Beeronomics: Spatial Economics and Where to Locate a New Brewpub

NOTE: A rare cross-post from the Beeronomics blog - but this one is econ-heavy.

Migration is my bell-weather:
questionable quality, but great location
and lots of punters despite a lot of local competition.  

Recently I was chatting to a fellow who is planning on opening a new brewpub in Portland.  A discussion ensued about whether it is better to find a nice untapped neighborhood or locate near other brewpubs.  There are really two aspects to this question that, to my mind at least, relate immediately to economics: location theory and externalities.

Location theory is pretty straightforward at first.  Imagine a city being one big circle with people distributed evenly within that circle.  If you are the first brewpub in Portland there is a strong incentive to locate centrally to minimize the average distance from customers.  In Portland density is not uniform and there are lots of natural barriers to travel that make it more complicated but to a first approximation, this is essentially correct.  Now what if you are the second brewpub?  Should you try and distance yourself from the first to set yourself apart?  Well if you do, you have to go nearer to an edge of the city and you potentially lose customers.  So the interesting result is that, in general, the best move is to move in next door and share the customers.

The easiest way to conceptualize this is to think of a long linear boardwalk (a la the Hotelling model) where there is a hot dog vendor right in the middle.  If you are another vendor where do you set up?  Well suppose you set up half way between the existing vendor and one end.  Assuming the hot dogs are the same and you are charging the same price then customers will simply come to the closer one (and we will assume that for those customers for whom the two vendors are equi-distant will split evenly between the two carts), you get all the customers between you and the end and, between the two carts, you get the customers that are nearer to you.

Now, is this the best you can do? No. If you move a bit closer to the one in the middle, you'll get more customers between you and the end - all of which buy from you - and the cut off point between your customers and the other stand's gets closer to the stand in the middle.  Thus you sell more hot dogs by moving closer.  This is true as long as there is some distance between you and the other stand.  The end result is that you end up right next to each other.  

There are, of course, lots of strong assumptions here (uniform distributions, same product and price, low enough prices that all customers want to buy, etc., etc.) but next time you are traveling around to smaller towns and see two supermarkets located near each other, you'll have an idea why (this was true, for example, in Ithaca, NY where I lived for 5 years).

Is this applicable to the brewpub market?  Not entirely because you would not expect to divide up customers by traveling distance alone and density of brewpub customers varies a lot.  So you probably face the trade off of finding a neighborhood with no brewpubs to locate in and capturing most of the local custom versus sharing the customers in a high brewpub goer density market.

Which brings us to the other aspect I mentioned: externalities.  Most people think of smokestacks and smog when they hear the term, but externalities can be good as well.  In the case of brewpubs, I tend to think neighboring brewpubs compete for customers but they also bring more potential customers to the neighborhood.   So the presence of one more brewpub in a small area with existing brewpubs increases the total demand for all of them (though it may well diminish the individual demand as you are dividing the customers by a bigger number).

In the end then there is no right answer but, all else equal, my instinct would be to try and stay pretty central Eastside - very high density of brewpub customers, thriving existing brewpubs.  Especially starting up, you need folks to discover you. I would be very hesitant to locate too far afield as I might capture the local market but not attract any others and it might be hard to make a reputation that would get people to come from other neighborhoods. That said, there are still many pretty close-in neighborhoods that are, as yet, untapped or barely so.  I would think that there are still some sweet spots in Portland.  Good neighborhoods with no pubs.  Or, perhaps even better, one with just one pub where a second would boost the custom for both. 

Of course, if it were me and I was a great brewer that was going to start an exceptional brewpub there is one obvious choice: Sellwood.  Yes, that's it - Sellwood.  Sellwood is the clearly the best place for a great brew-pub.  You could not do better than Sellwood.  Unless your beer is going to be mediocre then Sellwood is not for you.  Stay away.

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.

Bike-o-nomics: Of Social Norms, Externalities, Tipping Points and Bike City, USA

Hawthorne Bridge bike traffic.
(Photo © J. Maus)

[Yes, back to the o-nomics thing...]

This is a post about social norms, externalities, tipping points and Bike City, USA. It was inspired by the many complaints in the paper, among friends, on Twitter, etc. about bad biking behavior in Portland. As I am on the Springwater Corridor path between Sellwood and Downtown constantly, I see bad bike behavior constantly - almost always on the part of fast and impatient bikers.  But bad biking behavior is everywhere in Bike City, USA and this post will argue that we have reached a point where our approach to regulating biking in the city has to change.

First let's fix ideas with a primer on the economic principles of which I speak.

Social Norms: Social norms are just that - behavioral standards that are set by society but are generally unenforced by an authority.  Consider the lesson you were taught as a child not to stare at strangers.  Your parents probably told you this and maybe even scolded you once or twice for doing so.  Over time this became part of the set of bad behaviors that one doesn't engage in as a member of polite society in good standing.

