their own livelihood. The overall reduction in confidence, combined with sticky wages, and reduced expenditure, results in a general economic slowdown. It turns out that the biggest reductions come from investment, not from consumption. That is, consumption is somewhat smooth over the business cycle. Investment is very unstable, dropping dramatically during slowdowns, both because lenders are unwilling to lend, and because borrowers are afraid to borrow for expensive investments when times look bad.

Why did the housing bubble happen? Some blame the Community Reinvestment Act, although that is probably not to blame. It has too small an impact, and happened too far back in time. Some blame changes in regulation, or deregulation, although that is also not clear. Mark Jickling has a great list of possible causes and criticisms of those causes here. The sad truth is that we do not really know why bubbles happen at some times, and not at others. That may be the very nature of bubbles—that they are unpredictable and inexplicable.

In addition to the housing bubble collapse, there is a related credit crunch. As a result of some strange financial dealings, many companies bought financial instruments—such as credit default swaps—that turned out not to be a good idea. Again it is unclear why they took off at this time (but not earlier), and it is unclear if regulation could have stopped this from happening (remember regulators aren’t perfect either). So now many companies hold financial assets that are dangerous—toxic assets, they are sometimes called. That is, some companies hold bundles of “securitized mortgages” which may be worthless, because the mortgagees are likely to default. Companies are reluctant to reveal whether or not they are holding such mortgages, because they do not want to frighten their business partners and potential lenders. This has at least partially frozen some credit markets, however—because lenders are worried that they may be lending to people holding toxic assets, they are reluctant to lend to anyone. Why didn’t stockholders restrain companies from engaging in this risky behavior? We don’t know; they seemed to be asleep at the wheel. Why didn’t these assets blow up earlier? We don’t know.

All of this leads me to a general complaint about macroeconomics: We lack data. Yes, we have years of data, but we only observe the world as it existed. We do not get to run back the clock, try something else, and see what would have happened. In microeconomics we often have a wealth of tiny natural experiments, as different counties or states do different things, or as different firms do different things. Not so at the federal level. To put it another way, we’re trying to do statistical work on depressions with only one observation: The Great Depression. It is very difficult to conclude much from this. Perhaps in a few years we will have another depression to look back upon (let us hope not), giving us two data points.

As a result there are many economists providing many different explanations for how we got here, and how to get out of this mess. There is a lack of consensus on basic macroeconomic variables. Which ones are endogenous? Which are exogenous? What direction does causation flow? I do not think I am exaggerating. Read the various reputable economics blogs—Paul Krugman, Brad Delong, James Hamilton, Arnold Kling, Greg Mankiw—and you will come away bewildered. Are there aspects of macroeconomics on which economists agree?

Most economists prefer to rely on the Federal Reserve to stimulate the economy. The Fed’s preferred method for doing this is to increase the money supply in order to drive down interest rates. As the Fed reduces interest rates, some businesses are encouraged to borrow to build factories, invest in new equipment, tools, training, etc. Ideally this increase in investment and employment would restore consumer confidence and get us out of recession. At the moment, however, the Fed has effectively reduced its target interest rate to zero. There is little more it can do on this front. The Fed has some other tools available, and is trying new tools, but it may have reached the limits of its influence.

Because of this, many economists turn to fiscal policy. Fiscal policy consists of changing government spending and taxes to stimulate or slow down the economy. The goal is to spend money in ways that put currently unemployed resources—workers—back to work. It may be necessary to borrow money to fund this sort of stimulus (tax receipts are down in recessions, and government spending goes up), but it might be worth it to get out of the recession. After all, once the economy speeds up again, the borrowing can be paid back with higher taxes.

Now two problems appear. First, in the real world, governments spend money according to who has political influence, and not necessarily according to what will stimulate the economy. So there has been a great deal of effort by lobbyists to get pieces of the stimulus bill. Politicians want to send money back to their home states to get votes to help them get reelected. Spending on many of the projects—such as green energy—will probably not put to work those workers who are currently unemployed. That is, an unemployed Wall Street guy is not going to become an environmental or electrical engineer building a new clean power plant (not fast enough to stimulate the economy, anyway). Other areas of spending, such as road construction and bridge repair, may indeed re-employ currently unemployed workers (so construction workers who are currently idle may go work on building roads and bridges instead). A portion of the money won’t provide a stimulus now because it won’t take effect until next year. Even the money spent now will not have an immediate effect because these things take time. It is prudent to be skeptical regarding the effectiveness of the stimulus program.

The second problem is that resources devoted to uses dictated by this government spending are not available for alternative uses. That is, there is no free lunch. If we spend $2 billion on building a green power plant today, some of that $2 billion represents resources that will not be available in the future. It depends, again, on which of those resources are currently idle and which are not, and on which resources are finite, like concrete (once used, it’s not available for other uses), or not finite, like labor (that is, using it for one thing now doesn’t mean it can’t be used for other things later, and if it’s idle now, it’s probably better to use it than not). In this sense, dollars are really irrelevant; what matters are resources. Government spending either moves money around from one person to another (like social security) or consumes real resources (like building a dam). It may be worth it to build this power plant, or it might not, but if it is not going to put to work currently out-of-work workers, then the criteria we should use for deciding whether or not to expend resources on it is cost-benefit analysis, and it’s not stimulus.

Bob Higgs has argued that the Great Depression’s duration and end were caused by “regime uncertainty”—businesses were unsure about how much Roosevelt would change the rules of the game. This made long-term investments risky. The same may be true today. Businesses may be holding off on investment spending because they are unsure of what the government will be doing. Will the stimulus package help them or their competitors? Will regulation in their industry increase or decrease? Will health care reform reduce their costs or raise them? This can lengthen the adjustment process, as firms wait to find out how this uncertainty is resolved. For this reason it might be best for Congress and the administration to hurry up and do something, however bad, and stick with it in a predictable way.

A further, more subtle point: Arnold Kling points out that the finance industry (and I would suggest the construction industry) got too big during the bubble. It needs to shrink. Trying to reinflate them by bailing out banks and trying to keep them operating, by encouraging people to take on more debt and buy houses, and generally act the way they did three years ago is simply trying to reinflate the bubble. This is a bad idea. It may be the case that the only way to readjust our resources is to suffer a recession for a year or two. We need to recognize that we built too many houses, and spent too much time and effort trading pieces of paper, and stop doing that, not try to do more of it.

Other proposals have included more income tax rebates or cuts in income taxes. Based on recent evidence, these do not seem to work, because workers save most of the money (often by paying off debt), rather than spending it.

