With the continuing drought in South Texas, the issue of how to allocate scarce water resources has flared up again. Rice farmers south of Austin want water from the Colorado River for their crops; yet the two storage lakes on the river, which provide most of the Austin area’s drinking water, are less than half full. As one rice farmer told the the Austin American-Statesman: “Water availability should be based on sound hydrology and not on political pressure.” It should be based on neither—it should be based on economics—what is the opportunity cost of the water? In particular, one might ask why the U.S. is growing rice at all. It is hard to believe we have a comparative advantage in rice-growing and that it shouldn’t all be imported. That’s especially true about rice grown in dry South Texas. We grow rice because of entrenched interests that obtained water rights many years ago. The rice farmers get heavily subsidized water precisely because of the political pressure this man deplores—and they now want to compound the effects of bad policy.
For more than eight decades, some of the smartest people in the economics business have worked on index-number theory. The basic issue is how to measure price inflation. A few years ago the government (Bureau of Labor Statistics) started publishing measures (chain-weighted price indexes) that no longer fail to account for consumers constantly shifting the bundle of goods they buy toward those whose prices are rising less rapidly, as the standard CPI does. Consumers do substitute when relative prices change, and the new measures recognize this.
This issue is technical, but it has become crucial in the “fiscal cliff” discussion. Republicans wish to use the new measure to index (link to inflation) benefits of transfer programs, particularly Social Security (OASDI). Liberals don’t like this — it will slow growth of incomes among Social Security recipients (me included). I hate to say it, but the Republicans have it right on this one: using a chain-weighted price index better reflects the true rise in the cost of living. If we are indexing benefits, as we have now for many years, it should be done properly. And here’s a case where economic theory, coupled with careful applied research by a government agency, has produced the right answer. It’s time to use it.
My university uses thin brown paper towels in all bathrooms. They cost less than white paper towels. My student claims that the opportunity cost of student and faculty time in extra hand-wiping because the brown towels absorb so little moisture means that the social cost of brown towels exceeds those of white ones. (I sympathize—my practice on this is take towel, rub, then finish drying hands on jeans!) This makes sense to me—with a captive group of users, the university is minimizing its private cost, not social cost.
Another student, an Iraq veteran, writes that the armor on the vehicles he rode in was too thin to offer proper protection to soldiers, government behavior that he claims is similar to that of the university—in this case, undervaluing its soldiers’ lives. This seems less logical—surely the U.S. Army is greatly interested in protecting its soldiers and is willing to incur huge costs in doing so. I hope/pray that my soldier-student is wrong. (HT: JC.)
The hit movie of a few weeks ago was Breaking Dawn Part 2, which several of my grandkids saw on opening night. A grandson reports that at the first showing there was a full 30 minutes of advertisements before the movie, more than he’d ever seen. He figured correctly that the captive audience (people lined up for hours to see the first showing) would fill the theater immediately, implicitly increasing the demand for advertisements. That made the advertising time more valuable, so the theater responded by offering more ads. I would bet too that they charged the advertisers more per minute for the right to show their ads—implicitly thus increasing price as well as quantity. (HT to SCH)
Rational? I’m at a hotel and was given a coupon allowing me to eat the excellent breakfast buffet at no cost. Sounds good; but instead, I go next door to Caribou Coffee and buy a coffee and blackberry scone for $5. Is this utility-maximizing?
I think so. I know that if I get the “free” buffet, I’ll eat a lot—probably orange juice and a large Belgian waffle with lots of syrup. Having pigged out over Thanksgiving, my weight is already up. Spending the $5 is a self-control mechanism: I know that once I’m done at Caribou, I’ll be sufficiently less hungry that I won’t want to spend time at the buffet (and won’t have eaten more than I should). There’s more to utility than increasing income and/or reducing spending!