But why do we continue to behave in this way even when we grow up and our parents no longer have authority over us?  I mean, there are many interesting people in the world and we would get a lot of enjoyment from closely studying their behavior/appearance/manners from afar.  And the real cost is basically nil - perhaps a dirty look, but no real sanction is involved.  So from a optimal decision making standpoint, the best thing to do is to stare away when it pleases you.

We don't because the social norm of good behavior has been ingrained into our psyche and we do feel a psychic cost from violating the norm.  So, in general, people don't stare.  Social norms work fine in cases such as this, when there is no monetary gain to engaging in boorish behavior.  A simple ingrained lesson in etiquette can sustain a no-staring equilibrium.

They also work fine when there is a self reinforcing cost and benefit system like the norm of driving on the right side of the road.  Once we all agree to this norm, the cost of violating it is severe and so we all find it in or individual best interest to continue to drive (or ride) on the right.

The problem comes when there are real payoffs to violating the norm.  For example, we could try and regulate the speed of traffic through residential neighborhoods by norm, but as each driver gets a direct benefit from going too fast, many will violate the norm. So activities with substantial payoffs need enforcement and thus we move beyond norms and into laws, speed-bumps and enforcement.

Externalities: This one is more straightforward - the violating of norms of laws comes with it an expected cost born by the bad actor him or herself, but it also imposes a cost on other people that the actor doesn't have to pay.  For example, the person who speeds through a neighborhood imposes a cost in terms of the reduced safety of residents of the neighborhood, but the driver only factors in the real expected cost of getting caught or causing an accident.  In terms of biking, bad behavior on part of some bikers in the form of going too fast, passing dangerously, ignoring traffic laws, etc., makes every other biker and pedestrian less safe.  And not just form the direct consequences of the bad bikers actions, but indirectly as well, as drivers of cars become frustrated, confused and upset, they begin to behave badly (mostly more aggressively) as well.

Tipping Points: Malcolm Gladwell has popularized the idea, but economists have been talking about this for years.  We often refer to a type of tipping point that includes external costs or benefits a threshold externality: this is when just a tiny bit of extra activity with which an externality is associated causes a huge jump in the externality itself and adds substantial additional costs to everyone else.

In this case, when there are only a few bikers on the roads, and bike lanes and paths are uncrowded, having 5% of bikers behaving badly doesn't matter that much because the external cost is basically nil. But once you reach the point where there is crowding on the roads, lanes and paths, one bad biker can impose substantial risks to others.  In fact I submit that the external costs skyrocket while the internal costs rise only marginally and the benefits rise as well.

Take the Hawthorne Bridge as an example: when there are only a few bikes and pedestrians on it, riding crazy imposes almost no external cost but also doesn't have that much benefit - one doesn't have to be dangerous to go fast.   But when crowded, riding crazy by one rider substantially increases the risk to others and, as congestion means slower traffic, dangerous riding has a real benefit - being dangerous can get you across much faster.

Bike City, USA: Portland, Oregon.

So here is my thesis: Portland has reached a point in its evolution as Bike City, USA where biking has become so popular that we are reaching a threshold in the bad biking externality.  This represents a tipping point because as the city tries to encourage more riding it will find itself constrained by a small percentage of bad riders who impose a large cost to others and this will dissuade new riders from emerging.

Essentially, save for a few times when the Police monitor a specific stop sign and issue citations for rolling stops, biking in Portland is regulated by social norms.  This is fine when the benefits to violating the norms are small, but congestion has now raised the real benefit for violating norms, and it is quite possible that bad biking behavior will only increase in the current system.  We may be at that point where they can no longer rely on social norms to regulate bike traffic.

Thus, it may be the case that regulations and enforcement need to be increased.  Portland may have to come to the realization that in order to make continued progress in getting people to choose a bike instead of a car, more direct intervention into regulating and enforcing these biking regulations is necessary.

I don't know precisely what is appropriate but starting with hand or coaster brakes and a bell as required equipment seems a good idea.  Regulations that mandate the use of said bell, prohibit passing unless safe, maintaing a safe speed and prohibiting earphones are other good ideas.  Some of these are already on the books so having an active enforcement regime is the logical next step.

The good news is that a little regulation and enforcement could go a long way for, if a few bad actors impose large negative externalities, than cracking down on the behavior of those few will have large and immediate benefits.

I wonder if Portland could set up a team of quasi-official bike police who are not real police and have the right only to issue citations for moving violations and improper equipment.  This would be a relatively inexpensive way to get on top of the problem.

In any event, the tipping point may be near and Portland would do well to think seriously about how it deals with bikes.

