Economist's Notebook: Bertrand Price Competition and Pizza

Photo Credit: Hiroko Masuike/The New York Times

One of the great puzzles of living in Portland is how the market sustains such high pizza prices.  When I lived in Ithaca, NY I was used to New York style pie and prices - both great.  Somehow in Portland pizza commands premium prices: a large "very veggie" pizza at Pizzicato is $24!  You have got to be kidding.

It is a puzzle to me because it is such a contestable market and a pretty standard product.  Pizza kitchens are pretty darn cheap compared to regular commercial kitchens: just get an oven and you are off.  And, sure there are quality differences, but making good pizza is pretty easy, doesn't take a lot of work or training.  In economics this market seems to be characterized most closely by the Bertrand model of price competition.

This model assumes some market power (so not perfect competition which would fail to capture the product, location and brand differentiation) and that firms compete on price.  It does assume homogeneous goods, so it is not a perfect description, but pretty close. But the conclusion of the model is that through strategic interaction, competitors will undercut each other on price because consumers are pretty indifferent about the different pizza shops so they'll just go to what is cheaper.  In the end what you get is prices that equal the marginal costs or providing it - exactly what you get from perfect competition.  

So I was heartened to see this article from The New York Times which describes the knock down drag out pizza wars of Manhattan that has lead to 75 cent slices:

It’s best to start at $1.50 a slice.

That is what pizza was selling for about a year ago at a family business that is a combination vegetarian Indian restaurant, candy store and pizza parlor on Avenue of the Americas (also known as Sixth Avenue), between 37th and 38th Streets. It is called Bombay Fast Food/6 Ave. Pizza.

Then a Joey Pepperoni’s Pizza opened near the corner of 39th and Avenue of the Americas, offering pizza for $1, a price that has in recent years been favored by a number of New York pizza establishments.

So Bombay/6 Ave. Pizza shrank its price to $1 too.

All was good until last October, when a third player entered the drama.

A 2 Bros. Pizza, part of an enlarging New York chain of 11 shops that sell slices for a dollar, opened virtually next door to Bombay/6 Ave. Pizza. The only separation is a stairwell that leads up to a barbershop and hair salon.

Price stability at a buck all around persisted until eight days ago, when both 2 Bros. and Bombay/6 Ave. Pizza began selling pizza for the eye-catching price of 75 cents a slice, tax included — three slender quarters.

This is exactly what you would expect to happen in this market from the application of the Bertrand market.  The article goes on to quote a pizza shop owner who claims that there might actually be predatory pricing: pricing below marginal cost to try and force competitors out of the market.

But the $1 slice that appears like it might be about MC is a heck of a lot cheaper than Portland prices and in a city where rents are a lot cheaper than NYC.

So, armchair economists, explain to me the high Pizza prices in Portland.  I have my own pet theories, but I'd like to hear yours first.  And while you are at it, explain to me the $10 pub cheeseburger.  

UPDATE: It appears Greg Mankiw has beat me to the punch on this.

Economist's Notebook: Scalpers

I suppose it is going to be a surprise to no one that I, an economist, do not have a problem with scalpers.  I appear to be a distinct minority, for example, the some in the Timbers Army are dead set against them:

Don’t buy from them.
Don’t sell to them.
Don’t acknowledge them.

The argument against scalpers generally follows along the lines of them simply enriching themselves while providing no value. Vultures, parasites and the like are generally the terms used to describe scalpers.

But they are providing value.  To an economist they are providing a service: creating a market where there was none prior. That the service they supply is valuable is evidenced by the fact that they do make a living doing it. People use scalpers to be the intermediaries for ticket transactions that are hard. Now sites like Stub Hub provide markets for these transactions, but they still generally work only when you know in advance that you'll be missing a game.

The right thought experiment is to imagine the case where there was no resale market at all.  Without scalpers for example if someone got sick the night of a game and could not attend, they would lose the opportunity to recover some of the value of the ticket and someone who wanted to attend the game but could not get tickets would be denied the opportunity of attending.  This is clearly a worse outcome than a scalper.  Sure the scalper may make some money in the transaction, but this is the reward for the time and effort they spend buying and selling tickets.

So simply denigrating scalpers serves no purpose.  Creating more effective resale markets is. One useful response in the case of the Timbers has been to tap into social media, in this case Facebook, to provide a market expressly for those that have a preference for selling their tickets at face value to those that are passionate about the Timbers. Once again this is a response to a missing market and I think it is wonderful. Those whose preferences match will use this venue.

I think the thing that really upsets people is the fact that the resale market with scalpers works to the advantage of the wealthiest consumers and serves to keep out less well-resourced fans that may be more passionate.  Economics says that this is efficient - those with the highest valuation should attend - but the unequal outcome is somehow disturbing.  I would argue that this is not really different than the regular ticket market but that is another issue.  That market efficiency and equality are not linked is one of the ongoing themes of economics, especially when it comes to policy.

But it is not alway so.  On opening night the seat next to mine was occupied by a dude who had spent his very last $10 on the ticket - well below face value.   Obviously a scalper had a single ticket that was hard to unload and in the end the market price ended up being quite low.  So the seat was filled, my broke neighbor had a great time and the owner of the ticket was able to recoup some of the cost.  Everybody wins...except, I suspect, the scalper who probably took a loss on this ticket.

Economist's Notebook: Externalities

I am very fearful of wading into a morass of politics and values but this essay criticizing the mandate that health insurance cover birth control struck me as particularly odd coming from an economist:

I put "insurance" in quotes for a reason. Insurance is supposed to mean a contract, by which a company pays for large, unanticipated expenses in return for a premium: expenses like your house burning down, your car getting stolen or a big medical bill.