“Render unto Caesar what is Caesar’s”? In many European countries, religion comes at a price: If you want the services of a religious community — for marriages, burial, and other activities — you pay a tax. (In Germany, for example, there is an 8 percent surcharge on your income-tax bill.) A very nice Finnish study by Teemu Lyytikäinen and Torsten Santavirta, “The Effect of Church Tax on Church Membership” (Journal of Population Economics, forthcoming), uses this institution to examine the demand curve for religion. The price elasticity of demand is fairly small—not more than 0.05—but that is partly because until 2003, Finland made it difficult to opt out of a religious community (and opt out of paying the tax). Not surprisingly, once the transactions costs of tax avoidance were reduced, the elasticity of demand appears to have risen.
My Dutch friend walked into his bank for a short transaction and was kept waiting for 45 minutes. Infuriated, he told the manager that his time was too valuable for this. Ten days later a credit of €25 appeared on his account!
Why can’t service organizations that keep you waiting an overly long time all do this? Admittedly the proper price is not easy — Bill Gates’s time is more valuable than mine. But companies that offer a credit on your account if you have to wait more than some posted time would have a competitive advantage in attracting clients; and the threat of payment would provide lower-level managers an incentive to improve efficiency. The only example I know of this practice is our plumber, who advertises that if he is more than 30 minutes late, the cost of labor is waived. (HT to GAP)
I was on the public-radio show Marketplace Tuesday evening, interviewed about waiting (sparked, I assume, by lines of people waiting to vote). I never vote on Election Day and never have to wait to vote: I take advantage of Texas’s early voting, which is quick and easy. I estimate the opportunity cost of people waiting in line on Tuesday — the value of their time — was around $1 billion. Those resources would have been much better spent creating facilities for early voting in all states. For that sum, a lot of election workers’ salaries could be paid and polling facilities could be kept open from late October through early November. An additional virtue is that more people might vote, and expanding democracy would be a good thing. Who couldn’t support this reallocation of resources?
A student writes that she understood arbitrage at age seven. She brought Scooby-Doo Fruity Snacks from her grandmother’s house (no charge to my student) to her Vacation Bible School class. She was a monopolist in the class—nobody else brought snacks; and since the demand was quite inelastic, she was able to sell her Fruity Snacks for a good price. Regrettably, her business was shut down because, as the teacher said, she was engaging in “uncharitable exploitation of [her] peers.” She was also invited not to return to Bible School, showing that clever economic behavior may only pay monetarily. (HT: CAP)
From mid-July to mid-October, I became addicted—to the Presidential election. By October 20, I was looking at the FiveThirtyEight blog at least four times a day, and was constantly checking Google News and other websites. This was a classic addiction—after three or four searches each time, I stopped because my marginal utility was diminishing. But after another hour without my “fix,” I had to search again and got tremendous pleasure from that first search. The addiction was interfering with my work.
The theory of rational addiction suggested a solution—go cold turkey. So I vowed not to look at the FiveThirtyEight blog—and I’ve now been “clean” for 6 days. To mitigate my withdrawal symptoms, watching the NLCS and the World Series has served as my methadone. Watching baseball for me has the virtue that it’s self-contained—I’ve not developed any addiction and only watch the games. And if I can stay clean through Nov. 6, my problem will be solved!
The Tigers (bravo!) and Giants are in the World Series, with possibly 4 of 7 games to be played in San Francisco. The majority of games will be played there because the extra game (if necessary) goes to the team representing the league that won the All-Star Game. The purpose of the rule (adopted in 2003) is to offer players and managers an incentive to provide more effort in the All-Star Game. I’m doubtful that this incentive matters much. First, with large teams each player is to some extent a free-rider — why risk injury, why strain yourself, if your efforts have little effect? That is especially true if by July you realize that your team has no chance of making it into the Series. Second, and even more important, I doubt that any player or manager’s effort is very responsive to this kind of incentive.