Econ 539-Public Policy Analysis: Market Failures 1 - Externalities

Now that we have reviewed: the basics of choice theory and how people respond in predictable ways (in aggregate) to incentives; the basics of the free market efficiency result; the basics of economic growth; the basics of strategic behavior and the sub-optimal market outcomes that can result; the basics of data analysis and the challenge of causality; and the basic economics behind budget analysis; we are now ready to study some classical market failures. [By the way, that is a lot of basics I just listed which is a good reminder of what I am trying to accomplish in this class: a good intuitive understanding of the logic of economics and how it applies to policy]

Today we will study the most talked about market failure: externalities.

These are most often discussed in environmental policy but can be both positive and negative and can arise anywhere. We will study how the presence of externalities - costs and benefits that do not accrue to the agent engaged the the particular economic activity - can lead to inefficient market outcomes and the policy perscriptions to deal with externalities. We will also take a closer look at pollution in particular and talk about the difference between Pigouvian taxes, strict caps and cap-and-trade.

For examples we will have a look at Portland's Business Improvement District, the US Department of Energy's Weatherization Assistance Program and the Ash Grove cement plant.

Speaking of Externalities...

Around the corner from my house someone has replaced their front lawn and parking strip with artificial turf. Is this imposing a negative or positive externality for those that live nearby?

This also represents a bit of an environmental conundrum: it uses no water but it is made of plastic....

Pay Me for Riding My Bike

Perhaps the stupidest public policy idea I have ever heard of is the proposed bike tax. It is not worth talking about the proposal itself as it is not going anywhere and is, as I think I mentioned, stupid. But what is interesting to me is that, in fact, the appropriate public policy is to subsidize bikes, not tax them.

Why? The negative externalities associated with bike riding: virtually none. Minimal wear and tear on roads, sometimes a slight slowdown in traffic and a extra line of paint for a bike lane. Positive externalities associated with bike riding: lots. Reduced congestion and emissions from those that bike in lieu of taking a car, and better health and fitness of riders reducing the toll on the public health system. Public economic teaches us that to get an efficient amount of economic activity that has externalities you have to get the price to reflect the true cost of the activity. In this case the true cost is less than the price of a bike.

Okay, so this will never happen, but we do get part of the way by providing a better biking infrastructure.

Election 08: Ballot Measure 63

So I shall finally take a breather from the national and international economics news of the day (it's bad) and at long last get to my economic analysis of the measures that shall grace our ballots this fall. Where to start? Well, I'll just piggyback on the main editorial in today's Oregonian and talk about measure 63. This measure proposes to exempt from the permitting process any home construction project with a total value that does not exceed $35,000.

I shall frame the question thusly: does government regulation of residential home improvement through building permits make good economic sense? The simple answer is yes: there are externalities involved making the cost of improper construction not strictly private and potentially quite significant.

Perhaps the best way to begin is to set something straight at the outset: free markets work their magic when the costs and benefits of the activity the market is involved in is purely private and accrue to only the participants in the market. Such a market probably doesn't exist and so the relevant questions are: what is the nature of the market failures; and, are they significant enough to intervene in a market, which almost assuredly guarantees a second-best outcome (compared to the ideal)? It is pretty clear from recent events, for example, that credit markets have significant spill-overs and the inefficiency that would result from increased regulation and oversight is probably worth it.

One could argue that the externailites associated with poor construction are minimal compared to the bureaucratic drag on investment that comes from building permits. For instance, the likelihood that if my house catches on fire thanks to an improperly installed gas stove and then catches your house on fire is pretty small. But the fact that there is a higher probability of houses catching on fire in an environment where there is no oversight does impose a cost on me through increased insurance premiums, increased cost of fire prevention and suppression, increased burden on public health for those whose house burned down with them in it, etc., etc. There are also the ancillary costs of lost home equity due to the fact that my neighbor's house is now a heap of charred remains. This is all part of the the public good aspect of home ownership: while houses are private property they do have external costs and benefits that accrue to the community in which they reside.

So the idea that there is enough private incentive to make sure work is done right is not accurate. The true cost of improper construction is quite a bit higher than the personal cost, and thus there is a clear incentive to cut corners. This is especially true for 'flippers' who, once the house is sold, have little fiduciary responsibility to the buyers. The incentive to cut corners would be that much greater.

This gets to another problem that arises in the resale market: asymmetric information. While it is true that there can be plenty of construction that happens illegally, the permitting process is a way to reduce the information asymmetries between buyers and sellers of houses. This asymmetry can be quite damaging to the efficiency of the market and, ironically, hurts the people who don't cut corners the most.

What about the cost of the bureaucratic intervention? Well, for starters, the building permitting process for all other projects will remain in place so the marginal cost savings are likely to be low in terms of the size of the bureaucracy. What about lost investment in building projects? This is impossible to say for sure, and I have no doubt that there is lost investment, but I can't imagine that it is anywhere near the magnitude of the social cost of unregulated construction. I stand ready to be corrected however.

