The Liberal Order

An Old Stupid Game That Never Dies

Apparently the drivel espoused in the picture below is once again making the rounds. For some reason it never dies. 

This is why such nonsense should never get the play it's receiving.

Suppose that you have a job where you are paid on commission on a daily basis. For every item you sell you earn, say, 10% of the sale price. Your customers buy from you on a consistent basis and you sell $2,000 worth of the good each day. Your total annual sales are $500,000 and your income is $200 per day, or $50,000 per year. (Assume no inflation for now and that you work 250 days each year.) 

Your customers, who again, buy your good on a consistent basis every day and can't seem to get enough of it, think that you earn too much money, notwithstanding the fact that the benefits they receive from the good you sell far exceed your salary. Even still, they desire to punish you for your income and have all agreed to not purchase anything from you on April 15th. None of them have ceased consuming your good at all, only that they will not purchase anything from you on April 15th.

Let's say that in order to fulfill their demand for what they would normally have purchased on April 15th, half increase their daily purchase on April 14th, for total sales of $3,000 that day, and half on April 16th, for total sales of $3,000 that day. Your daily income looks like the following:

Without the boycott: April 14th = $200; April 15th = $200; and April 16th = $200. Total income over those three days is $600.

With the boycott: April 14th = $300; April 15th = $0; and April 16th = $300. Total income over those three days is $600.

Are you made worse off by your customers' decision to boycott you for one day? What if they did it for a week?

As long as they continue to consume the exact same amount, on which day or days they purchase your goods is largely irrelevant. Yes, it may be inconvenient that you don't have the income consistently, or that you might have to borrow on some days to tide you over until they come back to buy more of your good on the next day, but your average daily income has not changed.

In fact, I would argue that such ideas actually make the gas companies better off. If they knew for certain that nobody would be coming in to purchase gasoline that day, they could simply shut down, saving themselves labor costs and other costs or operation. Competition is what makes gasoline companies and retailers produce and sell every day. If they could collude in order to shut down one day with no cheating on the collusive agreement, gas companies and retailers are made better off at the expense of customers who want to purchase gasoline on that day. What a sham that the customers who appear angriest at the gas companies are the ones promoting the financial interests of the gas companies.

If you want to punish the gas companies, walk, ride a bike, don't go anywhere on that day and vow to not do what you would have done that day on a different day. In other words, as long as you continue to consume the same amount it doesn't matter on what day you buy it.

Actually, I agree with this. Everyone, buy all the gas you need for the next week today. DO NOT BUY ANY GASOLINE FOR THE NEXT WEEK. If you are successful and the price of gasoline plummets, thank you very much. I'll be filling up my cars one day during your boycott.

A fine explanation of price discrimination.

Here is a good primer on price discrimination through online retailers. Unfortunately, it doesn't do enough to explain the benefits to consumers of price discrimination.

And this is something I wasn't aware of.

Some sites, for example, gave discounts based on whether or not a person was using a mobile device. A person searching for hotels from the Web browser of an iPhone or Android phone on travel sites Orbitz and CheapTickets would see discounts of as much as 50% off the list price, Orbitz said.

Both sites are run by Orbitz Worldwide Inc., which in fact markets the differences as "mobile steals." Orbitz says the deals are also available on the iPad if a person installs the Orbitz app.

"Many hotels have proven willing to provide discounts for mobile sites," said Chris Chiames, Orbitz's vice president of corporate affairs. Hotels on Orbitz mobile sites also offer discounts "that might target shoppers in a specific geographic region," as determined by the physical location of the user, as well as "other factors."

Note to self: Use an iPhone for making reservations.

A basic rule of thumb for pricing is that P = [MC/{1-(1/e)}], which says that price your good or service equal to the marginal cost of producing that good or service, divided by one minus 1 over elasticity of demand. As the elasticity of demand for some good or service increases, the price of that good or service tends toward the marginal cost of producing it. Airlines charge vacation travelers less than they charge business travelers because the elasticity of demand for the former (i.e., e) is greater than it is for the latter. People going on vacation have many alternatives—including doing without—relative to business travelers.

Here is how Staples utilizes this practice.

Staples.com showed higher prices most often—86% of the time—when the ZIP Code actually had a brick-and-mortar Staples store in it, but was also far from a competitor's store. In calculating these percentages, the Journal excluded New York City and used the more than 29,000 "standard" ZIP Codes in the 50 states and District of Columbia. This meant things like ZIP Codes with only post-office boxes weren't counted.

Prices varied for about a third of the more than 1,000 randomly selected Staples.com products tested. The discounted and higher prices differed by about 8% on average.

Lacking competitors in a given area means consumers in those areas have a less elastic demand curve for office supplies, enabling Staples to charges customers in those areas higher prices. 

