Category: Microeconomics

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.

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.

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.

The Rising Risk of Antibiotic Resistance

Scary theme of the week? Rising antibiotic resistance.

Megan McArdle highlighted this challenge in her presentation at the Kauffman bloggers event on Friday; if you have a moment, check out her chart at the 2:00 mark, showing that resistance to new antibiotics has been developing faster and faster.

You’ll hear more about resistance later in the week, as the World Health Organization will make make it the focus of Thursday’s World Health Day. It’s also the subject of a helpful overview in this week’s Economist.

Antibiotic resistance isn’t new. Indeed, as the Economist notes, Alexander Fleming identified this threat in the 1940s. But it appears to be getting worse. Evolutionary pressure combines with market failure to speed the creation of resistant bacteria:

Convenience and laziness top the list of causes of antibiotic resistance. That is because those who misuse these drugs mostly do not pay the cost. Antibiotics work against bacteria, not viruses, yet patients who press their doctors to prescribe them for viral infections such as colds or influenza are seldom harmed by their self-indulgence. Nor are the doctors who write useless prescriptions in order to rid their surgeries of such hypochondriacs. The hypochondriacs can, though, act as breeding grounds for resistant bacteria that may infect others. Even when the drug has been correctly prescribed, those who fail to finish the course are similarly guilty of promoting resistance. In some parts of the world, even prescription is unnecessary. Many antibiotics are bought over the counter, with neither diagnosis nor proper recommendations for use, multiplying still further the number of human reaction vessels from which resistance can emerge.

In economics lingo, there is an externality. If I take an antibiotic, I get the health or psychological benefits. But I also increase the odds of a new resistant strain of bacteria developing, particularly if I don’t take the drug appropriately. But patients and doctors often don’t take that risk into account when deciding whether and how to use an antibiotic.

That’s a tough problem to crack. The standard economist playbook says we ought to disseminate better information and strengthen incentives so that patients and doctors take these risks into account. Better guidelines for prescribing doctors, perhaps, along with better ways of monitoring and rewarding patients for taking the drugs appropriately. One might even consider a Pigouvian tax to discourage antibiotic use, although that raises a host of concerns of its own.

In addition, we could try to expand the supply of new antibiotics.

That raises the usual questions of how best to encourage innovation through patents, prizes, government-subsidized R&D, changes to the drug approval process, etc. But even intelligent policy can’t overcome nature itself. As the graph from the Economist suggests, the potential pool of antibiotics may be drying up.

State and Local Pay vs. Private Pay

Do state and local workers get paid more or less than their private sector counterparts?

That old question has taken on renewed life with the budget and labor disputes raging in Wisconsin and other states. Unfortunately, it’s not an easy question to answer.

As Ford Fessenden notes in a nice set of graphics at the New York Times,one reason is that observers disagree on what “paid” and “counterpart” mean.

If you simply compare average pay and benefits, for example, state and local workers come out well ahead:

But the two workforces differ. State and local workers are more educated, on average, than private ones. About 50% of state and local workers have a college degree, for example, while only 29% of private workers do. Controlling for that reduces the compensation differential.

But then you need to consider other factors as well, such as the generally longer hours and lower job security in the private sector.

Fessenden doesn’t reach a firm conclusion. Some data suggest that public employees are indeed paid more. But some narrower (and therefore more precise or less representative) comparisons show parity (hospital workers) or higher private pay (higher education).

Well worth flipping through the charts if you are interested in this issue.

The Touch and Feel of Record Cotton Prices

Cotton prices hit another record earlier today. As noted by the San Francisco Chronicle:

Cotton futures in New York jumped to a record, gaining by the daily limit for a third day, on signs that growers may struggle to meet mounting demand from China, the world’s biggest consumer.

Cotton for March delivery gained 2.7 percent to $1.5412 a pound on ICE Futures U.S. in New York at 4:15 p.m. Tokyo time. Prices have more than doubled this year, heading for the biggest annual gain since 1973.

Output in China’s Shandong province, the nation’s second-biggest producer, dropped 22 percent this year from 2009 after natural disasters hurt crops, the region’s Agriculture Information Center said in a report Dec. 17. Demand in China is forecast to exceed supply by 17 million bales in the year ending July 31, according to the U.S. Department of Agriculture.

What’s behind this move? Well, judging by everything I’ve read so far, it sounds like good old-fashioned demand (up) and supply (down).

But just to be sure, I decided to check in with two famous economic commentators. I tracked down the talking “bunnies” over on YouTube (ht SK) and, sure enough, they agree that supply and demand fundamentals are what’s driving the cotton market.*

Unfortunately, the critters have a much more serious tone than in their famous explanation of QE2 (except for some gratuitous language at the very end, which tries to pay homage to their earlier work). But they do speak with authority

Update: Unfortunately, the critters have gotten shy. No public video now (12/22).

* OK, these guys don’t really look like bunnies. More like stuffed animals — perhaps dogs or bears. Which, come to think of it, would make them even more expert on cotton markets.

Steve Martin Gives a Lesson on Sales Taxes

Steve Martin–yes, the wild and crazy guy–has a new novel. “An Object of Beauty” tells the story of Lacey Yeager, an up-and-comer in New York’s art world in the mid-1990s. I’m 19% of the way through the novel (up to location 779 in Kindle-speak), during which Lacey has been climbing the ladder at Sotheby’s, the famous auction house.

