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The Consequeces of Artificially Low Prices
By Chris | December 10, 2008
Fights are breaking out at Chuck E. Cheese’s (CEC) across the country. From the WSJ:
“In Brookfield, Wis., no restaurant has triggered more calls to the police department since last year than Chuck E. Cheese’s…. [I]n some cities, law-enforcement officials say the number of disruptions at their local outlet is far higher than at nearby restaurants, and even many bars.”
It appears that many fights breakout over the use of popular games:
CEC is considering systemwide signs at popular games such a machine that draws digital pictures of customers to let people know there may be a time or token limit. Making the machines more expensive to use is another option, but Mr. Huston says that is “inconsistent with our value message.”
How is setting a market-clearing price inconsistent with Chuck E. Cheese’s values? While I have not been to Chuck E. Cheese’s, I have visited similar restaurants as a kid. CEC sells a lot of food alcohol. The marginal cost of alcohol is quite high and the marginal cost of giving someone an extra token is very small. CEC has an incentive to keep the prices on its games low so kids will keep playing games while their parents spend money on food and alcohol.
Allocating scarce game time through lines and time limits may also be another way of peak load pricing. Games are effectively cheaper when no one else is there to get in your way. This encourages customers to come on off days. The problem with this pricing scheme is that the lines and congestion can lead to some major altercations between patrons. Consider this example:
Flint, Mich.: Jan. 26, 2008
Flint Township police responded to a call about a large fight at Chuck E. Cheese’s that involved as many as 85 people, according to police reports. A fight inside the restaurant between three females erupted, pepper gas was sprayed and people flooded outside the restaurant into the back parking lot.
Topics: Economics | No Comments »
Diarrhea, Foreclosures and the American Dream
By Chris | November 22, 2008
Interesting stories I came across this morning:
Diarrhea kills more people than AIDS, tuberculosis, or malaria:
According to the estimates of one sanitation specialist George cites, each of the 2.6 billion people who live without sanitation may ingest up to 10 grams of fecal matter a day. The consequence is often diarrhea, which is a mere irritation in the West, but in the developing world a lethal condition that kills 2.2 million people a year — more than AIDS, tuberculosis or malaria. And it’s all for lack of a toilet, which may be why George isn’t one for toilet jokes. “I don’t think 2.6 billion people without a toilet is very funny,” she writes.
Why you’ll need to buy lots of door knobs if you’re thinking of purchasing a foreclosed home:
The couple stopped paying the mortgage in December 2007 and defaulted in April, owing $436,151, according to county records….By Erickson’s count, the house is missing 29 door knobs, 28 light fixtures, 10 floor registers, eight faucets or shower heads and one air conditioner.
“This is what we call a clean strip job,” Erickson said. “They didn’t beat in the doors. They didn’t put holes in the Sheetrock. They just took things they thought had value.”
Too many American families own their own homes (85 percent). Why owning your own home is one of the biggest myths of the American dream:
Here’s the new wisdom: Social demographics are changing. Family dynamics are shifting. The new data reveals that we are an increasingly fluid, itinerant culture, no longer nearly as rooted to specific towns and neighborhoods as we were 50 years ago. The swell, rose-colored Norman Rockwell image of Americana, all porch swings and free parking and kids riding Big Wheels on the sidewalk next to neighbors who’ve lived on the street since the Eisenhower administration? Fading fast, if it ever really existed at all.
