The Liberal Order

Oh, the miracles of market capitalism!

In 1876, bananas were first introduced to the United States public through the Philadelphia Centennial Exposition of America. They sold for 10 cents apiece.

Source.

Let's look at a couple of miracles of market capitalism.

First, look at the map below showing all the countries where bananas are produced for consumption in the U.S. Why would anyone living in, say, Honduras, who has probably never met a U.S. resident and is likely to never do so in his or her life, ever spend their time and resources growing and harvesting, and then shipping, bananas for our pleasure?

Second, adjusted for inflation, the price of bananas in 1876 would be about 1.8 U.S. dollars today (i.e., $1.80). And yet I went to the store the other day and paid just 55¢ per pound of bananas, getting nine bananas for $2.14, less than 24¢ each. The standard of living in the U.S. increased roughly eighteen-fold since 1876, but the price of bananas increased by only about 2.4 times.  

 

The Bi-lateral Harm Of An Externality

I do not smoke, and quite frankly, cigarette smoke annoys me. But I do not favor legislation like that passed in North Carolina in 2010 that bans restaurants and bars from setting their own rules about smoking in their establishments. Paternalistic bullies like this group push for such legislation. I would not dine at a restaurant (I don't frequent bars) that allowed smoking, but I believe that the owners are in a better position than am I to determine the true value to themselves and to their patrons of allowing smoking.

Starbucks, which has never permitted smoking inside their restaurants (at least as long as I have ever gone) is now banning smoking within 25 feet of its stores, even in their outside patio areas. Good for them!

This presents an opportune time to bring up Ronald Coase's great insight, and for what he was awarded the Nobel Prize in 1991.

The general consensus is that if someone is smoking, say, in a restaurant, and it bothers me, then that person is harming me. I am having a cost imposed on me by a person who lights up and we must therefore stop the infraction of my right to be free from such externality. Coase's great insight was that harm is not unilateral in that that person's smoke wafting in my direction is bothering me; it's a bilateral harm in that my face (or nose) got in the way of that person's smoke. Had I not been there and no one else cared about the smoke, then there would be no harm done. It's not just that their smoke interfered with my olfactory nerves (?), but that my olfactory nerves got in the way of their smoke.

Now, people have a hard time conceiving of this argument. A exhaled smoke in the direction of B, which changed the environment in and around B, therefore A is a fault for changing some percieved natural environment surrounding B. I think if it weren't about smoking, which has such a negative perception at this time, we might see this differently. So let me offer a different example.

My daughter is repulsed by the smell of peanuts and peanut butter. (I know, this should be illegal in this country. At least in my house.) She is not allergic to peanuts (which is actually not a nut, but a legume), but she has allergic reactions to many tree nuts and a total aversion to peanuts. If I were to sit down next to her at the table to eat our lunches, and I had a peanut butter sandwich, she is made worse off by the smell from both my sandwich and from the residue inside my mouth as I talk in a totally breathy voice directed at her. (All right, not really that last part, but indeed from the smell coming from the peanut butter in my sandwich.) It's not that she just doesn't like the smell, the smell of peanuts and peanut butter makes her nauseous. I therefore tend not to eat peanut butter sandwiches for lunch when she is around.

So my question is, who is harming whom? Am I harming my daughter by eating a peanut butter sandwich for luch, a seemingly innocuous activity? Or is she harming me by limiting my enjoyment of eating a peanut butter sandwich at lunch, opting instead for a lesser desired ham sandwich?  

And who ever thought of this?

For those days when just a cookie doesn't seem to be enough, there's this to satisfy your double cookie craving.

Fast-food Workers Stage A Walkout - Why That Might Not Bring Many Of Them Christmas Cheer

Employees from McDonald’s, Wendy’s, Burger King, Taco Bell and KFC staged protests Thursday in locations around New York City, demanding $15 an hour in pay – more than double the minimum wage some receive – and the right to form a union.

“What we’re finding is that there’s huge support among fast-food workers to form a union and to fight back against the poverty wages that they’re being paid,” said Jonathan Westin, organizing director of New York Communities for Change, which is helping to organize the strike.

“Most workers are being paid minimum wage, they can’t afford rent, they can’t afford to put food on the table,” he said. “Many people rely on public assistance to subsidize their wages.”

The story is here.

The value I place on obtaining a gallon of milk is, say, $10. When I go to the grocery store though, I only pay around $3. Better yet, I place enormous value on a gallon of water—it sustains my life—but I pay less than $1 for a gallon of it. Why is our value for water so high, but the price we pay for it so low?

