Wednesday, February 15, 2012

Light bulbs and implied discount rates

What does your choice in light bulbs say about your attitude toward the future? In terms of discount rates, quite a lot.

An incandescent 60W bulb costs around 50 cents to buy, while a 15W CFL costs about $9. The government estimates that an incandescent bulb will cost $4.80 in electricity annually, while the CFL will cost $1.20 if used an equal amount.

Assuming a five year time span - roughly how long a CFL bulb is expected to last, and during which a new incandescent bulb will have to be purchased every year - if you just add up the costs, the incandescent will cost $12 more. Why would anyone buy an incandescent bulb? The answer is time preference.

Plugging the numbers above into Excel and using "Goal Seek" finds an implied discount rate of 39%. That is, someone would have to value one dollar a year from now 39 cents less than a dollar today in order to be indifferent between an incandescent and CFL light bulb.

People discount the future when making decisions, and the discount rate is not always consistent between all activities. Few people would want to pay a 39% rate on a credit card, but some are willing to do the equivalent when the cost is on the electric bill instead of the credit report.

There are a number of other potential explanations: maybe some renters don't expect to stay a full five years or have electricity included with the rent; some consumers might be cash-constrained and can't afford the pricey bulbs; or there could be some cognitive bias or plain lack of information about electricity costs. But, given the plenitude of "green" or energy conservation campaigns and general worry about global warming, behavioral factors might also push in the other direction.

If varying discount rates are distributed throughout the population, there may be enough people in the "tail" - with extremely high discount rates - to keep incandescent bulbs on the shelves for some time to come.

Monday, February 13, 2012

What is law?

Early in my Law & Economics course, taught by Don Boudreaux (professor and former chair of the economics department at GMU, blogger at Cafe Hayek) he made a controversial point about the nature of law. While most of us associate "law" with legislation, handed down by Congress or other governing bodies, Dr. Boudreaux argues that we should see law as an emergent phenomenon, developed by the public's expectations for social behavior. For the curious, a similar lecture he gave can be found here.

To borrow his example: if I set down my books at a table in the cafeteria and go to get food, I have a reasonable expectation that when I return, no one will have taken the seat where those books were placed. It's generally accepted that a book (or coat, or other personal item) can act as a stand-in for a person's presence in reserving a space. Someone who took that spot would be breaking a law, even though that standard has never been written down or codified anywhere.

Sometimes law and legislation can be synonymous (e.g. people understand murder is wrong, and it also carries criminal penalties) and in other cases they are contradictory (e.g. speed limits that no one follows, or underage drinking at college that is illegal but generally tolerated). Legislation on the books has no power except to the degree that people will accept it, or the powers of government are willing to use force in order to apply it.

Generally, this makes a lot of sense to me: the Federal Register, which added over 75,000 pages in 2010 that probably less than a dozen people have actually read, probably plays less of a role in public daily life than seat-saving etiquette for restaurants, even though each part of the Register could (theoretically) be enforced with the full power of the United States Federal Government.

My only complaint is a semantic one. This conception of law subsumes and replaces the role of customs, norms, and social mores; those become redundant terms given this definition of "law." This is not necessarily a bad thing - it may even be good, if as Boudreaux argues, we should reframe the public understanding of law as being opposed to legislation - but the loss of precision from duplicating "norms" and "mores" bothers me. (Maybe my attachment to those terms is just the sociology minor talking.)

If I were starting this issue afresh, I'd propose a definition of law as the intersection of legislation and publicly accepted norms. This is much narrower (it includes the prohibition on theft and murder, but excludes unwritten social rules) and arguably has greater analytic power, because it creates a new category for what is both expected by society and enforced by the powers that be.

Of course this issue isn't being started afresh, and any new definition of law has to battle a centuries old Anglo-American tradition of treating legislation as identical to law. Changing that entrenched belief will be a challenge, no matter what theoretical or practical merits a new conception of law might bring.

Friday, February 10, 2012

Cigarettes, a case study in price discrimination (China vs. U.S.)

Economists predict there will be price discrimination when there is a monopolist supplier (or at least some degree of market power) and arbitrage between different groups of customers is costly. The United States tobacco market meets one of the two conditions - re-selling cigarettes without a license is barred by law - but the industry is still competitive between the large tobacco companies. In China, by contrast, both conditions are met because the China National Tobacco Company has a de facto monopoly on all cigarettes sold.

