It's hard not to do good

Tyler Cowen points to a great question from a reader:

There was an idiotic movie in the 80’s (“Brewster’s Millions”) where Richard Pryor had to burn through $30 million in 30 days in order to inherit $300 million.  There were some conditions:  “. . . after 30 days, he may not own any assets that are not already his, and he must get value for the services of anyone he hires. He may donate only 5% to charity and lose 5% by gambling, and he may not waste the money by purchasing and destroying valuable items. Finally, he is not allowed to tell anyone. . . .” [Wikipedia].

Anyhow, I was thinking of a similar movie one could make.  Awful, but perhaps instructive to students of economics.

Similar premise, similar challenge.  But my twist is that the stipulation now is that he can do whatever he wants with the $30 million, on the condition that he NOT HELP ANYBODY with the money.

I don’t believe this is possible.  Consider:

If he were to simply keep in in the bank and not touch it, the supply of loanable funds would shift to the right, lowering the cost of borrowing money, thereby helping others to improve their lives in various ways.

If he were to spend the money, he would create gains from trade, a positive-sum game.  People would consider themselves better off for having sold him a good or service . . . or they wouldn’t have.  Plus multipliers.

If he gave the money away, the recipient would doubtless consider himself better off, at least initially.

If he burned the money, he would be, albeit in a small way, helping the nation’s economy as a whole, since that $30 million represents a claim on the nation’s goods and services that now will never be called in.

I guess what I’m getting at here is that I don’t believe there’s any way a rich person can avoid helping others with his money.

First up, Brewster's Millions was brilliant. I loved how he decided to waste his money with a run for office.

But the substantive question's a tough one. It's easy to come up with examples that have negative externalities and so impose some harm on others. And it's not impossible to come up with ones where the negative externalities might result in net harms. But ones where nobody is made better off?

And it's related to an older problem in preference-revelation mechanisms.

Recall that in the old Tideman-Tullock demand-revealing process, in which a Clarke tax could induce truthful preference revelation, you could only be sure that you had truthful revelation so long as the participants were neutral about the use of the collected taxes. If you gave the money to charity, people might overreveal their preferences since the collected funds would go to a cause they supported anyway. But if other people hated that particular charity, they might underreveal their preferences. Given the very flat payoff curve, these kinds of considerations might matter.

Tideman and Tullock's solution was that the collected taxes had to be spent on real resources produced in perfectly competitive markets so that no rents were conferred by having bought the resources, and then the resources had to be destroyed. That still doesn't work, though, because a lot of people have strong preferences against waste per se.

But it does hint at a solution to the question: if you want to spend money while helping nobody, buy something that is produced in a perfectly competitive industry that uses only inputs that come from perfectly competitive industries too.

I love this thought experiment. It is hard to come up with examples where trade does not benefit the people you're trading with. And yet political rhetoric often comes from the opposite starting point.

The more plausible examples in the comments over at MR have to resort to illegal activities to make them work: buy hand grenades and use them to blow up the manufacturer/vendor of the hand grenades.

Markets hate profits

Unless there's some barrier in the system preventing it, no firm can sit on excess profits forever. Competition erodes away the excess profit until everybody's again earning a normal rate of return. Today's case in point: alcohol minimum pricing. I've made the point before, but it's worth walking through again as the logic isn't immediately obvious to non-economists.

Neil Miller argues:

Because most craft beers are currently priced over the $2 a drink threshold, it could be argued that they will become closer in price to mainstream beers which might encourage drinkers to “trade up”.  However, the costs to the big breweries will not have increased and they will basically be making more money for the same beers.  This means they will be able to increase marketing and distribution efforts.  Mr Albertson’s point about minimum pricing putting pressure all the way up the chain is critical.  

He's right that the big brewers will have more money for marketing and distribution. But they're pretty unlikely to be making more money for the same beers. Let's walk through the logic.

Suppose I'm one of the big brewers and Labour takes power. Lianne Dalziel announces a $2 per standard drink minimum price. Doug Sellman shouts about how it should be $10. My product previously retailed at $1 and cost me $0.25 to produce. I got $0.05 in profit and the rest was distribution / retailing costs. Can I suddenly start pocketing $1.05 in profits for that drink?

Minimum pricing hasn't made my competitors go away. I expect that they'll be trying to increase market share. What should I do? The first thing I'd try is a new promotion: Every 4th case (24 pack) of beer has $20 inside. My production cost goes up by a bit over $0.20 per bottle, so I'm only pocketing $0.85 in profit per bottle. But if my market share goes up by enough, it's totally worth it.

My competitors try it too. They promise $20 in every 3rd case. Then somebody in Parliament figures out that the real cost of alcohol to consumers is nowhere near $2 per standard drink as we're effectively rebating a big pile of the minimum price to consumers as a cash lottery. So that gets banned.

