Author Archive

Credit cards carry hidden fees, cell phone plans have two year contracts, hotels rip you off if you get a Kit Kat from the minibar etc etc.

It is possible to explain these features in  the “rational firm, dumb consumer” paradigm if there is one rational firm, i.e. a monopolist. Things get trickier if there is competition. If one firm is offering a deliberately confusing pricing scheme to extract surplus from boundedly rational consumers, why doesn’t another offer something transparent and steal customers? Then the usual logic of Bertrand competition should eliminate intransparent pricing and lead to a zero profit equilibrium. There are two theories (I know of) for why this might not happen.

The first is the adverse selection story of Ausubel. If one credit card company cuts prices, instead of attracting confused, profitable consumers, it attracts unprofitable, risky customers who might default. The deviation is not worthwhile and this undercuts the usual Bertrand logic.

The second is the add-on story of Ellison and Gabaix and Laibson. Let’s say hotels are pricing hotel rooms below cost and making profits on the add-ons (minibars, pay per view, phones etc.). One hotel deviates and prices the room just above costs and gets rid of the rip off pricing on the add-ons. Confused consumers learn they have been confused and go to the hotel which prices rooms below cost and remember to take their cell phone and laptop (to watch streaming movies) and pack a few energy bars. The hotel that prices just above costs does not get new customers and the deviation was not worthwhile.

You can’t purchase the subsidized cell phone from ATT without signing on to the rip off two year plan – so the add-on story is hard to apply. There might be some adverse selection towards TMobile because you can pay for the cellphone in installments so you can default. But this effect does not seem large and could go the other way – stay with ATT, get an even more subsidized cell phone and default on the two year plan.

So, does that mean the upstart maverick player TMobile has triggered competition and cheap plans await us?

Harvard grad student (?), Seth Stephens-Davidowitz, studies Google searches for racial epithets 2004-2007 to control for reverse causation. He used this to define an area’s racism. He finds:

Racially charged search rate is a significant, negative predictor of Obama’s 2008 and
2012 vote shares, controlling for Kerry’s 2004 vote share. The result is robust to controls
for changes in unemployment rates; home-state candidate preference; Census division fixed
effects; demographic controls; and long-term trends in Democratic voting….

The preferred point estimates imply that, relative to the most racially tolerant areas in
the United States, prejudice cost Obama 4.2 percentage points of the national popular vote
in 2008 and 4.0 percentage points in 2012. These numbers imply that, among white voters
who would have supported a white Democratic presidential candidate in 2008 (2012), 9.1
(9.5) percent did not support a black Democratic presidential candidate.

Congress is wading through NSF funded research to weed out projects they consider unworthy. One study they hit upon studies duck penises. The lead author, Patricia Brennan of UMass- Amherst, describes the act of duck procreation:

Male ducks force copulations on females, and males and females are engaged in a genital arms race with surprising consequences. Male ducks have elaborate corkscrew-shaped penises, the length of which correlates with the degree of forced copulation males impose on female ducks. Females are often unable to escape male coercion, but they have evolved vaginal morphology that makes it difficult for males to inseminate females close to the sites of fertilization and sperm storage. Males have counterclockwise spiraling penises, while females have clockwise spiraling vaginas and blind pockets that prevent full eversion of the male penis.

Evolutionary arms races between predator and prey are not unusual. Arms races between males are not unusual – peacock tail effects. But an arms race between males and females of the same species does seem unusual. Males seek to inseminate as many females as possible and have evolved elaborate penises. Females want to choose their mates so they have evolved an elaborate defense mechanism. The mechanism minimizes the chance of egg fertilization if sex is forced. But if the female is a willing partner, insemination is easier.

This research seems quite interesting. It is basic science. No pharmaceutical company is going to fund it. Seems better than funding weapons that the Pentagon does not want.