Wine Spectator includes a feature (subscription required) on Nicolás Catena, who received the magazine’s Distinguished Service Award for 2012. His online bio states, “One year, Domingo [Nicolás’ father] realized that it would cost him more to harvest than to leave the fruit on the vines. He asked his twenty-two-year-old son Nicolás, a recent Ph.D. graduate in economics, what to do about such a dilemma. Nicolás advised him not to harvest.” You don’t need a Ph.D. to see the sense of Nicolás’ advice — if price is too low to cover average variable cost, shut down. Sadly, “Domingo could not follow his son’s advice with a clear conscience and picked anyway.” No doubt the family vineyard lost even more money than if Domingo had listened to his son.
Traffic in Austin is a mess, mainly because the city is long and linear (east-west travel is made difficult by the topography). In increasingly long rush hours, traffic barely moves on either north-south freeway. To solve the problem, the city is adding one lane in each direction to one freeway, but there will be tolls on that lane. Moreover, the tolls will be variable — but not by time of day or day of week. They will vary with traffic speed, rising when the average speed in the lane drops below 50 mph. Pretty neat — peak-load pricing taken to its logical extreme. The technology that makes this possible is fairly recent. And it’s a good example of how technical improvements raise well-being — in this case, allowing those whose value of time is high to substitute money for their time and reducing congestion on the “free” lanes for the rest of us.
More than 25 per cent of trade between the U.S. and Canada goes over the Ambassador Bridge between Detroit and Windsor, Ontario. The bridge, built in 1929, has since 1979 been owned by one individual — Matty Moroun. He also owns duty-free stores and sells gasoline that escapes taxes. The Bridge isn’t quite a monopoly—there is also a tunnel; but the Bridge is more convenient for a lot of traffic.
Michigan has a constitutional amendment on the ballot requiring that any new bridge be approved by voters before state money is spent on it. Perhaps unsurprisingly, the Bridge owner is funding a large advertising campaign supporting the amendment. No monopolist likes to have the stream of monopoly profits diminished, which a new bridge would surely do. His political advertising is a smart move for him—a good way to ensure a continuing flow of profits. Whether it’s good for Michigan, for U.S.-Canada trade and the well-being of the average North American consumer is questionable. (HT to DJH)
As I do each year, I auctioned off candy (this year Reese’s peanut butter cups) to my class. None were bought at a price above $0.50, all 23 were sold at that price. As usual, a nice illustration of downward-sloping demand curves. I had kept one piece at the start, extolling its taste while eating half of it (and thus presumably causing an increase in demand). The other half fell off my lectern, and I stepped in it after returning to the front of the room. The first half piece of candy was really tasty, and I was dying for another one.
What to do?
Can’t resist chiming in on Mitt’s “47%” comment, as I was asked to do so by USNews and World Report:
I’m a freeloader/slurper from the public trough. But I’m also producing something—educated citizens and workers, and useful research—that taxpayers’ decisions in political markets have determined to be socially valuable.
Read the rest here.
The attached picture is a display at the local CVS in Ann Arbor, Mich. My thought was that this shelf display is a great example of complements: Enjoy a chocolate bar together, and who knows what nice things might follow? My son thought that it depicted substitutes — no luck in love, so drown your sorrows by eating chocolate. I don’t know who is correct, but the example illustrates well the fact the complementarity/substitutability can depend on the specific situation being examined.
My wife took four grandkids to the Adventure Aquarium in Camden, New Jersey. Looking for a parking space, she noticed the usual handicapped parking spots near the entrance, but also parking spaces reserved for hybrid vehicles. The Aquarium, though not government-run, appears concerned about environmental issues and apparently tries to encourage energy conservation by making a visit easier for those who have chosen energy-efficient vehicles. The private sector is implicitly subsidizing the purchase of hybrid cars, not by offering monetary incentives, but by subsidizing the time cost of owning these cars. I suppose one can object that the subsidy matters more to those whose time is more valuable—presumably higher earners; but it’s still a neat way for the private sector to encourage energy efficiency. I wonder how many other examples exist of explicit non-monetary subsidies by the private sector? (HT to FWH)
Men in the ultra-Orthodox religious community in Jerusalem object to women walking on the street in short skirts or sleeveless blouses, even attacking those who venture out in such unacceptable outfits. Very few women will dare to go out dressed that way in certain sections of this magnificent city. News of the Weird reports a solution that shifts the cost of enforcing the policy to the men: Members of “modesty patrols” are now selling ultra-Orthodox men glasses that blur distant images, thus preventing them from seeing “immodestly dressed” women. This is a neat application of the Coase Theorem, and it seems a fair one: With these glasses, the costs of enforcing the men’s religious beliefs will be borne by the men rather than by women who choose how they wish to dress.
