Month: April 2011

Why Free Is a Bad Price

Marco Arment is the brains behind one of my favorite apps. Instapaper allows you to store articles off the Web for later reading; very useful, for example, when I am surfing and come across an article I want to share with my students or use in a future blog post. And the editor of Instapaper periodically shares excellent reads that I might otherwise miss.

Instapaper is currently available for both the iPhone and the iPad for $4.99. As Marco discusses in his blog, however, the iPhone version has sometimes been available for free (but with ads).

Based on his pricing experiments, Marco has decided that free is a bad model. In part that’s because ads provide weak revenues, and it’s expensive to support two versions of the app. In part it’s because the free app cannibalizes sales from the paid version.

But that’s not all. Another problem is that the free version attracts “undesirable customers”:

Instapaper Free always had worse reviews in iTunes than the paid app. Part of this is that the paid app was better, of course, but a lot of the Free reviews were completely unreasonable.

Only people who buy the paid app — and therefore have no problem paying $5 for an app — can post reviews for it. That filters out a lot of the sorts of customers who will leave unreasonable, incomprehensible, or inflammatory reviews. (It also filters out many people likely to need a lot of support.)

I don’t need every customer. I’m primarily in the business of selling a product for money. How much effort do I really want to devote to satisfying people who are unable or extremely unlikely to pay for anything.

Free is a risky price because it allows people to get something without really thinking about whether they want it. That’s why health insurers insist you pay at least $5 to see your doc or get a prescription.  And it’s why DC’s nickel bag tax has been so effective in cutting use of plastic bags.

Kudos to Marco for sharing his results and calling on others to run similar experiments. But I won’t be one of them. Free continues to be the right price here in the blogosphere.

A Tepid Quarter for GDP

Thursday morning brought the first official look at GDP growth in the first quarter. Headline growth was a disappointing, if not surprising, 1.8%.

Here’s my usual graph of how various components of the economy contributed to overall growth:

Consumers continued to spend at a moderate pace; their spending grew at a 2.7% rate, thus adding 1.9 percentage points to overall growth. Equipment and software investment (up at a 12.6% rate), inventories, and exports also contributed to growth.

Residential investment fell back into negative territory, reflecting the latest down leg in the housing market. But the real negatives were structures (down at a 21.7% rate, thus cutting 0.6 percentage points from growth) and government (down at a 5.2% rate). Defense spending fell sharply (11.7% rate), and state and local continued its decline (down at a 3.3% rate).

Note: As usual, imports subtracted from growth as conventionally measured. As discussed in this post and this post, I’d like to see GDP contributions data that allocate imports across the other sectors. Such data would reveal, for example, how much consumer spending contributed to growth in the U.S. economy itself. Presumably it’s less than the 1.9 percentage points shown in the chart, which reflects consumer spending that was satisfied by both domestic and international production, but we don’t know by how much.

A $5,000 Bill on the Sidewalk

Someone is offering a free $5,000 bill tonight over at Intrade.com:

That’s right. You can sell 9,999 shares of The Donald (not me, the other one) at $0.52 a piece. In just that one trade, you can pocket almost $5,200 of free money. Unless, of course, you believe that Donald Trump could actually be elected president.

So why haven’t I picked up this $5,000+ bill? Because I haven’t seen an unambiguous  statement that buying and selling on Intrade is completely legit for U.S. citizens. Not worth the risk.

If Gary Gensler (Chairman of the Commodities Futures Trading Commission) or other relevant regulator would issue a ruling clarifying that Intrade trading is copacetic, that would be much appreciated.

For the latest Trump action, click here.

P.S. For sticklers: yes, the margin requirements on this trade could be rather a nuisance.

Fiscal Policy Highlights Around the Net

1. Over at Third Way, Bill Rapp used my data on debt limit votes to make a great graphic showing that those votes are about politics, not principle.

2. Over at the Tax Policy Center, Eric Toder pushes back against the idea that tax expenditures — spending in the tax code — are loopholes and earmarks:

The House Budget resolution promises an individual tax reform that “simplifies the broken tax code, lowering rates and clearing out the burdensome tangle of loopholes that distort economic activity.” The Fact sheet describing President Obama’s new budget framework calls for “individual tax reform that closes loopholes and produces a system which is simpler, fairer, and not rigged in favor of those who can afford lawyers and accountants to game it.” The bipartisan National Commission on Fiscal Responsibility and Reform notes that the tax system is riddled with tax expenditures and adds, “These earmarks not only increase the deficit, but cause tax rates to be too high.”