David Pogue’ followers have been worried about e-book resales and their impact on authors. I also offered my speculations on the same topic. Pogue went to the trouble of looking at the patents and finds:

[The] patents also give the publisher or bookstore the right to impose a minimum price for reselling an e-book. That limit could drop over time, as Apple’s patent makes clear: “As another example, all digital movies must be sold for a minimum of $10 until six months after their respective original purchase date. After the six month period, all digital movies must be sold for a minimum of $5.”

Both proposals suggest that publishers could also limit the number of times a digital item can be resold: “A threshold may limit how many times a used digital object may be permissibly moved to another personalized data store, how many downloads (if any) may occur before transfer is restricted, etc.,” says Amazon’s patent. “These thresholds help to maintain scarcity of digital objects in the marketplace.”

It would be fun research project to work out the optimal scheme: how many new e-books should be produced each period, how should they be priced, how should the “second-hand” e-books be priced etc. Might be easy in the full commitment case. The limited commitment case might be more fun….

I resigned as Editor of BEJTE last month, along with the other Editors. The journal was sold by Aaron Edlin to DeGruyter Publishing. Speaking for myself, there were two issues:

1. Commitment to open access: Initially, DeGruyter were going to charge for articles and access. We thought we convinced them that this would be a terrible idea, especially as BePress was a pioneer in open access publishing. And we joined as Editors in the old model. I showed the DeGruyter people the Theoretical Economics webpage. Editors at other BePress journals resigned when initially DeGruyter stuck to its guns with a policy of charging for articles. This seemed to move them towards our position. However, the journal webpage still confusingly quotes prices for individual purchase while having a link to Free “Trial” Access. Why is there a link for purchase if the journal is open access? Why the world “Trial” if the journal is committed to open access? So, the message to us was confused.

2. Execution: Along with the transfer of ownership came a transfer of software. BePress actually had quite good software. DeGruyter switched to software sold by Thomson Reuters (perhaps the same software as used by AER, but I am not sure?). They hired just two guys to manage the transition. They were totally overwhelmed. Emails went unanswered. Authors were confused. The software screwed up submission and resubmission of articles so there were constant emails from exasperated authors. There was no intellectual work and all the work was operational, helping DeGruyter fix its problems.

These two problems led to our resignations last month. Although we are still listed as Editors, we have in fact resigned.

Amazon and Apple are moving towards settting up resale markets for e-books and other digital material:

In late January, Amazon received a patent to set up an exchange for all sorts of digital material. The retailer would presumably earn a commission on each transaction, and consumers would surely see lower prices.

But a shudder went through publishers and media companies. Those who produce content might see their work devalued, just as they did when Amazon began selling secondhand books 13 years ago. The price on the Internet for many used books these days is a penny.

On Thursday, the United States Patent and Trademark Office published Apple’s application for its own patent for a digital marketplace. Apple’s application outlines a system for allowing users to sell or give e-books, music, movies and software to each other by transferring files rather than reproducing them. Such a system would permit only one user to have a copy at any one time.

Meanwhile, a New York court is poised to rule on whether a start-up that created a way for people to buy and sell iTunes songs is breaking copyright law. A victory for the company would mean that consumers would not need either Apple’s or Amazon’s exchange to resell their digital items. Electronic bazaars would spring up instantly.

In principle, a resale market is good for the orignal seller. A buyer is willing to pay more to buy the product in the first place if he can recoup some of the cost by reselling the product later on. If the original seller can design the resale market, setting the terms of trade and the quantity traded, the resale market has to increase profits. The main difficulty is that the current owners of e-books say will compete with the original seller for new business. But if the price of resale and perhaps even the quantity is set by the original seller, the competition can be controlled while increasing revenue.

The main problems come with the inability to control the resale market. Today’s ebook buyers compete with the original seller. Ebooks do not depreciate so there is no vertical product differentiation. Price competition will be intense. This reduces the profits the original buyers can make from resale and thus also the higher price the original seller can charge. The original seller also faces competition from the books she sold in the past and this reduces her profits. But then how are authors or publishers going to make any money?