A more interesting recent proposal is the elimination of the payroll tax. Payroll taxes are taxes taken out of everyone’s paycheck up to the first $102,000. Income over that amount is not subject to payroll tax. Payroll taxes are essentially a tax on employment; they are a disincentive for workers to work, and a disincentive for employers to hire. Getting rid of the payroll tax would instantly put money in the pockets of both workers and employers, encouraging the former to spend (although they might just save most of it) and, more importantly, encouraging the latter to hire. Several economists, including Greg Mankiw, suggested eventually replacing payroll taxes with a higher gasoline tax, or a carbon tax, in order to reduce pollution. I think this sounds like a much better idea than a messy spending bill, which may do very little. Or maybe it will do a lot. I’m not a macroeconomist, and my opinion on this may not be very valuable. On the other hand, I’m not convinced that the real macroeconomists know, either.

Another Win for Singapore

2009-03-31T11:18:00.000-07:00

Singapore's parliament has passed a law allowing payments to organ donors (found on William Saletan's blog). But don't get too excited.

The new legislation will bring Singapore in line with similar practices in the United States and Britain where donors are financially compensated, according to Khaw.

Apparently all this law does is make it legal to pay a donor's medical expenses--nothing more. The U.S. and other countries have similar laws. Saletan suggests that what is interesting here is the argument being used to pass the law--that denying payment to donors is unfair to them. He thinks that this argument might be used to persuade people to accept even more substantial payments to donors (which economists usually support on the grounds that it would result in a greater supply of organs, helping more people in need).

I don't think that's necessarily the case. I suspect that most people will say that fairness says donors get compensated for their costs, and nothing more. People are uncomfortable with the idea of profiting from the sale of one's organs.

Earth Hour, Buy Nothing Day, and Gas Boycotts

2009-03-30T17:37:00.000-07:00

Last Saturday my wife and I experienced Earth Hour during the intermission of a play (On the Town) at Belmont College in Nashville. It reminds me of Buy Nothing Day, or the occasional gasoline boycotts that occur when gas prices are high.

In general, these sorts of boycotts should not be expected to do much. This is because refraining from buying a good on a particular day, with the intention of buying it on a different day instead, doesn't really change supply and demand for the good. If you decide to buy gasoline on May 16 instead of May 15, it really doesn't matter much. If a really large number of people went along, then prices might fall on the 15th, if prices are flexible enough, but it's not likely--and even if the price did drop, this would just lure more people in to buy on that day, pushing the price back up. That is, the drop in price that one person is trying to create is an opportunity for someone else to buy cheaper gas. The likely result: gas prices don't change at all. The same goes for Black Friday.

Of course, the intended goal of these sorts of events may not be to affect prices. They may be intended to simply get publicity and encourage consumers to behave differently. This is more plausible than changing prices, but I still think it unlikely to have large effects.

Is Earth Hour like this? To some extent, yes. A factory that turns off its lights for an hour is probably just going to make up that hour later. Also, some people will end up driving around in their cars in the hopes of seeing what their city looks like with the lights off, creating more pollution, both in terms of particulates and in terms of light pollution.

Having said that, Earth Hour is also different. If you turn all your lights off and just sit there enjoying the darkness, you don't turn on double your usual lights afterward to make up for lost time. Because that hour in the dark is a sunk cost, it can't be recovered. Some people might stay up later to do things they would otherwise have already finished, using more energy, but some will not. It is therefore possible that Earth hour could, on net, reduce energy consumption. Of course, a more efficient way to do this would be to simply raise the marginal cost of energy using a tax. This way, people could decide for themselves when the best time to save energy was, or whether or not, in their particular case, saving energy was worthwhile.

Macro Odds and Ends

2009-03-18T07:50:00.001-07:00

From calculatedrisk via Brad Delong, this graph is interesting. Leaving aside the ups and downs of the business cycle, there seems to be a general downward trend in capacity utilization. I wonder what accounts for that. Apparently the capital stock is expanding faster than we can make use of it. This could also be a measurement problem of some kind.

Arnold Kling has a fantastic blog entry on financial regulation. This is something that seems to elude most commentors on economics: regulation is always backward-looking; it is not prepared to deal with new kinds of crises. It is even possible that the old form of regulation is what leads to new forms of crises. Because markets almost always innovate faster than regulators can keep up, financial crises (bubbles, bank runs, etc.) may be inevitable and unavoidable. Sure, they always seem avoidable in hindsight--"if only we had done X, this crisis would not have occurred"--but setting up institutions to stop these problems before they start may be impossible.

Note that I'm not saying (and Kling is not saying) that markets always get things right. What I'm saying is that it may not be possible to create regulation that keeps markets from sometimes going wrong.

Privacy and Price Discrimination

2009-03-15T16:12:00.000-07:00

I'm doing some research on privacy policies and prices charged on webstores. There has been a great deal of work by Taylor, Varian, and others developing models that try to determine whether websites can use data collected on past purchases to change the prices that consumers face for future purchases. That is, if a website notices that you've purchased many action movie DVDs in the past, you might see higher action move DVD prices the next time you visit the site than someone who doesn't buy such movies. The goal would be to increase profit, with possible side effect of making some consumers better off.

As far as I can tell, the only clear example of this being done is Amazon, which tried it for a while in 2000. Customers were outraged, so Amazon stopped. The CNN link just provided says that this Annenburg study says that other sites may do it as well. Reading the actual paper, however, I can't find mention of the photography site example mentioned at the CNN link. It seems to me that this sort of price discrimination would be very hard to carry out, since one could evade it by clearing one's cache. It will naturally tend to anger customers, too. Suppose a friend links you to a good deal, and you click the link only to find that, for you, the price is higher. Wouldn't you find this irritating? The ease with which consumers can search for and compare prices should make price discrimination of this sort difficult.

So I ask you, have you ever seen something like this happen? Are you aware of any examples of hidden price discrimination online?* That is, has anyone else done anything like Amazon, charging different people different prices based on their purchase history, or based on sites recently visited? If there are no such examples, I cannot help but wonder why some economists have devoted so much effort to this issue. Online privacy is an interesting topic, but I don't think it has much to do with price discrimination.

*I am not referring to old-fashioned price discrimination here. For example, airline websites still charge customers more for flights that leave tomorrow than they do for flights that leave in five months. That's merely a continuation of what they used to do offline, and they're not secretive about it.

Are Rape Simulators and Rape Substitutes or Complements?

2009-03-09T14:36:00.000-07:00

Now there's a title I never thought I would type.

Apparently there is a Japanese "rape simulator" game that some are trying to stop from entering the U.S. At the moment no stores want to carry it, but it can be illegally pirated online. Would it be bigoted of me to say that Japanese culture is frequently strange and disturbing? Apparently the game is just part of a genre of similar games.

Two questions come up. The first question, and the less interesting one, in my opinion, is "Does the First Amendment protect this?" I think the answer should be "yes". Whether the answer actually is "yes" is beyond my knowledge of pornography law.