There is strong evidence of price differences between types of cigarettes sold in China. This paper by Li, et al, finds
...the price differential among brands is large. The self-reported cigarette price ranged from 0.70¥/pack to 100¥/pack, which gives smokers more choices in the price of cigarettes. In other words, Chinese smokers have more flexibility in choosing different prices of cigarettes than most Western smokers.
There are two, potentially complimentary stories to explain the wide difference in price of Chinese cigarettes. First is price discrimination to take advantage of different elasticities of demand between smokers; one person may value the marginal pack of cigarettes less than another. Charging lower prices for "inferior" brands of cigarettes will enhance monopoly profits, by selling a higher quantity at a lower price.

This type of price discrimination doesn't rely on direct knowledge about consumer preferences; the tobacco company can set a variety of prices, then smokers self-segregate according to their willingness to pay. Such a strategy would be less effective in the U.S. because cigarette taxes are so high, the relative price difference between brands is always comparatively small.

Another possibility is social signaling. In the United States, smoking is not a symbol of high status, in fact quite the opposite: it's more common that poor and uneducated people will be the ones who smoke. In China, gifts of tobacco are common and socially accepted, and expensive cigarettes are used to demonstrate affluence. By offering a wide range of prices for cigarettes, more different levels of social status can be signaled. One might expect that as general affluence in China increases, new forms of social signaling will become more popular instead.

Tuesday, February 7, 2012

Netflix original programming: trying to stay ahead of the competition?

Netflix has been through some hard times lately, and the industry is evolving in ways that will continue to challenge their core business model. A combined deal between Redbox and Verizon has been struck in order to offer streaming video. Redbox is also buying out DVD kiosks owned by Netflix' old rival, Blockbuster, to expand their on-the-ground presence.

Netflix is already in a market with big-name competitors for streaming video - Hulu, Apple, Amazon and Walmart, to name a few - as well new outfits such as Zediva (which offered rock-bottom prices, but ran into legal troubles due to avoidance of content licensing fees). Netflix sets itself apart with the DVD mailing program, but Redbox is now well-positioned to compete on that front as well.

How to stay ahead of the curve? Netflix just introduced their first offering of original programming, Lillyhammer, with more shows planned in the next year.  Now, with Netflix moving toward an "HBO model" of producing and distributing their own content, their core business will be changing.

There is some clear logic to this decision: instead of paying extravagant licensing fees to stream content (the deal with DreamWorks is estimated to place a $30 million price tag on each film) new shows can be produced internally. New exclusive content could also pull in subscribers drawn to a particular actor or show; this may explain why Netflix is rumored to be producing Arrested Development Season 4.

During the short-lived introduction of 'Qwikster', some speculated that Netflix was drifting away from its core expertise. It's not immediately clear how DVD mailing translates to streaming content. Now, the company is shifting its role once more, and one is left to ask whether film production is also part of the Netflix tool kit.

Vertical integration in the entertainment industry is hardly a new phenomenon. But, most television networks started off producing content, and then acquired more means for distributing it. Netflix got into the distribution business first, and now is trying to backpedal into producing as well.

It's unclear whether the few big-name offerings which Netflix will produce are enough to distinguish them from the other streaming services. But, facing stiff competition in both physical and online distribution channels, moving up the content production chain may be the only choice they have in order to stay relevant.

Sunday, February 5, 2012

The value of flexible labor markets

Three stories in the news today highlight the importance of labor market mobility.

The United States has had some good news lately. With job spurt, US economy races ahead of Europe:
Some 1.9 million US jobs have been created in the past five months, bringing the number of people working nearly back to the levels of late 2008.
Jacob Kirkegaard, economist at the Peterson Institute for International Economics, said the latest developments in the labor market show the resilience of the US economic model.
"When you're a US employer, you barely hesitate to hire because you know if you take a worker for a peak in business, you can easily lay off that person if it doesn't turn out as planned," he said.
"In Italy, in Spain, in France, in Greece, the costs for that are high." 
Those high costs are creating problems in Greece. Employed But Not Paid, Some Greeks Voice Protest:
If ALTER TV laid off these workers, the owner would have to pay millions in compensation. Under Greek law, white-collar workers, for example, with 24 years on the job are entitled to 28 months of severance pay.
These days, few employers can afford that, says Vassilis Masselos, a shop owner who has been pressing the government on business reforms.
"It's not a matter of choice, it's a matter of necessity," Masselos says. "They can't find the money to pay employees. They cannot fire them. So they are locked into a sort of limbo that nobody can get out of."
Inflexible labor markets make economic contractions worse, and also slow the pace of recovery. Meanwhile, Canada is offering visas to Indian professionals as their economy improves. Human capital is the largest resource in any economy, so allowing movement toward higher-valued uses is essential for productivity and growth.

