Rational Gus Guzzling
By Chris | April 26, 2008
It infuriates me when Congress calls on the CEO’s of oil companies to justify their profits. Economists routinely study gasoline prices and find no evidence of price manipulation. Washington State recently commissioned a report on gas prices (HT Knowledge Problem:
The report, written by University of Washington economist and petroleum expert Keith Leffler, didn’t find gas gouging or other illegal conduct. It attributed the differences to local competition and the cost of obtaining and transporting fuel to stations.
Leffler said the differences are because of wholesale costs, the cost of transporting gas from the terminals to retail stations, land costs, density of gas stations in a given city and the presence of chain gas retailers such as Costco and Wal-Mart.
“The data supports what we’d expect to see in a competitive marketplace,” McKenna said. He added that unlike energy and utilities, gasoline is not regulated.
This finding has been replicated in other studies as well. In a fascinating study, John M. Barrona, John R. Umbeckb and Glen R. Waddell were given permission from a major gasoline retailer to change the price at the 54 gas stations by +/- 2 cents. By inserting exogenous price changes into a real market setting the authors were able to study the reactions of rival stations and consumers. The authors’ findings support:
… that an increase in the number of rivals increases the price elasticity of demand of an individual seller and that the reaction of rivals to an exogenous price change by one seller in the market will decrease with an increase in the number of rivals.
Different physical locations and perceived differences in gas quality prevent the gasoline market from being perfectly competitive. However, the market for gasoline follows standard economic theory. Consumers are more price sensitive when there are more gas stations competing for their business and the pricing power of a gas stations decreases rapidly as competitors enter the market.
Not surprisingly, consumers in my native Pacific Northwest are responding to escalating gasoline prices. The Sightline Institute recently reported that residents of Idaho, Washington, and Oregon:
…used on average nearly a gallon less each week in 2007 (7.8 gallons) than they did in 1999 (8.7 gallons), the lowest per-capita level since 1966.
Topics: Economics, Markets | 2 Comments »
Interesting Links
By Chris | April 21, 2008
Why you should read Wikipedia articles with a grain of salt. The open source encyclopedia is controlled by a small group of editors.
Protectionism in Ping-Pong (HT Ben Casnocha). My chances of representing the U.S. in the 2012 summer games increased dramatically.
Topics: Economics | No Comments »
Selection Bias at the Carnival
By Chris | April 21, 2008
This last weekend my university campus was open to prospective students and their families. Following the spring football game, the university hosted a small carnival with amusement rides and traditional carnival games. I went with a couple friends who satisfied their inner thrill-seeker with a ride on the ferris wheel. However, I was able to convince my friend Laura to accompany me on The Octopus, a traditional ride that I had enjoyed at the small amusement park in my hometown. She hated it, screaming incessantly during the ride and appearing nauseous when it was over. So I asked:
“Why did you agree to ride it if you knew you would hate it so much?”
“I didn’t think it would be so scary. The people on the ride earlier didn’t scream at all, so I figured it wouldn’t be too bad.”
“That’s the mistake of selection bias!” I exclaimed, thrilled at this illustration of statistics. The riders we had been watching earlier were not a random sample of the population. They were much more likely to be the type of person who enjoys being spun around in circles at fast speeds.
On another note, all of the traditional games at the carnival were purchased with tokens. You paid $1 per token, and then paid 1-2 tokens to try your luck at winning a stuffed animal. Behavioral economists note that removing cash from a transaction changes consumer behavior. I couldn’t help but think that it is easier to fork over 2 tokens to play rigged games for cheap prizes than it is to hand over actual cash. Tokens act as a buffer that prevents carnival goers from thinking of the game as one would rationally evaluate an investment. Is a 25% chance at a $2 stuffed bird really worth the price of $2? Tokens may also be used because they limit employee theft and discourage people from thinking at the margin.
For the record, I shot baskets at one of the booths and missed both of my shots.
Topics: Behavioral Economics, Economics | 26 Comments »
Price Discrimation in Education
By Chris | April 9, 2008
The president of a regional liberal arts college gave a presentation at my university today about price discrimination in higher education. Private colleges almost universally set tuition at a high rate and then offer a combination of need and merit-based scholarships to students based on their willingness to pay. In theory, poor students with rich parents are charged the most and bright students with poor parents are charged the least. By charging students different prices for the same product, universities maximize their revenue.
