Microeconomics – Page 5

DC’s New Mayor Should Say No to Taxi Medallions

I love taxi medallions.

As an example for my microeconomics students, not as policy.

Just last week, I used New York City’s medallion system to show how an entry barrier — the requirement that each yellow taxi have one of a limited number of medallions — could create profits in an otherwise viciously competitive industry.

How much profit? Well, according to the most recent data from the city’s Taxi and Limousine Commission medallions for independent cab drivers traded at between $610,000 and $620,000 in October. If you figure 8% as a reasonable rate of return of this asset, that translates into almost $50,000 in pure profit each year from driving a cab, thanks to the entry barrier.

Good exam question: Who gets that profit? Hint: It isn’t the cab driver, who either has to lay out $600,000+ for a medallion or lease one at perhaps $50,000 per year.

Of course that profit comes at the expense of taxi riders, who face a double whammy: they pay more for the cab rides they can get, and they end up taking fewer cab rides (the latter effect is known as a deadweight loss – society loses the benefit of the cab rides that would have happened without the medallion system).

Given that background, I was horrified to learn from Matt Yglesias that taxi drivers in Washington DC are lobbying Vincent Gray, the city’s new mayor, to introduce a medallion system. Yglesias quotes Alan Suderman of the Washington City Paper thusly:

Derje Mamo, a taxi driver who helped run transportation for the mayor-elect’s campaign, said cabdrivers already are pushing Gray to reshape the Taxicab Commission and allow for the creation of a medallion system. A medallion or certification system would limit the number of cabs operating in the city. Proponents of such a system argue that too many taxis are flooding D.C. streets. ‘He’s got one year, that’s it,’ Mamo said.”

As Yglesias notes, this is a really bad idea. There’s no reason to believe that there are too many cabs on DC streets (except, of course, from the view of cab drivers who hate the competition), and in some neighborhoods there may well be too few. A more plausible concern, as some commenters on his blog note (but I can’t link to because of some glitch), is that current taxi fares might be a bit too low. Taxi fares are still a new thing in DC–until 2008 the city had a zone system that many passengers, myself included, found bewildering–and it may be that the initial levels weren’t set exactly right. If Mayor Gray wants to do something for the cabdrivers, he should ask the Taxicab Commission to ponder whether some upward tweaks to fares might induce some extra supply that passengers would value.

Update: For further discussion, please see this later post.

Behold the Power of Cheese

American cheese policy is full of contradictions. (If it were full of holes, it would be Swiss cheese policy.)

What, you didn’t know America has a cheese policy? Well, we do, as part of our larger dairy policy. And over the years the dairy policy’s failures have led to caves full of uneaten cheese, subsidized cow euthanasia, and, as Michael Moss documents in the New York Times this morning, the creation of a marketing board whose goal in life is to encourage Dominos and Taco Bell to use even more cheese on their pizzas and quesadillas:

Every day, the nation’s cows produce an average of about 60 million gallons of raw milk, yet less than a third goes toward making milk that people drink. And the majority of that milk has fat removed to make the low-fat or nonfat milk that Americans prefer. A vast amount of leftover whole milk and extracted milk fat results.

For years, the federal government bought the industry’s excess cheese and butter, an outgrowth of a Depression-era commitment to use price supports and other tools to maintain the dairy industry as a vital national resource. This stockpile, packed away in cool caves in Missouri, grew to a value of more than $4 billion by 1983, when Washington switched gears.

The government started buying only what it needed for food assistance programs. It also began paying farmers to slaughter some dairy cows. But at the time, the industry was moving toward larger, more sophisticated operations that increased productivity through artificial insemination, hormones and lighting that kept cows more active.

In 1995, the government created Dairy Management Inc., a nonprofit corporation that has defined its mission as increasing dairy consumption by “offering the products consumers want, where and when they want them.”

Dairy Management, through the “Got Milk?” campaign, has been successful at slowing the decline in milk consumption, particularly focusing on schoolchildren. It has also relentlessly marketed cheese and pushed back against the Agriculture Department’s suggestion that people eat only low-fat or fat-free varieties.

The pro-cheese policy thus runs exactly counter to the anti-cheese policy of the Agriculture Department’s nutrition efforts.

The whole article is worth a read for its glimpse into how Dairy Management operates. The organization is private in many regards, most notably the $633,475 in CEO compensation. But it is ultimately financed by the power of the government, which imposes a levy on dairy farmers. The standard argument in favor of this structure is that dairy marketing is a public good, from the perspective of the individual farmers, and that the government role is necessary to coordinate that activity. On the other hand, many industries manage to create trade associations without any government role.

