HowTo: Two-part tariffs

Proof that my students are on the ball! One of them, at least. After I gave them the Gillette 4-pack of razor blades as a pop-quiz, he discovered, and forwarded, this story:

We’ve been here before.

1. Is Gillette charging $5 for the 5^th razor blade? No;
2. Is Reader Jordan making a rational decision, abandoning Gillette for Schick based upon this $5? No (caveat: I am aware that he may be giving the matter proper thought).

So – what’s going on, here? Two-part tariffs. Price discrimination. When Gillette charges $8.99 for a 4-pack of razor blades, are they charging you $2.25 per blade? No. Why?

Marginal utility declines, as we consume more. We get more Marginal Benefit from the first razor blade than from the second razor blade – and less from the third than the second. This is the reason why demand curves are downward-sloping, yeah? So. Ordinarily, if Gillette wanted you to buy 4 razor blades, it would need to figure out your willingness to pay at the 4th razor blade, and make that the market price – let’s call it P* = $2:

What a waste! Consumers are getting all that Consumer Surplus by paying less than our Marginal Benefit for blades 1, 2 and 3:

Now. Let’s suppose that Gillette somehow figured out a way to force us to purchase razor blades in whatever manner it chose to sell them. Say, by…making us first purchase a handle, on which only Gillette razor blades would fit. There’s your two-part tariff. “Razors” are sold in two parts! Why? Well, now Gillette can force you to purchase razor blades 4 at a time. So what is $8.99, then? Why, it is the sum of each Willingness-to-Pay, taken straight from our demand curve:

(the numbers aren’t a perfect match).

The result? No more Consumer Surplus! Perfect price discrimination. Disney, by the by, does the same thing. You pay to enter Disney World, then you pay to ride – and Disney takes all your Consumer Surplus in the process.

Back, then, to the Consumerist. Is Gillette charging $5 for the 5^th razor blade? No That’d be ridiculous. What they are doing, however, is marking up the price of each of the 5 blades, taking advantage of the fact that we already have the handle.

Now, Reader Jordan. Is he acting rationally, by switching? Possibly. There’s no guarantee that his Willingness(es)-to-Pay are sufficient to pay $14 for 5 blades. And he may be considering the opportunity cost of switching, correctly – meaning he’s figured the cost also of purchasing a new handle, and buying his way into a new razor market. His switch could be optimal.

True, he’ll be pissed if he does all that and then discover Schick follows Gillette’s example. But you pay your money and you take your ride, I guess…

Thank you Nick! You better earn an A in Friday’s Mid-Term. I won’t give you one for free, but I hope to see you earn one.

Time Warner HowTo: extract Consumer Surplus

Consumer and Producer Surplus are one of the truly great, arbitrary fantasies of Economics. Short version: Consumer Surplus is acheived (by the consumer) when the market price of a good is less than the willingness-to-pay for that good. So (from one of my slides), imagine the purchasing of coffee:

Similarly for Producer Surplus. At each quantity sold, Producer Surplus is the difference between the market price and the Marginal Cost of production (the minimum price that the producer would have been willing to accept):

So here’s the first logical implication: Consumers and Producers would dearly like the market price to be lower and higher, respectively, because they want to get more of their own Surplus (at the cost of the other’s Surplus). Yeah?

So, given the opportunity, how would Producers pull this off? Well, look at the Consumers. See how the first Consumer (let’s assume there are 5 Consumers; you can also assume there is 1 person purchasing 5 cups of coffee) has a higher Marginal Benefit and Willingness-to-Pay than the second? And the second Consumer has a higher Marginal Benefit than the third, and so on? At the market pice of $2, the Producer is selling 5 cups of coffee, but Consumers 1 through 4 are getting positive Consumer Surplus.

How can the Producer get their hands on the Consumer Surplus? Well, suppose they could identify each Consumer, according to their Willingness-to-Pay, and charge 5 different prices. Bingo! The Producer could charge exactly each Consumer’s Willingness-to-Pay, and all the Consumer Surplus would be ‘extracted’ by the Producer – who would get all the Surplus.

And that’s the goal: find a market in which you can discriminate amongst Consumers, and get them to pay different prices. Good example: hardcover books vs. paperback. Get the impatient Consumers to pay a higher price for the earlier product (slightly differentiated) and extract some Consumer Surplus.

Here’s today’s example: Time Warner.

Time Warner Cable said it will experiment with a new pricing structure for high-speed Internet access later this year, charging customers based on how much data they download.

The company, the second-largest cable provider in the U.S., will start a trial in Beaumont, Texas, in which it will sell new Internet customers tiered levels of service based on how much data they download per month, rather than the usual fixed-price packages with unlimited downloads.

But, you say, this is wrong: Time Warner is talking about charging higher prices, as it moves out along the demand curve. Here’s the thing: they will charge Consumers a fee-for-set-of-products (like buying razor blades in packs of 4 or 8). Meaning that the low-users will pay a lower fee for their package than the high users, but the low users will pay a higher fee-per-megabyte than the high users.

Why? Because they have a higher Willingness-to-Pay. Consumers are only willing to consume more at a lower price-per-unit (this is Declining Marginal Benefit). Time Warner is moving away from a situation of charging $2 to sell all 5 cups of coffee (i.e. a price-per-month for all users, up to and including the high users) to one in which it can segregate users, such that it only needs to offer the low price-per-unit to the high users (with the lower Willingness-to-Pay-per-unit). The lower users have a higher Willingness-to-Pay-per-unit and will get a higher price-per-unit as a result.

And, at the very end, Time Warner will get its hands on some of the Consumer Surplus. It hopes. It all depends upon the reaction of the Consumer. When it comes to things like razor blades, we go along with this idea (the point of the 4-pack is that you’re paying a higher price for the 1st, then the 2nd, 3rd and 4th blade – but you just don’t realise it when you pay a since cumulative price for the box – neat trick, eh?). Sometimes, though, we don’t – and the internet is absolutely an area in which our sense of entitlement really kicks in.

If Time Warner gets greedy (sells too-low a download package, with heavy over-use penalty-rates, to try to ‘trick’ low users into incurring higher costs) it will certainly backfire. If they do it in a straightforward manner, though, there’s no reason why it shouldn’t work.

Now, readers: if you had the technological know-how, how might you engage in arbitrage? Given that Time Warner will segregate the markets, in order to charge a higher price in one than the other, can you think of the way to get between them and make some money?

GM, unplanned investment, and what about the environment?

Unplanned investment, as opposed to planned investment (yes, economists’ obsession with the incorrect use of ‘un’ bites us, once again). This is the measure by which we can determine, after the fact, how the/an economy is doing, macroeconomically.