Topics: College, Economics | No Comments »
Voting is Rational, but People Don’t Vote Rationally
By Chris | November 20, 2008
I’m about a month later than most to ponder the workings of our democracy. But, given that a few elections are still up in the air, the topic is still somewhat timely. The book I learned the most from this year, was “The Myth of the Rational Voter” by Bryan Caplan, which I reviewed last winter here. Caplan argues that because the marginal impact of a single vote is almost zero, people vote to indulge their biases and satisfy their consciouses. Mainstream economists often note that from an individual’s perspective, it is irrational to vote. If there is a 1/100,000,000 chance of deciding an election that might increase my wealth by 10,000 dollars, the expected value of voting is a fraction of a penny. However, such analysis ignores the positive externality of a well-informed vote. If your vote has a 1/100,000,000 chance of deciding an election that will save the country 1 billion dollars, the expected value of your vote to the country is $10. I want other informed people to vote. Other informed people want me to vote. If we all act strictly rationally and stay home, we are all worse off. There is a reason people call voting a civic duty. By voting and expecting other intelligent, informed people to the same, I marginally increase the social pressure to vote. It is rational for a society to want it’s informed citizens to vote. And it is rational for individual citizens to want to encourage that norm. Sure, as an individual I can stay home from the polls and free ride on the social norms that motivate informed citizens to vote. However, social norms aren’t decided by a majority. And, my individual decision is much more likely to shift social norms in an expected way than it is to influence the election. This is particularly true if my sphere of influence is quite large. And, even if it is rational to free ride on everyone else’s civic duty, humans seem hard wired to follow social contracts. Most people don’t run red lights. Even if it is 4:00 in the morning and no one is around and the chance of being caught is almost nil. We know we’re being irrational, and yet something inside us says we shouldn’t do it. We’ve agreed to a social contract and undermining that norm is scary enough that we patiently wait for the light to turn green.
So it is rational to vote, or at least to encourage other informed people to do so. However, people don’t vote rationally. Bryan Caplan argued that people fall victim to common biases such as the anti-market bias, anti-foreign bias, make-work bias, and pessimistic bias. What confused me is why so many people insist on voting for a one of the two major parties? Why not just vote (to encourage the social norm) and then secretly vote for whoever you like best? It’s not as though voting for Nader over Obama will swing the election one way or the other. I voted for a third-party this election and found it to be personally gratifying. I get to voice my principles, avoid the disappointment of voting for the loser, and dodge the need to defend the actions of the person I helped vote into office. And yet, people overwhelmingly vote for one of the two major parties. There is something alluring about one’s vote have meaning, even if it will almost certainly be inconsequential.
Topics: Political Science, College, Economics | No Comments »
Sunk Costs: Literally
By Chris | November 13, 2008
When the cost of maintaining a boat exceeds it’s value, owners abandon them. From MSNBC.com:
Unlike cars, wooden and fiberglass boats have virtually no scrap value. So rather than pay the high cost of hauling their boats to the dump, people ditch them or sell them for as little as $1 to anyone who will take them. The boats often break up and go under, or pass into the underground economy of nighttime scuttlers— who, for a fee, remove traceable identification numbers, strip out salvageable items and sink the vessels.
In Georgia, Charles “Buck” Bennett, a natural-resources enforcement manager for the state, regularly finds wooden shrimp boats run aground and left to break apart in the Atlantic Ocean swells.
“I’m not an economist, but when putting 500 gallons of fuel in a shrimp boat costs more than the boat is worth, that is a sad thing,” Bennett said.
Bennett keeps a growing list of broken down boats slated for removal, currently 152 statewide. But with lean economic times and a declining shrimp industry, he guesses there are hundreds more hidden along the state’s shoreline and waterways.
“Oil, gasoline and sewage from these boat leaks into the aquatic environment,” said Sejal Choksi, program director at San Francisco Baykeeper, an environmental organization. Boat paint often contains chromium, lead, mercury and other toxic chemicals, and as a vessel deteriorates, the coating flakes off and settles on the sea floor or river bottom, where fish swallow it, Choksi said.
Government officials and environmental groups are calling for more programs and funding to prevent and clean up the junkyard flotillas.
But removing just one sunken sailboat can cost upwards of $12,000, and taking away larger commercial vessels is even more expensive.
I liked this article, because it illustrates that firms will shut down when they can’t cover their variable costs. Moreover, many of their initial fixed costs are sunk. It also is a good example of negative externalities. “Sunk” boats pollute the environment and may endanger others.