In a recent New Yorker column, one of our best economics journalists, James Surowiecki, discusses Mayor Bloomberg’s proposal to ban sales of soft drinks in containers exceeding 16 ounces. Mayor Bloomberg clearly believes, and Surowiecki seems to agree, that people would consume smaller amounts of soft drinks and fewer calories if a ban were enacted.
But would the effect result from behavioral considerations—many people will drink only one serving whether it is 8 oz. or 32 oz.? Or would it result from the second drink costing more time—the effort to get up and order a second 16-oz. drink after buying one—and more money—because the per-ounce price reflects the additional cost of serving two 16-oz. portions instead of one larger portion? Outside the laboratory, what many argue is evidence for behavioral economics can often be explained by standard neoclassical considerations of money and time costs in demand.
A recent paper (full PDF here) by Young Hoon Lee and Seung Chan Ahn makes a clever point about occupations in which people are paid for a main activity and a secondary area where success depends on productivity in the main activity. If success in the latter also depends on some other characteristic, people who are well-endowed with that characteristic will invest more in the skills needed to be productive in the main activity: the incentives created by that synergy will spill over to earnings in the main activity.
Their example is the Ladies Professional Golf Association (LPGA). Better-looking golfers get lower scores (perform better) — but only going from average-lookers to the best-looking. Below the average, there’s no effect of differences in looks on tournament scores. That makes sense — you probably won’t get more endorsement opportunities if you’re average-looking instead of bad-looking. Although not golf, one might call this the Sharapova Effect. Are there other labor markets, or other activities, in which a similarly unusual synergy exists??
A few months ago, I discussed the tourist drug ban in the Netherlands, with a focus on my town, Maastricht. NPR just ran a story on the intermediate term effects of the new regulations. Some of the “coffee shops” (places where one could buy a pre-rolled or roll-you-own joint for €3) have reopened, as I predicted; others have not. Unsurprisingly, what has happened is that drug dealers, who previously had dealt only in hard drugs, are now also selling marijuana illegally. While total consumption of weed has probably dropped, buyers are worse off, as are coffee-house owners, with the main beneficiaries being drug dealers. As always, something that raises price in a legal market will increase demand in the illegal market.
Dividends in the U.S. are taxed at only 15 percent (much lower than wages/salaries). The argument is that since corporate profits, from which dividends are paid, are already taxed, taxing dividends is double taxation. But what about capital gains—why are they taxed at 15 percent too? The standard argument is that we should be taxing real capital gains, not nominal gains. Okay, but it would be easy to include the Consumer Price Index for each of many years in TurboTax or TaxCut, base taxes on real gains and tax the real gain at the same rate as wages. The administrative cost of calculating real gains has disappeared. Another argument for a lower tax on capital gains might be that investment/risk-taking is more responsive to net returns than is labor supply, justifying a lower tax rate as optimal taxation. Perhaps, but at best the evidence is scarce. My guess is that the real justification is the ability of wealthy people, who are the main beneficiaries of this tax giveaway, to get Congress to enhance their net incomes. (HT: PLM).
The Berlin Half Marathon charges €30 to each of the first 5,000 registrants, €35 for the next 10,000, €40 for the next 10,000 and €45 for the next 2,500, at which time registration closes. This pricing strategy is new to me: in the more than 100 road races I’ve done, including one in Europe, a fixed entry fee is charged that jumps up shortly before the race date. Why the difference? I don’t think this pricing mechanism is playing off demand elasticities: those who register earliest would be the most avid, low demand-elasticity runners. I don’t see the purpose of what is to me a novel pricing strategy for road races.