And the poor tend to have more inelastic demand curves, mostly due to fewer alternative brick-and-mortar stores in their areas, as well as limited online options.

In what appears to be an unintended side effect of Staples' pricing methods—likely a function of retail competition with its rivals—the Journal's testing also showed that areas that tended to see the discounted prices had a higher average income than areas that tended to see higher prices.

Price Controls and Gas Lines

Don Boudreaux reminisces about price controls on gasoline and having to wait in line for twelve hours just to purchase some back in 1979.

I worked at a gas station in high school at that time. I, too, remember those days well.

First, it was not uncommon for someone to pull up to the pump after waiting in line for three or more hours to say, "Fill it up." After about ten to fifteen seconds, the pump would stop - it was filled. 

"It didn't even take a gallon." I would say.

A typical reply was, "Oh, I know. I wanted to fill it up today because I knew I couldn't get gas tomorrow and didn't want to run out."

In a stroke of genius, President Jimmy Carter signed into law that, in order to allocate gasoline more efficiently, you could buy gas on odd numbered days only if the last digit of your license plate was an odd number, and on even numbered days if it was an even number. People responded accordingly.

Also, being partial to females, it was also not uncommon to either turn the pumps back on for an attractive female (Come on, I was a teenager.) or to extend the time we were open in order to permit an attractive female to get gas. It's called allocation by seller preferences.

Do Mac users pay more?

Pete Boettke has a contest going on where he is offering an autographed book to the person with the best explanation for why the Kindle version of his book is priced at $9.99, while the iBook version is priced at $21.99.

I responded (as did many other people) that it's price discrimination in that Mac people are willing to pay more for stuff Apple, so Apple willingly obliges their loyalty. But it seems that Mac people are willing to pay more for other things as well.

Orbitz found Mac users on average spend $20 to $30 more a night on hotels than their PC counterparts, a significant margin given the site's average nightly hotel booking is around $100, chief scientist Wai Gen Yee said. Mac users are 40% more likely to book a four- or five-star hotel than PC users, Mr. Yee said, and when Mac and PC users book the same hotel, Mac users tend to stay in more expensive rooms. 

Do I win the book, Pete?

Advertising when the Google car comes by.

A very funny - though grossly under-appreciated - movie was Dick, released to limited success in 1999. It spoofed the Watergate scandal, making it of little interest to younger people. But it starred Kirsten Dunst, Michelle Williams, Will Ferrell and that other guy, making it unappealing to older people who thought it too juvenile and a movie geared for a younger crowd. 

Essentially, Betsy Jobs and Arlene Lorenzo (played by Dunst and Williams, respectively) befriend Nixon and become his official dog walker. They soon discover the ways of "Tricky Dick" and turn against him. During the final scene, Jobs and Lorenzo decide to show Dick Nixon what they think about him by flying a banner from the rooftop of Jobs' Georgetown home just as Nixon passes overhead on his way out of office. The banner read, "You suck, D***." (Notice the placement of the comma.)(It shows up about the 1:53 mark in the trailer below.)

It appears that we may see more of this kind of activity thanks to Senator Chuck Schumer (D-NY). You see, Google and Apple are racing to become the leader in 3-D navigation maps for PCs and handheld devices. In doing so, the two companies, especially Google, plan to drive and fly by areas they are mapping, as well as using sharply focused satellite imaging. And in doing this, they are apparently catching people unaware.

Schumer's great idea is, along with a few other things, to make Google and Apple advertise when and where they will be imaging a specific location.

All right, maybe a nice effort to prevent me from being photographed in my pajamas while retreiving the morning paper and ultimately to protect individual privacy. I'm on board with Schumer on that count. Unfortunately, the unintended consequence is to create the incentive for morons hoping to make it into Google Maps naked or making obscene gestures or flying banners that say, "You suck, Chuck." (Wow, this doesn't have the same comedic appeal.) 

 

Should you negotiate with kidnappers?

It is generally believed that paying ransom to free a hostage simply rewards the business of kidnapping. If the returns to kidnapping are high enough, more people enage in kidnapping, putting more people at risk. (The same applies to bailing out banks as well.)

But if it's your loved one who is taken, that alternative is less attractive than paying the ransom to secure their release.

There is actually an industry that specializes in negotiating with kidnappers known as risk-management firms.

Usually run by former special forces, intelligence analysts and lawyers, these firms have a good record of bringing kidnap victims home safely if expensively (only the rich or the insured can afford the rates, which start at $3,000 per day). 

Heads of such firms consider it immoral to not negotiate for the release of a loved one.

Richard Fenning, head of Control Risks, which has 34 offices from Berlin to Bogotá, counters that bans are morally indefensible. When governments cannot protect aid workers, journalists and businesspeople, stopping their friends and loved ones from acting infringes on their liberty.