Colleges actually hire consultants to help them set revenue maximizing tuition levels. The consultants run econometric models to predict the price sensitivity of different categories of students to changes in tuition. For example, if you have a high GPA and excellent test scores you have more elastic demand. Or, if you visited the college and your parents are alums you are probably less price sensitive.
Financial aid offices use the econometric predictions to craft aid packages. The speaker I listened to shared data from the financial aid offers his college made and I was shocked by the results. I expected that poorer students would receive significantly more aid then richer students with similar academic credentials. I was wrong. The relationship was very weak and was actually reversed for top students. Applicants with the highest academic credentials were offered greater aid packages if they had less financial need. In other words, students with high GPA’s and test scores were offered more money if they didn’t even fill out a FAFSA (indicating no financial need).
The econometric model was telling the financial aid office that top students with a high ability to pay, had a very low willingness to pay. This counter intuitive result isn’t a fluke. It is quite possible that wealth and willingness to pay are negatively correlated. Talented students from wealthy families likely have the opportunity to pay full tuition to go to more prestigious schools. Small liberal arts schools must use price to compete. These parents and students may feel entitled to scholarship money for all the work the kids have done. Lastly, many wealthy families got that way because they have frugal tendencies. By nature, these people are more price sensitive. (In addition, the relatively smaller aid offers made to low income students may have been compensating for the federal loans and grants that these students are receiving).
When I took principles of economics, my professor used ski resorts as an example of price discrimination. Students and senior citizens are often given a discount. Students are poor and have a lower ability to pay. What about seniors? Contrary to popular belief, seniors are the wealthiest group of Americans. They just aren’t as interested in hitting the slopes. They have a high ability to pay, but a very low willingness to pay. Ski resorts and colleges have a lot in common; they are both trying to maximize revenue (costs are relatively fixed). They aren’t altruistic. It doesn’t matter if you’re poor or just frugal. If your willingness to pay is low, price discriminating institutions will cut prices to get as much revenue as they can.
Topics: Economics, Education | 1 Comment »
Markets in Everything: Substitute Grandchildren
By Chris | April 6, 2008
A Japanese toymaker designed dolls for the elderly:
As Japan produces fewer children and more retirees, toymakers are designing new dolls designed not for the young but for the lonely elderly – companions which can sleep next to them and offer caring words they may never hear otherwise.
Talking toys have become such a hit that some elderly people have embraced them as substitutes for the children who have grown old and deserted entire neighborhoods in the rapidly greying country.
The Yumel doll, which looks like a baby boy and has a vocabulary of 1 200 phrases, is billed as a “healing partner” for the elderly and goes on the market Thursday at a price of ¥8 500 (R472).
People often worry about the consequence of overpopulation. However, many developed countries such as Japan and much of Western Europe are experiencing stagnating population growth. This story illustrates some of the relational consequences of low birth rates. The economic repercussions are no less depressing.
Topics: Markets | No Comments »
Skin in the Game
By Chris | April 2, 2008
While grocery shopping with a friend of mine, she mentioned that she always buys the slightly more expensive eggs. The higher price signals that the eggs are of higher quality. If the pricey eggs are still on the market, someone must be buying them for a reason. In unfamiliar markets consumers often use price to estimate the quality of goods. However, in some markets price directly influences the quality of the product. In the book Predictably Irrational, Dan Ariely discovers that patients find painkillers more effective if the pills are more expensive. In a similar fashion, paying for your education makes you a more serious student. Growing up, my mom repeatedly told me, “I started studying so much harder in college when I calculated how much I was paying for each lecture.” Scholarships fully covered my own tuition and I remember thinking at times, “it’s okay if I skip this class to play frisbee golf, it is free anyway.” Of course, I was being irrational. My scholarships only lasted four years, and the opportunity cost of performing poorly was quite high. Nevertheless, it is hard to deny that people care more for things they have to pay for out of pocket. While reading one of Megan McArdle’s posts I came across the following comment:
Topics: Behavioral Economics, Economics, Education | 2 Comments »
Tips at Starbucks
By Chris | March 31, 2008
A little over a week ago, a superior court ruled that Starbucks was violating California law by compensating shift supervisors out of the tip pool. The judge ordered Starbucks to pay baristas over 100 million dollars in illegally distributed tips. Under California law, employers are not allowed to pay managers out of tips.