All nine nominees for office in the American Economic Association are from private universities, all from states on an ocean. (All but one member of the Nominating Committee was also on a coast.) Two are friends of mine, and all are good people, but: isn’t this evidence of reverse discrimination? Surely there are scholars from public universities, or from the several top-ten non-coastal private schools, who are at least as qualified.
Like others, we economists favor those like us. That’s the bad news—and it’s been shown in conferring other honorifics (Hamermesh and Schmidt, 2003). The good news is that, where it really matters—in judging scholarly papers for publication—economists are remarkably fair (Blank, 1991; Abrevaya and Hamermesh, 2012), ignoring an author’s affiliation, gender or prior reputation.
Given human nature of helping one’s friends, perhaps we should be congratulated for indulging ourselves only where it’s not important.
A headline on the UK news talked about complaints that the government is using an additional 3500 soldiers to help with security at the Olympics. Why complain? The security seems crucial; and given that the soldiers are being paid anyway, and were not going to be deployed elsewhere, the opportunity cost of their time does not seem very high. (I’m assuming that the British Army is not maintained permanently larger for use in security in such events.) This seems much more efficient than hiring some temporaries for security, who might not be as well-trained and who would require pay.
The local coffee shop and bakery near my apartment in Berlin charges €1 for an excellent cup of coffee. The similar shop near my office, but on a main tourist street, charges €1.99 for an equal quality cup. Similar quality coffee can be had for €1.50 at a bakery one block from my office in another direction, in a less touristy area with many office buildings. I can explain the €0.50 difference from my local shop to the third shop as cost-based discrimination: I assume higher real-estate prices generate it. The €0.50 difference between the two shops near my office must be mainly due to demand-based discrimination: Tourists are unwilling to search, implicitly have a low demand elasticity and are an easy mark for the shopkeeper.
My first full day in Berlin and I’m off for a great run in 60-degree weather. Only problem: I take my office key, which looks very much like my apartment key. I return to discover I’m locked out and stand around for an hour on the street in my running shorts (since there is no information about a house supervisor or any other contact). Fortunately, a painting crew arrives. I ask one fellow to help me break a window (the apartment is on the ground floor). He says OK, but it would probably cost me €300 to have it repaired; instead, he claims he can jimmy the lock and will do so for €80. I am dubious, but after 45 minutes of hard work, he succeeds (without damaging anything). He was pleased. He may have earned producer surplus of at least €60, as I doubt that he earns as much as €20 (untaxed!) for 45 minutes of work. I’m delighted, got about €220 of consumer surplus, since I would have had to pay that much extra to break the window. This is what exchange is about — both sides gain.
The City of Austin has given us a windfall: As of October 1, it will pay 12.8 cents per kilowatt-hour for power generated by our new solar system instead of the previous 3 cents/kwh. Of course, this seems fairer to me—but it also reflects more closely the value of the power we generate for the grid. Demand varies over the day and season, and the city prices higher when more power is used (in summers, mostly for air conditioning)—it engages in peak-load pricing, a form of price discrimination. Supply is limited by capacity, and in some cases in summer the capacity constraint is reached. The power we produce is storable, presumably for release during the peak times when its opportunity cost is highest. Thus the increased price paid to us reflects the value of what we generate. Regrettably, my joy at this windfall is tempered by the simultaneous substantially increased price when we must purchase power because our system fails to generate enough for our needs!
In the town where we stay on the New Jersey shore the local movie theater advertises: In case of rain, we will have an extra show at 1PM on weekdays. Pretty clever. If it’s rainy, the demand curve for going to the movies shifts rightward—who wants to go to the beach in the rain. Accordingly, the theater increases the amount of showings supplied to the market. But why don’t they raise the price of tickets on bad-weather days? Presumably because it would create bad will among customers who might feel exploited, but perhaps there are other reasons. (I can’t imagine that it is difficult to alter prices on a daily basis.)
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