First, consider the Business Cycle:

This is the cyclical pattern of Aggregate Expenditure – as ooposed to a nice, straight, increasing line (i.e. no business cycle, just steadily increasing wealth). The oscillations come with non-stationary investment expenditure (amongst other factors, but we’re interested, here, in investment).

Now then: equilibrium. Macroeconomic equilibrium occurs when Aggregate Expenditure, given by

Aggregate Expenditure = Consumption + Planned Investment + Government Purchases + Net Exports

At equilibrium this equals GDP. When Aggregate Expenditure is less than GDP, people are buying less than firms are producing: this is called an unplanned increase in inventories, or unplanned investment:

So to the news!

The way that auto executives here have been talking, 2008 will be a bad year to sell cars and trucks in the United States. Every time one company predicts how the industry will fare, another seems to come up with an even more dismal number.

Most forecasts now come in ranging from 15.5 to 15.9 million vehicles, an estimate that would mark the worst year for sales in the United States since at least 1998.

…

Meanwhile, G. M., which had a five-month supply of unsold pickup trucks at the end of November, said it is cutting first-quarter production by 11 percent. Ford has announced a 7.4 percent cut in the same period.

The combined market share of the three Detroit companies fell below 50 percent during two months of 2007, July and November, something that had never happened before. Their production cuts mean the chances of that happening in 2008 are even greater.

Remember that line about “as goes GM”?

(click for larger version)

Now, the environmental aspect:

… several big foreign carmakers, including Toyota and Honda of Japan, are projecting that their sales in the United States will increase in the coming year in spite of the housing slump, high gas prices and lackluster consumer confidence.

…

“I think we’re going to have a great year,” said Terry Baier, general manager of the Oakbrook Toyota dealership in Westmont, Ill. “I don’t think the market is going to hurt us like it’s going to hurt the domestics. Right now I have a showroom full of customers, and you don’t see that at a Chevy store. We’re looking for a phenomenal year.”

So: good for foreign auto-makers (since they make cars with actual standards of fuel efficiency, and that aren’t moronically over-sized). Also good for pedestrians: reasonably-sized cars means better fields of vision for us, crossing roads. It will be interesting to see the trade-off between this and the exchange rate – although the appreciation in petrol prices alone, not to mention declining disposable incomes, will be more than enough to offset any such advantage.

Bad for the environment. This gets back to my dislike for the Prius: if/as people ditch their idiotic American monster cars (since this argument presupposes that we’ll end up with more cars than otherwise would have been the case), those cars do not simply disappear. They still exist. This still just means more new cars, more old cars in landfills, etc.

HowTo: Altruism and the “Warm Glow” effect

Being that ’tis the season and all. I’ll put Indigenous health outcomes work aside for the moment. Wait. Those two weren’t related.

Also, this really should be properly referenced, but odds are that I won’t bother.

Why do we ‘give’? Where does altruism come from? We’ve certainly had the Smithian perspective punched into our brains since before we learned to love Billy Bragg (not you? Oh):

… man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. Nobody but a beggar chuses to depend chiefly upon the benevolence of his fellow-citizens. Even a beggar does not depend upon it entirely. The charity of well-disposed people, indeed, supplies him with the whole fund of his subsistence. But though this principle ultimately provides him with all the necessaries of life which he has occasion for, it neither does nor can provide him with them as he has occasion for them. The greater part of his occasional wants are supplied in the same manner as those of other people, by treaty, by barter, and by purchase. With the money which one man gives him he purchases food. The old cloaths which another bestows upon him he exchanges for other old cloaths which suit him better, or for lodging, or for food, or for money, with which he can buy either food, cloaths, or lodging, as he has occasion.

Adam Smith manages the issue reasonably well. The trouble is our interpretation of benevolence. People do things out of self-interest, by which law most altruism is irrational. Some is not: giving to charity in times of national (or other crises) are self-interested in a social capital, fabric-of-society kind of way. It can preserve markets, prevent the spread of disease, etc. When a mining company builds a hospital in South Africa it is not benevolence, per se, but an attempt to keep its workforce healthy enough to work.

Some altruism – a lot of altruism – however, does not qualify thus. It is just … irrational. How is it in my self-interest, then, to keep dollars in my pockets, when I’m in the city, to give to people who ask for them? I’m not religious – there is no theological trope guiding my Samaritanism (although the morality is functionally the same – something that will come up later) – I get nothing from it.

In fact this is not the case. I could experience the “warm glow effect” each time – that is, the warm glow of having done something nice for my fellow person (or animal, or tree – I’m a freakin’ hippy, after all). The same effect has been attributed to the receipt of gifts (i.e. why do we feel gratitude for things we don’t want? Because it’s the thought that counts, not the practical utility generated by the good or service given). The warm glow effect is/can be why we donate to charity, or give blood, or pay a quarter for lemonade that you just know is going to taste way too sour and, paradoxically, way too sweet. I say it can be why we act charitably: the warm glow may be merely the effect of the act, but what happens if it also becomes the motivation for the act? If we pursue the warm glow effect, of course, we are no longer altruistic.

Caveat. I’ll insert, here, early work into ‘impure altruism’. Suppose a hat was passed and you saw every one of your peers give – would you? Of course, whether you felt like it or not. That is impure altruism: no warm glow, just the avoidance of cold stares and an empty feeling inside as your peers think you’re a dick. Jon Elster described it as not an absence of self-interest, but a need to be perceived to be motivated by something other than self-interest.

So interesting is this problem, in fact, that Elsevier has dedicated an entire of their Handbooks series to it: The Handbook on the Economics of Giving, Reciprocity and Altruism. We can use Jon Elster’s contibution to build upon the understanding started with Smith. He demonstrates, in this chapter, that many things can mimic altruism.

Interest can mimic altruism. He argues more generally that prudence can mimic morality (just as my morality, from above, can mimic Samaritanism): (i) we may ‘do the right thing’ because we understand that, ultimately, it is in our interests (giving blood, donating to hurricane relief); (ii) we may ‘do the right thing’ because in a social exchange of kindnesses, more kindnesses may flow back to us (Kolm’s reciprocity. Any Corporation pursuing goodwill is an example).

An extension of part (i) is pursued in Ythier’s chapter from the same handbook: the economic theory of gift-giving. In certain social constructs, the interdependence of utilities will mean that altruism is, again, hard to pick: I will do things for my wife, as a rule. Do I do these things because my welfare loss (of, say, mere money) is compensated for by the welfare gain I experience from the gain in my wife’s welfare? Elster calls this “other-regarding self-interest” – it is not altruism. Do I do these things even though I suffer a net welfare loss? That would be altruism. Do I do these things without regard for my net welfare at all? That is also altruism. Here’s a final kick: do I do these things because I just don’t think about such things, all that much? That’s not altruism. Per se: I do such things for many people. And animals, and trees, etc. My guess is that I have a little difference engine hard-wired into my brain that says, if someone needs something, they will probably benefit from the resource more than me, so I give it up. I don’t even get that much of a warm glow. I just don’t think that much about it. Is being a soft touch altruism?