California Labor Code Section 351 states:
No employer or agent shall collect, take, or receive any gratuity or a part thereof that is paid, given to, or left for an employee by a patron, or deduct any amount from wages due an employee on account of a gratuity, or require an employee to credit the amount, or any part thereof, of a gratuity against and as a part of the wages due the employee from the employer. Every gratuity is hereby declared to be the sole property of the employee or employees to whom it was paid, given, or left for.
Since then, class action law suits have been filed in Washington, Minnesota, and other states. Starbucks is appealing.
The decision reminded me of a summer I spent working at Paradise Inn in Mt. Rainier National Park. The assistant general manager would always stand outside to carry luggage and get tips. It made the bellhops furious. The manager was depriving them of their main source of compensation. I was sympathetic with the bellhops.
However, I don’t think Starbucks is wrong in this case. “Shift supervisors” are making drinks and serving pastries along with regular baristas. Customers tip with the intention of compensating those who serve them. It seems reasonable that the tips should be split between people doing the same work. Tips act as an incentive for workers to provide high quality service. Preventing shift supervisors from sharing in tips removes a positive incentive for them to provide good service.
The judges ruling changes the rules after the game has started. Starbucks has a reputation for treating its employees well. Regular baristas were aware of the tip sharing agreement upfront. If this judgement stands, I suspect lots of shift supervisors will be stepping down.
Note: The judgement was calculated using an average tip payment of $1.71 an hour for shift supervisors. That makes me feel much better about the small tips that I occasionally leave for baristas.
Topics: Law | 1 Comment »
Location Matters When it Comes to Trading
By Chris | March 31, 2008
From an excellent Economist article surveying talent in the asset management industry:
Some quants have a long-term perspective, but many take advantage of the liquidity of modern financial markets to trade very frequently indeed; companies such as AQR, D.E. Shaw, Highbridge and Renaissance often form a substantial portion of daily trading on the New York Stock Exchange. They may aim to conduct their trades in a matter of milliseconds as they try to exploit fleeting anomalies. Some funds put their computer servers very close to stock exchanges for a minuscule reduction in the time it takes for data to be transmitted down the wires.
Topics: Uncategorized | No Comments »
Social Capital, Entrepreneurship and CB Radios?
By Chris | March 9, 2008
I’m in a group in my economics department that discusses microeconomics literature and research ideas. During our last meeting we discussed “Does Social Capital Promote Industrialization? Evidence From a Rapid Industrialization” by Edward Miguel, Paul Gertler and David Levine. This 2005 paper used evidence from Indonesia to dispute an earlier conclusion by Putnam (1993) that social capital is critical for economic growth. It seems intuitive that having relationships with the right people is a major asset for aspiring entrepreneurs. Strong relationships generate trust which facilitates business transactions. Short-run conflicts of interests disappear in the face of long-term relationships. Wide social nets provides an entrepreneur with access to many knowledgeable individuals, eliminating some of the problems of asymmetric information. I don’t have the statistics, but it is well known that most seed money for new business comes from family and friends.
How is it possible that social capital didn’t drive growth in Indonesia? It is true that some aspects of social networks can discourage entrepreneurship. Social norms may discourage competition with established businesses and pressure people into staying in their current line of work. How many parents are pleased when their children drop out of college or quit a good job to pursue a start-up? However, I think Migeul et al. comes to it’s startling conclusion by choosing poor measures of social capital. Scout groups, places of worship, art groups, and credit cooperatives aren’t good proxies for the type of social capital that is likely to drive entrepreneurship.
We all know that social capital is important. My brother quit his investment banking job and recently launched RightChannelRadios.com. If you are looking to purchase a CB radio and antenna or have some e-commerce expertise you could share with him, you should check it out. In the process you’ll be illustrating one way social connections impact economic growth.
Topics: Markets, Opportunities, Updates | No Comments »
Combating Bias with Bias
By Chris | March 6, 2008
I’m reading Colin Camerer’s overview of Behavioral Economics. My mom doesn’t have an email address, so the following passage made me laugh:
Microsoft had a hard time getting its programmers to take customer complaints seriously (despite statistical evidence from customer help-lines), because the programmers thought the software was easy to use and couldn’t believe that customers found it difficult (a “curse of knowledge”). So Microsoft created a screening room with a one-way mirror, so programmers could literally see for themselves how much trouble normal-looking consumers had using software. The trick was to use one judgment bias—the power of visually “available” evidence, even in small samples— to overcome another bias (the curse of knowledge).
Topics: Behavioral Economics | 1 Comment »
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