Insurance is a bad idea for small, regular and predictable expenses. There are good reasons that your car insurance company doesn't add $100 per year to your premium and then cover oil changes, and that your health insurance doesn't charge $50 more per year and cover toothpaste. You'd have to fill out mountains of paperwork, the oil-change and toothpaste markets would become much less competitive, and you'd end up spending more.

Okay, so we can quibble about the semantics of insurance, but there is a huge difference between oil changes and contraception: externalities. The social costs from someone not taking proper care of their car is pretty small - it may run less efficiently and release more smog, for example, but most of the cost of poor maintenance will be born by the owner. Unwanted pregnancies can have major social costs born by society at large - health care, infant care, foster care, crime (if you believe Levitt) and so on. In econo-speak, there are large negative externalities that come from unwanted pregnancies.

So there is a good reason government stays out of the decision to get an oil change for your car, but potentially has a big stake in helping prevent unwanted pregnancies.

The author does finally mention the externality issue near the end:

But what about the fact, you may ask, that unwanted children are a burden on society as well as to their mothers? Perhaps there is a social interest in subsidizing birth control? Perhaps there is—but if so, this is an awful way to do it.

Which is, in my mind, the same as admitting the whole essay is about obfuscating by referring to a red herring.  Yes, the real question is whether it makes the most economic sense to subsidize birth control in this way.  Politically, perhaps, this this the only realistic alternative, but that discussion is the right one to have.  Talking about oil changes and toothpaste is completely beside the point.  And besides, this incorporates the subsidy in the private sector rather than making another government program, something that is supposed to be preferred.

So discuss away whether the externality is big enough to warrant intervention into the private birth control market, whether there is an efficient solution that can correct the market failure and if this program is the best way to do it.  But don't deliberately distort the issue by talking about oil changes in cars.

Economist's Notebook: On Economics

I had never encountered this quote before I read it in Greg Mankiw's New York Times Op-Ed this past sunday.  It is from Keynes:

“The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique for thinking, which helps the possessor to draw correct conclusions.”

I think this is about as perfect a statement on economics as there can be.  I often describe economics as simply a system of logic - a precise way to think about how the world is organized.  In another article in the same Times, Nobelist Tom Sargent referred to a former TA who called economics 'organized common sense,' which is also a good description as long as the emphasis is on the 'organized.'

I like economics because it allows me to see connections clearly, understand society better and be able to be precise and clear when I think about economic challenges and potential solutions.  In fact it was the frustration of living and studying in India as a junior in college that really cemented this in my mind: all around were examples of exceptional poverty and economic malaise and all of the discussions about the cause of the problems were notional and poorly focused.  I wanted answers, or lacking that, a precise way to think about the problems.  Economics gave me just that, and I now spend my life trying to find answers.

But the discipline of economics does not promote capitalism, nor any particular political philosophy.  You can be as liberal as Krugman or as conservative as Friedman and still understand that economics allows us to understand markets clearly - both the benefits and the drawbacks - and reasonable people can draw very different conclusions about the way society should be organized around them.  This is a strength, not a weakness of the discipline: we are looking for facts, not considered opinion.  

What you shouldn't be is an advocate for any economic structure without understanding neo-classical economics.  Which is why, frankly, I think the bulk of the heterodox folks, who have established a separate and parallel discipline, have it wrong.  You have to base your advocacy for non-market based economic systems on a reasonable critique of market outcomes based on neo-classical economics. By dismissing the core of economic thought and attacking straw men caricatures of the same you are not even competing in the marketplace of ideas, but relegating yourself to the fringe.

I say this because if the Occupy movement wants to argue that the current system is flawed and needs fundamental reform, they should study hard in principles of economics rather than walk out and dismiss it out of hand.  There is plenty there to serve as the foundation of a progressive critique of the current system. And there is plenty there to serve as a conservative rebuke as well.  Such is the beauty and utility of economics.

Economist's Notebook: Lake O Streetcar and Accounting v. Opportunity Costs

An article in The Oregonian discusses the new and improved cost figures for the proposed Lake Oswego Streetcar extension. In it, there is a discussion about whether the cost of the land that was purchased years ago should be included. This is a classic lesson in accounting versus opportunity costs in economics:

The new figure also does not include land owned by the government that originally had been included with capital costs. That alone reduced the price tag now being promoted by $80.3 million.

"I don't think it's disingenuous at all," said Obletz, who argued that the land is "not a cost to the project."

It may be correct to say the land is not an accounting cost for the project going forward, but it is entirely incorrect to say it is not a cost of the project. The reason economics makes the distinction is that the opportunity cost includes the next best alternative usage for the land and thus deciding to use the land for this project makes it unavailable for other uses.

In other words, if the land can be sold say for $100 million than utilizing it for this project denies that $100 million for any other use.  So, if you are doing a cost-benefit analysis of a project you have to include this cost as well, it is just as important as any real accounting cost going forward.

I kinda hope the streetcar guts built, it'd be pretty cool, but let's be real about the cost.

Economist's Notebook: A Lesson in Cost Disease

From Jack Bog's Blog I find this wonderful picture from a Radio Shack ad that was in a Popular Mechanics magazine from 1987.

Note the super duper lightweight portable cellular phone for only $1499!  That is almost $2900 in today's dollars.  Not only are cell phones remarkably cheaper, but they are an order of magnitude more capable.  You can buy an iPhone for $300 that is a super-computer by 1987 standards.