One other solution relies on commitment – the commitment to sell very few books. In the first period, very few Grishams are produced and a commitment is made that no more will ever be produced. Anyone who wants to read it will have to buy one from the lucky people who currently own one. The resale market will sustain high prices and the author will be able to charge a high price for the first editions. Grisham ebooks will be proudly displayed like Picassos. The Koch brothers mansions will each have a Kindle room with readers nailed to the wall. Paul Ryan will be able to walk up, switch it on and see a Grisham flicker up on the screen. Authors and publishers will boast of the price they got at auction not the millions sold in the first few months.

Or, of course, it will be impossible to commit, particularly when the cost of production is zero. Grisham will be forced to tour as relentlessly as Miley Cyrus, reading out unreleased short stories to rapt audiences of deeply unfulfilled practising lawyers.

Via NYT:

“It’s disturbing because I don’t know what it means about whether they could look at my own e-mail,” said Oliver Hart, an economics professor. “We need to have a discussion and a better understanding of the policy.”

He and other professors said the searches would prompt him to conduct more business through private e-mail accounts outside of Harvard’s reach.

If one activity is being monitored by the Principal, then the Agent switches to another one. The only problem is that Google looks at the other one.

Via the New York Times:

The new standard, which was agreed to at a meeting of the International Air Transport Association in October, will allow airlines to ask customers searching for airfares through travel agents or Web sites to first provide their names, frequent flier numbers, contact details and other information before presenting them with prices. A few airlines are expected to test this approach this year, and it could be widely adopted in a few years, according to the trade group. A majority of the group’s 240 members, which include most American airlines though not Southwest, voted for the standard.

Industry officials say the standard, which they call “new distribution capability,” is simply a way for airlines to better tailor their services to the needs of their customers. For instance, an airline might offer a package that includes free checked baggage, an aisle seat and a 10 percent discount to frequent fliers. And customers would be able to compare competing bundles from different airlines. They also say customers will still have the option of shopping anonymously for basic fares if they choose not to provide any information about themselves.

Thank God for Southwest.

Yogurt for Men.

Mutually Assured Destruction did not succeed in bringing the Democrats and the Republicans back to bargaining table to renegotiate the sequester. So, a reporter facetiously suggests locking up everyone in a room till an agreement is reached.

This is not so facetious as it seems – the sequester was meant to create agreement because the spending cuts were a hostage that no-one wanted to lose. Schelling thought about this sort of thing but the obvious reference is Oliver Williamson’s “Using Hostages to Support Exchange”. So, let’s go the whole way and think about who we would have to hold hostage to give good incentives for Congress to renegotiate the sequester. We would have to have one Democrat and one Republican to give both sides a hostage to release.

First off, John Boehner is not a good candidate for the Republican hostage. The real sequester leaves the Republicans divided – the defense hawks hate it but the deficit hawks want it. Similarly, a significant fraction of the Republican House caucus would just love to leave Boehner hostage. They are not going to negotiate a grand bargain to get him out. Extrapolating this logic to the Democrats, it is pretty clear Hillary Clinton would be a great hostage – all the Democrats would want to release her. This intuition further suggests Hillary will be great candidate in 2016, should she want to run. She would unify Democrats behind her and is a centrist so she would be a good candidate in the general election. My intuition is that Biden does not generate the same enthusiasm for hostage release.

So who is a good Republican hostage? Reagan, if he were still around, would be great. Who is today’s Reagan? Let’s face it, Jeb Bush does not inspire – Republicans would leave him hostage to get a good deal to free Hillary. Ditto Chris Christie. Rubio? Ryan? If Rubio were left hostage, the Republican Party would not lose a “thought leader” as we say in b school. They could pretty much survive without him intellectually. McCain is a leader on immigration reform, Rubio’s key issue. Sure, they lose diversity but not leadership. Ryan on the other hand is a leader when it comes to fiscal matters. No-one is the House can take his place and the Senate budget experts may have expert opinions but lack charisma (e.g. Portman).