It is not how much I or any other individual values something individually that necessarily determines its price, but instead its price is determined by the marginal value placed of the last unit produced of that good or service. (Depending on the nature of competition in a specific market, the marginal value of that last unit is equal to the marginal cost of producing that last unit.) The case with McDonald's is no different than the example of milk and water above. Without labor, McDonald's would have to shutter its restaurants, costing the average franchisee about $2.7 million in lost revenue. It therefore seems that any given employee is very valuable to a McDonald's franchisee—they stand to lose a lot of money without workers. But it's the value of the marginal worker that is relevant here, not the absolute or average value of any given worker.

There is such an abundance of people with the skills needed to do the job of a McDonald's worker that the marginal value of a fast-food worker is relatively low. (Note, it’s the marginal value of such workers that is low, not their absolute value of any given worker.) McDonald's will continue hiring workers up to the point that the last dollar it earns from hiring a worker equals the last dollar required to hire her. In other words, if a franchisee can hire a worker for a total hourly compensation of, say, $9 (there are more than just money wages to consider here), then that franchisee must see his or her total sales increase by at least $9 per hour or they will not hire the additional worker. If the hourly compensation increases to, say, $21, then the firm responds by decreasing the number of workers it hires until the marginal revenue product equals $21. (See the chart below. Remember, all workers are assumed to be equally productive.)

Again, much like the example of water above, there are so many people with the skills needed to do the job of a McDonald's worker that the marginal value (not the absolute value) of that McDonald's worker is low relative to higher paid workers in other fields.

Similarily, lacking additional skills that provides a worker alternative employment options, the opportunity cost of a McDonald's worker is quite low. This means that McDonald’s can hire, say, six workers at $9 per hour each, and since no other firms are competing for the labor services of these workers, McDonald's does not have to make them a higher wage offer in order to retain them.

The low wage for fast-food workers signals that we have too many people with the skills required to work at McDonald's and not enough people with more advanced skills needed to work in other higher paying fields. Without these lower paid workers increasing their skills, any arbitrary change in their wages is likely to have adverse consequences. The most obvious is that fewer workers are hired, leaving unemployable more people without the skills needed for existing higher paying jobs, or even the now-higher wage fast-food jobs. Additionally, firms will find substitutes for labor as its labor costs increase, therefore hiring fewer workers. In either case, low skilled workers lose what few employment opportunities they have.

Lastly, if, in order to reap some of the surplus enjoyed by consumers, milk and/or water producers colluded to raise the price of their products closer to the value I place on them, consumers would be up in arms and call for government to step in and limit the prices these producers can charge for their products. Why are we irate when firms collude to raise prices, and consequently our cost of obtaining their products or services, but not irate when labor does exactly the same?

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Fast-food workers walk out in New York

The Poverty of State Collectivism - Government School Edition

In a market capitalist system properly conceived, in order to make me better off I have to make you better off relative to what anyone else is offering you with similar resources. Competition forces me to continually improve on quality at any given price, which also means discovering ways of producing the same quality at reduced cost, and therefore reduced price. Failing to do so, I go out of business and people quit dealing with me.

Why does this seem so foreign to government school bureaucrats and those with egalitarian mindsets?

Annica Eriksson, the head cook at the Falun school, received an order from the municipality to decrease the quality of her cooking after it discovered she served a variety of 15 vegetables and freshly baked bread to students each day. The municipality claims that these offerings are “unfair” to students at other local schools, who consume meals of a lesser quality, The Local reported.

School choice (and I mean total school choice - free schools from any state mandates, including curriculum requirements) forces schools to compete for students by continually innovating and discovering ways to serve students' needs rather than the interests of teachers and public school bureaucrats.

This egalitarian ideology has had tragic consequences, leading to mass murdering of millions of people around the world throughout the Twentieth Century. This is not to say that forcing the lunch lady to reduce the quality of her meals is going to lead to mass genocide in Sweden. But egalitarianism is a slippery slope, and if it's important that something as trivial as school lunches be equal, and you're willing to force one school to degrade the quality of its lunches so students at other schools don't feel slighted, you're probably pretty far down that slope. 

Here is an old post on the travesty of choice in North Carolina schools. 