Saturday, February 4, 2012

Komen Foundation Pilloried for Planned Parenthood Policy - and Rightly So

Earlier this week the Susan G. Komen for the Cure Foundation said they'd be eliminating their grants to Planned Parenthood for breast cancer screenings. The resulting social media uproar, however, quickly caused them to reverse that decision and issue a sickly-sweet apology press release.

I know blood in the water when I see it; my duty to the blogosphere wouldn't be met without helping to smear Komen's momentarily-vulnerable public image further. After all, it's not every day you can feel righteous while slinging mud on a charity.

The recent furor raises a broader question: how much of what the Komen Foundation does is actually getting us closer to a cure for breast cancer? According to their website, 84% is spent "on our mission." But, that "mission" is defined pretty broadly.

From Komen's donation page.

The screenings, research, and treatment services that Komen provides are definitely valuable, but those only make up 46% of the overall budget. That leaves 54% percent taken up by administration, fundraising and "education" (a.k.a. advertisements). Basically, for every dollar that Komen takes in, a little over half of it goes out toward seeking another dollar. It's inefficient.

Maybe "education" about the risk of breast cancer is important, and causes some people to get treatment who otherwise would not. But, there are obviously some diminishing returns to awareness. Breast and prostate cancer are the number two causes of cancer-related deaths for women and men, respectively, but breast cancer receives much more public money and attention.

Data source: Aminou R, Altekruse SF, Edwards BK, et al. SEER Cancer Statistics Review: 1975-2006. Cancer Statistics, National Cancer Institute. May 29, 2009

A cynic would say that it's more fun to talk about breasts than the inside of men's asses, and probably be right. Some recent "sexy" breast cancer awareness campaigns help to reinforce that cynical view. While the incidence of prostate cancer has risen rapidly over the last 20 years, much faster than the rate of breast cancer, the National Cancer Institute spent twice as much on breast cancer as it did on prostate cancer in 2008.

There shouldn't have to be a fight between different anti-cancer organizations for funding. All of these diseases deserve serious study and research toward a cure. But, there also shouldn't be pseudo-political organizations like the Komen Foundation sucking up resources for runs, pink ribbons, Facebook campaigns, "awareness", and other things commonly known to not stop cancer. If you want your donation to make a difference, write a check to a research lab, not a lobbying group. With their stance on Planned Parenthood, the Komen Foundation has revealed itself to be much closer to the latter.

Thursday, February 2, 2012

Productivity is bad for job growth?

Scanning the news feed for something worthy of being shared with Twitter, I happened across this good news/bad news article from USA Today: Unemployment benefit claims, worker productivity fall. Less benefit claims is a sign that more people are going back to work, although drops in productivity temper optimism about the speed of economic recovery.

Instead, apparently the author of this piece took it be good news/good news, claiming
Weaker productivity growth can help boost hiring if economic growth picks up.
This argument is motivated by the lump of labor fallacy (the idea that there are only so many jobs to be done, so higher productivity will leave more out of work) and a preoccupation with firms as purveyors of jobs rather than producers of products. Both of these ideas are largely discredited among economists.

In reality, productivity growth is the driving factor behind economic expansion. For economic growth to pick up, we need the inputs of production (labor, capital, etc.) to become more productive, not slow down! This allows us to both become richer and create more jobs as a society.

At the micro-level, theory predicts that a firm will not pay a worker more than their marginal product; i.e. if a machinist can produce $50 worth of goods in an hour, a company that pays him/her $51 per hour will be losing money. USA Today misses the irony when going on to claim
consumers have been weighed down by wages that haven't kept pace with inflation.
If that is occurring, it's because worker productivity hasn't kept pace with other factors in the economy. This argument is made in more detail by several recent books: Race Against the Machine by Erik Brynjolfsson and Andrew McAfee, and The Great Stagnation by Tyler Cowen both explore the phenomenon of declining worker productivity, and neither are excited about that decline as a source of new jobs.

Lower productivity means reduced living standards for future Americans. It doesn't even rise to the level of a placebo for our current unemployment woes; generally, placebos are expected to do nothing, not make the problem worse.