Good point. So why not provide ex-post protection from kidnapping rather than ex-ante negotiations with kidnappers? Probably because the returns to protecting individuals is less than the returns from engaging in the kidnapping racket itself.

Risk-management firms profit from the kidnappers (some are said to charge a percentage of the ransom). Still, today’s hostages—an estimated 3,000 worldwide—probably welcome their role, even if it puts others at risk tomorrow.

Airline Seat Fees and Gouging

Some airlines have begun charging additional fees to occupy premium seats, including coveted window and aisle seats. This of course makes it more difficult for families traveling on the same plane to sit in adjacent seats without paying an additional $29 per seat (Delta is actually charging $39) to occupy the window and aisle seats in one row. By choosing to not pay the premium they are stuck sitting in center seats in different rows.

This has raised the ire of some passengers, passenger advocacy groups, and of course politicians who want to use this to posture and act as savior to supposed victimized travelers. For example:

Sen. Charles Schumer is urging airlines to allow families with young children to sit together without paying extra.

The New York Democrat is reacting to an Associated Press story last week detailing how families this summer are going to find it harder to sit together without paying fees that can add up to hundreds of dollars over the original ticket price.

“Children need access to their parents and parents need access to their children,” Schumer said in a statement. “Unnecessary airline fees shouldn’t serve as a literal barrier between mother and child.”

* * * *

Schumer is asking Transportation Secretary Ray LaHood to issue rules preventing airlines from charging parents more to sit next to kids. He is also asking the industry’s trade group, Airlines for America, to persuade carriers to voluntarily waive the fee for families.

“A parent should not have to pay a premium to supervise and protect their child on an airplane,” Schumer wrote in a letter expected to be sent Sunday to Nicholas E. Calio, the trade group’s president.

Today's Wall Street Journal has an interesting story explaining airline expenses and profits. Not surprisingly, flying is not a very profitable business, at least not for most airlines. The profit earned from ticket revenue (return on sales), including taxes, is less than 1%. As the graphic below shows, the prices paid by 99 out of 100 passengers go to cover the airline's costs.

Airline travel is a brutally competitive business. Because there is no core (i.e., due to high fixed costs and very low marginal costs), an airline often charges less than its average total cost to fly a passenger on any given flight. For example, if the average total cost for a flight between Raleigh and San Diego is $300, and the marginal cost just $50 (i.e., a soda, bag of peanuts, and a slight increase in the drag on the plane), an airline is better off charging a passnger anything greater than $50 rather than leaving the seat empty. A passnger paying, say, $100 allows the airline to cover its cost of adding that passnger to the plane and the remainder used to offset its fixed costs of that flight.

This competition means that airlines, especially during periods of unexpected spikes in its costs, must find other means of generating revenue. Airline travel is largely homogenous, so an airline that tries to raise its ticket prices will find competitors undercutting them in order to attract flyers to their airlines.

So what airlines have turned to is price discrimination; charging users for what they consume. By employing an a la carte pricing scheme rather than tying different amenities into one set price, airlines can target those who value certain amenities and charge them a higher price. Passengers who do not value those amenities are not subsidizing those who do.

Suppose a movie theater charged a standard $20 per customer for admission to the movie and a bucket of popcorn. A competitor will find it profitable to move in and charge just $10 for the ticket and an additional $10 or more for those who want popcorn. Movie goers who do not want popcorn and prefer the cheaper admission price pay just $10, while those who value the movie with popcorn have that option. This offers greater options for movie goers, especially families, allowing more who could not afford a movie at $20 to attend it now at $10. By attending the theater and paying just $10 without popcorn, these patrons are revealing their preference (or lack thereof) for popcorn with their movie. 

But it's folly for someone, including a family, to pay $10 per ticket for admission to the movie and then complain about having to pay an additional $10 or more for a bucket of popcorn. If they wanted the popcorn rolled into the price of the ticket they had that option, it just would have cost them more. They chose to not buy it.

This same issue applies to airline pricing today. By lowering the price of its tickets to travel and then charging for the added amenities, including to occupy premium seats, airlines are increasing travel optitons available to travelers. This makes us better off, not worse off. Some just suffer from status quo bias. 

UPDATE: Edited for clarity.

Can we ever have too few airline accidents?

A great test question that Walter Williams used as part of his Intermediate Microeconomics exam was, "Given that airline safety is costly, can there ever be too few airline accidents?" The answer, of course, is yes. It is a simple application of supply and demand where diminishing marginal benefits of some spending or action goes against increasing marginal costs. This applies to everything, including to airline safety. Certain safeguards and safety checks provide tremendous value at little cost, but you eventually encounter spending that provides almost zero benefit at extremely high cost. (Can you say, TSA screening?)