Lessons to be Learned from the Chick-Fil-A Fiasco

I'm not getting in the middle of this other than to say that the responses of the moronic mayors (Rahm Emanuel of Chicago, Edwin Lee of San Francisco, and Thomas Menino of Boston), who supposedly serve the interests of all residents of their cities not just the majority, were despicable. As Voltaire stated, "I disapprove of what you say, but I'll defend to the death your right to say it." This should be the response of any politician, but these guys instead took on the typical politician's stance, falling to the ground and kowtowing to their political base rather than standing up for principle and defending the rights of even those with whom they disagree, as they swore to do when they took office.

But the primary lesson is for managers to refrain from putting the reputations of their companies they manage and own on the line by making political statements. Although Chick-Fil-A is privately owned, a CEO of a publicly traded company jeopardizes the investments of shareholders.

The other lesson is the response Mr. Cathy's statements generated. They appeared to have backfired. But then again, here is an interesting history of boycotts.

But beyond their commercial effect, boycotts, even losing ones, have a way of highlighting a cause. They connect individuals to larger political forces that otherwise feel abstract and distant. For Chick-fil-A, that means the broader question of gay rights. Huckabee’s consumer action could generate more debate about same-sex unions than a ballot initiative would have -- and far more direct reflection on individual responsibility and agency. The boycott and counter-boycott gave consumers a stark choice, and a clear connection between their actions and their beliefs. 

Discrimination Comes At A Cost

Whether you agree with the baker or the gay couple, it is true that when you discriminate you impose a cost on yourself. The couple in the video below were willing to pay up to $1,000 for a wedding cake (WOW!@!) and the baker refused to make one for them.

 

Always Interesting Lessons To Be Learned On Shark Tank

There was a great learning opportunity in this episode of Shark Tank.

Raven Thomas is pitching her company that makes chocolate-covered pretzels. After Kevin O'Leary remarks that the market is flooded with people already making, or who could enter the market for, chocolate-covered pretzels and what makes her pretzels any different, Lori Greiner asks her point blank, "If you had to say to us right now why we should invest in this, give us your very best. Why should we invest in this?" Raven's original response failed. She immediately went on about her and her sons and how it's important for them to see that if you put your mind to it you can achieve anything.  .  . and blah, blah, blah.

Rule of thumb: A successful entrepreneur - and you are an entrepreneur any time you're selling yourself, whether it's asking someone out on a date or interviewing for a job or selling a product or selling an idea or every time you are pitching yourself - convinces people of how by entering into a relationship with them they will make the potential partners better off. Convince me of how you are going to create value for me and I'll do business with you. You have to explain better than anyone else with whom I can partner how my relationship with you will make me better off than what anyone else is offering.

On the flip side, it's not a one way street. I, too, must convince you of how I will create value for you by partnering with me.

In any mutually advantageous voluntary relationship, all parties enter into them only if they perceive that by doing so they will be made better off relative to any other option, including not entering into any relationship. Too many people fall into the trap of explaining how entering into a trade or partnership will make themselves better off rather than their partners. We are all self interested, but in a market capitalist system, in order to make me better off, I have to make you better off.

Convince me of how you are going to make me better off and I'm interested in listening. Start telling me how you are made better off by partnering with me and I'm out! 

Roo Cup Pricing Explained

A couple of students have asked about the Roo Cup (given my rant) and why Kangaroo Express would sell soda for 25¢ per cup, especially during the summer when demand is expected to be higher. Here is my explanation.

Assume that the weekly demand for sodas purchased by the average soda consumer at Kangaroo Express (KE) can be defined by the following equation: 

P = 3.75 - .875Q

where P is the price and Q is the quantity of sodas sold per week to the average soda customer. Let’s also assume that (and this is my guess, not an official statement from KE) the marginal cost to KE of a soda is constant and is 25¢ (i.e., KE’s cost of producing one more soda).  

If KE can charge only one price, it maximizes profits by setting its output where the marginal cost of producing one more soda (i.e., 25¢) is equal to the marginal revenue earned from selling it to the average customer. We calculate marginal revenue using our demand equation above so that: 

MR = 3.75 - 1.75Q

Setting marginal revenue equal to marginal cost and solving for Q we get: 

.25 = 3.75 - 1.75Q    ⇒   1.75Q = 3.5   ⇒   Q = 2 & P = $2

If KE can charge only one price, the company maximizes its profit per customer by setting its price at $2 and the average KE customer buys two sodas each week. (This is shown in Table 1 below and in the diagram Graph 1 below.)

