This post is inspired by Google's aquisition of DoubleClick, in which they outbid Microsoft and others to obtain. There is a well known result of auctions known to economists as "The Winner's Curse," that you would see in an advanced game theory course. This is the idea that we would expect whoever wins the auction probably got a bad deal. Assume that the bidders have similar budget constraints. Prior to going into the auction, each bidder will make estimations about the value of the aquisition (assuming that it's the same for both groups), from which this value would represent the maximum bid. Statistically as a group, we know that on average the bidders would come up with the correct estimate. That is, the bidders will have an equal amount of over- and under- estimation of the true value so that the errors will cancel each other out. However, the winner of the auction will be the bidder who overestimated the true value by the largest amount. It's an interesting idea you should keep in mind with auctions that might fit the assumptions like the Google example above. Another that might work is the Boston Red Sox's bid for the rights to negotiate with Daisuke Matsuzaka.
Update (April 14, 2007): It appears that others believe Google drastically overpaid, supporting my earlier post regarding the Winner's Curse.
Friday, April 13, 2007
Tuesday, April 10, 2007
Why Did Gas Prices Rise Over the Weekend?
Predictably, gas prices rose over the weekend. While prices have been rising for a few weeks now for reasons related to wholesale oil, we always expect gas prices to rise on this past particular weekend every year. Why?
Sunday, March 11, 2007
Are textbooks too expensive?
An article on CNN reports the new political debate regarding the "high" prices of textbooks. There are a number of problems with the discussion in the article. I just decided to enumerate a few of them:
1. The student estimates he spend $4,500 for a career in college on textbooks. My guess is that he choose to ignore the fact that he probably was able to sell them back for a figure less than that which would probably lower that figure by 60%. The article later states that the average student pays $900 per year on textbooks and supplies, which is no where near what this guy spent. That figure also excludes the resale value.
2. Ambiguous regulations for professors to be cost-conscious. I do not know a professor who does not take this approach already. While there is technically an incentive for professors to choose high prices, there is much more incentive to choose the best book at the lowest price. If I choose the most expensive book, it probably would only earn me an extra few dollars on the resale market. However I would lose much more valuable time in answering questions for students who do not buy the book because it is too expensive or do not understand the book because it does not match my lecture very well. Chances are this regulation would do much more harm than good.
3. Textbooks are the "hidden" costs of education. This was claimed by Rep. Frank Moe. Frank apparently believes people are systematically stupid. Everyone knows that they will spend money on books and they include that estimate in their own cost-benefit analysis of enrollment. While they may over or underestimate the cost, on average they will be right. To say that no-one realizes the costs of textbooks is equivalent to saying everyone who plays darts will miss the bulls-eye to the left.
4. Much of the article is accurate in explaining why textbooks are expensive relative to other books, but they miss a big one. Comparatively low sales volume and a used book market that cannibalizes future sales are good reasons to expect prices to be high relative to the books at Barnes & Noble, but local monopoly power is a big reason too. See fellow Econ professor John Whitehead's blog post against high book costs for his students for a nice explanation.
5. "The textbook industry pulls in more than $6.5 billion dollars a year...." I don't know what this means, or what it is supposed to imply. It sounds like from the sentence that this is the industry revenue, which means nothing as profits might be really low due to costs. I don't know if this is the case or not, but I also think that there are many textbook companies, so this would be distributed among many suppliers and the economic profit would be low. I also suspect that this is a risky industry, so we should expect there to be some economic profit.
6. What is the alternative? Regulations will increase costs, causing prices to rise. You can pretty much guarantee that if the university or the government takes over the industry, both its quality will decline and prices will rise. Just look at the post office, DMV.
7. Rick Howden complains of buying books he never opens. Whose fault is that? If you weren't going to use it, why did you buy it in the first place?
1. The student estimates he spend $4,500 for a career in college on textbooks. My guess is that he choose to ignore the fact that he probably was able to sell them back for a figure less than that which would probably lower that figure by 60%. The article later states that the average student pays $900 per year on textbooks and supplies, which is no where near what this guy spent. That figure also excludes the resale value.
2. Ambiguous regulations for professors to be cost-conscious. I do not know a professor who does not take this approach already. While there is technically an incentive for professors to choose high prices, there is much more incentive to choose the best book at the lowest price. If I choose the most expensive book, it probably would only earn me an extra few dollars on the resale market. However I would lose much more valuable time in answering questions for students who do not buy the book because it is too expensive or do not understand the book because it does not match my lecture very well. Chances are this regulation would do much more harm than good.
3. Textbooks are the "hidden" costs of education. This was claimed by Rep. Frank Moe. Frank apparently believes people are systematically stupid. Everyone knows that they will spend money on books and they include that estimate in their own cost-benefit analysis of enrollment. While they may over or underestimate the cost, on average they will be right. To say that no-one realizes the costs of textbooks is equivalent to saying everyone who plays darts will miss the bulls-eye to the left.
4. Much of the article is accurate in explaining why textbooks are expensive relative to other books, but they miss a big one. Comparatively low sales volume and a used book market that cannibalizes future sales are good reasons to expect prices to be high relative to the books at Barnes & Noble, but local monopoly power is a big reason too. See fellow Econ professor John Whitehead's blog post against high book costs for his students for a nice explanation.
5. "The textbook industry pulls in more than $6.5 billion dollars a year...." I don't know what this means, or what it is supposed to imply. It sounds like from the sentence that this is the industry revenue, which means nothing as profits might be really low due to costs. I don't know if this is the case or not, but I also think that there are many textbook companies, so this would be distributed among many suppliers and the economic profit would be low. I also suspect that this is a risky industry, so we should expect there to be some economic profit.