Passion can mimic altruism. This too is impure altruism. From Elster’s chapter:

The desire to be well thought of by others, independently of their capacity to confer material rewards or punishments, can be a powerful mechanism for mimicking motives that one does not really feel. Equally strong, perhaps stronger, is the desire not to be badly thought of. These desires are linked to the emotions of pride and shame that guide a large part of human behavior.

In what he calls the transmutation of motivations, Elster identifies the question of altruism: is it possible and knowable? So many motivations can produce acts that are attributable to altruism, and often precisely because they will generate that conflation:

Let me conclude by reconsidering the person who drops money into the collection box of an empty church. What might his motivation be? One possibility is that he is trying to buy salvation. Various theologians tell us that this aim is unattainable, since salvation is essentially a byproduct of actions undertaken for other reasons [Elster (1983b, Chapter II)]. Yet many believers have tried to attain it, some by donating money and others by choosing martyrdom. Another possibility is that he is trying to gratify the inner audience, not only by his donation but by the apparently virtuous choice of a place for giving where he cannot be observed. A third possibility is that he wants to help others in need, that the collection box was simply a convenient vehicle for the donation, and that he would have chosen it even had others been present to observe him. Until the day scientists can conduct brain scans at a distance, we shall not know.

So, in the end, I have tricked you. There is no “How To” of altruism. It either is, or it isn’t, and you will almost never truly be able to infer whether or not it was. Sure, when you observe someone (maybe me) give a bum 2 dollars, it could be. You might, however, be seeing a guy trying to impress a girl. You might be seeing a guy hoping to get into heaven (not understanding that that isn’t how it works – if heaven is his motiviation. At least as far as I understand it). If you see someone give money to a pan-handler on the train, it might be altruism. It might be a guy trying to impress the rest of the train. It might be a guy trying to not be scorned by the others on the train. It might be a guy trying to get the pan-handler the hell out of his carriage. It might be a guy who’s son ran away, who gives money away in the hopes that it makes some karmic difference. None of these are altruism, and you’ll never pick those people apart from the guy who does it because he genuinely wants the pan-handler to have a better day than yesterday.

In general what you observe is, sadly (or not – remember: whatever the motivation, if the act is the same, with the same outcome, who cares? Beggars cannot be choosers. If I have a church to build, do I really have the time to care about why a person is donating the money?), not altruism. Politicians, corporate goodwill, Big Oil and their ‘green’ agendas. You name it, I can cynic it into not making you smile anymore. And I’m probably right. Cynicism is a natural reaction that we have to people mis-representing their motivations, and we do this because there is a hierarchicy of motivations in society – and their has been since the Ancient Greeks. If you do something out of Pride, but pretend that it is Altruism, it is because Altruism is noble. Cynicism is just the way that we try to filter bullshit.

During the course of my Eco 1 class, our textbook contains a discussion of the Tsunami from 2 years ago. At the time, Americans (for example – it’s an American text, after all) gave for days. The generosity was tremendous. The result? For the subsequent year, American and other charities found that they received less. American households (and, by extension, others) have a budget; they have a sense for the limits of net welfare gain or limited welfare loss that they’re achieving with their charity, and they do not give beyond that.

The key is that altruism is never irrational. Even within the idea of the bounded rationality of people, generally, altruism (pure or impure) is a rational thing, according to the utility functions that you cannot observe. If you’re still interested, I recommend Altruists.org – specifically, their references page. It is naive and optimistic, frankly, but nobody was ever truly the worse for that.

HowTo: barriers to entry – licenses and medallions

Ever ridden in a taxicab? Those medallions on their bonnet (sorry, Americans: hood) are there for a reason: taxicabs are strictly limited. The right to drive one in Manhattan (for 20 years), for example, auctioned for about USD300,000 a go, back in 2004.

These are a form of barriers to entry, one of the guiding criteria for determining the competitiveness of the market model with which one is working (well may there be over 10,000 taxis in the city, but there are also over 1.5m people living in Manhattan alone).

It’s also, of course, a bloody good way to make some money. Just imagine the revenue to the city: 126 medallions were auctioned off in the story above, and 900 more have been since. Uh-huh. Exactly (sidenote: Marginal Revolution has followed this up with a brief comparison of medallions/licensing, vs. taxation. I’m not that free-market; I think there’s an information problem wherin the Government should serve as an agent, although that, too, has its drawbacks. There’s a decent consideration of the matter here).

This is all off the topic. Today’s licensing story is not New York City Taxis but, rather, New York City vendors.

Out in front of the crowded entrance to the Metropolitan Museum of Art is one of the more lucrative spots in Manhattan to sell hot dogs. It is so good, in fact, that one of the largest pushcart vending companies in New York City pays $574,000 a year to the city for the right to place two hot dog carts there.

The story being about the fellow who has the third cart – without paying any money to the city for the pleasure.

“I’m not really doing it for the money, I’m doing it for the veterans,”Mr. Rossi said while selling hot dogs briskly one recent Sunday afternoon. Mr. Rossi said he is a Vietnam veteran and claims that the city, about a decade ago, wrongly began limiting the number of pushcart permits given to war veterans.

…

City Councilman Tony Avella of Queens, who also criticizes the city over permits for veterans, held a news conference on Tuesday morning at City Hall to call attention to what he said was a “disgrace by the city, to forget its veterans.”

“The right of veterans to get permits has a long history in this city, and for the past few years, when veterans try to apply for one, they can’t get one,” he said. New York State has allowed veterans free vending permits since the Civil War, he said.

“Free” in the sense that it doesn’t cost them anything – not “free” in the sense of “for-al”:

The city waives fees for veterans and gives them priority on the waiting list of roughly 2,500 people hoping to get permits. But because the number of food cart permits is capped at 4,100 to avoid cart congestion, and few vendors let their licenses lapse, new ones are not given out very often.

Which is where the problem comes in. Mssrs Rossi and Avella oppose the “unfair” treatment given to veterans – but, supposing the number of vendors is capped, how are veterans to get licenses? Do they seriously think redistribution is the answer – taking licenses from other vendors and handing them to veterans? First, the city wouldn’t do that – who’d throw away that sort of money? Second, of course, VA-based welfare policy is one thing; this is something else, and the two should not be so conflated.