What next? Free t-shirt! Free shot glasses! Free beer mugs (collect all 8!). Then Parliament bans bundling any kind of good with the beer.

What next? It depends a lot on how different cohorts of drinkers respond to increased product quality versus increased related amenities. Maybe I can turn my bottles into something that's beautiful, with a stopper cap on a wire that makes it useful for re-use as a water bottle. Maybe I can make my labelling nicer. Maybe I can open up my own bottle shops where I sell only my own product but there's just an awesome environment for my customers: free massage from a Tui Girl with every purchase.

Think I'm kidding? Look at what happened in the US when airline prices were regulated. The airlines were banned from competing on prices. So what did they compete on instead? Better meals, better drinks, and more attractive stewardesses.

Unless there's some barrier to competition somewhere in the system, nobody gets to sit on free profits. These kinds of rents get eroded pretty quickly. Customers either wind up buying alcohol that actually costs $2 per standard drink (less normal profit) to produce, or that's bundled with amenities they find more valuable than improvements in the quality of the drink but that still cost $2 per standard drink (less normal profit) to provide.

Who might get to enjoy excess profits - rents - out of minimum pricing? My first pick are those who have bottle shop licences in poor neighbourhoods. They'll have local monopoly rents, especially when their customers have a harder time going across town for bargains. That will be capitalised into the price of the firm, and the next guy who buys the bottle shop will only then be earning normal profits, but there's likely a windfall gain to some small bottle shops.

Markets hate free profits: somebody's always rushing in to try to grab them. That competitive process runs until everybody's just earning a normal rate of return. I'd expect that the only conditions under which the big breweries get to keep selling current product at a $2 per standard drink minimum profit and just bank the profits are the conditions under which they could do it without a minimum price. Basically they need a strong cartel that prevents entry. Fortunately, we're nowhere near that kind of a world, at least in New Zealand.

Helium futures

Matt Yglesias points to a potential coming helium shortage.

None of the stories about peak helium have made much sense. Even if the U.S. government is selling its helium off cheaply, surely others have incentive to store helium for later sale.

But I think I get it now. The US Federal Government controls a big geological formation that provides really cheap helium storage; by legislation, they're selling down those reserves at relatively cheap prices. Funding pressure then might shut down the whole reserve. Then, the private sector is left with more expensive storage options.

I don't believe the nightmare scenarios around MRIs running out of helium. Anybody who puts high value on having reliable access to helium can buy and set up storage tanks. The cost of helium for those users will be much higher, given differential storage costs, but it's pretty hard to believe that some private storage solution wouldn't come up for those really high value users.

I wish somebody would set up futures markets in delivered helium so the high value users could ensure longer term supply and so that we'd have a better sense of what the market expects future scarcity to look like. Why isn't there one?

There seems to be policy failure all over the place on this file.

By 1996, however, the Helium Reserve looked like a waste. Blimps no longer seemed quite so vital to the nation’s defense and, more important, the reserve was $1.4 billion in debt after paying drillers to extract helium from natural gas. The Republican-led Congress, looking to save money, passed the Helium Privatization Act, ordering a sell-off by the end of 2014.

Why was the federal government subsidizing the production of helium in the first place? I can see an argument for the government paying for helium extraction and on-selling it afterwards if they were the only reasonable owner of the big geological formation, but that sure doesn't provide an argument for subsidising the production of so much helium that they wound up selling it below total cost and running large debts.

Given Congress's handling of the project, are the potential losses from a private owner earning Ricardian rents on storage cost differences really that much worse than the deadweight costs of how the government's run things? In other words, it could have made more sense to sell off ownership of the field rather than the helium inside it.

Market failure watch: Adverse selection at the buffet table

“The aim of this study was to investigate whether the eating behaviors of people at all-you-can-eat Chinese buffets differs depending upon their body mass. The resulting findings could confirm or disconfirm previous laboratory research that has been criticized for being artificial.
METHODS AND PROCEDURES: Trained observers recorded the height, weight, sex, age, and behavior of 213 patrons at Chinese all-you-can-eat restaurants. Various seating, serving, and eating behaviors were then compared across BMI levels.
RESULTS: Patrons with higher levels of BMI were more likely to be associated with using larger plates vs. smaller plates (OR 1.16, P < 0.01) and facing the buffet vs. side or back (OR 1.10, P < 0.001). Patrons with higher levels of BMI were less likely to be associated with using chopsticks vs. forks (OR 0.90,P < 0.05), browsing the buffet before eating vs. serving themselves immediately (OR 0.92, P < 0.001), and having a napkin on their lap vs. not having a napkin on their lap (OR 0.92, P < 0.01). Patrons with lower BMIs left more food on their plates (10.6% vs. 6.0%, P < 0.05) and chewed more per bite of food (14.8 vs. 11.9, P < 0.001). DISCUSSION: These observational findings of real-world behavior provide support for laboratory studies that have otherwise been dismissed as artificial.”