So, Ryan should be the Republican hostage and he should be locked up with Hillary Clinton until a “grand bargain” is reached.

Stanford researchers conducted this experiment:

One at a time, 30 men and 30 women entered the simulator and strapped on a set of goggles that transported them into a digital cityscape. A woman’s voice then explained their mission: A diabetic child is stranded somewhere in the city, and you must find him and deliver an insulin injection.

With a whoosh of air, the subjects left the ground – either controlling their flight by a series of arm motions, like Superman, or as a passenger in a helicopter. As they scoured the city, wall-mounted speakers gave the impression of wind whistling by; powerful speakers in the floor produced vibrations to simulate riding in a helicopter. The experiment was set so that two minutes into the simulation, no matter what mode of transport, the subject found the sick child.

After removing the virtual reality goggles, each person then sat with an experimenter to answer a few questions about the experience. This questionnaire, however, was a ruse: During the interview, the experimenter would “accidentally” knock over a cup filled with 15 pens. She would wait five seconds to see if the subject would help her pick them up, and then begin collecting the pens, one pen per second, to give the person another opportunity to come to her aid.

The people who had just flown as Superman were quick to lend a hand, beginning to pick up the pens within three seconds. The helicopter group, however, picked up the first pen, on average, after six seconds (one second after the experimenter began picking them up herself).

The superhero group not only pitched in first, they also picked up about 15 percent more pens on average. While everyone who flew like Superman picked up some pens, six participants who rode in the helicopter failed to offer any help at all.

So, video games where you play the superhero help you behave like a superhero. I’m off to play Zelda for the next couple of hours. Then, I’ll go to work and see if I am (even) nicer to everyone than I am normally.

Adam Davidson at NYT reports on the Justice Department’s action against the merger of Anheuser-Busch Inbev with Grupo Modelo of Mexico:

For decades, [the Justice Department] argue, Anheuser-Busch has been employing what game theorists call a “trigger strategy,” something like the beer equivalent of the Mutually Assured Destruction Doctrine. Anheuser-Busch signals to its competitors that if they lower their prices, it will start a vicious retail war. In 1988, Miller and Coors lowered prices on their flagship beers, which led Anheuser-Busch to slash the price of Bud and its other brands in key markets. At the time, August Busch III told Fortune, “We don’t want to start a blood bath, but whatever the competition wants to do, we’ll do.” Miller and Coors promptly abandoned their price cutting.

But:

Budweiser’s trigger strategy has been thwarted, though, by what game theorists call a “rogue player.” When Bud and Coors raise their prices, Grupo Modelo’s Corona does not. (As an imported beer, Corona is also considered to have a higher value.) And so, according to the Justice Department, AB InBev wants to buy Grupo Modelo not because it thinks the company makes great beer, or because it covets Corona’s 7 percent U.S. market share, but because owning Corona would allow AB InBev to raise prices across all of its brands. And if the company could raise prices by, say, 3 percent, it would earn around $1 billion more in profit every year. Imagine the possibilities. The Justice Department already has.

Here is the Justice Department’s complaint. Davidson says they use game theory models to forecast the impact of the merger. But I do not see that in the complaint.  Is there a publicly available document outlining their analysis?

Hat Tip: Arasan Aruliah

I just got back from a short trip. I flew United. I used my app to check our flight status. Surely enough, the incoming plane was delayed by thirty minutes. Decided to spend the extra time in Nature wallowing in the beauty she has created –  a dolphin frolicking in the distance in the warm sea – rather than in the Southwest Florida International Airport in Fort Myers suffering in the sterile concrete lump Man has created. After all, I’d already printed off boarding passes and even checked in baggage before arrival.