With rising concern about obesity, perhaps now is the time to get the government out of the cheese marketing business? Dairy Management could still exist as a fully private entity, but the government would no longer face a conflict between encouraging healthy eating and pushing quesadillas.

Gender Arbitrage by Multinationals

Economists often argue that market competition can limit some of the economic inequities from discrimination (this idea goes back at least to Gary Becker’s 1957 treatise The Economics of Discrimination). If some businesses refuse to hire well-qualified women or minorities, for example, that creates an opportunity for other businesses to hire those workers at lower cost. Non-discriminatory companies could then gain a competitive advantage over their discriminating rivals. Over time, the success of the non-discriminators could bid up wages to the disadvantaged group of workers.

The practical impact of such competition depends, of course, on the willingness of some employers to be non-discriminatory in their hiring practices. The week’s Economist reports an interesting example of how foreign multinationals are playing that role in South Korea:

Working women in South Korea earn 63% of what men do. Not all of this is the result of discrimination, but some must be. South Korean women face social pressure to quit when they have children, making it hard to stay on the career fast track. Many large companies have no women at all in senior jobs.

This creates an obvious opportunity. If female talent is undervalued, it should be plentiful and relatively cheap. Firms that hire more women should reap a competitive advantage. And indeed, there is evidence that one type of employer is doing just that.

Jordan Siegel of Harvard Business School [and Lynn Pyun of MIT and B.Y. Cheon of Hanshin University report] that foreign multinationals are recruiting large numbers of educated Korean women. In South Korea, lifting the proportion of a firm’s managers who are female by ten percentage points raises its return on assets by one percentage point, Mr Siegel estimates.

You can find the original working paper here. The money quote from the abstract:

Using two unique data sets from South Korea, we show that in the 2000s multinationals have derived significant advantage in the form of improved profitability by aggressively hiring an excluded group, women, in the local managerial labor market.

Perhaps needless to say, the fact that these firms are earning higher profits indicates that there’s still plenty of room to bid up the salaries of managerial women in South Korea.

Can the Chilean Miners Solve the Cartel Problem?

The rescue of the Chilean miners was a heartwarming miracle. The miners have both my sympathy and respect – I can’t even begin to imagine what those first 17 days were like, trapped far underground without any hint that rescue was even possible. I wish them the best as they try to return to normal life.

I also thank them for providing an excellent case study for my microeconomics class. According to media reports, the 33 miners agreed to a pact of silence in which none will speak about the details of the first 17 days of their ordeal. In addition, they struck an agreement to coordinate the telling of their story and to share equally the resulting profits.

In short, the Chilean miners formed a cartel. A justified and moral cartel to be sure — they deserve whatever profits they can jointly extract from their ordeal — but a cartel nonetheless.

All of which raises a natural question: Can such a cartel be successful? Or will it succumb to the perennial challenge that confronts all cartels: how to enforce a joint agreement in the face of individual temptations? A unified silence may well maximize the financial value of the story and defend the privacy of those moments that some miners do not want to share with the world. But the media circus will tempt some miners to cheat on that agreement either for monetary gain or to ensure that their individual perspective gets reported.

I wouldn’t want to downplay the solidarity among these men, but over at the New York Daily News, Jaime Urabarri reports that there are already concerns that the agreement may break down. In “Chilean miners may break pact of silence, for the right price,” he writes:

Some of the rescued Chilean miners are apparently willing to tell their story for the right price, despite a promise made between all 33 of them that none would reveal details about the worst of their 69-day ordeal buried underground.

During a special Sunday mass held in honor of last week’s dramatic rescue, miner Jorge Galleguillos said that the pact was non-binding and hinted that he’s entertaining offers to spill the beans on exactly what happened.

“I have to think about myself,” he argued, without going into specifics about what information he’d be willing to share.

There are also rumors that some of the miners have already reached deals to tell their story. El Mercurio reported last week that Victor Segovia agreed to sell the contents of the journal he kept during his time in the mine for $50,000 to German newspaper Bild.

My prediction? Regardless of how this turns out, the Chilean miners will show up in the next edition of many economics textbooks.

Water Funds: Coase in South America (and New York)

Rivers often create important resource conflicts. Downstream cities want clean water to drink. Upstream residents want to make a living, but that sometimes damages water quality. In the highlands above Quito, Ecuador, for example, residents often convert land to farming and ranching; that allows them to raise valuable crops and livestock, but weakens the land’s ability to naturally cleanse water before it flows downstream.

How can we solve this problem? One response would be for a central government to enact laws and regulations that force the upstream folks to take better care of the watershed. Such laws can play an important role in improving water quality, but they raise several practical concerns. For example, regulatory burdens may place undue economic burdens on upstream residents. And the laws and regulations may be hard to enforce, particularly if local communities view them as an unwelcome burden.