From NCBI ROFL.

The main puzzle isn't how the researchers managed to measure how many times the patrons chewed each bite of food; rather, it's why prices manage to induce a pooling rather than separating equilibrium: we don't see only Mr. Creosote at the buffet table.

Candidate explanations:

• Low consumption consumers with a strong preference for diversity within a meal? But then surely there would be buffets for them with smaller plates and "Seconds ok, thirds bad" rules.
• Strongly risk averse customers with appetite uncertainty? Highly implausible.
• Lots of places have lunch buffets rather than dinner buffets: time then serves as constraint on customers, and folks who can eat a lot quickly pool with folks in a big hurry to eat and willing to pay a premium for a speedy meal. I like this one, but buffet dinners still exist.
• The buffet is loss-leader for overpriced drinks. But then we'd expect high appetite folks happy with water as drink to drive a similar result
• Restaurants tend to be frequented by groups that will include both low and high appetite types. But isn't there evidence of some sortition of friend groups along BMI? And even absent sortition, wouldn't friend groups with highest average appetites be most likely to choose a buffet for the group?
• Quantity and quality preferences are negatively correlated: the high consumption folks eat a higher proportion of cheap starches and carbs while the low consumption folks eat a higher proportion of more expensive meats? The study makes no mention of high versus low cost item proportions, but it seems plausible. Mr. Creosote was so odd because he wanted all of the really high quality stuff mushed together in a bucket, after all...
• Restaurant margins are high enough that losses on the high demand customers don't matter much. This seems implausible given rather low margins in this market; and, in that case, wouldn't we expect entry with cream-skimming (again, a small-plates buffet with perhaps no more than one allowed refill)?
• Rules allowing them to kick out or refuse seating to high demanders; of course, then there are the lawsuits by those whose rapacity knew no satiety. I've never seen anyone outside of the Simpsons actually kicked out of a buffet; it's been years since I've been to one though.

Other explanations welcome!

Peak load pricing: Rugby World Cup edition

The New Zealand Minister for the Rugby World Cup (yes, such a portfolio exists) apparently reckons that tourists to New Zealand during the Rugby World Cup would prefer that there be no available accommodation than that it be available at high price. From today's National Business Review:

Rugby World Cup Minister Murray McCully has written to the Hotel Association asking it to persuade its members not to risk damaging New Zealand's tourism reputation by over-charging for accommodation during the rugby World Cup.

The event is still well over a year away but there have been reports of accommodation providers in Auckland ramping prices up several hundred percent above usual rates and adding long minimum-stay provisions.

The CEO of Rugby World Cup is more sensible:

Rugby World Cup chief executive Martin Snedden said last month that prices being charged in what would be a peak time were generally reasonable, and organisers were confident that the free market would lead to those overcharging having to reduce their prices or face the prospect of empty beds during the tournament.

We ought, of course, note that some package deals of tickets plus accommodation will see premium prices not because of hotel overcharging but rather because tickets for some events will be at below market clearing prices: the package deals provide a mechanism allowing markets to clear via prices rather than queuing. I'm with Snedden, though. All that's achieved by hotel operators charging less than the market can bear is that some visitors will be unable to find accommodation.

Economics of Scalping: Trent Reznor edition

Economists have for some time been trying to figure out why concerts are priced below market clearing. Surely the artist does better by having fans allocate scarce supply by willingness to pay rather than by willingness to queue. The scalper profits by the arrangement rather than the artist, venue or promoter: why not reallocate the surplus back up the chain by charging market-clearing prices? Some candidate explanations, and rebuttals:

• Queuing generates news stories the publicity value of which outweighs revenues forgone
  • But why not achieve the same outcome by pricing only half of the venue below clearing and have premium seats sold at market clearing prices? Is it really plausible that there's more press from queuing than from stories about sales of $1000 tickets?


• Queuing sorts fans by fandom rather than by willingness to pay. This has benefits for the artist by increasing the average attendee's willingness to pay for complementary higher margin goods like t-shirts and posters, by ensuring that the mosh pit is filled with the most enthusiastic fans and thereby improving the concert experience for everyone.
  • But this could be achieved still by segmenting the venue; it doesn't explain why concerts without mosh pits (or active floor seating) are priced below clearing. Steve Landsburg likes the t-shirt explanation, but it's unclear to me why this predicts overall queuing rather than queuing for the floor seats and market-clearing prices for the rest.
• Contractual arrangements between artist and venue give the artist stronger incentives to promote sale of ancillary goods than to maximize profits over both ticket sales and t-shirt sales; see discussion of sorting by fandom, above.
  • Then why don't they write better contracts?