Which is a nice jumping off point for the discussion of 'cost disease.'  Which is actually a fairly simple concept.  When we measure inflation through time, we use the average price increases over a whole basket of goods which means we do it over a whole range of industries.  Some of these goods/industries (like cell phones/consumer electronics) are prone to huge productivity increases - meaning we can make the same good much less expensively now than before.  Other things are not a prone to such increases.  Books, for example, or (you know this was coming) craft beer.  

For example, I grabbed a book I bought around the same time off my shelf: In Exile from the Land of Snows. It has a cover price of $9.95.  The very same book today has a cover price of $16.00. [This was bought and ready during my time studying and traveling in India and Nepal, it is an account of the Dalai Lama and the Tibetan government in exile and is is highly recommended]  The price increase for the book is slightly lower than inflation but partly this represents the fixed costs (the price of the manuscript) being spread ever more thinly.  But in general, though we can now do electronic type setting and other productivity enhancing things, the printing of the word onto paper and binding it to ship and sell has not seen a lot of productivity enhancement over the last 25 years.

Anyway the point is that some products are less prone to productivity increases. The classic Baumol example is the symphony orchestra which takes just as many musicians just as much time to play a Mozart or Beethoven piece today as in the late 1700s.  There has been no productivity gain at all.

When you put them altogether and average the price increases across all different industries, you will see industries (like symphonies) that routinely see price increases greater than inflation and other industries (like consumer electronics) where prices actually keep falling.  We describe industries of the former type those that experience 'cost disease' because it is a natural consequence of an industry where productivity does not increase much.

Economist's Notebook: Tenancy Rent Control

This map, created using 2010 census data, shows vacant housing units in the Bay Area

Source: The Bay Citizen (http://s.tt/12lM2) Credit: Eric Fischer

Via Greg Mankiw I find this fascinating article about the affect of tenancy rent control in San Francisco.  Tenancy rent control is a term Kaushik Basu and I coined to describe the type of rent control that is attached to a tenancy as opposed to the old-style price ceiling attached to a rental unit.  Tenancy rent controls (often found in the form of tenant's rights laws) are the far more common modern version of rent control and do not fit the classical textbook price ceiling model that we still teach our econ 101 students.  Which is why Kaushik and I wrote two papers that attempt to model the effects of these types of rent controls (you can find them here and here).

Here is an excerpt from the article in the Bay Citizen:

Koniuk, who himself lives in suburban Belmont, gave a half-interest in the building to his older son in 2007 so he could evict a tenant and move in himself. But under San Francisco’s extraordinarily pro-tenant housing laws, landlords can do this only once per building.

So while Koniuk desperately wants to move his younger son into the building’s other four-bedroom apartment, he cannot. He is exploring legal options. Robert Murphy, who has lived there for 30 years without a lease, remains, paying $525.82 a month.

Last spring, Koniuk offered Murphy $45,000 to move out. Murphy’s lawyer demanded $70,000, a sum Koniuk says he does not have. Meanwhile, the city’s Rent Board notified Koniuk that he was allowed to increase Murphy’s monthly rent this year by $2.63.

Murphy is afforded extra protections as a renter because he is more than 60 years old. Koniuk might still be able to evict Murphy and allow his younger son, Adam, to move in by invoking the Ellis Act, which would entitle Murphy to about $10,000 in compensation and give him a year to vacate. But doing so would impose permanent restrictions on the Divisadero building’s future use, seriously depressing its value. And should 24-year-old Adam decide to move elsewhere, the Koniuks would be legally required for a decade to offer Murphy his old apartment, at his old rent. Invoking the Ellis Act would also mean that any new tenant to the unit, should Murphy decline the chance to return, would also be entitled to Murphy's old rent amount for many years to come. So the Koniuks would likely opt to just leave it vacant.

Kaushik and I were neither condemning nor supporting such laws, rather we were simply trying to understand how they impact an economy.  What we found was that long stayers (those who were able to remain in an apartment for a long time) ended up paying less than they would in a free market and short-stayers paid more.  Landlords were no better or worse off on average.  So whether tenancy rent control is  a good thing depends on what type of tenant you are: older, less-mobile people probably benefit at the expense of younger more peripatetic people.

For example, this story could have been told from another POV that focused on the aging man who has lived in his little apartment for 30 years being saved from homelessness by the good laws of the city.

A research question left open, that I have never returned to, is what economic impact might such legislation have on a city's economy.  As it leads to a lager concentration of older tenants and keeps the younger ones out.

As far as market equilibrium, if there is a higher concentration of long-stayers, this increases the cost of renting an apartment and initial rents have to increase as a result.  In the end, at least in San Francisco, the result is a lot of vacancy.

Increasingly, small-time landlords like Koniuk are just giving up. One of his Divisadero Street neighbors has left two large apartments on the second and third floors of her building vacant for more than a decade, after a series of tenant difficulties. It’s just not worth the bother, or the risk, of being legally tied to a tenant for decades.

“Vacancy rates are going up because owners have decided to take their units off the market,” said Ross Mirkarimi, a progressive member of the Board of Supervisors. He attributes that response to “peaking frustrations in dealing with the range of laws that protect tenants in San Francisco that make it difficult for small property owners to thrive.”

Perversely, that is hurting the city’s renters as well, as a large percentage of the city’s housing stock is allowed to just sit vacant, driving up rents that newcomers pay for market-rate housing.

Sadly, though price ceilings are almost nonexistent as rent controls these days (at least in the US) it is still the general framework people use to think about all such rent control laws thanks to econ 101.