Another strategy is for the downstream water users to pay the upstream residents for keeping the water clean. Such payments can make protecting the watershed into a profit center for upstream communities and can encourage them to accept rigorous approaches to monitoring and enforcement. (In the economics literature, this approach is often distributed as Coasian, in honor of Ronald Coase, who emphasized it in his work.)

Last week Esther and I dined with some officials of the Nature Conservancy (TNC) and learned that they are encouraging exactly this approach to water conservation in South America. TNC is helping create water funds:

Water users pay into the funds in exchange for the product they receive — fresh, clean water. The funds, in turn, pay for forest conservation along rivers, streams and lakes, to ensure that safe drinking water flows out of users’ faucets every time they turn on the tap.

Some water funds pay for community-wide reforestation projects in villages upstream from major urban centers, like Quito, Ecuador, and Bogotá, Colombia. In other cases, like in Brazil’s Atlantic Forest, municipalities collect fees from water users and make direct payments to farmers and ranchers who protect and restore riverside forests on their land through water producer initiatives.

“These ‘water producers,’ as we call them, are being fairly compensated for a product they’re providing to people downstream in Rio de Janeiro and São Paulo: fresh water,” explains Fernando Veiga, Fernando Veiga, Environmental Services Manager for the Conservancy’s Atlantic Forest and Central Savannas Conservation Program in Brazil. “They’re receiving $32 per acre, per year, for keeping their riverside forests standing.”

TNC has an informative interactive graphic that illustrates how it works in the headwaters above Quito. (Note to TNC: the graphic would be even better if it involved less clicking.)

Perhaps needless to say, this idea is not unique to South America. New York City, for example, has been pursuing a related approach, buying up buffer land around the upstate reservoirs that supply the city.

Nickels Matter: Pigou and the Plastic Bag

On January 1, Washington DC introduced a 5-cent tax on disposable shopping bags at grocery, drug, convenience, and liquor stores. The fee had two goals: to reduce the number of bags, in particular plastic ones, that end up blighting the landscape and to raise funds for cleaning up the Anacostia River.

The fee appears to be succeeding on both counts, but not equally so. As Sara Murray and Sudeep Reddy report over at the Wall Street Journal, shoppers have cut back on bag use more than anticipated; as a result revenues are running below expectations:

[T]he city estimated that [bag use] would decline by 50% in the first year after the tax was imposed. …. [A]n informal survey of corporate headquarters for grocery stores and pharmacies with dozens of locations in the city estimated a reduction of 60% or more in the number of bags handed out. … Through the end of July, the city collected more than $1.1 million from the bag fee and small donations. At that rate, receipts are likely to fall short of the expected $3.6 million in the first year.

I’ve witnessed the sharp decline in bag use during my daily lunch run. Last year, the Subway folks would automatically put your sandwich and a napkin in a plastic bag. Now they ask if you want one. I always decline, as do most other customers.

Why has there been such a strong reaction to a nickel fee? I think it’s a combination of two factors.

The first is a traditional microeconomic explanation: there are often good substitutes for a disposable shopping bag. For example, I find it just as easy to carry the wrapped sandwich as to carry the old Subway bag. And if I buy some dental floss at CVS, I can just pop it in my pocket for the trip home. So even a relatively small fee can get results.

The second is a behavioral explanation: people act weird when things are free–they acquire things without really thinking about it. If you start charging a price–and thus change the default from “here’s your bag” to “do you want a bag?”–you can witness large responses.

P.S. As noted in a previous post on the bag fee, Arthur Cecil Pigou is the father of environmental taxes.

The Economics of Damien Hirst

Future generations will remember September 15, 2008 as the day that Lehman died. But the art world has another memory of that fateful day: the opening of a London auction of works by artist Damien Hirst. Over a period of two days, Sotheby’s rapped the gavel on almost $200 million of his new works, marking the high point of the contemporary art bubble that accompanied all the other asset bubbles.

Not familiar with Damien Hirst? He’s probably most famous for a 14 foot tiger shark preserved in formaldehyde (titled “The Physical Impossibility of Death in the Mind of Someone Living“), spot paintings, and an as-yet-unsold skull covered with diamonds (“For the Love of God“).

The Economist marks this anniversary with enjoyable retrospective on the auction, which was notable not only for the amount of money that changed hands, but also because it was a very rare example of an artist using an auction in the primary market. Artists usually sell through galleries, where dealers try to place new works in the hands of “worthy” buyers. But Hirst decided to take his new work directly to the auction market — with stunning, if transient, success:

The Economist suggests that Hirst was frustrated with the traditional model, in which initial buyers sometimes flipped pieces at a profit in the auction market after buying from a gallery. Hirst thus set himself a mission, saying “The first time you sell something is when it should cost the most” and “I’ve definitely had the goal to make the primary market more expensive.” And he certainly succeeded, albeit with a little help from the credit market.