Thus far, my favorite passage depicts how sensitive wealthy art collectors can be to taxes. Sotheby’s has sent Lacey to Washington to deliver a painting to the winning bidder in a recent auction. After getting off her train, Lacey heads over to Georgetown:

The white door of the brownstone swung open with a faint jingle-bell tinkle, and Saul Nathanson waved with full panic shouting, “Don’t come up the steps!”

So many interpretations. Was he shouting at Lacey, the painting, or the taxi driver? “Don’t step on the walkway!” Was the concrete wet? But Saul ran toward them more sheepish than commanding, and they all stayed put.

“I thought by having you bring the picture,” Paul said, panting, “that we were taking delivery of the picture in Washington. But it seems to be disputable that this might constitute taking delivery in New York.”

Lacey looked at Saul, then at the taxi driver. He pulled his cap back and scratched his head. “Oh yeah, sales tax,” he said.

“What?” said Lacey.

“My wife sells jewelry. There’s always a sales tax issue.”

Saul pointed at the driver with a silent “bingo.” “We’ve got to have it shipped to us from New York by a reputable carrier.”

Lacey muttered, “I’m reputable.”

“But unlicensed. We’ve got a questionable situation here. You’ve got to take it back. It’s a difference of almost ten thousand dollars,” said Saul.

The statement hung in the air, until the taxi driver said, “You mean that box is worth a hundred and fifty thousand dollars?”

Lacey turned to him. “Who are you, Rain Man?”

Saul was balanced on his toes. “I’m so sorry, Lacey, we tried to turn you around, but we just learned it an hour ago. Here’s something for you”–he handed her a folded hundred-dollar bill–“and don’t let the painting touch the walkway.”

“I’ll be a witness,” said the grinning taxi driver, implying there could be another tip due.

“I can’t even invite you in,” said Saul. Then he turned to the half-opened door. “Estelle! Wave hello to Lacey!”

Estelle poked her head out of an upstairs window. “Hello, Lacey. Saul’s insane!”

Or maybe he’s highly rational?

The Grinch Recast as Economic Parable

Over at Forbes.com, Art Carden has a brilliant retelling of Dr. Seuss’s “How the Grinch Stole Christmas” (ht: Greg Mankiw). Carden recasts the story as a parable about externalities and property rights.

He starts with the Grinch’s view that Who singing is a nuisance:

He hated the shrieks of the Who girls and boys
For fifty-three years he’d put up with it now—
He had to stop Christmas from coming, somehow.
He asked and he questioned the whole thing’s legality
Then his eyes brightened: he screamed “externality!”
He reached for his textbooks; he knew what to do
He’d fight them with ideas from A.C. Pigou.

As regular readers know, Pigou argued that externalities — pollution, singing Whos, etc. — could be addressed by levying taxes that reflect the harm imposed. So maybe, the Grinch might reason, he should help himself to some Who presents and roastbeast whenever they sing.

But wait, as Ronald Coase noted years ago, it takes two to tango … and to create an externality. So the Whos have a rebuttal:

“We know that we’re noisy all through Christmas Day,
But if you don’t like it, it’s you who should pay!
“For we were here first, and homesteaded the rights
To sing, to make noise, and to hang Christmas lights
“The costs of our Christmas joy helped you to save!
They were fully reflected in the price of your cave!”

I am so using this in my class in the spring.

Thanksgiving Reading

So many fascinating economic issues, so little time to blog.

Here are some of the fun items that I would have discussed in recent days if I had infinite time:

Have a wonderful Thanksgiving.

Economics in Action: Is Groupon Worth It?

Over at the New York Times You’re the Boss blog, Jay Goltz provides a great example of economic reasoning (ht: Jack B). His topic: how should small businesses think about the costs and benefits of participating in daily coupon sites like Groupon? Participants can see big spikes in traffic, at the expense of slashed margins. Is it worth it?

Goltz deploys many of the standard concepts we professor types teach our microeconomics students: distinguishing variable and fixed costs, the importance of thinking incrementally (i.e., at the margin), etc. But, frankly, he does it in a more entertaining way.

Here’s his basic set-up (but check out the whole article for how this calculation works out):

There are eight key calculations you need to consider to determine whether this is a better advertising vehicle than something else you may already be doing

1. Your incremental cost of sales — that is, the actual cost percentage for a new customer. If you are giving boat tours and have empty seats, your incremental costs for an additional customer are next to nothing. If you are selling clothes, your incremental costs might be 50 percent of the sale price. Food might be 40 percent. In any case, don’t include fixed costs that you would be incurring any way.

2. The amount of the average sale. If the coupon is for $75, will the customers spend more that that? I have seen more than one retailer complain that nobody spends more than the value of the coupon. That’s unlikely but I am sure it can feel that way, and that is my point: Keep track.

3. Redemption percentage. You don’t really know until the end, but from my experience and from what I have heard, 85 percent is a good guess.

4. Percentage of your coupon users who are already your customers. I’m sure this number varies tremendously depending on the size of your city, how long you have been around, and the type of business.

5. How many coupons does each customer buy? (The more they buy, the fewer people are exposed to your product or service.)

6. What percentage of coupon customers will turn into regular customers? Again, it can seem as if they are all bargain shoppers who will never return without a discount, but that’s almost impossible. Is it possible 90 percent won’t return? Sure.

7. What is the advertising value of having your business promoted to 900,000 people — that’s the number on Groupon’s Chicago list — even if they don’t buy a coupon?

8. How much does it normally cost you to acquire a customer through advertising? Everything is relative.