Arrive at the counter and attempt to actually check in aforementioned bags. No such option was offered on the electronic check-in terminal. Find a wandering United clerk who repeats the procedure and encounters the same problem. She finds a higher-up United clerk who tries a third time. Then, the higher-up tells us that bags can only be checked in up to thirty minutes before the SCHEDULED departure not the ACTUAL departure. Luckily, sense is seen and baggage is checked in after some complaining.

So, United expects you to make decisions as if the flight is leaving on time even though it is common knowledge that it is not. Then, why tell you flight status? If they do not tell you, you are more likely to make the decisions they want you to make. If they give you up to date information, you are certainly going to make decisions based on the information. Yes, you can find out the information via other websites. But then if you are late, can’t check in bags etc., it’s your own problem. If United has told you flight status and you’re late, then it’s their problem too. Surely, there is some footnote somewhere on some website that says you should be on time even if the flight is late but who’s going to read that?

Dani Rodrik has an interesting article about the pernicious effect of political economy research on policy making:

Frustrated by the reality that much of our advice went unheeded (so many free-market solutions still waiting to be taken up!), we turned our analytical toolkit on the behavior of politicians and bureaucrats themselves. We began to examine political behavior using the same conceptual framework that we use for consumer and producer decisions in a market economy. Politicians became income-maximizing suppliers of policy favors; citizens became rent-seeking lobbies and special interests; and political systems became marketplaces in which votes and political influence are traded for economic benefits.

In order to change the world, we need to understand it. And this mode of analysis seemed to transport us to a higher level of understanding of economic and political outcomes.

But there was a deep paradox in all of this. The more we claimed to be explaining, the less room was left for improving matters. If politicians’ behavior is determined by the vested interests to which they are beholden, economists’ advocacy of policy reforms is bound to fall on deaf ears. The more complete our social science, the more irrelevant our policy analysis.

But then he becomes more positive and extols the impact of  ”ideas” on politics:

Ideas determine the strategies that political actors believe they can pursue. For example, one way for elites to remain in power is to suppress all economic activity. But another is to encourage economic development while diversifying their own economic base, establishing coalitions, fostering state-directed industrialization, or pursuing a variety of other strategies limited only by the elites’ imagination. Expand the range of feasible strategies (which is what good policy design and leadership do), and you radically change behavior and outcomes.

Indeed, this is what explains some of the most astounding turnarounds in economic performance in recent decades, such as South Korea’s and China’s breakout growth (in the 1960’s and the late 1970’s, respectively). In both cases, the biggest winners were “vested interests” (Korea’s business establishment and the Chinese Communist Party). What enabled reform was not a reconfiguration of political power, but the emergence of new strategies. Economic change often happens not when vested interests are defeated, but when different strategies are used to pursue those interests.

I agree ideas matter but they too can be used to in political discourse to maximize the benefits to powerful vested interests. Deliberate misapplication of ideas is the age old strategy

First, take the “markets work” idea. Yes, free markets are great is some circumstances, when competition is perfect. But some kind of regulation is ideally warranted when they are imperfect. But the firms in imperfectly competitive markets would love to be deregulated. They can argue that their market is actually perfect. They can hire lobbyists to persuade politicians and perhaps succeed. In this case, ideas lead to deregulation when it is not warranted.

Second, take the “markets fail” idea. Yes, markets fail is some circumstances, when there are externalities. But  there should be no regulation if they are perfect. But the firms in perfectly competitive markets would love price supports, tariffs against foreign competition, entry barriers etc. They can argue that their market is actually imperfect. They can hire lobbyists to persuade politicians and perhaps succeed. In this case, ideas lead to regulation when it is not warranted. We economists are enamoured on the “invisible hand” and have many examples of this scenario. We have fewer examples of the first partly because we do not look for them. But such examples are a favorite of liberals.

So, Rodrik has an interesting perspective of the pernicious effects of positive political economy and the nihilism is generates towards policy. But he is too optimistic about the power of ideas. Ideas can be misused deliberately by vested interests