Trent Reznor, the genius behind Nine Inch Nails, provides some insight. In short, scalping could be stopped immediately, without price changes, if concert promoters or venues wanted to stop it: simply print names on tickets and check against photo ID at the door. Why don't they do it? Let's turn it over to Trent.

The ticketing marketplace for rock concerts shows a real lack of sophistication, meaning this: the true market value of some tickets for some concerts is much higher than what the act wants to be perceived as charging. For example, there are some people who would be willing to pay $1,000 and up to be in the best seats for various shows, but MOST acts in the rock / pop world don't want to come off as greedy pricks asking that much, even though the market says its value is that high. The acts know this, the venue knows this, the promoters know this, the ticketing company knows this and the scalpers really know this. So...

The venue, the promoter, the ticketing agency and often the artist camp (artist, management and agent) take tickets from the pool of available seats and feed them directly to the re-seller (which from this point on will be referred to by their true name: SCALPER). I am not saying every one of the above entities all do this, nor am I saying they do it for all shows but this is a very common practice that happens more often than not. There is money to be made and they feel they should participate in it. There are a number of scams they employ to pull this off which is beyond the scope of this note.

In short, the ticketing agents have already made a deal with the scalpers to split the surplus without appearing like jerks by having high posted ticket prices. As Eric Cartman would say, it's like having your cake, and eating it too.
What's NIN done about it? Again, over to Reznor:

NIN gets 10% of the available seats for our own pre-sale. We won a tough (and I mean TOUGH) battle to get the best seats. We require you to sign up at our site (for free) to get tickets. We limit the amount you can buy, we print your name on the tickets and we have our own person let you in a separate entrance where we check your ID to match the ticket. We charge you a surcharge that has been less than TicketMaster's or Live Nation's in all cases so far to pay for the costs of doing this - it's not a profit center for us. We have essentially stopped scalping by doing these things - because we want true fans to be able to get great seats and not get ripped off by these parasites.

I assure you nobody in the NIN camp supplies or supports the practice of supplying tickets to these re-sellers because it's not something we morally feel is the right thing to do. We are leaving money on the table here but it's not always about money.
Being completely honest, it IS something I've had to consider. If people are willing to pay a lot of money to sit up front AND ARE GOING TO ANYWAY thanks to the rigged system, why let that money go into the hands of the scalpers? I'm the one busting my ass up there every night. The conclusion really came down to it not feeling like the right thing to do - simple as that.

That story's consistent with the fandom explanations above. I can buy that the artist would want the most enthusiastic fans up at the front rather than the boring folks who can afford to pay $1000 per ticket. Giving an economics lecture is a lot worse if the students up front seem less interested than you think they ought to be, and I'd fully expect that the effect is greater for musicians. Why shouldn't they trade off some monetary income for being able to put on a show that's more fun for them? I certainly put non-trivial weight on how fun a given lecture will be for me to deliver; I wouldn't expect anyone else to do otherwise.

Reznor concludes:

My guess as to what will eventually happen if / when Live Nation and TicketMaster merges is that they'll move to an auction or market-based pricing scheme - which will simply mean it will cost a lot more to get a good seat for a hot show. They will simply BECOME the scalper, eliminating them from the mix.

Nothing's going to change until the ticketing entity gets serious about stopping the problem - which of course they don't see as a problem. The ultimate way to hurt scalpers is to not support them. Leave them holding the merchandise. If this subject interests you, check out the following links. Don't buy from scalpers, and be suspect of artists singing the praises of the Live Nation / TicketMaster merger. What's in it for them?

I'm a bit confused at this point. If the prior argument was that collusion between the ticketing agencies and the scalpers allowed an arrangement maintaining the facade of "fan friendly pricing" while allowing for extraction of rents, why would a merger between the venues and the ticketing agents allow that solution to become explicit with true market-clearing pricing? If the current constraint is wanting to maintain the veneer of low prices, what about the merger removes that constraint?

I'd argue instead that we're just seeing a trend towards market clearing prices because prior arrangements where concerts effectively served as loss-leaders for albums has had to change with file-sharing; now, the CD tracks are the loss-leader for the concerts and ancillary products, and we'd have to expect a move towards clearing via prices.

Reznor provides a nice compendium of links on scalping, including Russ Roberts' discussion over at EconTalk! Reznor listens to Roberts. Worlds colliding....

Update 23 March: I told you recordings are a loss leader for the concert. See Reznor's distribution of free EPs for folks signing up for email updates on his upcoming tour with Jane's Addiction (awesome) and Street Sweeper (never heard of 'em, but almost certainly worth trying on given the recommendation).