So, supposing the number of vendors wasn’t capped?

A proposal he introduced to the City Council last year about permits for veterans had not been granted a hearing … In Mr. Avella’s plan, about 100 disabled veterans would sell “in specified areas of Manhattan that are otherwise closed to vending due to local law, ordinance, rule or regulation.” The legislation seeks to remove “the limitations on food vending permits for disabled veteran vendors.”

What has my attention is the “local law, ordinance, rule or regulation” line. This is the agency problem, again: has the City limited vendor licenses/positioning for the benefit of the people (for example, Mr. Rossi’s cart is directly in line with the Museum steps, whereas the licensed vendors are to the side – pretty much where I’d rather they be), or done so for the benefit of themselves (those two carts pay the city over half a mil per year to be there)?

Perhaps it is not right for the idea not to get a hearing – but the NY Times was not specific about why. Yes, there are more important things in local government, and the City could well have been dealing with those. They could also all be off doing lines of coke, for all I know – the Times writer could have improved our understanding of the issue by letting us know, though. There is also the issue of waiving these restrictions for disabled veterans. Given where many of these restricted sites probably are, the City could well (a) see the lawsuits coming a mile away, from injuries and God knows what else, or (b) just not want the hassle of less-mobile vendors plunking down in heavily-traffic areas (like directly in front of a bloody museum).

It’s an interesting story – one that melds well with Marginal Revolution’s tax idea, to boot. Yes, taxes that mostly made up the license fee would remove the control part of the problem, and just keep price-rationing in place, but there’d soon be equal call for tax-free status for veteran vendors – who’d promptly appear everywhere.

At the end of the day, this ‘stand’ is not a great one. I’m hardly dismissing the need to preserve/improve the quality of life of veterans, but that’s a different policy concern: doing it at the expense (potentially) of the quality and security of life for the rest of the people in Manhattan is more than a little near-sighted.

“It has to be brought to New Yorkers’ attention the injustice that the city is denying a kid coming back from Iraq the right to sell hot dogs,” he said. “I chose this spot because it has a reputation as the premier location, and a lot of people are going to see me.”

He added: “Don’t get me wrong. If I’m going to vend, I may as well make money.”

At least he doesn’t go comparing himself to Ghandi.

HowTo: deal with inflationary economic contraction

This is a shorter-than-intended post. WordPress lost the first one, and I’m just not that into doing it all twice.

I mentioned this in class today (going so fast that I’m not sure anybody heard anything, at all – end of semester dash).

Ben Bernanke put the Federal Reserve on a path towards a December rate cut in a speech on Thursday night in which he said the relapse in financial markets had resulted in a “tightening in financial conditions” that had the potential to harm the real economy.

The Fed chairman also said recent data on household spending had been “on the soft side” and warned that the combination of higher petrol prices, the weak housing market, tighter credit conditions and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

Fortunately (for me, and probably only for me, and even then only with respect to having been right all semester), the Fed is, by all appearances, openly addressing its conundrum: Fiscal policy having done very little, it is left to Monetary policy to push along the economy – not one of its better uses – but, worse, trying to boost the economy while also containing inflation. This is something we like to call impossible. The short version: here is a business cycle, from the ever-helpful site tutor2u:

Inflation and Unemployment occupy different spaces. In the Slump/Recession part of the cycle, Aggregate Expenditure is low, i.e.:

Aggregate Expenditure = Consumption + Planned Investment + Government Purchases + Net Exports

is less than

GDP = Consumption + Actual Investment + Government Purchases + Net Exports

We have unplanned investment, or an unplanned increase in inventories. Result: people start getting laid off, as we stop selling/making so many goods and services.

Yes, I still hate Economics’ obsession with ”un”. Oh well.

At the other side of the business cycle, the opposite is true. We are selling more goods and services than intended, with an unplanned decrease in inventories. So we hire more people, we pay overtime, we run our factories longer during the night. We have to compete for factors of production: pay higher wages, pay higher input prices. Here inflation is the problem: higher wages, highe input prices mean higher final prices; higher prices mean higher wage demands, etc.

The government has two basic sets of policy for macroeconomic management: fiscal and monetary. Fiscal is government purchases – increasing expenditure or cutting taxes (for a slump). Having blown the whole thing on tax cuts it couldn’t afford and a war it couldn’t afford (and one that, bizarrely, is doing very little to help the economy), fiscal policy is pretty-well ‘no-go’ for the time being.

This is already a problematic situation, because one prefers not to have only one policy tool. Particularly since Monetary is not nearly as good at direct boosts to economic activity. It has a long tail, can very easily be overdone – thereby causing the next dis-equilibrium to be worse – and is evermore subject to capital market speculation, domestic and foreign.

Monetary policy is interest rates. The Fed buys or sells treasury bills (or makes myriad other interventions, these days), in order to reduce or increase the level of cash in the economy and, by decreasing or increasing the money supply, increasing or decreasing the interest rate (interest rates are the price of money: increase the money supply and the price goes down, and vice versa). So in a slump, the Fed lowers interest rates, increasing consumption and investment – principally investment, which is more variable than consumption anyway. In a boom period, it does just the opposite.

What does it do when it faces both? It wishes it had never taken the job.

Managing inflation and unemployment simultaneously is practically impossible. Managing it with the same policy tool is impossible. Inflation and unemplyment are not supposed to occur at the same time – one can see the current situation as a combination of endogenous factors – bad macroeconomic management, bad financial sector regulation – and exogenous factors – low agricultural yields, declining oil supplies/exports. The economy just cannot be boosted and restrained at the same time.

This, for example, is my idea of why China is so happy with its low Yuan. It cannot deal with unemployment, so it will accept high inflation, so long as it means 150m Chinese people have the surplus jobs.

In the US, the situation may not be that different. One of the advantages of continuing to use core inflation long after it made much sense is that two interest rate cuts with inflation is daft: 2 interest rate cuts with steady core inflation is fine. It is convenient for the Fed to pretend, as long as possible, that one problem just doesn’t exist, because it’s the only way it can attack the other.

Back to the story, then:

… new revised figures showed the US economy grew at its fastest rate in four years in the third quarter. An export surge fuelled by a weaker dollar and global growth more than offset the impact of the deepening slump in housing.

Gross domestic product grew at 4.9 per cent in the quarter, almost twice the Federal Reserve’s estimate of the maximum sustainable rate for the US economy.

However, a sharp rise in inventories reinforced fears of weak fourth-quarter growth.