6. What is the alternative? Regulations will increase costs, causing prices to rise. You can pretty much guarantee that if the university or the government takes over the industry, both its quality will decline and prices will rise. Just look at the post office, DMV.
7. Rick Howden complains of buying books he never opens. Whose fault is that? If you weren't going to use it, why did you buy it in the first place?
Monday, March 5, 2007
What is a lifetime of sex worth?
How much would you have to be paid in order to give up a lifetime of sex? What is the dollar value of your life? What is your reputation worth? These are the kinds of questions economists are called in to answer in the courtroom and is known as foresic economics. It is an aspect of our field that some people would probably find "morbid" because it is like putting a price tag on something that many would consider priceless. An economist would probably suggest in a wrongful death suit that a 65-year-old woman's life would require lower compensation than a 20-year-old man's, ceteris paribus. If a doctor botched a surgery that left a woman unable to copulate with her husband for the remainder of her life, an economist would likely be called in to put a price on that.
If you are interested, here is a blog by forensic economist Ralph Frasca (I've met him once, he's a nice guy) and here is a list of example cases in Ohio.
If you are interested, here is a blog by forensic economist Ralph Frasca (I've met him once, he's a nice guy) and here is a list of example cases in Ohio.
Thursday, March 1, 2007
Negative Externalities in the NK deal on Iran
It appears that the agreement with North Korea to disarm their nuclear facilities has been interpreted as an increased probability of U.S./Israel air strikes against Iran, as evidenced by the Intrade Trading Exchange on Current Events. On this website, people buy shares of stock based on the probability that a certain event will occur by a particular date, and if it does then those who hold stock will be paid a dollar per share they hold. Based on the link I provided, it appears that over the last few days as these talks with North Korea have advanced, people have increased the price they are willing to pay for these shares, i.e. they think it is more likely that the U.S. will attack and the shareholders will get paid that dollar. So even though Iran was not involved with the treaty, they appear to bear some cost of that transaction.
Gas Price Gouging Bill
Lawmakers in the House have introduced a bill creating a Federal Law against "price gouging" at the pump. According to the article, Rep Bart Stupak (D-MI) says he is concerned gas prices will again reach $3/gallon. This is essentially creates a price-ceiling for the retail gas market. What will happen with this?
Suppose there is some big shock: Iran gets enthralled in War, another bad hurricane in the Gulf Coast, another massive earthquake in Alaska, or whatever. Oil is traded on a global market, and one of these shocks would trigger a fast spike in oil prices. If this spike in prices is large enough, gas would need to be sold above $3/gallon for there to be any profit. Now, U.S. refineries and other U.S. gas retailers would be unwilling to purchase oil from world suppliers because it would be too expensive relative to what they could sell it for. Clearly, the result would be empty gas stations in the U.S.
Additionally, what would happen to the little bit of gas that did make it here? Even if it was sold at a retail price of $3/gallon, the individual who managed to get it would have a big incentive to turn around and sell it "black market" to somebody willing to pay a whole lot more. We'd be left with a gas shortage and paying very high prices for gas on a black market.
Remember, "high" prices does not equal price gouging.
Suppose there is some big shock: Iran gets enthralled in War, another bad hurricane in the Gulf Coast, another massive earthquake in Alaska, or whatever. Oil is traded on a global market, and one of these shocks would trigger a fast spike in oil prices. If this spike in prices is large enough, gas would need to be sold above $3/gallon for there to be any profit. Now, U.S. refineries and other U.S. gas retailers would be unwilling to purchase oil from world suppliers because it would be too expensive relative to what they could sell it for. Clearly, the result would be empty gas stations in the U.S.
Additionally, what would happen to the little bit of gas that did make it here? Even if it was sold at a retail price of $3/gallon, the individual who managed to get it would have a big incentive to turn around and sell it "black market" to somebody willing to pay a whole lot more. We'd be left with a gas shortage and paying very high prices for gas on a black market.
Remember, "high" prices does not equal price gouging.
Wednesday, February 28, 2007
Moral Hazard and the Catholic Church
There is an article on yahoo about the San Diego diocese filing bankruptcy because it cannot afford to pay the damages to its sexual assault accusers. Bankruptcy creates a well-known moral hazard problem because it reduces the cost of making a risky decision. In essence, if you are weighing the benefits and costs of a risky decision, the ability to file for bankruptcy means you do not have to pay back all of your creditors and others you owe money to. This reduction in cost means some people may end up making choices they otherwise wouldn't make and we have more bankruptcies as a result. It also is a problem for creditors, because they know that if someone is on the verge of bankruptcy, they are less likely to be repaid and are less likely to lend to those who are in the most need.
What is interesting about the article above regarding the SD diocese is that according to the plaintiffs' lawyers, the Catholic Church is able to hide more embarrassing information about their behavior, which means there is a second source of moral hazard in bankruptcy. Remember, they are in trouble because they were helping to cover-up for priests who sexually abused parishioners. Apparently, the ability to declare bankruptcy reduced their cost of getting caught doing this. While bankruptcy may not have made the difference in their decision, it certainly reduced the cost of the cover-up, giving them more of an incentive to engage in this behavior.
What is interesting about the article above regarding the SD diocese is that according to the plaintiffs' lawyers, the Catholic Church is able to hide more embarrassing information about their behavior, which means there is a second source of moral hazard in bankruptcy. Remember, they are in trouble because they were helping to cover-up for priests who sexually abused parishioners. Apparently, the ability to declare bankruptcy reduced their cost of getting caught doing this. While bankruptcy may not have made the difference in their decision, it certainly reduced the cost of the cover-up, giving them more of an incentive to engage in this behavior.
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