…

But the largest tax expenditures are not loopholes or earmarks snuck into the law in the dead of night to benefit a shadowy handful of super-wealthy individuals or well-connected corporations. Rather, they benefit tens of millions of taxpayers. Among the biggest: itemized deductions for home mortgage interest, charitable contributions, and state and local taxes, exemption of income accrued within tax-preferred retirement saving accounts, and the exemption from tax of employer contributions to health insurance plans. IRS data show that 39 million taxpayers claimed deductions for home mortgage interest and charitable contributions in 2008, and 35 million deducted state and local income taxes.

3. The Committee for a Responsible Federal Budget offers a helpful side-by-side comparison of four leading budget plans:

Defense Spending Deserves Close Scrutiny Too

My latest column at the Christian Science Monitor makes the case that defense spending deserves close scrutiny as America evaluates its fiscal priorities. Excerpt:

This year the US will spend about $110 billion in Afghanistan and $44 billion in Iraq. Regular defense spending is even larger, at about $550 billion. Military spending will total more than $700 billion this year.

That spending gets far less scrutiny than it deserves. Discussions of our long-run budget challenges usually emphasize the big entitlement programs – Medicare, Medicaid, and Social Security – and the need for new revenues. Congressional budget debates, meanwhile, have bogged down on the sliver of spending that goes to domestic discretionary programs [written before the 2011 budget deal].

Defense should be on the table as well. Military spending has more than doubled over the past decade. Some of that increase has been necessary to respond to the 9/11 attacks and the new challenges they revealed. But not all. Some of the increase has simply been excess.

Adm. Mike Mullen, chairman of the Joint Chiefs of Staff, made this clear in remarks in January. Because of the dramatic expansion of the Pentagon budget, he said, “We’ve lost our ability to prioritize, to make hard decisions, to do tough analysis, to make trades.”

We also have embarrassingly little ability to track that spending. When the Government Accountability Office recently audited the government’s finances, it concluded – as it has for many years – that the Defense Department’s books are so poorly kept that they can’t be audited. Taxpayers are thus giving $700 billion a year to an organization that can’t prioritize and can’t tell us where the money is going. That’s unacceptable.

Yahoo’s Self-Inflicted Winner’s Curse

Over at Managerial Econ, Luke Froeb highlights a nice example of the winner’s curse. Like Google, Yahoo uses automated auctions to sell ads. One wrinkle is that some advertisers prefer to pay for impressions, some prefer to pay for clicks, and some prefer to pay only for resulting sales. Yahoo thus needs some mechanism to put these different payment approaches on a comparable footing:

To choose the highest-valued bidder, Yahoo develops predictors of how many clicks and sales result from each impression. For example, if one click occurs for every ten impressions, an advertiser would have to bid more than 10 times as high for a click as for an impression in order to win the auction.

Yahoo was very proud of its predictors, but was puzzled that they systematically over-predicted the actual number of clicks or sales after the auctions closed.

This is the winner’s curse in action. As auction guru (and Yahoo VP) Preston McAfee explains in the paper Luke cites:

In a standard auction context, the winner’s curse states that the bidder who over-estimates the value of an item is more likely to win the bidding, and thus that the winner will typically be a bidder who over-estimated the value of the item, even if every bidder estimates in an unbiased fashion. The winner’s curse arises because the auction selects in a biased manner, favoring high estimates. In the advertising setting, however, it is not the bidders who are over-estimating the value. Instead, the auction will tend to favor the bidder whose click probability is overestimated, even if the click probability was estimated in an unbiased fashion.

McAfee then goes on to explain how Yahoo overcame this self-inflicted winner’s curse, and other strategies to improve auction performance.

Rainfall, Human Capital, and Democracy

To what extent do natural environments explain political development? A lot, according to a recent paper by Stephen Haber and Victor Menaldo. They find that rainfall and democracy go together like porridge and Goldilocks – to get democracy to flourish, it shouldn’t be too wet or too dry:

Why are some societies characterized by enduring democracy while other societies are persistently autocratic? We show that there is a systematic, non-linear relationship between rainfall levels and regime types in the post-World War II world: stable democracies overwhelmingly cluster in a band of moderate rainfall (550 to 1300 mm of precipitation per year); persistent autocracies overwhelmingly cluster in deserts and semi-arid environments (0 to 550 mm per year) and in the tropics (above 1300 mm per year). We also show that rainfall does not work on regime types directly, but does so through the its impact on the level and distribution of human capital. Specifically, crops that are both easily storable and exhibit modest economies of scale in production grow well under moderate amounts of rainfall. The modal production unit is a family farm that can accumulate surpluses. In such an economy there are incentives to make intergenerational investments in human capital. A high level and broad distribution of human capital makes democratic consolidation more likely.

ht: Roger K., who referred me to a recent Amity Shlaes column that cites this research.