Working backwards: A ”sharp rise in inventories”: unless that was a planned sharp rise in inventories, I’m going to take that as indicative of further weakness in an already soft economy. Meaning unemployment. Meaning, yes, expansionary macroeconomic policy. Such as it is possible with increasing prices. Hence the next part. A 4.9% increase in GDP: with unplanned increases in inventories, we’re making things but not selling them – so that can’t last.

However. GDP = P x Q. Therefore ΔGDP = ΔP x ΔQ. Some of the change in GDP is ΔQ, but some of it – I’m guessing a significant amount – is ΔP. From the Burea of Economic Analysis:

One can see, first, how Net Exports is becoming more and more important to our economy, these days. This will be why we hear Secretary Paulson always going on about a strong dollar, but never doing anything about it. We’re the new China, you see.

Second, Consumption expenditure is up, but flagging. Given that this includes transport, food, etc., it’s hard to imagine that this decline is that small. My guess is negative ΔQ coupled with positive ΔP – meaning the negative ΔQ will be a lot larger than these numbers appear.

This will be why the Fed is awaiting the latest matching data from the Burea of Labour Statistics: try to figure out how the employment and CPI numbers fit into the GDP data, to see just which of the two problems it should put above the other. Given the way capital markets are acting, and given that corporate profits are still high, overall (i.e. relative to previous history, not just earlier this year), I don’t see why rates should be cut again. Given the need for foreign capital in/by the US, honestly, cutting rates and hitting the dollar a third time is just as likely to hurt the economy, a little farther down the line.

We shall see, I suppose. The next BEA release is in a few weeks. The BLS employment numbers are due in a week (their last employment numbers were hardly positive, though); CPI numbers in a fortnight.

HowTo: Prepare for exams

I just gave this class (talk? I didn’t really prepare it, but I’ve had to give it to sophomore classes before). I figured I should write it up. The internet lives forever, after all: now I’ll never need to remember it myself.

So. This is – by and large – everything I learned about preparing for exams in the 10 years I’ve been a student, a student-and-a-teacher, and now merely a lecturer. It should be of value to every student, up to and including those with photographic memory who can remember everything they need anyway (and don’t we hate them for it).

Final Exams

What is it that makes finals so bloody hard? To some extent yes, it is the content of the exam. Final exams are usually cumulative, they are usually a few hours long, and they are the final exam. They’re supposed to be hard.

I refer however to Final Exams as an event, as a period. Specifically as a period in which you will need to revise and prepare for anything from 3 to 5 final exams, in a relatively short period of time, then turn around and do those exams in a shorter period of time. It is this that makes finals such a nightmare. One exam, fine. Multiple exams, optimally spaced through time, also fine. Multiple exams in 10 days? Not so fine.

Having established this, one must appreciate what we need to do to prepare us for finals. We have a tendency to try to force-feed as much information into our brains as possible.

This is the wrong approach.

Memorisation is not the key to final exams (accounting majors excepted). Performance is the key. One excels not – typically – according to how much information they can stuff into their heads, but how well they can organise that information, and how efficiently and accurately they can recall that information at the appropriate times. Having established this as the goal of revision, a different paradigm emerges.

It is not staying up until 4am on caffeine, reading as much as we can. It is not sitting with your head in a textbook, the day of the final. Those are Very Bad Things To Do.

Athletes! You will be best-prepared to absorb this lesson. Do you stay up until 4am, the day of the Big Game, learning new plays and watching video-tapes of the opposition? No (let us hope). Because you need to perform for the big game. Mentally, physically, you need to be rested and prepared to turn everything on for the few hours that it will be required.

Introduction over, let us proceed. There are two pillars of exam preparation: (1) Physical; and (2) Scholastic.

Preparing physically

First: Sleep

Undergraduates in particular, and American undergraduates moreso (this is not cultural: it is a by-product of living in dorms), sleep terrible hours, made worse when an exam approaches.

The Circadian Rhythm is an endogenous sleep cycle enjoyed by all living things. Typically it is 24 hours. Humans, for example, sleep 1/3 of our cycle, and are awake for the remainder. Attempting to do otherwise will inevitably mess you up.

This is not an Area of My Expertise, so I’ll go non-technical. When was the last time you de-fragged your PC? PCs need de-fragging so that they can sort out their memory, organise everything and generally make themselves faster and more efficient processors and retrievers of information. We are the same. Our brains are not sponges, they are PCs. They cannot absorb information for hours, then give it back to you the next day. They need downtime, every day, to sort that information out. Figure out what’s important, what gets kept, what goes in what folder.

The better you leave your brain to the business of sleeping and organising the information you give it, the better your brain will be at being able to answer all of your questions, when you need them answered.

How much is needed? Anything from, say, 8 to 10 hours. One’s sleep needs to be consistent (i.e. in a rhythm), so as many hours as you need such that you don’t have to sleep in on a Saturday. One should be sleeping your optimum, every night, and not need more or less sleep on any given day. Teenagers usually require more than adults, mind.

It is endogenous (in that we are born like that), but – for humans, definitely – our sleep cycle is synchronised by an exogenous force: the sun. We do not merely sleep 1/3 of our ‘day’, we sleep when it’s dark: our Circadian Rhythm is di-urnal. This means that, amongst other things, sleep that one gets before midnight will be better than sleep after midnight. Eight hours from 12-8am will not serve as well as 8 hours from 10pm-6am.

So not only does one need to sleep consistent hours (number) but consistent hours (time of night). The same number of hours, at the same time, every night. This will improve the body’s daytime performance – which is, after all, the point.

Mess with this at your peril. Come to finals yes, you will lose sleep, skip meals, etc. The first impact is tiredness, then poor performance in exams, then all the way to too tired to eat, have a conversation. You’ll end up with barely a functional cerebral cortex, falling down stairs.

Second: Food

What one eats is equally important. I have less to offer here, since it’s fairly easily-managed (allowing, again, for dorm-living, college dining halls, etc.). The key to food is natural. Complex carbs in the morning, no carbs after 7pm, 4 to 6 smaller meals rather than 3 bigger meals. And above all, natural foods. The goal is to have clean blood: the less shit you consume, the cleaner your blood(stream) is, the more oxygen it carries, the more it carries to your brain, and the better your brain absorbs, sorts and recalls information. Your brain is the muscle, remember; you need it for that Big Game.

Sugar: if you need sugar for energy, have it. Have it naturally, though. Don’t eat/drink things because they’re sweet: that is not the same as sugar. Corn syrup, High Fructose Corn Syrup and God-only-knows what else is not the same as pure cane sugar. Put it in tea, put it on Kiwi fruit, put it in a milkshake.

Black Tea: loaded with anti-oxidants. Dump your sugar in black tea. The caffeine will keep you up without making you wired. When that wears off, when the sugar wears off, peeing every 20 minutes will keep you up. Whatever works, yeah?