We know that when you spend other people's money you overspend relative to how you spend your own money. A great example of this is provided by today's News & Observer with this story on North Carolina and its push to pave every state-maintained road.

The state has spent hundreds of millions in the past two decades to blacktop 13,000 miles of roads, bringing asphalt to the driveways of nearly 200,000 homes, DOT records show.

Crews are still at it and now are reaching the bottom of the list, with only 1,842 miles still eligible for paving. They are working in the most rural and least populated spots, such as Mark Teague Road, and in hard-to-pave, mountainous terrain in the west, such as at Lower North Fork Road in Jackson County near the Tennessee border.

Crews there have nearly finished widening work and are preparing to pave a 2.5-mile dead-end road that climbs up the side of a mountain. It has about 30 houses, half of them considered “part-time” or second homes. There are no churches and, except for a bed-and-breakfast, no businesses.

Taxpayers are spending nearly $3.8 million on the project.

Granted, at least one resident who lives on this road is happy to see it paved; she obviously benefits from it. But not everyone sees the great benefits of seeing paved even the roads on which they live.

Mark Teague Road near Pittsboro in rural Chatham County is a half-mile-long strip of gravel that cuts through some woods and then dead-ends at a vacant brick ranch house surrounded by farmland.

The state road looks more like a driveway for Elizabeth Hopp, whose family lives in one of three houses off the lane. When crews showed up recently to widen the road bed, build erosion control for a pond and get ready to pave the road with asphalt, she wondered why the state was upgrading a road that goes nowhere. The cost to taxpayers: $225,000.

“I don’t really see the need for this,” Hopp said. “Maybe this is some kind of progress, but it seems sort of strange to me.”

And it's not as if even the News & Observer doesn't see the inefficiencies in all this.

The program costs have increased sharply over the past 23 years, and the benefits have diminished.

More miles were paved, on roads serving more houses, before 1997 than during all the years since, according to DOT figures. During those first eight years, the paving program served 18 homes for every mile of asphalt. DOT’s upcoming two-year work plan calls for paving roads that average 8 homes per mile.

Fast-rising prices for fuel and asphalt have pushed up construction costs for all kinds of road projects. DOT’s average cost for paving gravel roads has increased from $250,000 per mile in 2007 to $350,000 today. At that price, it would cost the state $644 million to pave those remaining miles.

Now if only the N&O's editorial staff could see that this applies to education spending as well. 

Obama's Greatest Challenge

Although Intrade is currently predicting an Obama victory in November, he does have some challenges to overcome. President Obama is running on the weakest of records of any president, and if gasoline prices and employment don't change (the former down and the latter up), he may find his fortunes fading by November.

Although presidents are unfairly blamed for many discouraging things over which they have little control, or boast unfairly about many positive things over which they too have little control, the public holds them accountable. For President Obama, things don't look good.

The following chart shows the dramatic decline in the labor force participation rate since Obama took office. Forget lower unemployment rates, if people are leaving the labor force discouraged, they don't show up on the unemployment figures.

Although gasoline prices have come down a bit over the past week or so, we're moving into the travel season, so they're likely to go up again. The real average price of a gallon of gasoline in the U.S. is about as high as it's ever been.

Should An Airline Own its Own Fuel Refinery?

Delta Airlines has purchased a refinery near Philadelphia to supply its east coast operations with jet fuel. The primary argument for Delta's acquisition is that the purchase will stabilize fuel prices for the struggling airline. I don't buy it.

First, Delta could enter into futures contracts for jet fuel to stabilize its costs like Southwest Airlines does. 

More importantly, Delta's core competency is not in refining jet fuel. (From my most recent experience it's not in passenger air service either.) It's not to say that vertical integration is necessarily a bad decision for a firm, but that decision should be based on the firm reducing its total operating costs by a) having a comparative advantage over its current owners in producing the good or service, and/or b) reducing the transactions costs involved in the supply of goods or services produced by the target firm. This is what's implied in the price volatilty argument made by Delta.

But any cost advantage Delta expects to accrue from reduced transactions costs will likely be more than offset from both the airline's lack of competency in fuel refining, including its inability to benefit from economies of scale in refining fuel, and its opportunity cost of consuming the fuel it produces.

It's this last part that's most puzzling - the ignorance of opportunity costs by Delta management. Any transfer price for jet fuel that is sold internally should equal Delta's price of selling in external markets. If the firm can sell its jet fuel on the open market for, say, $3.50/gallon, then profit maximizatin requires that its transfer price between divisions be $3.50/gallon. Given this argument, Delta hasn't reduced its costs of operation at all since profit maximation dictates that the firm raise its internal price as the market price of jet fuel changes.