Economist's Notebook: Missing Markets, Design and the CRC

Deck Truss CRC

The recent decision to proceed with the deck truss design for the Columbia River Crossing project rather than the more expensive but more aesthetically pleasing options (at least to some minds) brings up an interesting topic - how do we value design?

Cable Stayed CRC

In private architecture (by which I mean designing for a private client) the client decides how much aesthetics are worth to them and they pay to have a design whose marginal aesthetic value is equal to the marginal cost of said aesthetics.

And thus, for example, we get office buildings that are more than just square boxes:

Hearst Tower NYC

Apartment and condo towers also have this quality.  Part of the selling point to any apartment or condo is the aesthetics of the building itself:

Calatrava's Concept for Condo Tower in Manhattan

Even public buildings that are funded at least in part through private donations - the aesthetics are an important aspect to convince donors that they are helping realize something unique and inspiring:

Seattle Public Library

Milwaukee Art Museum

But public works projects are often lacking aesthetically and it is no wonder as there is no market for aesthetics in such projects.  In economics we call this a missing market.  It may be that residents of Oregon and Washington prefer a more aesthetically pleasing bridge and would even be willing to pay a little to have a bridge that inspires rather than stultifies but there is no method for them to do so.  Even if there was there is the remaining problem common to any public good - the free rider problem.  Few would actually give money for such an endeavor hoping that others will and they they can get the benefit for free.

Since there is no real market for aesthetics we cannot know what the optimal level of aesthetics for such a project is.  It is quite possible (perhaps likely?) that the simple deck truss is the right option for a bridge that is not in the middle of Portland.  If we had to remake the Marquam Bridge downtown I suspect there would be overwhelming sentiment for something beautiful in its place.

As for me I am not sure how much I would be willing to pay for a beautiful CRC - a little perhaps but not a lot.  The bridge is not in a place where I see it much and when I do it is for utilitarian reasons (I am driving over it).  But I would imagine that the city of Vancouver would have a much more interested population as it is going to be a permanent part of the scenery.  Which is probably why there was enough momentum to choose a reasonably beautiful design for the new Tri-Met bridge and a less than horrible design for the new Sellwood Bridge:

Modern bridges, it seems to me (knowing nothing about bridge building), require much less structure and so there are fewer opportunities for design elements to be incorporated.  I am thinking now of the Golden Gate Bridge which is beautiful in both structure and design, but the design elements are almost incidental to the structure itself.  By this I mean that you had to design the towers and the rest somehow so there were ample opportunities to add design elements and as such it was a minor part of the overall construction budget.  Without as much structure upon which to add design elements, the design of the structure itself is now pre-eminent:

Puente de Alamillo-Calatrava

Still, even when we do emphasize design we don't always get it right:

The publicly funded Portland Building

Actually, I have to admit, I still like the Portland Building - it is anything but boring and makes downtown just that much more fun and quirky.

Economist's Notebook: On-Line News and the Prisoner's Dilemma

I received this today in my e-mail box:

Dear New York Times Reader,

Today marks a significant transition for The New York Times as we introduce digital subscriptions. It’s an important step that we hope you will see as an investment in The Times, one that will strengthen our ability to provide high-quality journalism to readers around the world and on any platform. The change will primarily affect those who are heavy consumers of the content on our Web site and on mobile applications.

***

If you are a home delivery subscriber of The New York Times, you will continue to have full and free access to our news, information, opinion and the rest of our rich offerings on your computer, smartphone and tablet. International Herald Tribune subscribers will also receive free access to NYTimes.com.

If you are not a home delivery subscriber, you will have free access up to a defined reading limit. If you exceed that limit, you will be asked to become a digital subscriber.

This is how it will work, and what it means for you:

On NYTimes.com, you can view 20 articles each month at no charge (including slide shows, videos and other features). After 20 articles, we will ask you to become a digital subscriber, with full access to our site.

This has been coming for some time now and it will severely hamper my blogging as I rely on The Times for a lot of my content. There is a lot of talk among those who study the news business about this model and if it will work - will people really (finally) pay for content on the web?

NPR recently had a nice piece on The Times of London's experience with a pay wall where they lost about 95% of their audience after instituting it.  So there is every reason to expect the NY Times' experiment to fail as well - though the London Times is still sticking with it and embracing the remaining 5% as the right sort of people (how very British).

To me this is a classic game theory problem: the payoffs to any one news outlet's decision to charge is a function of other news outlets' decisions. To wit, if all the major news organizations decided to charge for on-line content then to read news on-line consumers would have to pay and all the news organizations might be able to sustain healthy readership as there would be no other alternative to those seeking news.

Of course this is not how it works. There are so many sources of news that any one decision to charge sends readers scurrying elsewhere ala The Times of London. But if all of the players could coordinate and contract over charging for the service, they would all be better off.  If there was no one free alternative there would probably be enough custom to go around and keep many papers in newsprint microchips.

This is the classic market failure that we associate with strategic situations in economics and is precisely the point of the prisoner's dilemma game: in strategic situations (where an individual's outcome depends on the decisions of other players) acting in your own self interest can lead to inefficient outcomes. In fact the best outcome is to be the one provider that doesn't charge - gets an amazing amount of visitors and can charge a decent amount for advertising.

Not coincidental, I think, that in the same week as the New York Times institutes a pay-wall, the still free Washington Post unveils a major web-site redesign. Ah the games we play...

Economist's Notebook: Prices and Rationing

I have a great person who cuts my hair in Corvallis.  It used to be easy to schedule an appointment with her but apparently her skills are becoming more well known and now it is much more difficult to find a time that matches with my free time in Corvallis (which is very scarce).  