The more interesting question is "Should we want to allow this on utilitarian grounds?" I think the First Amendment should be used to protect unpopular speech, because it is the speech most in danger of being suppressed by the government, and because governments cannot be trusted to wisely get rid of dangerous speech. Not all speech is valuable; some of it is trash. If we had a benevolent bureaucrat god, he or she could presumably eliminate speech that does more harm than good. Would this game fit that description?

It's possible that it might. If simulated video game rape encourages rapists to go out and commit more rapes--that is, if rape simulators and rape are complements--then the rape simulator is probably, on net, harmful. On the other hand, what if some would-be rapists stay inside and play rape simulators instead? That is, what if rape simulators and rape are substitutes? Then we might, in the interests of womens' health and safety, and reduced use of the legal system, want to allow rape simulators. There is some evidence that pornography and rape may be substitutes. The same could be true of rape simulators and rape.

So who wants to go out and join me in a protest in support of rape simulators? Anyone?

Naomi Klein vs. Rahm Emanuel

2009-03-08T08:41:00.000-07:00

Apparently White House Chief of Staff Rahm Emanuel has been quoted as saying "You don’t ever want to let a crisis go to waste: it’s an opportunity to do important things that you would otherwise avoid." I can't find a reference to when or where he said that, but if he did say it, I wonder, will Naomi Klein claim that he, too, is part of the vast neoliberal conspiracy to make everyone miserable?

Klein has argued that Milton Friedman and other free market types espoused using crises as opportunities to advance their radical free market agenda. She hasn't let facts get in her way, as has been thoroughly documented. Apparently the conspiracy extends to slightly left-leaning presidential administrations, too. Perhaps she would argue that the Obama administration isn't really progressive after all. The Rahm Emanuel quote sounds an awful lot like the Milton Friedman quote that Klein willfully misunderstands, except that Emanuel's quote sounds more like the sinister interpretation Klein uses (which is not to say that I think Emanuel is actually being sinister and plotting).*

I would like to give the Obama administration thanks for ending the federal raids on medical marijuana facilities. Hopefully we'll move a few steps closer to legalization.

*For those curious, here is the quote:

Only a crisis--actual or perceived--produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.

Klein misinterprets the first part of the quote as prescriptive, rather than descriptive. She thinks that Friedman wants to manufacture crises to get his ideas implemented. Rather, he is simply saying that when a crisis comes along, it's wise to have good ideas developed and ready to be used. So she thinks that Friedman conspired with Pinochet--which is untrue--and that groups like CATO support the Iraq war in order to get radical free market ideas implemented in Iraq. In fact, CATO opposed the Iraq war, which Klein would know if she bothered to do the slightest bit of research.

For Future Reference: How to Fire an Incompetent Teacher in New York

2009-02-11T07:43:00.000-08:00

I happened to stumble across a repost of this pdf on Reason's Hit and Run blog:

http://oldsite.reason.com/0610/howtofireanincompetentteacher.pdf

I had looked for it before but forgotten where I saw it. So here it is again, for my own future reference, so that it will be easy to find it.

Thoughts on the Stimulus

2009-01-27T07:32:00.000-08:00

There's been a lot of debate about possible stimulus packages, both in Congress and amonge economists. I'm going to try to summarize the basic arguments for and against. I've read enough of this that I now confuse who said what, and where, and when, so I'm not going to link or even cite sources for all this (although I will cite when something sticks out in memory). I realize this is sloppy, and I apologize in advance.

Why have a fiscal stimulus at all? Why not let the Federal Reserve conduct monetary policy? Gary Becker wondered how we all became Keynesians, relying on fiscal policy instead of monetary policy. Brad Delong's answer is that the Federal Reserve has already used up all its tools, and is now close to powerless. It can't push interest rates lower, and it has already dramatically expanded its regulatory powers. It has, at most, slowed the rate at which we slide into recession, rather than reversing it.

This only partially answers Gary Becker's question, I think. That is, it makes sense to resort to fiscal policy if fiscal policy works. Why do we all think it will work?

Fiscal policy could work if government spending employs resources that would otherwise be idle. A multiplier effect could cause wisely-spent government funds to have a large impact, restoring potential GDP, shortening the recession. It is worth pointing out where these unemployed resources are: finance and construction (those are the biggest and most attention-grabbing areas, anyway--we're certainly shedding jobs in automobiles and other manufacturing, too).

A critic (like Kevin Murphy) of a spending stimulus package would therefore suggest that the proposed areas to be stimulated are not the proper areas. That is, building and repairing roads and bridges will not employ out-of-work financiers (although it might employ out-of-work homebuilders). They will not put down their briefcases and pick up shovels. Arnold Kling would, I think, argue that the finance industry got too big, anyway, and that even a stimulus package that targeted finance workers would be a bad idea. We want that industry to shrink, shifting jobs elsewhere. That may not happen in the short run, stimulus or not. We might just have to wait for that adjustment to take place.

A related critique is that much of the proposed spending is either pork or irrelevant to fiscal stimulus. For example, expansion of environmental spending is probably going to transfer jobs from one area to another, rather than employ previously unemployed resources. James Hamilton says that he takes the large lobbying effort by special interest trying to get pieces of the stimulus package to be evidence that it is less about stimulus and more about rent-seeking. I think there needs to be more discussion of these Public Choice issues in this debate than there has been.

A critic might also point out that the multiplier concept is a bit fuzzy. The multiplier is surely not constant, or we could just spend our way to prosperity and forget about economic growth. But if the multiplier declines as spending grows, then how fast does it decline? If it declines quickly, then the stimulus effect will be small. On the other hand, if the multiplier declines slowly, a stimulus package could have a large effect.

Any borrowing to pay for stimulus will have to be paid back at some point, which will require taxes, which have deadweight losses (that is, they discourage production and consumption of the goods that are taxed). This is a general argument against taxes, and therefore against government spending. It might be worth it to suffer eventual deadweight losses if the short-run stimulus effect is large.

Speaking of borrowing, there is also the Ricardian Equivalence problem. If people know that big government borrowing means big future taxes, then they will reduce their expenditures even more now, in order to save money to pay for those future taxes. This will at least partially counteract the stimulus package. It seems to be the case that the tax cuts given last year had little effect, as they were mostly saved (perhaps for the reason explained above), resulting in little stimulus effect. Nonetheless some still argue that tax cuts would have a larger stimulus effect than spending cuts.

Then there is the problem of crowding out. Increased government borrowing may increase interest rates, which causes a decrease in private investment. A business owner might have been considering building a new factory, but increased government borrowing might have increased the demand for loanable funds (or, in Mankiw's preferred form, decreased the supply of loanable funds) , which drives up interest rates, making the business owner less willing to take out that loan to build that new factory. Interest rates are so low right now, though, that I have a hard time believing that a modest increase in interest rates would affect investment.