How can states deal with this problem? Well-meaning environmentalists and government officials pushing for more clean-up programs are misguided. The problem won’t go away unless you can change the incentives of boat owners. I would suggest a tax on boat sales to finance a boat buy-back program. Owners could recover the deposit they paid on their boat by returning it to the government when it was no longer operable. The program would be similar to the soda can tax and recycling schemes used in some states. In Michigan, “People return 97 percent of the 5.5 billion cans and bottles for which they pay a deposit”. Boats would no longer be “sunk” if they could be sold to the government for a few hundred dollars. It might also be productive to increase the penalty for abandoning a vessel.
Topics: Environment, Markets, Economics | 2 Comments »
Discouraging Spam
By Chris | November 12, 2008
I just spent the last 30 minutes deleting over 2500 blog comments “Awaiting Moderation” because my filters indicated they might be spam. All of them were. I was deleting them 25 at a time through the WordPress interface, before a Google search showed me how I could delete them all in one fell swoop using MySQL (the database on my server that holds all my posts and comments). Isn’t the free transfer of information great, and frustrating at the same time? I also installed some software that should delete more spam comments before I even have to look at them.
I was prompted to address my spam problem after reading an article about the Economics of Spam (HT: Al Roth’s new blog) . It summarizes the research of UC Berkley computers scientists who hijacked a spam network and used it to test the conversion rates of unsolicited electronic advertisements. An excerpt:
While running their spam campaigns the researchers sent about 469 million junk e-mail messages. The vast majority of these were for the fake pharmacy campaign.
“After 26 days, and almost 350 million e-mail messages, only 28 sales resulted,” wrote the researchers.
The response rate for this campaign was less than 0.00001%. This is far below the average of 2.15% reported by legitimate direct mail organizations.
“Taken together, these conversions would have resulted in revenues of $2,731.88—a bit over $100 a day for the measurement period,” said the researchers.
Scaling this up to the full Storm network the researchers estimate that the controllers of the vast system are netting about $7,000 (£4,430) a day or more than $2m (£1.28m) per year.
It amazed me how little spammers make from their campaigns. I see two implications from the study:
- If you ever purchase products you hear about from Spam, you are imposing a large negative externality on the rest of country. In this instance, 350 million emails resulted in only 28 sales. In other words, for every sale, 12.5 million emails don’t convert. Spammers will continue to send out unsolicited emails as long as the marginal cost of an advertisement equals the marginal revenue it brings in. The marginal cost of an email is so low for the spammer that even one likely sale provides the incentive for millions of emails. Purchasing a product introduced to you by spam is a lot like giving money to beggars, except there is nothing morally redeeming about it.
- We could eliminate spam if we charged .1 cents per email. 1/10th of a penny would do it if the conversion rates in this study are representative of the industry as a whole. I think that we could integrate payment into email without reinventing the wheel either. People could simply buy credits from their email provider (gmail, yahoo, or some other third-party). If the email they sent was accepted, there would be no charge. If it was not marked as legitimate, the sender would be charged. People who didn’t guarantee their email with payment from a third-party would still be able to send email, it would just be more likely to be filtered out. I imagine most people wouldn’t mind paying a few cents a day to make sure that relevant emails to people they may be emailing for the first time would’t end up in the spam filter. I know I wouldn’t. While this idea has been proposed before, the study above seems to show just how cheap it would be to implement.
Topics: Economics, Web 2.0 | No Comments »
Happy Halloween!
By Chris | November 1, 2008
He was consistently ignored by the economic graduate students at the department party.