I have been going to her since 2006 when I first moved back to Oregon and she always reminds me that her prices have stayed the same in that time.  "Still $25, as always!" She proudly proclaims.

This time it was especially hard to make a suitable appointment so she was quite surprised when I responded that I wished it was more so I could make an appointment more easily.  

To her this was crazy talk, but to me this is how scarce resources (her talent in this case) is rationed efficiently - prices rise until demand meets supply.

She still wasn't buying it - especially when I told her she might actually do better with higher prices and a less full schedule.

And so I will continue to struggle to schedule appointments....alas.

Economist's Notebook: Exercise and Climate

From The Economist a little blurb on some CDC data abut exercise and climate showing people in colder climates exercise more.  The Economist seems to find this a surprising correlation wondering why don't people in warmer climates get outside and exercise more.

One explanation is that in colder climates it is harder to be outside and idle, you need to be active to stay warm, and that warmer climates in the US are very very warm and often quite humid, making exerting yourself quite difficult.  Another is that these colder climates also are disproportionately places where there is magnificent natural wilderness and recreational opportunities.  A third is that people choose to live where they do for a reason and a lot of people who live in the west and in states in the north like Vermont and Maine do so to take advantage of the outdoor recreational opportunities.

Thats is all to say I don't find it that surprising.

Economist's Notebook: The Economics of Moles

[I resisted the temptation to call it Mole-o-nomics, aren't you all proud of me?]

This summer a mole (I shall henceforth call him Morris, though in truth I know not its name nor gender) decided to make himself at home in my back yard.   At first I was okay with this development, feeling I could live in harmony with my subterranean little friend.  And at first, this symbiotic arrangement seemed to be working out just fine - a couple of mole mounds appeared, but only one in the grass and I tended to all of them easily.  But then old Morris started to expand his home at the expense of my yard that I had only just completely rehabilitated.  Not really being a good guest this Morris, thought I. And recently he has really gone into overdrive digging up my yard and making a general mess of my lawn.

So what to do?  Well. I went down to the local hardware store to look for mole traps but I quickly began to have serious misgivings as I looked at the description of the violence promised to Morris.  These traps are also difficult to set (requiring lots of digging and careful placement) in addition to their being quite horrific.  Inflicting such horrors on poor old Morris seemed to be cosmically quesitonable, after all Morris is simply being a mole.

But then the good salesperson introduced me to the 'sonic spike.'  This is a device that sends out sonic waves in the ground and claims that this will drive away moles.  My first instinct is that this type of application of technology never works and a quick check of the intertubes reveals less than satisfied customers.  Nevertheless, the manager of the hardware store was claimed to have personally used them successfully in my neighborhood so I figured it was worth a try.

Besides, this approach has economics on its side.   What I mean by this is that the principle of the sonic spike is to make life in my yard not unbearable but marginally less pleasant than other places.  In economics we know that economic decisions are made at the margin.  In other words, Morris doesn't think 'well the benefits of Emerson's yard outweigh the costs even with this annoying noise (which is probably true), so I'll stay.'  No, Morris, being subject to the same incentives that influence us superterranean beings, thinks 'hmmm...here are two yards seperated only by a fence, but one is just slightly more annoying so I think I'll go to the more peaceful one.'  So, assuming I am right about the response of moles to incentives, it'll work.  But even if it doesn't, it makes for a good economics experiment.

Now, you have by now seen the er...moral ambiguity associated with this plan.  My mole strategy has an external cost that will be born by my neighbors: I am not removing the mole, only hoping to get it to move next door.  This is an example of a classic externality problem: if a the total cost of an activitiy is not born by the actor, too much will be done.  I am a good self-interested rational agent, and since I don't have to pay the cost of my neighbors' mole problem, I do not figure it into my calculation of relevant costs and benefits, so I choose the spike.

However, a bigger problem arises if all the neighbors decide on the same mole strategy.  If we all plant sonic spikes, the old Morris will think that every yard is as good as the next and whatever made him choose mine will cause him to chose it again. 

So I am not convinced it is the solution to my problem (and there is the downside of little high-pitched hums that eminate from the spike about every 30 seconds), but it'll be interesting if it is, at least for now.  And it keeps me karmically safe in the interim.

Failing that I may go with what seems the next best route: stick a hose from the tailpipe of my car into the ground and gas old Morris to death.  My big quesiton here is how do you get the car to not stall out due to clogging the tailpipe - isn't this similar to the old banana in the tailpipe trick?

Economist's Notebook: Self-Selection and Oregon's SAT Scores

Oregon kids' performance on the SAT exam is better than the national average crows the State Board of Education.

SALEM, Ore. (AP) -- Oregon high school students taking the SAT college entrance exam did better in reading and writing this year and held steady in mathematics.

The state Department of Education said Monday the average scores of 521 in reading and 496 in writing were two points higher than last year. The average in mathematics was 523.

The department said all three scores outpace national averages.

More than 14,000 public school students took the SAT test this year.
The ACT test taken by 11,000 students this year reported scores up slightly from last year.

If the SAT were a standard test administered to all high school students in the US then we could talk about comparing across states.  But the SAT is a voluntary test taken by those kids that would like to continue on to college, so you can't compare across states unless you can control for selection.