It is probably the case that, if we waited long enough--perhaps a year or two--the economy would self-correct. It is worth pointing out that the unemployment rate is not really into frightening territory yet--7.2% is not that bad, by historical standards. On the other hand, it is thought that it will go up, possibly as high as 10%, which is pretty bad. There is also an argument that this measured unemployment rate is too low, and that a more useful unemployment rate (which counts workers who have given up looking for jobs, for example) is closer to 13%. One would need to show that this number has been rising more quickly than the ordinary unemployment rate in order for this to be relevant, I think. I'm not sure if that's the case, and I'm currently too lazy and busy to look it up. Keynes thought that this focus on the long run--the idea that the economy would eventually self-correct--was erroneous, since we live in the present, and that if we could smooth the business cycle, we should do so.

So can we? I don't know. I am skeptical. To sum up, there are two basic kinds of objections: theoretical (even if we implement the best possible stimulus package, it won't do much) and practical (we are not likely to get anything close to the best possible stimulus package). For these reasons I think it might be best to simply avoid repeating the mistakes that caused the Great Depression to be more than just an ordinary recession (and I think we've already accomplished that), and let the macroeconomy do the rest. Still, this is in part a debate about magnitudes of effects. How big is the multiplier, and how fast does it decline? How much do people anticipate future taxes when they see current government borrowing? Will government spending target unemployed resources, or will rent seeking cause it to simply shift already-emplyed resources around? How fast will the economy correct itself if left alone?

But I am not a macroeconomist, I dislike macroeconomics, and I do not really understand it, so it would probably be better for you go to read Brad Delong or Arnold Kling or Greg Mankiw or Larry Summers or Martin Feldstein anyone else.

A Strange Contract

2009-01-13T10:30:00.000-08:00

At lunch today I had a great conversation with Art Carden and Patrick Gray. Patrick brought up a fascinating example of a strange contract. Warning: This gets pretty weird and uncomfortable, especially toward the end. My former Law and Economics students should enjoy this.

Apparently a woman from San Diego has decided to auction off her virginity. She has many takers, and the bid has gotten quite high. There are so many interesting questions raised by this that I don't know where to start.

First, why an auction? Why not a list price? One reason that auctions are used is that many markets are thin, rather than thick. That is, there are so few things for sale that there is no established market price. Auctions allow a seller to discover the best price to charge. Except for illegal prostitution markets, there is no established market price of virginity.

Second, is this legal? The auction is being conducted by a brothel near Carson City, Nevada, where prostitution is legal. If someone within the state is the highest bidder, the transaction could be legal. On the other hand, the auction will be handled through the ranch's website (she tried running the auction on eBay, but eBay removed it). This means that someone from out of state could participate, which brings the Interstate Commerce Clause into play. In this situation I would guess the auction would not be legal. The arrangement could be considered criminal.

Third, should it be legal? An economist's default answer to this question is something like "if both sides enter the exchange fully informed and consenting, then both sides must benefit, and the transaction should be allowed to occur". If there were some third party harmed by the transaction (as in the case of, say, me selling you some gasoline, which you use to produce pollution), an economist might want some form of intervention, but there does not seem to be any such party in this case.

Fourth, leaving aside statutory law, would this be an enforceable contract? Suppose that this woman decides not to go through with it. The court could declare the contract "unconscionable", which means that they find it morally unacceptable or unfair, although I would also guess they would require her to return the money. To do otherwise would basically be court-mandated rape. In any case, even in contracts that are valid, courts rarely require specific performance. That is, if I pay you to paint my house, and you get halfway finished but quit, the court will usually require you to pay me some of my money back, rather than forcing you to finish painting my house. There are two reasons for this. First, you and I probably don't want to deal with each other any more after the unpleasantness of a court case. Second, you are likely to do a sloppy job.

The more interesting question is what would happen if the seller and auction winner had sex, and the auction winner then refused to pay (assuming that pay was not demanded up front). If the court declared the contract unconscionable, the auction winner would not have to pay anything (which seems to be rewarding pretty awful behavior), yet if the court declares the contract valid and enforceable, they are in essence sanctioning future prostitution contracts. I have no idea what they would do.

Fifth, Patrick Gray had a brilliant suggestion. Some pro-abstinence group could bid, win, and then simply hold the option unused. That is, they would in essence own the woman's right to have sex. Granted, this might be difficult for a non-profit, given that the bid is now in the millions of dollars, but it's still an interesting situation. Suppose she breaches the contract, losing her virginity. What damages would the court assign? She would probably have to return the money, plus interest. Ideally the court would assign some form of expectation damages, so that the non-profit would be paid an amount that makes them indifferent between performance and breach, but it is probably impossible to determine what that number would be. That is, what is the value to the non-profit of the woman's virginity staying preserved? It is probably higher than the amount they paid (the difference between their willingness-to-pay and what they actually pay being their "consumer surplus").

Sixth, if one group does this, what would be the long-run result? Many women might choose to sell their right to have sex to such groups, establishing a market price--a price which would surely be lower than that paid to this first entrepreneurial woman. Would these organizations be willing to put their money where their mouths are, and pay many women not to have sex (presumably until marriage)? Such a program would probably not work for men, due to the cost of verifying that a man has not had sexual intercourse.

Suppose that organizations offer a standard price for such contracts, say, $20,000. Some women are considered more attractive than others; they may find that there are men who are willing to pay them more than $20,000 for their virginity. Some might sell to such men, while others refuse and stick with the pro-abstinence organizations. Women who cannot sell their contract to men at this price (due, unfortunately, to unattractiveness) would sell their right to organizations. As a result, pro-abstinence organizations might find themselves overwhelmingly holding the contracts of unattractive women, who might be the least likely to lose their virginity in the first place.

On the other hand, this might not be true at all. I seem to recall from reading The Red Queen that people tend to sort themselves by attractiveness, choosing mates of similar levels of attractiveness. So less attractive women might be no less able to find a mate (a less attractive mate, though) than attractive women.

Watchmen, Fox, WB, and Adverse Possession

2009-01-10T08:29:00.000-08:00

There is a process in the common law known as adverse possession, under which a person may come to own another's plot of land by simply using it for a long period of time. The requisite period is determined by local common law or statutory law, and so it varies by jurisdiction (it's usually something like fifteen to thirty years). Surprisingly, economists tend to think that this legal rule is efficient. This is suprising because economists are normally big fans of secure private property rights (for example, economists are generally skeptical of the Kelo vs. New London decision).

The efficiency justification for adverse possession is that land should be put to its highest-valued use. If an owner is neglecting land, and someone else can use it in a productive way, then the land should eventually be allowed to transfer to the productive user, whether the original owner likes it or not. The long time interval is desireable because it gives the original land owner plenty of time to wisen up and use the land in a productive fashion. He or she can, at any point, kick off the trespasser and make use of the land. If the land owner does not, however, and the trespasser makes use of the land, then courts give the land to the interloper.