Topics: Economics, Updates | No Comments »
Politics, Manufacturing, and Change
By Chris | October 25, 2008
In the United States, the victorious presidential candidate must win a majority of the electoral votes. Almost all states are winner takes all. The magnitude of victory or defeat is irrelevant, all that matters is the outcome. It is not surprising then, that presidential candidates spend most of their time campaigning in “battleground states.” Wikipedia defines these as states where the victor’s margin of victory is 5% or less. Take a look at this map of swing states in the 2004 election. The three battleground states with the most electoral votes in 2004 were Ohio, Pennsylvania, and Michigan. Between 2001 and June of 2008 Michigan lost more manufacturing jobs as a percentage of total employment (5.6%) than any other state. Ohio and Pennsylvania also felt the brunt of the declining manufacturing sector. This map shows a snapshot of job losses as of last December:
Of course, I’m always skeptical when people start measuring prosperity in terms of jobs. That is particularly true when discussing just one sector of the economy. Work for work’s sake is a bad thing. A person’s standard of living is what we really care about. I wouldn’t mind being unemployed, if I could afford to travel and buy ice cream. But, I’m getting off track.
Given the concentration of manufacturing job losses in a few states, it is not surprising that we hear so much protectionist rhetoric from the presidential candidates. They spend most of their time campaigning in the states that have visible losses from trade. Often, China and their “manipulated currency” is blamed for the loss of “American” jobs. I was intrigued, however, to read this Forbes article that notes that many U.S. states benefit from trade with the East.
Moreover, small states without any traditional ties to Asia have reaped major monetary benefits from U.S.-Asian trade. Idaho, New Mexico, Maine and Vermont all rank among the top 10 U.S. states in terms of their share of exports to Asia in 2007.
The Pacific coast states of California, Oregon and Washington enjoy huge manufacturing exports to Asia and very substantial export-generated employment. Almost 300,000 jobs in California, over 100,000 in Washington and nearly 60,000 in Oregon are directly tied to merchandise trade with Asia.
When I traveled to China a couple of years ago, I had the opportunity to have lunch with Idaho’s trade representative to China. I was surprised to learn that China was Idaho’s largest foreign trade partner.
Competition from Asia has certainly contributed to the decline of the U.S. manufacturing sector, but the manufacturing sector was inefficient to begin with. There is a reason GM is worth less today than it was in 1929: it was managed poorly. Many companies have prospered by exporting goods to China and all consumers have benefited from lower prices on imported non-durable goods. And, while foreigners don’t vote, we should acknowledge that American trade with the East has lifted millions of foreigners out of poverty.
Lastly, it is important to remember that manufacturing jobs aren’t such a bad thing to lose. What kid wants to grow up to install seats in Ford Explorers day in and day out? As we tap into an endowment of unskilled labor across the world and utilize technology to complete menial tasks we create the wealth to fund creative enterprises. As said in a fantastic article on education by Charles Murray:
The need for assembly-line workers in factories (one of the most boring jobs ever invented) is falling, but the demand for skilled technicians of every kind—in healthcare, information technology, transportation networks, and every other industry that relies on high-tech equipment—is expanding. The service sector includes many low-skill, low-paying jobs, but it also includes growing numbers of specialized jobs that pay well (for example, in healthcare and the entertainment and leisure industries).
Topics: Political Science, Trade, Economics, Outsourcing | No Comments »
Why I Won’t Vote for Obama
By Chris | October 16, 2008
I saw this ad on T.V. the other day. Obama may understand the benefits of free trade, but he preys off the average American’s fear of it. That is even more disgraceful than American-made laws.
Note: I try not to talk too much about politics on this blog, but this video really disturbed me. This post is not an endorsement of John McCain.
Topics: Political Science, Economics | 1 Comment »
My Visa Credit Line Just Increased
By Chris | October 12, 2008
By 25%. I wouldn’t know we were in a “credit crunch” if I wasn’t reading the news. About 3 weeks ago Alex Tabarrok wrote a post pointing to evidence that consumer, industrial, and real estate loans are at all time highs. While these numbers don’t include the latest data, housing prices have been sliding for quite some time now. Shouldn’t the credit markets have contracted over the last year?