Take a simple example - two states with identical distributions of student talent (both inherent and taught).  Suppose however that in one state (for whatever reason) almost all students sit for the exam regardless of preparation or intent to go on to college, while in  the other state only the kids who definitely plan to go on to college sit for the exam.  Now if all students in both states were forced to take the exam we would expect the distribution of scores, including the mean and median, to be the same based on the assumption of equal talent across the two states.  But would the mean and median be the same based on the self-selection story I described above?  No.  In fact we would expect the mean and median to be much higher in the state where only college-bound kids take the test.  And in practice, there is a high correlation between participation rates and average SAT scores across states.

So how does Oregon stack up?  Not bad actually.  In 2008 it was 20th in participation rates, so its better than average performance is not just a self-selection story, but many other factors including demographics are important as well.

This is not to say that Oregon is not doing well, they could be doing fantastically well, it is just to say that you can't tell either way from the data.

By the way, the process of comparing SAT scores across states is actively discouraged by the College board so it is disappointing that the Dept. of Ed. would even mention it. This is the disclaimer that is all over their web site:

A Word About Comparing States and Schools
The SAT is a strong indicator of trends in the college-bound population, but it should never be used alone for such comparisons because demographics and other nonschool factors can have a strong effect on scores.

Beeronomics and Economist's Notebook: Does Drinking in College Hurt Performance?

I figured I'd put this in the Beeronomics sphere as well as the Economist's Notebook as beer is one of the beverages of choice among collegge students: A new NBER paper [HT: Freakonomics] reports that drinking in college impairs performance.  From the abstract:

This paper examines the effect of alcohol consumption on student achievement. To do so, we exploit the discontinuity in drinking at age 21 at a college in which the minimum legal drinking age is strictly enforced. We find that drinking causes significant reductions in academic performance, particularly for the highest-performing students. This suggests that the negative consequences of alcohol consumption extend beyond the narrow segment of the population at risk of more severe, low-frequency, outcomes.

Uh oh. This should come as no surprise to anyone who has ever been, or been exposed to, college students: students drinking alcohol is common and the effects of alcohol (as most college students will tell you) impedes their academic performance.

But look more closely at the abstract to understand just what it is the authors are doing in this paper, and the actual story becomes less less clear.  The authors took data from the US Air Force Academy where underage drinking is not tolerated and can lead to immediate expulsion and compared the performance of students just before their 21st birthdays and the performance of students just after their 21st birthdays.

So it is not the alcohol itself the authors are isolating, but the entire change in lifestyle and time management that happens when students turn 21. The authors claim that the USAFA data are a source of strength, but I actually see it as a major weakness.  With such a tightly controlled campus, 21st birthdays may traditionally be a moment of liberation, not just to drink alcohol but to become more social off campus and perhaps less serious on campus.  Now, I imagine that they have a control group for comparison of students who didn't drink prior to age 21 and who don't drink after turning 21, but this is not really a counterfactual because not drinking may also signal a rejection of the entire post-21 lifestyle of which I speak.  [I don't have access to NBER working papers through OSU]

This is just another problem of identifying causality that always happens with social data: is it the alcohol that impedes performance or the behaviors correlated with alcohol?  I suspect both.

Another point is that students are maximizing utility functions that include academic performance, social performance and just plain fun.  Many students recognize the tradeoffs inherent in drinking, and in socializing in general, with academic performance and make their own decisions about where their optimum point lies.  The question then is do they accurately estimate the effect of alcohol consumption on academic performance or do they not understand the deleterious effects?  If the former, than there is nothing to say unless there are significant social costs. If the latter, than we need to understand these effects and transmit the knowledge to students. Unfortunately, I don't think this paper does this.

Finally, the other important question is if there really are significant social costs.  Underage drinking has many by the way, which is why we prohibit it, but I am talking here only of the effect on academic performance.  Well, there are social returns to education so if alcohol impairs individual performance, it should also have a social impact as well, as a less well educated population is less productive.  But how significant are these costs is an important question and one we don't have the answer to.

So it is an important research agenda, but a tough causal link to uncover.  

Economist's Notebook: Economics of Sports

Photo Credit: Beth Nakamura, The Oregonian

The family decided to spend Labor Day at PGE Park attending the latest of the Beavers farewell season closers.  Absolutely picture perfect weather and an entertaining game: it was great.  For the first time in recent memory, the crowd was actually paying attention to the game and it was a very entertaining one as well: lots of lead changes and home runs an even a nail-biting finish.  It was a great day.

The Oregonian has been a bit overwrought about the Beavers leaving - too much so I feel.  Editorials about how it is a failure of leadership by the city government, a column by John Canzano (who hardly ever even bothers to mention the Beavers in his column), ever the opportunist, calling out Sam Adams, and a long series of farewell pieces all graces the pages recently.

But why all the hand wringing and fuss?  This is not the same baseball team that was here until 1993, and no one remembers the Portland Rockies (Rockies, really, couldn't that have at least called themselves the Cascades?  Salt Lake City Bees (né Buzz) anyone?  Yep, those are the old Beavers.  It is also not the last team that will play baseball in Portland.  Portland is the biggest non-baseball market in the country, there will be something.

But the fact is that baseball at Civic Stadium is no longer viable (as PGEs naming rights deal is expiring, I am choosing to call it by its old moniker).  This is something people don't seem to get. 2,000 people showing up for a game in a 16,000 seat stadium is not a winning proposition.  When people grumble about soccer displacing baseball, they should be happy that an economically viable use for Civic Stadium has been found and that the wonderful old stadium shall have a new life.