This brings me to a recent dispute over distribution rights between Fox and Warner Brothers over the movie version of the Watchmen graphic novel. Fox argues, apparently correctly, that it still owns some of the distribution rights for a Watchmen movie, as a result of its 1986 purchase of all the movie rights, and a 1994 agreement with the current producer. During this entire time Fox did nothing with these rights; they have been squandered. Eventually Warner Brothers decided to make what looks to be a pretty faithful adaptation of the graphic novel, to much nerd acclaim. Last February, as production finished up, Fox filed a suit to delay the release and eventually receive some of the profits.

This has understandably angered many people. Fox could have tried to make a movie at some point, but did not, and now they are trying to free-ride off of the work of WB. On the other hand, they are within their rights, if these contracts are real.

Watchmen started movie development several years ago, and was picked up by Warner Brothers in 2005. Fox could have put in its claim for distribution rights at any point during these years of negotiations. It could have said something during the past three years of active movie production. Instead, Fox waited until the very last minute--until most of the film was completed--to make its claim. This strikes me as opportunistic, to say the least.

Here's where the adverse possession argument comes in. Perhaps distribution rights should be treated the same way as property rights in land. I think a court would be entirely justified in saying that Fox let its rights lie unexercised for too long; Warner Brothers has gained them by adverse possession. Granted, thirty years haven't gone by, but the entertainment world moves much more quickly than the land development world, so a shorter time period is probably reasonable. Finally, this is exactly the situation that adverse possession is intended to address: The original rights-holder is not making productive use of his rights, so they should move on to someone who will. A last-minute grab at those rights by the original holder should be denied on the grounds that the original holder has allowed them to go unused for too long. If Fox wanted to maintain its rights, it should have acted in a timely manner.

The common law is very slow to change (with good reason) and I doubt that this argument would persuade a judge. Nonetheless, I think it makes some sense.

UPDATE: Matt Freeman informs me that this is called a laches defense; the argument would be that Fox "slept on its rights". It's not clear if Fox actually did this, however. In this article Fox is quoted as claiming that they did in fact notify the producers before production began. Maybe one could still make the argument that they should have begun legal proceedings earlier, but maybe Fox is in the right after all.

More on Game Console Economics

2009-01-09T06:57:00.001-08:00

I had several interesting comments regarding possible explanations for game console manufacturers to repeatedly underprice their products.

Jeffrey correctly pointed out that some of the commenters may be missing the point of the puzzle. Bean is correct that charging a lower console price will cause more people to want to buy the console. If the company can sell all the units it wants, this low console price may be made up for by sales of peripherals, accessories, and games, which may be more profitable. This is basically a form of price discrimination. As benh57 said, the printer/ink model is another example of this--sell the printer for next to nothing, then charge a lot for the ink. This means that customers with the highest willingness-to-pay (those who will use the printer or game console a lot) end up paying more than those with a low willingness-to-pay.

But as Jeff said, this only makes sense if console makers can sell all the consoles they want at this low price. If there is a limit to how many consoles they can sell, and they still charge a low price--a price so low that there is excess demand--this is a puzzle. To put it another way, suppose Nintendo could sell just as many Wiis, and therefore just as many accessories, peripherals, and games, if they were to raise the price by $25. Why wouldn't they just raise the price? Even if they're trying to price discriminate, they're not following the optimal price discrimination scheme. Kudos to Jeff for seeing the deeper question.

Suppose Nintendo had initially sold the Wii for $400, and then lowered the price to $250 after making all possible sales at that price. Jeff proposes that bad will from quickly lowering the price could be important--buyers could be angered, and this might affect future sales. I doubt this, though. People were initially angry about the iPhone's rapid drop in price, but they got over it quickly. He has a point regarding an upgraded product, of course (he mentions buyers waiting for a new DS to come out, rather than buying the current one), but we're not exactly talking about that. We're just talking about a lower price for the existing product.

Pup mentions that SKUs never go up in price; that's probably true, although there are ways around that, and it still begs the question of why all the console makers seem to get the price too low in the first place. The prices of electronics probably have a hard time rising because of contracts with distributors and retailers. One way to get around this problem is to simply release a new SKU (Say, a new Wii in black with stronger wrist straps) and charge significantly more for it. It's true, this might make them look greedy, but for a couple hundred million dollars, couldn't they live with this? They've been accused of it before, for other reasons, and survived. Pup also mentions that shortages create news and buzz, but so does selling out--and what good is additional buzz if there are no consoles to sell? The point of generating buzz is to sell more product when there is more product to sell. If a company is already selling all it can, buzz doesn't do much good.

Ted Vessenes suggests (I think) that the idea of selling online at a higher price might anger retailers, who might refuse to stock the product. This is possible, and if retailers are organized it might succeed. There's a prisoner's dilemma problem here, though. Suppose I am one of ten retailers selling Wiis. If the other retailers decide not to carry it, it's in my interest to continue carrying it, as I'll get all the sales of the remaining retail Wiis, regardless of what Nintendo does online. Again, this might work if the retailers are sufficiently organized. He mentions the case of labor unions, which are very organized.

Ted has a very good point regarding specialization and economies of scale. It may cost Nintendo so much to set up a mechanism for selling Wiis online (on eBay or whatever) that it's not worth it; it's better to just let Best Buy and Target and the other stores do the selling, since that's what they're good at.

I'm sad to say that the explanations provided on my Econ 265 exams were mostly disappointing. One interesting explanation was that Nintendo (which, if i remember correctly, started selling the Wii in Japan before the U.S.) made a mistake when bringing the Wii to the U.S., relying too heavily on sales information from Japan (and on Japan's anticipated demand for the PS3). A couple students suggested the price discrimination scheme, but they did not see the problem with that argument. It's a difficult problem, and hard to think through during a stressful exam (especially since the exam was on Law and Economics, and this was an extra credit general economics question).

Why is Gerber Offering Life Insurance for Children?

2009-01-09T06:25:00.000-08:00

Let me explain briefly how insurance works (because many people seem to wrongly think of insurance as a discount program or even a scam). Suppose the future has two possible states: One in which your house burns down, and one in which it does not. People who do not like risks (such as the risk of one's house burning down) would like to make that state of the world a bit better, and are willing to make the good state of the world (the one in which one's house does not burn down) a bit worse in order to do so.

Therefore such risk-averse people buy insurance. The agree to pay the insurance company a certain amount of money, in exchange for a promise that the insurance company will pay the insured if the bad state of the world should occur. The insurance company is, in a sense, taking a gamble that it will not have to anything (because the bad state of the world probably will not occur). In return the insured gets a reduction in risk--the bad state of the world is not as bad because it now involves being paid, and the good state of the world is not as good because the insured has to pay the insurer.