Milk is apparently under review, but you should err on the side of caution and go with don’t add milk to your tea. Caseins, the proteins in milk that go in Lactaid milk and all the bloody soy cheese, strip/block all those health benefits. Research seems to go back and forth on this one, but just use non-dairy milk and it won’t be an issue. If you don’t like the taste: there is also rice, almond, etc. Use vanilla soy milk with vanilla essence, and have vanilla black tea (quite nice). Whatever works.

Omega 3, 6, 9: Omega 3 fatty acids are why fish is brain food (and why our children will suffer as we did not). Cod-liver oil, flaxseed oil, linseed oil, these all come packed in capsules as supplements, also.

These are the only specifics of which I’m aware. Fresh fruit, fresh vegetables, lean meats (if you’re going to hell), etc. Like I said, the food rules are basic: one only has to watch out for the meal-skipping, late-studying behaviour.

Preparing academically

On to the scholastic part of exam preparation.

Revision

Time for some visuals. This is the hierarchy (and there is a hierarchy) of “information” or “knowledge”, as it applies to exam preparation:

Bad Habit Prime! Do not sit, waiting for me to hand out the exam, reading the textbook, the lecture notes, or anything that isn’t a single piece of paper with your well-condensed-and-revised notes on it.

I cannot stress this enough, and I see students do it a lot. The point is to take the primary sources of information thus: I use the textbook and distill it into lecture notes. You use my lecture notes and distill it into your lecture notes. Come the time to revise, one then has 3 sources of information to review, revise and condense. Then again, then again. At least 3 or 4 times. The idea is that this process forces the brain not to skim over information. One is forced to understand material in order to re-write it more efficiently, over and over. By the time of the exam, only 2 sides of a page are even needed, because everything else is properly understood.

This goes for formulae: do not sit with the textbook for the purposes of memorising formulae: it is alien, and throws at your eyes and brain more information that merely that. Those formulae should have been written and re-written many times already, finally ending up on that piece of paper. Take nothing else to the exam except the things you need to take the exam itself.

Related to this is another bad habit. Do not “quiz” one another. Our brains are not synchronised. Your friend will be asking you something while your brain is thinking of something else. When the exam arrives those two things will no longer be distinctly ordered/organised. Much like the football player spends the day of the game doing just enough to wake up his/her body for the performance soon to be required, our brains should be engaged in just enough, carefully filtered, activity to ‘wake it up’ and get it ready to switch on.

This seems excessive (and I’m not even finished). Remember this: finals are probably the most we will require from our brains, at least in our younger days. It is a pretty heavy burden we’re placing on ourselves and our brains, every semester, sometimes more often, and we need deliberate and careful preparation. You do not need to be as fresh, after your final exam, as you were on the first day of classes – but you do need to be as fresh at the start of the last exam as you were at the first. You need to make it to the end of the exam not just awake, but performing.

Practice questions

These are also ordered: loosely, past exams, then textbooks, then problem sets (or whatever term is given to the ongoing series of questions given to students, week-by-week).

Past exams: give the best impression of the format and style to expect, but not the content. Rather than looking at past exams and thinking, “These are the questions I’ll be asked”, one should look at them and think, “Now, suppose my lecturer asked this problem, instead. What would it look like? What aspects of this problem would be asked?”

Writing your own questions is an excellent method of practice, as you go along.

Textbooks: any relevant questions. Start with those with answers in the back, move on to the others. Remember: your lecturer is a resource, too. Find them and have them clarify any problem you have. Good ones will be available, by email, more or less continuously. A few minutes of our time is not that expensive that we can’t, when sitting here, answer your question.

Problem sets: our brains skim information. Whether we like it or not. For this reason, questions that one has already done will not work as well for revisions. Our brains skip bits, cut corners, etc. Familiarity, recognition, these are not the same as remembering and understanding.

Skimming is something against which one must always fight, when revising and practising questions. Always do every part of a question, especially as you are beginning to practise. Nearer the exam you can skip parts, as you’re more certain that they are understood.

Finally, expect your practise of problems to feed back into the process of revision and re-writing – leading, ultimately, to that final, fully informed 2 pages of material.

Chronology

Finals are, as stated, problematic because of their multiplicity. How does one determine the chronology of preparation? I have found this to be optimal.

First, determine the chronology of the exams themselves: the order in which they occur as well as the distance between them:

Then: revise and prepare in reverse order:

Huh. That did not resize well.

Why? Whatever else happens, one can only guarantee being perfectly prepared for the first exam. Every exam thereafter will struggle with deterioration. So this at least maximised performance on the first couple of exams.

Optimally, you will get at least 2 nights and 1 day between exams – enough time to sleep off the first, prepare for the second, and sleep on that. Any more or less (and it will vary, between exams) means you must adjust your preparation period. Use less of the earlier time for exams that have a longer lead-time during the finals period.

Be aware, however, of another brain-trick against which to fight: Hyperbolic Discounting (also discussed here).

You will not have as much time to study as you think.

You will not study as well during that time as you think.

These cannot be stressed enough. Your brain will tell you that things are do-able when they are not. Be very attuned to this form of bias in your time-preferencing. Being on top of this problem will also remove a lot of the stress of exam preparation and taking.

That’s it. That’s basically all I learned about preparing for, and taking, exams during my 10 years in higher education. Longer, really: I learned a lot of this while still in high school. My marks have, frankly, never been brilliant. My trick was managing to make certain to meet the fundamental rule of exams:

Your performance in an exam should only ever be as bad as your understanding of the material.

All of this advice is geared towards removing every other cause of poor exam performance. Hopefully it helps someone.

HowTo: Expected value

Found at Autoblog, via Opit:

Could Detroit be exporting cars to Europe soon?

With a weakening US dollar and more competitive union contracts, exporting vehicles to Europe from the US is looking more and more plausible with each passing day.

… Automobilwoche in Europe is reporting that Opel worker’s council head Klaus Franz called a US-built Zafira a “distinct possibility”

Many things are a distinct possibility. A strong holiday sales period over thanksgiving is a distinct possibility. I’d still keep my money under my mattress, though. In Euros.

If GM can pull off building a vehicle in the States destined for Europe, it would strengthen its plant utilization in North America while also increasing European capacity. While there is only a slight chance this will happen, we think it would be a huge stride towards profitability in the General’s largest market. While there is only a slight chance this will happen, we think it would be a huge stride towards profitability in the General’s largest market.

So. GM may pull this off, or it might not. It might make loads of money, or it might lose loads of money (although we’re talking about a company that can post a USD39bn loss and pretend it’s just a tax ‘thing’, no big problem). It’s also the company whose European arm had, last year, posted 6 years and USD4bn worth of straight losses.