Financial institutions are certainly spooked. Plummeting short-term treasury yields indicate that investors are seeking the safety of short-term government bonds. Overnight LIBOR rates have oscillated violently and the market for commercial paper has dried up while overnight rates have doubled. This Economist article does a good job describing the extent of the crisis:
Almost every country’s banking system is stricken with three interrelated problems: having taken huge losses, the banks need capital; because they cannot borrow in the longer-term paper markets, they are short of the funds they need to finance the share of their assets not covered by their deposits; and because the short-term money markets are closed, the banks are cut off from their main source of liquidity.
The decline in housing prices has left a lot of financial institutions insolvent and short of capital. It is not surprising that it has become more expensive for corporations and municipalities to access credit. I think the Federal Reserve has taken the right steps by pumping money into the financial system. However, I strongly opposed the Paulson Plan.
The Paulson Plan attempts to solve the current credit crunch by paying financial institutions more for MBS than their current market price. By purchasing these toxic assets, the Treasury hopes to recaptialize financial institutions and decrease their need for capital. I don’t like the plan because:
1. The housing market was grossly inflated. In my opinion, the housing bubble was the primary cause of the whole fiasco. The secondary mortgage market made things worse, but ultimately, the whole house of cards was built on the assumption that housing prices would keep rising. We still don’t know how much further housing prices will fall. Authorizing the government to blindly buy MBS does little more than transfer the losses from shareholders to taxpayers (reverse auctions won’t work if the quality of the mortgages is unknown by the government).
2. We need to reduce the bloated financial industry. I remember as an undergraduate finance major hearing that wages in the finance industry had outpaced all other starting occupations. I should have been suspicious. The Paulson Plan saves those institutions which have made the most egregious mistakes. The last thing we want to do is put these dying beasts on life support.
3. It crowds out private investment. Shortages only exist under price controls. Someone is willing to buy subprime mortgages if the price is right. The Paulson Plan encourages troubled institutions to wait to see what they can get from the government before selling their wares on the private market. This will lengthen the recovery process.
4. The Paulson Plan encourages risky behavior in the future. But, we can’t worry about moral hazard at a time like this you say. The entire financial system is on the brink of collapse. You’re wrong. The precedent the government sets right now will influence the actions of future financial institutions. Talk is cheap after the fact. If we want to discourage financial institutions from taking excessive risks, we need to convince them that they will not be bailed out. The only way to do that credibly is by letting them fail in the heat of the moment. It may be costly in the short-run, but it will pay dividends in the long-run.
The Paulson Plan received a lot of support from Economists who felt that we needed to do something to restore confidence in the economy. Others placed their trust in Bernanke’s wisdom. There is a chance that we could be heading into the greatest economic decline since the Great Depression. However, the market is resilient. Banks are still sending out credit card offers and offering poor graduate students more credit. The economy has lost a lot of wealth that never really existed in the first place. It is bound to endure some damage as the housing market comes back down to earth. Bubbles are scary. And, economists don’t understand why they happen. Nevertheless, we must resist the urge to embrace government as the solution to our economy’s woes. Markets are versatile and flexible, but the precedents and regulations we create today will be with us for decades to come.
Topics: Markets, Economics | No Comments »
Spies…Everywhere
By Chris | October 6, 2008
I’m talking about my students. I have 45 of them and I’m still learning their names and faces. They see me around campus and know who I am, but I don’t always recognize them. The other day I was tying my shoe in the library and I heard someone say “see you in class” before running up the stairs. Sometimes they say hi, sometimes they don’t. Regardless, it is a strange feeling to be so visible, and something I hadn’t expected. I find myself feeling the need to be mature whenever I’m on campus. As the semester progresses, I’m sure I’ll get to know all of the students in my class. Until then, I’ll have to act a little more professionally. That’s probably not such a bad thing.
Note: I recently gave my Intermediate Micro class its first test. The average was a 64 and I curved it. It’s tough to know when I’m failing to communicate material effectively and when students aren’t studying enough on their own. I’m tempted to require students to turn in more practice problems, but I hate to penalize the strong students with repetitive problems. Teaching undergraduates requires providing the right incentives…I still need to figure out what those are.
Topics: College, Economics, Education, Updates | 2 Comments »
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