In another sense, however, the insurer is not really gambling, because it insures a large number of people. This makes the rate of payouts predictable. That is, if there is a 5% chance in a given year that a person's house will burn down, and the insurer sells insurance to 10,000 homeowners, then it should expect to pay claims to about 500 people.

Okay, that's insurance. What prompted this post was a reminder from Richard Phillips, one of my students, about a new program from Gerber Life, an insurance company. At least, I think it's new--they started advertising it on TV recently. They are selling insurance for children. That is, a parent can insure themselves against a child's death. When the child turns 18, they take over the policy, and can presumably decide who the beneficiary is.

This is puzzling. It doesn't really make sense for a parent to insure against a child's death. Why? Consider this: In which state of the world is money more valuable to a parent, the state in which the child is dead, or the state in which the child is alive? I would hope most parents would say the latter. Money is more useful, and more fun to spend, when one has children. Toward which state of the world does this policy redistribute income? Toward the later. This is backward. Money cannot make up for the loss of a child, and in fact money is less valuable after a child's death. It would make more sense to avoid paying the premium altogether (i.e. not purchase the insurance policy) in order to have more money in the state of the world in which the child is alive.

So why is Gerber Life offering this policy? I'm not sure. Here's a ridiculous and somewhat offensive explanation: Suppose some children are likely to die by, say, blowing themselves up in a crowded place. Doing so creates a lot of damage, and an insurance policy might be valuable to a parent in order to pay for some of this damage. This could create an adverse selection problem, however--only those parents whose children are likely to blow themselves up are likely to buy the policy. This makes it a bad bet for the insurer, and therefore the insurer is unlikely to offer the policy. On the other hand, if parents are unsure whether or not their children are likely to cause significant damage to others upon their deaths, the policy might still be offered profitably.

Another unlikely explanation might be that this policy appeals to evil parents who plan to murder their children. The adverse selection problem would still exist, though. And of course, the policy might appeal to people who haven't thought clearly about this and think insurance is always good (and who apparently have money to throw away).

What other explanations could there be? Will this insurance program last long, or will it disappear?

UPDATE #1: I anticipate one argument being that this allows the child to take over a substantial life insurance policy at age eighteen. I'm not sure if this argument makes sense. First, a healthy 18-year-old shouldn't find life insurance very expensive anyway. Second, a parent could probably do better buying a broad index of stocks, waiting eighteen years, and then selling the portfolio to buy generous life insurance. Finally, most 18-year-olds don't have any dependents who would need a life insurance anyway.

UPDATE #2: Matt Freeman commented on this on Facebook, and I'm pasting his comment here:

These types of policies have been around for a number of years. The cost is truly de minimis relative to insurance for adults (as you would expect) and the pitch is that it is for the child in the event that the child would develop a medical or other condition that would make them uninsurable (or would make the cost of insurance excessive). For this de minimis price, you can be certain they will have access to this insurance policy. There are some risk advserse people for whom this would have appeal. For me personally, I look at the exorbinant rates I get charged for insurance compared to LeAnn since I am type I diabetic (about 10x the price for term and even a higher % for permanent insurance) and there is some appeal to the notion that if my child develops type I diabetes or some other condition that they would have a policy that would not be based on those inflated rates. (Inflated because they lump lower life expectancy type II and normal life exp type I's together).

That answers most of my questions. This insurance is really insuring the child against the possibility that they have serious medical conditions, which might later make it difficult to afford life insurance. That makes sense, although again I wonder if it would make more sense to just invest the money. That way, when the child gets older, there would be money that could be used for a variety of things, one of which might be expensive life insurance. There could also be an adverse selection problem here, if parents have an inkling of whether or not it is likely for their children to develop such a health problem (which is probably not the case).

Matt raises another puzzle, though: Why would an insurance company lump policy holders with Type I and Type II diabetes together? Doing so means forgoing profits. If people with type I diabetes live much longer, then the insurer is giving up substantial profits. It could lower premiums, sell more policies, and not have to pay out much in claims. They have dedicated actuaries who do nothing but calculate this stuff all day--why are they leaving money on the table?

More on the Single-Beer Ban

2009-01-06T08:23:00.001-08:00

There have been some more developments in the single-beer ban here in Nashville (I have blogged about it before here). Here is the text of the ordinance. The City Paper had an editorial on the subject. I think the editorial is mostly off-point, until the end, anyway. The editorial argues that the single-beer ban is unnecessary because there are already laws against littering. I think that misses the point; the ban is intended to stop litter before it starts. If it would reduce litter, most of the editorial's argument would be irrelevant.

I don't think it would reduce litter, however, and I don't think it would reduce public drinking. I sent the following to Erica Gilmore, my city council member, and to Diane Neighbors, the vice-mayor and president of the council:

I am a resident of the Salemtown neighborhood, an economist, and a concerned citizen. I am writing to oppose Ordinance No. BL2009-369, which would prohibit the sale of single cans or bottles of beer for consumption off-premises in specific parts of Nashville.

This bill also prohibits sale from an ice tub, although the reasons for this are unclear to me. If beer is kept cold, and the seller is licensed, why does it matter whether the beer is in a refrigerator or an ice tub? Perhaps this is related to a public health concern, although it’s not clear to me why standard tort law could not deal with problems here if any should arise. In any case, my concern is with the ban on sales of single beers.

The purposes of this ban, as I understand them, are two:

1) To reduce public drinking of beverages in certain areas.

2) To reduce littering.

I do not think this bill will achieve either objective. In fact, it could have the opposite effect in both cases.

Regarding the first argument: It is said that there are too many people drinking on street corners, sometimes in view of children. I do not see how this bill will stop this. Instead of buying a single beer at a time, people who want to drink will simply buy a six-pack, and drink them one at a time. Perhaps the concern is for the easy temptation of a single beer—but a person with a serious drinking problem is ill, not stupid. If they must buy six beers at once rather than one at a time, then they will buy six beers at once. In fact, groups of people often gather to drink and talk (outside the market at the intersection of 7^th Ave N. and Garfield St., for example). This makes it even easier to circumvent the single-beer restriction. Six people need merely contribute enough money to buy a six pack, have one of them go in to buy it, and bring it out. Now they each have a beer.

It is true that there is increased inconvenience to obtaining a single beer, and that this may reduce usage. On a per-beer basis, however, a six-pack is usually cheaper than an individual beer. It is not clear what the net effect of this could be. People could end up consuming more beer, because the beers are cheaper per bottle or can. In other words, it is possible that this bill would increase drinking, rather than decrease it. Regardless of the direction of the effect, I see little reason to expect a large reduction in drinking.