I think the economics of pro sports are clear in this case.  Minor league baseball is now a niche sport - a small but loyal fan base will support it but it does not have broad appeal.  It is not MLB: the media saturation of top level pro sports has given people everywhere front row seats to MLB games, made the stars household names, and I believe has lowered the demand for minor league baseball, at least in cities like Portland, where the team no longer has that community embrace that comes from a sense of ownership.  Now with free agency and mass player movement, the team doesn't even feel like part of some larger family, just a way station for players on the way up or down.

My demand for the Beavers is typical I think, I go a few times a year to spend some time on nice summer evenings chatting with friends, casually following the action and generally enjoying Portland summers.  I don't really go because I am a fan of the team.

[As an aside, even if the demand for the Beavers was like yesterday, the poor old Stadium could not handle it: concession lines were unbelievable]

Anyway, there will be a day soon, when someone - possibly even Meritt Paulson - figures out how to build a small stadium in town and baseball returns.  I don't really think it matters if it is triple-A or something lower.  And it will again be a place to spend warm Portland evenings. Until then I think we should stop the histrionics.

Economist's Notebook: Paying Students for Grades

I am about to go off on another short vacation, but this one will be without the internets (and phone, and cell phone and television and newspaper) so no posting until Friday after this post today.

And no time for a proper blog post today except for a quick comment on a Susan Neilsen column on Sunday about paying students for achievement.  In her column she is skeptical (but I am not sure that anyone has seriously suggested this as a state-wide policy, have they?) and mentions some disappointing results from a Harvard econ prof.  That prof would be Ronald Fryer and he has indeed had poor results from paying disadvantaged students for good grades.

What is interesting is something Steve Coate told me recently when I had lunch with him and three other present and former Cornell faculty who were all in town to attend the Western Econ Assoc. Annual Conference.  Steve had recently had a visiting prof. stint at Harvard and recalled that, during a conversation, Fryer had explained that the problem with paying kids for results is that they don't understand the production function.  What he meant by that is that it is no good paying kids to get As when they have no idea how to go about earning As.  What you have to do, Steve recalled him saying, is pay them for the process of learning, like some money for reading ten pages of a textbook.  Apparently there is some division among Harvard faculty about whether this is Fryer's opinion or what the data say themselves, but I found it interesting and reasonable.  Let's just say that it sounds notional and there may not yet be the data to support the theory.

Okay, that's all I got.  See you on Friday.

Beeronomics and Economist's Notebook: Creative Destruction, Shut-Down Conditions and Roots

Word that Roots Brewing was in trouble has been passed around for quite some time now, and recently John Foyston reported on the fact that Roots was up for sale, but it was still a bit of a shock (and quite sad) to get the word that Roots was closed for good.

But while the beer enthusiast in me is saddened, the economist in me sees this as (curiously perhaps) a sign of a very healthy beer economy in Portland.  A few weeks ago I attended Greenlight Greater Portland's annual Economic Summit and, while talking to Joe Cortright, Rich Read of The Oregonian came up and we were talking about the economy and small businesses. I was quoted as saying that it doesn't bother me to see many start-ups fail and what I meant by that is that in a healthy competitive economy many new ideas will be tried, will try to find markets and will not succeed because of other better ideas or more well-run businesses. The key is that new businesses are tried - and in a healthy marketplace only the best ones will survive.  Survival of the fittest if you will, but in economics we call this process of new and better ideas and businesses taking the place of established ones as 'creative destruction' and we view it as a good thing. [The term was popularized, though not coined, by Joseph Schumpeter] In Portland it is quite shocking to get bad food or bad service in a restaurant because there are so many great ones out there that if you don't do it very well, you won't last.  This is a good thing.  What would be bad is if we didn't see this dynamic and mediocre businesses succeeded.

Let me say straight out that Roots problems were not with the beer itself, which was fantastic, but with other aspects of the business.  My own history with Roots is troubled: the only two times I went to the pub with the intent to get a meal at lunch, I found the pub closed when it was supposed to be open.  I have bought their beer in the bottle many times, but I was one of the customers that got a bottle that shouldn't have been on the shelf, it was, quite simply, bad.  Complaints of bad service at the brewpub abound and with so many great choices for brewpubs around town, it is not hard to see why Roots quickly found itself in trouble. The point is it probably wouldn't have been in trouble in an economy in which there was not much brewing going on, so what the closure of Roots symbolizes is that, regardless of how wonderful the beer was, there is so much other wonderful beer being produced and served in Portland.  Long live Beervana, indeed.

The other thing that Roots' demise made me think of is the example of short-run and long-run shut down conditions that we typically talk about in a variety of economics classes, especially intermediate micro.  In econo-speak the short-run is any amount of time in which there are fixed costs.  Take for example a lease on a building in SE Portland: if you sign a one-year lease and you are on the hook for the lease payment regardless if your business is open or not.  In this case, it may make sense to keep the business running even if you are loosing money.  Why? Well, if you are able to cover your variable costs (labor, electricity, inputs, etc.) and part of your fixed costs (maybe one-half of your lease payment) it is better than shutting down and having to pay your entire fixed cost without any revenue.  In the long-run (a time period in which there are no fixed costs) you would shut down, because you would not renew the lease and so negative profits are a sufficient shut-down condition.

It would be great to see Roots rise again, perhaps as a commercial brewery only, but with the rapidly evolving dynamic of the local beer scene, it is hard to see Roots capturing the attention of the local beer crowd again.  Just like a chef who closes a restaurant, it may be time for Craig Nicholls to re-invent himself and his beer company.  And I think Roots will be far from the last brewery to close locally, with so many new places opening up, the forces of creative destruction will be pretty fierce.  Even though craft beer continues to whittle away at the market share of the macro-brewers, it is likely that the struggles to find shelf-space, tap handles and pub crowds will become more and more intense.  But just like the wonderful and creative food scene that has arisen in Portland, this dynamic is likely to create better and better beers and pubs.  So embrace it, I say.