                                Table 1

First, the company doesn’t want to price below its marginal cost of producing a soda, so that last row is not feasible and is there only to show that any price below 25¢ results in a loss. 

Second, there are people who are not willing to purchase even one cup at $2.00, but might be willing to pay, say, $1 for a cup. But KE doesn’t want to price at $1.00 per cup because then it’s not maximizing profits, it’s maximizing revenue. What it would like to do is charge customers their willingness to pay for each cup. In other words, charge the average customer $2.88 for the first cup, $2.00 for the second, $1.13 for the third, and 25¢ for the fourth. It stops at 25¢ because that is its cost of producing that marginal cup of soda. If KE could do this, its profit per customer would be as follows:

                                Table 2

So instead of earning just $3.50 in profit per customer per week, if KE could effectively price discriminate it would earn $5.26 per customer. KE wants to get more of the consumer surplus as shown in Graph 1 below.

Consumer surplus is the value consumers receive in excess of what they paid for some good or service. In the graph above, and from the charts above, the average consumer was willing to pay up to $2.88 for the first cup, but only paid $2.00 for it. His or her surplus from the first cup was $0.88. Total consumer surplus when the price of soda is $2.00 per cup is illustrated in Graph 1 as the triangular area from above the price line (of $2.00) and below the demand curve. By KE pricing at $2 and selling just two cups, it gives up that surplus to the consumer. It would like to have that.

Notice also that at $2.00 per cup, the average customer is willing to purchase only 2 cups per week. But that average customer would be willing to purchase 3 cups per week if the price was $1.13, and 4 cups per week if the price was just 25¢, KE’s marginal cost of producing soda. That triangle area to the right of 2 cups per week that is above the marginal cost curve but below the demand curve is surplus that neither KE nor the customer obtains when KE prices soda at $2.00 per cup. KE would like to have that, too.

Lastly, it’s also the case that, since I’ve used the average customer, there are customers who are not willing to purchase any cups at $2.00/cup, but might purchase at least one if soda was priced at, say, 50¢ per cup. (Really, somebody paying any price between 25¢ and $2.00 per cup for a soda benefits both KE and that consumer.) KE wants those sales as well, if it can get them.

How can KE get more consumer surplus that is currently enjoyed by current consumers and the lost surplus due to the price being $2.00. Easy!

Notice that the total surplus to the average consumer in excess of KE’s marginal costs of producing each cup (i.e., 25¢) is the area below the demand curve and above the red marginal cost curve. In other words, if KE priced its soda at 25¢ per cup, the average customer buys 4 sodas per week for $1.00 per week. KE earns no profit and consumer surplus is measured by the triangle $0.25 to $3.75 to 4 cups per week. Using geometry (i.e., 1/2 base times height) we can see that total consumer surplus is 3.5 x 2 = $7.00. The average consumer values 4 sodas net of KE’s cost of producing 4 sodas and the price they paid for them at $7.00.

The Roo Cup works this way: Consumers pay $7.00 for a plastic cup that cost KE probably $0.20 to manufacture, allowing them unlimited refills for 25¢ each throughout the summer months. Now you can see that what KE did was found a successful means of a) extracting all the consumer surplus without having to charge different prices. (An impossible task given it doesn’t have the necessary information to assess consumers’ value per cup and it cannot prevent customers with low values for a soda from buying cups at low prices and then turning around and selling them to higher valued soda consumers for less than what KE would have sold it to them.) And b) more importantly, it brought in customers who weren’t willing to pay $2.00 per cup for soda, but find attractive paying $7.00 for the Roo Cup and then 25¢ per refill to refill it all summer. These are people who aren’t even included as the average customer, but now find themselves going to Kangaroo once, twice, three times and more each week to refill their cup. While there, they buy milk, a hot dog, cigarettes, etc., The company maximized its profit, the customer feels like she got a bargain, and the deal generated a whole lot of free publicity for Kangaroo Express.  

A Brief History of Credit Card Users

A 1968 survey found that only 17 percent of Americans had credit cards, as opposed to the 62 percent who had gas cards. A 1971 study in the Journal of Marketing found that men who used credit cards were disproportionately affluent, urban and more likely to agree with statements like “I like to think I am a bit of a swinger.”

Those who didn’t use credit cards led more restrained lifestyles. Men without cards disproportionately believed that “hippies should be drafted,” that “liquor is a curse on American life” and that “a woman’s place is in the home.”

Story here.