It has been suggested that single beers are often dropped in the street, leaving broken glass and trash lying around. In light of the argument I have just provided, I do not see any reason for this to change. In fact, the amount of litter could increase, because six-packs come in cardboard packaging. Now we will have that lying around, in addition to the bottles. This is not an improvement.

To summarize, it does not seem likely to me that this bill will do anything other than provide a minor inconvenience to some people. I do not think it will achieve its desired ends, and it could actually make matters worse.

If you are not swayed, however, by these potential consequences, then let me make three other arguments. First, I do not think it is any of your business, or my business, or anyone else’s business, whether people buy six-packs, four-packs, or single beers. This is not a proper role for government. Surely there are more important problems to address. I understand that this is not a popular viewpoint, but it should be expressed. I don’t even drink alcohol (especially beer), but I do not want to infringe on the rights of adults to buy beer in a quantity of their choosing.

Second, suppose that this bill does nothing at all (that is, suppose I am wrong, in that it does not make matters worse, and its proponents are wrong, in that it does not improve anything). Or, for that matter, suppose that I am correct and this bill makes matters worse. How will you know? Where is the provision in the statute to measure its effect? Who will be keeping track of the change in litter? Laws that do nothing, and laws with bad effects, should be repealed This law will likely stay on the books, adding to a labyrinth of regulation, whether it works or not. If you really must pass this ordinance, let me suggest a simple change: Include a sunset provision. Set the law to expire one year from now, unless you vote to extend it. At least that way there will be a point at which the community can assess whether or not it has made any difference. I think this request is reasonable.

Finally, I find the geographic restrictions included in this bill strange. I understand that they are included because this bill is supported by some people within the specific geographic area. Nonetheless, banning single beer sales is a good idea, why is it a good idea only in these locations? Why is it not a good idea everywhere? I suppose this is not so much an objection as a cause of confusion on my part. I do not understand why single beer sales are acceptable everywhere else but not in these places.

Thank you for your time and consideration.

Having said all that, I am not optimistic that my words will change anything. Erica Gilmore's constituents are supporting her in this, and it is from them that she gets the votes that keep her in office. The other council members have no particular reason to care about whether this ban is a good idea or a bad idea. So long as they appear to be doing something, it may even gain them votes as well. Unless there is a large and vocal opposition to this ban--and I have seen no sign of one yet--it will probably pass, regardless of its merits.

P.S. I have not forgotten the post on Game Console Economics. I hope to summarize the responses given both in the comments and on the exam sometime soon.

Game Console Economics

2008-12-16T09:29:00.001-08:00

This post is related to an exam question for my Econ 265 students.

Microsoft, Nintendo, and Sony have all released new game consoles in the past three years (the Xbox 360, the Wii, and the Playstation 3, respectively, and in that chronological order). In each case, these companies apparently sold their consoles for prices below the market clearing price. Upon release, all three consoles sold out quickly, and could be found on eBay for prices significantly higher than their full retail price. Microsoft managed to address the problem fairly quickly with increased production. Sony had the problem solved for them as the high sales were not sustained. The Wii, however, continues to be difficult to reliably obtain, and still sells for a premium on eBay. Why is this?

To elaborate, the puzzle is as follows: Nintendo could have sold just as many consoles at a higher price, giving them higher revenue with no extra cost--that is, higher profit. Why didn't they sell the Wii for $300 instead of $250? Why not sell them on eBay and get whatever price they can get? Nintendo (and the other companies) is leaving hundreds of millions of dollars on the table. Why?

Tim Harford, who is a better economist and writer than me, tried to answer this question when the Xbox 360 shortages appeared. When I ask this question, I usually get the same wrong answers that he got. Let's first dispose of some answers that cannot be correct.

Bad Arguments:

1) Good will: These companies cannot be forgoing profits to accumulate good feelings from consumers. One reason is that they have to wait in lines to get the product, which probably doesn't make them happy. Another reason is that good will is only so valuable. If Nintendo sells 2 million consoles and foregoes $50 per console, they just gave up $100 million. They've now sold over 15 million Wiis. Again, if they're giving up $50 in revenue per console, that's $750 million foregone. Good will is nice, but it's not that nice.

2) Market share: It doesn't make sense to say that they're selling at such a low price to gain market share because they could sell just as many at a higher price.

-Getting media attention: This surely cannot be an attempt to gain media attention and free promotion, because they could also get attention by selling out all their product at a higher price. Besides, what good is media attention if you don't have any product let to sell?

3) Game console companies just goofed up, picking the wrong price. This raises the question of why they don't just change the price. Sure, it would anger some consumers, but the companies could probably live with that while carrying their extra hundreds of millions of dollars to the bank. On the other hand, they've already got agreements with retailers stipulating the price, so maybe it's just too costly to change it. This still doesn't explain why every console maker repeatedly makes this mistake.

Here are the good arguments that Tim Harford and his readers came up with.

Good Arguments:

1) Microsoft underpriced in order to avoid antitrust scrutiny. By charging a high price, they might be accused of being a monopoly charging a monopoly price. On the other hand, by charging a low price they could be accused of predatory pricing, so I'm not sure this argument works.

2) Customers for each console are extremely price sensitive. At a price of $350, everyone wants the Xbox 360. They'd be willing to pay up to $375, but if the price goes up the tiniest bit above that point, everyone waits for the Playstation 3. Microsoft, which isn't exactly sure of the proper price point, charges $350 to be safe (this explanation was proposed by Alex Tabarrok). It wants to do everything possible to prevent Sony from making sales. This explanation works fine for the Xbox 360, but doesn't explain the Wii or the PS3 very well.

3) Suppose that game developers are not sure which console manufacturers plan to stick around (because they have confidence in their product), and which ones plan to float their product and then cancel it if the launch doesn't go smoothly. This is important for game developers, as game development is very costly, and involves high fixed costs, which will be sunk and unrecoverable. Then console manufacturers that are confident in their product can signal their confidence by foregoing some revenue on the hardware. They know that they will eventually make up the lost revenue with game licensing fees, and as costs of production fall, they may even be able to make a profit on the hardware at the current price. The longer they plan to stick around, the more profit they can afford to initially forego.

Someone is likely to point out here that Nintendo actually does make a profit on the hardware right now, due to its low cost, but that's not actually the point. The point is that they could make a higher profit by charging a higher price and getting just as many sales. A console maker that is not sure if it plans to stick around for years cannot afford to forego revenue upon launch of the product. For any Econ 307 students reading this, think of the peacock signaling its genetic health with its big tail.

This argument was inspired by a paper presented by Angelina Christie at the SEA meeting this year (her paper was about signaling and IPOs, but it could also apply here). The console maker may also be signaling to consumers, indicating that it plans to support the console and release games for a long time. Consumers therefore feel safer buying the console, confident that they will have new games to buy for years to come.