GM’s auto profits, like most, are the poor cousin of its various income streams. Hell, they apparently lost USD2,311 per vehicle in 2004, with an average cost per vehicle of USD18,348. So these cars of theirs may (a) sell for a profit, (b) sell for a loss, or (c) not sell at all in Europe. Apparently there’s only a slight chance that they’ll sell.

Let’s assume, then, that GM will not manufacture cars specifically for the EU market, only to have them not sell. They’ll either manufacture-and-sell these cars or not: i.e., they will make some profit in Europe on these cars, or they will make zero profit because they won’t make the cars. This is probably a naive assumption, but it’s a nice conservative one.

Profit per vehicle? They apparently sold a little over 2 million vehicles in Europe, last year. They have 12 brands; those brands carry 42 models, between them. Clearly some brands and models are better sellers, but it’s late and I already don’t care that much. I’m going to call it around 50,000 sold per model (rounding makes my – admittedly abstracted, already – example easier), and a profit of who the hell knows, if they don’t make profits on their cars? Let’s give them Ford’s USD620 profit per vehicle (Ford had the highest for American firms – is it even worth making the damn things?).

If GM’s plan comes through, they’ll make π₁ = 50000 x 620 = USD31m; if it does not, they make π₂ = 0 (as opposed to making and not selling the cars, in which case π₃ = negative USD115.5m to negative USD916bn – though that’s clearly ridiculous).

The expected value, then, is the one in which we’re actually interested. When this is guaranteed to happen, we can become excited. Until then, we need to weight the payoff by the likelihood that it will occur, as well as weight the loss by the likelihood with which it will occur (in this case there is no loss). The expected value of GM’s deal is given by

EV(GM Zafria in Europe) = Pr(Zafria happens) x π₁ + Pr(Zafria does not happen) x π₂

EV(GM Zafria in Europe) = Pr(Zafria happens) x USD31m + Pr(Zafria does not happen) x 0

EV(GM Zafria in Europe) = Pr(Zafria happens) x USD31m

Now – what is Pr(Zafria happens)? A rule of thumb in statistics is that 5% is significant: a probability of 5% is small, but significant (unless it’s a risk of accident or cancer – then a probability of 0.005% is important). So I’ll split the difference and say that “slight chance” = 2.5%. Then

EV(GM Zafria in Europe) = 0.025 x USD31m

EV(GM Zafria in Europe) = USD775,000

Now, as I said, GME has posted losses of hundreds of billions for 6 straight years. A profitable car being sold would be good news indeed – it would be good news to any company (although it would absolutely blow the minds of companies that actually manufactured, say, plastic straws). Until those cars are wanted in – and/or get purchased in – Europe, we should work with our expected payoffs, accommodating the probability that there will be any payoff at all.

My numbers aren’t likely to be terribly accurate, but I also think I made kind assumptions, along the way, so I would not be surprised if my expected value was actually generous.

It certainly doesn’t seem like all that much about which to get excited.

HowTo: The Prisoner’s Dilemma. Or, strikes are neither good nor bad economics. Just economics.

This has been bothering me since I saw it (which is to say, since I began to have no time for anything but dealing with exams and looking up Mos Def clips on Youtube – what?).

From the Huffington Post, sometime during the weekend (just prior to the writers’ strike).

… the representatives of the Writers Guild have to remember is that all union contract negotiations are to set minimums, and that the effect of the change in residuals from DVDs and New Media they are seeking will not rise to the level of revenue they are asking for – or what the strike is going to cost the Guild’s active members. Once again, the eventual cost of a strike will exceed the financial gain being sought.

Going on strike to lose more than you gain is not smart negotiating.

The writer (Ari Emanuel) is making more than just this point, but this point is still his central one, and it betrays a lack of understanding of at least game theory.

Simultaneous Games

Let’s simplify the game a bit. Two players (writers and studios, i.e. a Duopoly) are bargaining for revenue (the payoff). They can co-operate or not co-operate (writers can strike or not strike; studios can pay the writers demands or not pay). This gives us the Prisoner’s Dilemma, and the following payoff matrix:

Or does it? In Payoff Matrix 1 (before-the-comma = Writers, after-the-comma = Studios), I’m suggesting more-or-less a zero-sum game, working from the status quo (i.e. revenues are re-distributed). Each player’s Dominant Strategy varies: Studios should not co-operate, but writers should – i.e. striking is, as Ari Emanuel suggests, a bad move (but not, I would remind you, bad economics – we’re having fun, right?). This is following his suggestion that they lose more than they gain (reflected in the payoffs). Striking is not the Nash Equilibrium.

Suppose instead that the payoff to co-operation includes some compromise, but ‘winning’ by non-co-operation secures higher payoff (since you then do not need to compromise – Gingrich revolution, anyone?). Then we’d have another imaginary payoff matrix, such as:

Here the Dominant Strategies converge to the classic Nash Equilibria of non-co-operation, and it’s perfectly sensible, since these are as the Dominant Strategies dictate (the Dominant Strategy is the one that has the highest payoff, irrespective of what the other player does).

The real lesson, I hope you saw, was that that we don’t really know the payoffs, and changing the payoffs changes everything. Clearly the writers believe that non-co-operation will benefit them. The other lesson is that we should be careful about dealing with this as a simultaneous game.

Sequential Games

Suppose that, rather than this paper-rock-scissors-simultaneity, the Guild of whomever and the studios bargain in an ongoing game, of which this is one episode. There is no Nash Equilibrium needed, necessarily, because repeated games inter-act (or, at least, their players do).

This then generates the real question: to what end does this strike tend? Is it designed to secure a higher payoff than co-operation in this game? Or is it designed to secure higher payoffs in future games? My thoughts are that it is more likely to be the latter.

The key to a good bluff, after all, is that, sometimes, you do need to be holding all the cards (Bernanke could do with being reminded of this, for example – if you can tear him away from cutting interest rates everytime he gets 4 other people into a room).

This, then, makes the writers’ strike an excellent game-theoretic move. Studios need to be reminded that there is punishment for repeated non-co-operation (remember, their Dominant Strategy was non-co-operation, so they will do that always) – periodically they will need to be punished for this. Every such player in every such repeated game needs such a reminder (Democrats might do with being reminded of this fact, if they can remember where they stashed away their backbones, back in ’95).

So, to Ari Emanuel’s claim that political posturing is going to interfere with good economics (question mark): the posturing – political or not – is part of the economics. He also closes his argument with calling for consideration of everybody else affected:

… not only for the sake of the writers, the studios, and the networks but for the millions of people in the community who will be hurt by a strike, including below-the-line workers and all those who aren’t in show business but whose livelihood is dependent on a Hollywood that is up and running.