Other interesting economic tidbits about Hirst’s work are his exceptional reliance on assistants to execute the works (he clearly understands the idea of the division of labor) and the uncertainty about just how many works he (and his team) have created over the years.

Another Observation on the Yield Curve

As a follow-up to my recent post about recessions and the yield curve, reader Joan F. points us to a piece by the FT’s James Mackintosh. The money quote:

[T]hose keeping faith in recovery also point to the fact that the yield curve has not inverted – 10-year bonds still yield 2 percentage points more than two-year bonds. Given that the 10-year yield has dropped below the two-year (and the three-month) before every recession since the second world war, perhaps a double dip is not looming.

Unfortunately, a quick glance at Japan suggests that once short-term rates hit the floor, the yield curve may no longer be a valuable indicator. While it warned of the recession that followed the bursting of Japan’s bubble, it missed the three recessions since.

It’s Back-to-School Season, Time to Lay Your Bets

According to an article over at the Huffington Post (ht Natalie), students at 36 colleges will have a new option when they start classes this fall. Thanks to an outfit named Ultrinsic, students can now bet on whether they will get good grades. Students put up money at the start of the semester and then get payoffs at the end depending on how they do.

Calling it a bet isn’t completely fair, however, since the payoff creates an extra incentive for students to do well. So think of it as a combination of betting (if you think your odds of doing well are better than Ultrinsic thinks) and using a financial incentive to get your future self to study a bit harder. Naturally, Ultrinsic emphasizes the incentive perspective in describing its “Reward” product:

Do you like getting good grades? The right amount of cash should provide you with the needed motivation to pull all-nighters and stay awake during the lectures of your most boring professors. At Ultrinsic.com, you will be able to earn cash while working to achieve your academic goals.

Obligatory note to my new crop of students: all-nighters are generally not an optimal learning strategy.

Like a race track, the company offers packages that pay off not only if you do well on a single course, but also if you perform well in multiple courses or over an entire semester. If a new freshman is really feeling motivated, he or she can also put down $20 up front for the opportunity to win (earn?) $2,000 for maintaining a 4.0 GPA throughout college.

And if students are feeling risk-averse, they can also buy insurance against bad grades. Bomb that final and get a cash reward.

Somehow I doubt many students will want to buy such insurance. Or that Ultrinsic will want to sell it given the risks of moral hazard. Perhaps Ultrinsic will screen for “pre-existing conditions” (like failing a related class) in order to limit the adverse selection. Or just offer such high premiums that only a few extremely risk-averse (or mathematically-challenged) students will apply.

The incentives product, however, seems much more promising. Indeed, it resembles some other efforts to help people modify their own behavior through financial incentives. See, for example, the folks at stikK.com whose service allows users to create their own incentives. For example, you could commit to give $500 to your favorite charity if you fail to lose 10 pounds by Christmas. Even better, you could commit to give $500 to your least-favorite charity if you fail to drop the pounds.

Ultrinsic is just applying this logic to college grades … and kindly offering to take a cut when students fall short.

The Chevy Volt Premium

The other day I noted that Amazon has been tussling with book publishers over the pricing of electronic books. Amazon would prefer a wholesale pricing model, in which it sets retail prices, rather than an agency pricing model, in which the publishers set the prices. One reason that Amazon would prefer the wholesale model is because it would allow it to sell e-books for less than publishers would prefer.

A similar pricing kerfuffle has arisen in the pricing of Chevy’s new plug-in hybrid, the Volt. Auto dealers operate under a wholesale pricing model–they buy the cars and then decide what to charge for them. In this case, however, early demand is so strong that auto retailers are charging more than Chevy (a unit of GM) would prefer. As noted on the Wheels blog over at the New York Times, some dealers are apparently charging $12,000 above the sticker price–$53,000 vs. $41,000–for scarce Volts.

This has miffed GM executives:

By law, General Motors cannot dictate vehicle pricing to its dealers. But Rob Peterson, a G.M. spokesman, noted in a telephone conversation that the company had impressed on sales managers to keep prices in line with the company’s suggested retail price.

“The dealers are independent, for better and, in very rare cases, for worse,” he said. “There are some who have moved in the opposite direction of our request. In response, what we’ve done is to urge customers who have contacted us about pricing discrepancies to shop around, because there are dealerships in their area that are honoring M.S.R.P.”

Bottom line: wholesalers are like Goldilocks, they want retail prices to be neither too hot nor too cold.