4) Vinit Jagdish presented a paper at the SEA meeting inspired by this very topic, and his clever argument was also information-related. Suppose that console makers are not sure the extent to which consumers consider their products to be close substitutes. Only after the products are released, and customers buy them, will producers gain information about the demand for these products. If two products--say, the Wii and the PS3 are perceived as close substitutes, then it is hard for the companies to avoid Bertrand-style Competition. That is, a price war might occur, with both companies slashing prices, resulting in lower profits for both firms.

But suppose that Nintendo releases its console at a very low price, so that it can only be rationed by queue. Sony has less information available than if Nintendo charged a higher price. That is, Sony doesn't know if the Wiis are selling because they're a cheaper alternative to the PS3, or because they're just plain cheap. Sony is therefore reluctant to start a price war, because it cannot accurately calculate the cross-price elasticity of demand.

One possible problem with this argument is that, of the current console generation, the PS3 and the Wii are the least likely to be close substitutes in the first place, given the large gap in prices and abilities of the two consoles. Nonetheless I think it does make sense.

Can you come up with other explanations? I'll be looking over the exams and posting interesting solutions here.

My thanks to Vinit and Angelina for their interesting presentations at the meeting.

Magnum P.I., Evolutionary Philologist?

2008-12-07T12:43:00.000-08:00

Or should that be linguist? Etymologist? I'm not sure of the proper term here.

While writing exams I've had episodes of Magnum P.I. playing on Netflix in the background. For those of you who have never seen it (I'm looking at my students, here), it's a good but goofy 1980s detective show, set in Hawaii, starring Tom Selleck. If you can put up with bad 1980s action music, it's worth watching.

In this particular episode Thomas Magnum is pursuing a cat burglar while working as a hotel detective. He gives the following monologue, which I recall enjoying when I last saw this episode years ago (I forgot all about the story and such, but I remember this bit):

I didn't think the cat-man's taunting note was the height of subtlety, either. And I guess neither is that old adage about killing two birds with one stone. But the reason clichés are clichés is because ultimately, they're either true, or they work. That's why you never hear sayings you've never heard before. Those are the ones that didn't work. Which is all to say why I was hoping this one would.

This is some fun evolutionary reasoning. On the other hand, what are we to make of contradictory clichés, such as "many hands make light work" and "too many cooks spoil the stew"? Presumably we are to balance the two, finding the point where Marginal Revenue Product equals Marginal Factor Cost. I suppose MRP=MFC isn't very pithy.

It Is Not Your Duty to Spend

2008-12-04T22:26:00.000-08:00

My colleague Art Carden wrote a great editorial on Christmas and consumption. On NPR a couple weeks ago I heard a discussion of consumer spending, and one of the panelists (I wish I could remember a name or the name of the show) suggested that it makes about as much sense to "spend to save the economy" as it does to say that we should all eat cholesterol-rich diets to make sure that cardiologists stay employed.

Over Thanksgiving a family member asked if we should be spending in order to stimulate the economy. It's frustrating to me that so many people seem to be pushing the view that consumption for consumption's sake is patriotic. There was an editorial in the Tennessean recently exhorting people to spend. I suppose one could argue that there is a sort of prisoner's dilemma in Aggregate Demand falling (if we both spend we could avoid recession, but if you don't spend and I do, then we enter recession and now I'm even poorer than I would have been if I had just saved), but trying to persuade people individually to carry on as usual seems about as productive as telling people to reduce their individual greenhouse gas emissions.

My advice: Be thrifty. Don't buy for the sake of buying. Do not buy because someone tells you it is your duty. Buy when you see a really good deal on something you need and you can afford it. Frivolous spending on things you don't really want is a waste of resources. This may sound obvious, but the fact that some people exhort us to spend, and some of us listen, suggests that my advice isn't completely trivial.

Used Game Sales Again

2008-12-03T15:29:00.000-08:00

I have posted previously about used video game sales. Game publishers and developers continue to take the position that used game sales are harmful to the industry.

I still cannot understand this logic. Suppose I would be willing to pay $35 to play a particular game. Its retail price is $50. I will not buy it. If, however, I could resell it when I'm done for $20, then my total willingness to pay is now $35+$20=$55. I choose to buy the game, with a net gain to me (a "consumer surplus") of $5. Every dollar I lose from inability to resell is a $1 reduction in my willingness to pay for the product in the first place.

It is true that the existence of used games means that some people who would have paid $50 end up paying $20, and that the producer of the game does not get any of this $20. This is not unique to video games, however. This is, in fact, true of all goods and services that can be resold. If you buy a painting for $1,000, and later resell it for $1,200, the painter does not get any of the $1200. Suppose there were a law prohibiting resale of the painting. Then the original buyer would be less willing to buy it in the first place. The painter would make money on resales, but he would make less money on the original sale.

The same holds true for video games. If I know that I cannot resell my game after buying it, I am less willing to buy--my willingness to pay is lower. Do video game publishers and developers really think they will make a great deal more money selling all games for, say, $30, and prohibiting resale? I don't see how.

So, then, what is the reason why publishers and developers take this position? Are they simply mistaken? They should know what is in their interest better than I do, but companies do sometimes ignore good opportunities and use flawed reasoning. Is there some other reasoning I missing? Maybe the companies pushing this position feel that reducing used game sales would somehow give them a competitive advantage against other companies, rather than helping all game companies.

Suggestions?

Popes and Private Roads

2008-12-03T15:13:00.001-08:00

When I was in D.C. for the Southern Economic Association meeting a couple weeks ago I rode the metro. There was an old notice posted on the train warning that some streets would be closed as a result of the Pope's visit.

It occurred to me that this is a strange example of the Theory of the Second Best. Suppose the government took a laissez-faire approach, keeping the roads open. If the Pope wants to get people off the roads, he has to pay them to stop driving. Obviously this encourages people to drive in order to be paid to stop to wait for his procession to pass. He could also simply refrain from visiting, but assuming the benefits from society of his visit are greater than the costs, this might be inefficient.

Given the inability of the market to solve this problem, the second-best (and very un-laissez-faire) solution is to simply ban driving in certain areas at certain times. The first-best solution might be to privatize the roads, if this were somehow possible.

The two crucial and questionable assumptions in this story are 1) there is no market solution available to the Pope and 2) privatizing the roads is possible and first-best. Maybe the Pope can, at low cost, take a helicopter everywhere he wants to go, making 1) false. 2) might also be false, if privatizing the roads leads to other market failures. I don't think this is necessarily the case, though. Shopping malls have private "roads" for pedestrians, and they work just fine. Some neighborhoods and businesses maintain their roads privately, although they not enforce traffic laws there. The real trick is how to get there from here.