That is, sad to say, bad economics. None of those people were in the game, for a good reason: they are not in the game. The writers’ guild is not responsible for the outcomes to non-writers. If those players want to participate, they ought to form collective representation and make the writers another offer not to strike – i.e. compensate the writers themselves, for the losses they will incur by leaving the studios to take advantage of them (again). Or compensate the studios for co-operating.

Something, though. The Dominant Strategies are the Dominant Strategies, and anyone trying to overcome those on behalf of negative externalities needs to come up with compensation to shift those Dominant Strategies to ones without negative externalities (the Coasean solution to negative externalities in repeated games – I think I just earned my Nobel prize).

The Agency Problem

A final problem, not addressed in the article, but still relevant with unions and industrial action. Consider the following:

Who strikes? The union.

Why? To secure better outcomes for the members of the union.

Really? Not necessarily, no.

What does the Union have to gain? More than just good outcomes for its members. What does the GOP have to gain from rail-roading Congress and the Senate away from a properly-functioning house of democracy? The people lose, but the GOP looks tough for its members – who re-elect them, support them, etc.

Unions can push a strike earlier than when a strike is deemed to be properly necessarily. They can push – and maintain – a strike when, in a repeated game, they come to be perceived as weak. This is the agency problem: the union telling you that you need to strike is the same one that will sell it to you.

We don’t like to think this way (I don’t – I’m Australian, for Cliff’s sake). However, we also do not like to think this way about doctor’s, dentists, lawyers (maybe not lawyers), politicians – the list goes on and on. Climate change scientists. Engineers. Why not unions?

This is, I should say, also neither good nor bad economics – just economics. People work according to their own self-interests. We assume unions push a strike because their self-interest accord with those of their members (like government, like the medical profession, like the sciences); there’s no reason why this always has to be the case, though. If their self-interests diverge, the Union, as an economic agent, will still operate in its own self-interest.

So: strikes. Neither good economics, nor bad. Just economics.

HowTo: Non-Price Rationing

This one is interesting on a few levels.

Brokers snatch joy from Hannah Montana fans

… when Disney announced a 54-city concert tour, starting October 18 in St. Louis, Missouri, it was an obvious birthday present for Cara. But the day tickets went on sale, Cara’s mom, Maureen Von Minden, found she was shut out before she got started.

Ticket brokers swooped up thousands of tickets within minutes of them becoming available online and shut out legitimate Hannah followers. Desperate fans found they would have to pay brokers $350 to $2,000 for the $63 concert tickets.

The first thing that leapt from my mobile phone was the subsequent passage:

Von Minden lives in Florida – in “Hurricane Alley.” “We’re hurricane people,” she said. “It’s price gouging … price gouging at its best. It would have been my daughters’ first concert for both of them, and we were looking forward as a family to going, and we can’t,” she said.

‘Hurricane People’? Never have I seen such weird victimhood and sense-of-entitlement thrown together so willingley. This woman is, surely, aware that she is, in one move, stigmatising her entire community. Surely. Are the rest of us to take special care of them, now, murmuring to one another, “they’s hurricane folk.” Fuck me. Plus, they’re called cyclones.

I’ll give her an mp3 of Kennedy’s inaugural address, and she can put that money towards getting the hell out of “Hurricane Alley”, if it’s that big a deal.

Experts say Disney and the Hannah Montana franchise are victims, too, but they see nothing that will hurt the Disney brand. Billy Ray Cyrus, Miley’s dad, has commented on the issue.

“There is a law of supply and demand, and … quite frankly, it’s beyond our control. We put together a concert tour, and I was really excited about Miley going out and playing for the fans,” he said. “That’s what her tour is about. It’s for the kids and all the families that are watching Hannah Montana.”

Nothing that will hurt the Disney brand. Here’s how it works:

Suppose there is a tour coming to down. One show, in a stadium with 20,000 seats. The fixed supply of tickets will look something like, say, this

Neo-classical notions of rationality suggest that the efficient price – clearing the market exactly, no waste, no fuss – is $140. The people whose willingness to pay for a ticket is that or greater will get tickets. Done.

This, however, is something that will hurt the Disney brand. Disney does not want to piss off the legion of fans whose parents will have a conniption over that sort of ticket price. We would, as consumers, rather have a $63 ticket price and a shortage of 20,000 tickets, than a price of $140 and a market that clears efficiently. We will not blame Disney if we miss out on tickets that we could afford. We will blame Disney if we miss out because we couldn’t afford the tickets. E.g.

Promoters and artists have tried different methods to recoup lost revenue.

For the Hannah Montana tour, AEG Live and Ticketmaster held an auction for tickets in some cities. But the auction, AEG concedes, was not for the average fan. The minimum bid for a single front-row seat at the Target Center in Minneapolis, Minnesota, was $2,605.

You don’t say.

Non-price rationing

This leads to what we call non-price rationing. Think health care. Australia and the UK have universal health insurance/provision. So there is no price rationing (conditions apply). There is, however, a waiting time for surgery, etc. This is non-price rationing.

Remove the internet from ticket sales, for a second – think of the new iPhone. Who got the first iPhone? People who lined up first, i.e. for the longest. People with the highest willingness-to-pay in terms of time, rather than in terms of money. The product is still in fixed supply: it will still be rationed. It is rationed according to something distributed more equally (conceptually, at least) than mere money, and we’re happy. If you are short on time but long on money, some people will wait for an iPhone, and then sell it to you on the secondary market.

Now, add the internet back in. What happens? Waiting times have disappeared. There is no non-price rationing. In fact there is no rationing whatsoever: the product will just run out in the first 2 minutes. So what had been a model for things like ticket sales has broken down. Not only are not missing out in a more democratic fashion, but the secondary market is perverted by the sheer scale of arbitrage-seeking scalpers (kindly referred to by CNN as brokers – God knows why).

The demand curve in the secondary market will be a lot more inelastic than in the primary market, and the prices paid (just like for the iPhone, PS3, etc.) will be a lot higher. The afore-mentioned auction pulled in top bids over USD2,000 – imagine what scalpers will pull in the tickets they’ve managed to steal out of the primary market.

Until something meaningful is managed – and, fair to say, promoters and labels are trying just about everything – this form of non-price rationing (Broker-rationing?) will pretty much remain, whatever it is. The supply of tickets will always be fixed. If the show is popular (sorry. K-Fed) it will always be less than the total demand, so the supply will always be rationed, one way or another. Odds are whatever your willingness-to-pay, or even ability-to-pay, many people will be able to surpass that.

Seriously, though. Hurricane People?