The Cost of Sunshine: The Downside of Disclosing Campaign Donors

Campaign finance rules emphasize sunlight. For example, all campaign donations above a modest amount (e.g., $200) must be publicly disclosed. That allows everyone to see who is providing financial support to which candidates.

That sounds good if you are worried about campaign contributions buying undue access to our elected leaders.

As I noted last year, however, that sunshine comes with costs. For example, it makes quid pro quo’s easier. Why? Because candidates know who is financing them. A completely anonymous system — in which no one, including candidates, knows the identity of donors — would make explicit quid pro quo’s much more difficult.

Full disclosure also discourages individuals from making donations that would be unpopular with their relatives, friends, neighbors, and employers. You can make anonymous donations to unpopular causes to your heart’s content without anyone knowing. But if you make even a modest donation to an unpopular political candidate that’s a matter of easily-Googleable public record. That can be a real deterrent.

Writing in today’s Wall Street Journal, James L. Huffman raises a related concern: that disclosure stacks the deck in favor of incumbent politicians:

[P]ublic disclosure serves the interests of incumbents running for re-election by discouraging support for challengers. Here’s how it works.

A challenger seeks a contribution from a person known to support candidates of the challenger’s party. The potential supporter responds: “I’m glad you’re running. I agree with you on almost everything. But I can’t support you because I cannot risk getting my business crosswise with the incumbent who is likely to be re-elected.”

…

Disclosure makes threats possible, and fears of retribution plausible. Within weeks of a contribution of $200 or more, the contributor’s name appears on the public record. Contributors know this, and they know that supporting the challenger can, should the challenger lose, have consequences in terms of future attention to their interests. Of course no incumbent will admit to issuing threats or seeking retribution, but the perception that both exist is widespread.

Huffman was the unsuccessful Republican nominee in Oregon’s Senate race in 2010. Depending on your view, that might mean that he speaks from experience or that he suffers from sour grapes. Without evidence, there’s no way to know how much, if at all, such concerns arose in his race.

But the broader issue he raises is worth pondering. Sunshine is sometimes the best disinfectant. But it also lets bad actors see what’s going on.

Taxi Medallions in DC: Who Would Win and Lose?

Today’s lesson in political economy: the looming battle over Washington’s cab market.

Three members of DC’s City Council (Marion Barry, Harry Thomas, Jr., and Michael Brown) want to require every taxi to have a medallion. The number of medallions would be much smaller than the number of cabs on the streets today.

As I noted a few months ago, this proposal would harm consumers more than it would help drivers. With fewer cabs on the road, it would be harder for passengers to find a ride and easier for drivers to turn down what they perceive as undesirable fares. If medallion prices rise, it may also make it easier for taxi drivers to lobby for higher fares in the future. All of that adds up to fewer cab trips.

The sponsors reportedly have close ties to some taxi drivers, so it isn’t surprising they favor drivers over consumers. What is interesting, however, is how they would favor some drivers over others.

The favored? Drivers with two or three decades on the road who are DC residents. In short, long-time incumbents who can vote.

The disfavored? Drivers with less experience or who live outside the district. In short, entrants and those who can’t vote.

This favoritism shows up in several ways in the proposed legislation:

  • Medallion prices. Under the proposal, initial medallion prices would vary by a factor of ten. A DC resident with 30+ years experience could buy a Class 1 unrestricted medallion for $500. A DC resident with 20+ years experience would pay $1,000. A non-resident with 20+ years would pay $4,000. Other qualifying drivers – if I am reading the proposal right, these would be DC residents who have filed DC income taxes for at least five years – would pay $5,000.
  • Right to purchase medallions. DC residents have priority over non-residents for most medallions, and priority further depends on seniority.
  • Property rights. Under the proposal, most medallions would become the buyer’s property and could be assigned or sold in the future. That means the driver would get the benefit of any price appreciation in the future. But that isn’t true for one category: Class 5 medallions that would be created for non-resident drivers who don’t get Class 1 through 4 medallions. Those medallions are not property and cannot be transferred; once the driver stops using them, they would be gone, and the number of taxis would decline further. (By the way, the price of Class 5 medallions is not specified in the legislation; instead it is left up to the Taxicab Commission.)

Bottom line: The proposal is a classic illustration of how the regulatory system might be used to favor (a) an organized group (taxi drivers) over a non-organized one (consumers), (b) incumbents over entrants, and (c) residents over non-residents.