Economist's Notebook: Unintended Consequences

NPR has a nice story on the unintended consequences of flooding Haiti with free rice:

L'Artibonite, a Haitian town two hours north of Port-au-Prince, wasn't damaged in this year's earthquake. But the foreign aid that flowed into Haiti after the quake has been a blow to the area.

Most of the people in l'Artibonite earn their living by growing and selling rice, Haiti's staple food. But the influx of foreign food aid has meant that many Haitians can now get rice for free. As a result, the price of rice in Haiti has plummeted.

Mirana Honorable, a rice farmer, has to choose between selling enough rice to pay for her children to go to school, and having enough rice for her family to eat.

Good to have a little economics training - would teach you to expect this and plan in anticipation. Buying local rice at regular market prices would be a good start.

Economist's Notebook: Game Theory and Athletic Conferences

In my Managerial Economics class this term we studied strategic interaction in great detail.  We saw how one player's actions can affect others' payoffs and how players can gain advantage through being first movers and making credible commitments.

I thought of all of this today as the news that Colorado has agreed to join the Pac 10 hit the news sites.  This decision by Colorado is likely to set of a cascade of movement across the Big Ten, Big 12, Big East and Mountain West conferences.

Colorado's decision to join the Pac 10 may seem abrupt, but they have employed a classic strategy and gained the first-mover advantage.  You see, there is widespread speculation that Texas, Texas A&M, Texas Tech, Oklahoma and Oklahoma State are going to join the Pac 10 and politicians in Texas were starting to make noise about preventing the Texas schools from joining the Pac 10 unless Baylor was included as well.  As the Pac 10 does not want more than 16 teams, this would have left Colorado out.  Seeing that this was changing the strategic landscape and not wanting to be left out in the cold, Colorado jumped first and gained the first mover advantage.

Now, every other team and conference's payoffs have changed and I expect to see some pretty swift defections right away.  Apparently Nebraska is about to leave the Big 12 and join the Big Ten (which will then become, humorously, a 12 team league).  Missouri may follow suit.  This leaves Kansas, Kansas State, Iowa State and Baylor without a conference and I imagine that the Mountain West which is employing a different strategy - wait and let the payoffs change to the point that you become an attractive option - will open up its arms to these schools.

If I were the Mountain West I would bring on board these four schools and Boise State pronto in the hopes of becoming a BCS conference.  But Kansas basketball battling it out in places like Ft. Collins, Reno, Provo, Laramie and Albuquerque?  Weird.

The most interesting piece is the play of Notre Dame, which has a lucrative deal for its independent football team but risks the rest of its sports getting lost in the conference shuffle.  My bet is that they end up in the Big Ten along with Nebraska, Missouri, Rutgers and one other - Syracuse maybe?

Anyway, this is all an incredibly high stakes game being played at the moment and it is fascinating to observe as a student of game theory.   The one player in all of this that does not seen to have any kind of winning strategy is the Big 12 conference.  It looks like a goner for sure.  Like I said, weird.

Don't know if this is a net positive or negative for Oregon State, but it hardly matters, the status quo is gone.  Little tiny stadiums like those in Corvallis, Pullman and Palo Alto are going to look awfully puny if Austin, Norman, College Station are added to the mix (all over 80,000 capacity).  And now there is the real prospect of two orange and black OSUs in the same conference...

Economist's Notebook: Money and Sports Drafts

On the morning after last year's number one pick in baseball, Stephen Strasburg, had a stunning debut for the Naionals...

AP sports writer Jimmy Golen has a nice article that wonders why Major League Baseball does not allow the trading of draft picks as do the NFL and the NBA.  MLBs prohibition doesn't make sense to economists who know that prohibiting voluntary transactions almost always leads to sub-optimal outcomes.  Why not let teams trade draft picks if they think it can make their club stronger?

Steve Levitt mentions this article on the Freakonomics Blog and Economist Richard Thaler is quoted in the article making the same point.

But I wonder why these economists have not mentioned the obvious question: why not monetize the draft?  In fact this is not my idea, it was the idea of a friend of mine from grad school who, before he went to grad school worked as an economic consultant and even got an audience with the NFL to suggest the idea.  Apparently he was not persuasive enough.

The idea is pretty simple: barter economies are much more inefficient than money economies.  If you have a kumquat and would like to consume an orange in a barter economy, you have to find someone who both wants a kumquat and has a orange to offer.  In a money economy you need only to find a buyer for a kumquat and then you can take your money and give it to the holder of an orange.

Trading in sports drafts is the same thing.  If you have the number one draft pick, but prefer, say, three role-players you have to find a team that both wants the number one and has three role-players that you want.

What if instead of getting to pick first, the worst NFL team from last season were given 10,000 "draft bucks," the number two team 8,000, the number three 7,000 and so on.  The absolute amounts are not important, only the relative amounts.  Then on draft day, you hold a big auction - e-bay style - on all players eligible that year.  Teams that value a certain player highly will bid a lot ( and will therefore have less to spend on other players if they win the auction), and teams that don't won't bid at all.

So instead of having the number one pick, you have the most money to spend, but you can spend it exactly as you see fit. It wouldn't have the drama of the draft and nowadays these things are big media events, but it should increase efficiency and improve the level of play in the league.

In fact, according to economic theory, what you should get is Pareto-efficient outcomes, outcomes that capture all of the total surplus available in the market.

What's not to like?