People often mistake economics as being about free markets (and a lot of other things). Not at all. Economics makes clear both the efficiencies of the outcomes of free and complete markets, but more importantly economics studies the implications of imperfect markets and helps figure out appropriate policy responses. This one is a no-brainer.

Portland's New Bridges: Do Economists Care About Uplifting the Soul?

Last weekend, I attended the graduation of my (much younger) sister from the University of Washington's College of Architecture and Urban Planning. The commencement speaker spoke of Architecture and Planning's ability to improve the human condition and uplift the soul. That got me thinking about the planning process for the new I-5 and Sellwood bridges and the question of whether the bridge should be striking and beautiful or just functional. In particular, it got me thinking about what economics has to say about such a question.

Contrary to what most people expect, economics does not just deal with dollars and cents. Economics starts with individual utility maximization. People buy art, commission architects and purchase beautiful things because it returns some utility - it makes them happy - and that happiness is worth some monetary payment. But what does this mean for a public works project like a bridge? Well, we run into the familiar problems of externalities, public goods and free-riders - problems that affect the building of the bridge regardless of the design.

If a beautiful design confers a benefit to users and residents then it has a real value and that values should be taken into account in any cost-benefit calculation dealing with bridge construction. But how do you measure such a benefit?

One way that economists have tried is through something called 'contingent valuation' - a survey of individuals willingness to pay for generally some non-market resource (like clean air). This allows economists to try and come up with a number that assesses the worth of such a resource. The problem is, of course, it is all hypothetical and the valuations, it turns out, can be highly influenced by how the question is asked. [One example: while I was in grad school, an Ag. Econ professor compared the results of a hypothetical 'how much would' you pay to save a tree' to a real tree he brought into the room and would threaten to kill if not enough money were raised - the real tree raised valuations a lot]

Another way is through some sort of democratic process, but as I have talked about previously, voting induces some selfish behavior, most notably free-riding: "I would love to have a nice bridge, and would even pay for it, but if I can get everyone else to pay for it and not have to myself, even better!"

So, in the end, I think policy makers will simply have to understand that design does matter, and that a beautiful bridge (like the Golden Gate and St. Johns above) is worth a lot.

The Glenn Jackson (to the left) is a inoffensive and very functional bridge, but forgettable. Below is Boston's new Zakim bridge. Which would you rather have? Oh yea, how much is it worth to you...?

The Fourth Estate

The Oregon Legislature, The Oregonian reported today, was scrambling yesterday to draft legislation to address a problematic practice by which individual school districts get teachers who have been disciplined due to sexual misconduct to resign in return for not disclosing the misconduct to potential employers (in many cases, other school districts).

This brings up two pertinent economic questions:

The first is the practice itself and if it indeed calls for legislative remedy. In this case we have what economists recognize as a classic incentives problem: the private incentive of a school district that faces a teacher who has been disciplined for sexual misconduct is to make the problem go away at the lowest cost to the school district. Thus cutting a deal to have a voluntary resignation is a very good strategy for the district. The cost of cutting such a deal is not born by the school district, but by society at large (assuming that even a small percentage of such teachers are recidivist). What do economists call such costs? Externalities. Externalities are a classic case of justifiable government intervention - often explained in terms of protecting the public interest in the face of private incentives which are opposed. However, there seems to be a couple of potential pitfalls to finding an appropriate policy solution. First, it is not clear to me how much this practice is based on allegations of misconduct, rather than confirmed cases through a system of due process. It seems to me that many school districts are simply trying to make a potential problem go away, so legislation prohibiting this practice would potentially force school districts to go through costly investigations and often costly litigation. Second, this is likely not a state problem but a national problem, so it is not clear that the remedy is a state-level one. If Oregon passes a law that says, for example, Oregon school districts must disclose allegations of misconduct to future employers, this will potential impose a huge cost on Oregon school districts and yet we may still have a large number of teachers who have been dismissed for misconduct coming into the state.

The other pertinent economic question that this raises is the fact that we rely so heavily on the news media to bring problems to our attention. If the news media really are the fourth estate and have a critical role to play in our democracy, is the for-profit model the way to go? What are the incentives of The Oregonian to do such investigation? Sales of papers. Is this private incentive enough to ensure that the socially optimal level of investigative journalism, a public good, is being achieved? No. We all benefit from this journalism whether we read the O or not, so a lot of us are free riding on this information that, once published, becomes a common property resource. Economists know that in these cases - private provision of public goods - the good is underprovided relative to the social optimum. This raises an interesting question - should the public finance investigative journalism?

Hmmm.....

Economist's Notebook: Why Doesn't OSU Pay Me to Get a Flu Shot?

Consider the external costs of my getting the flu: I could infect a number of students through my in-class interaction with them, I could miss class meaning that many students will miss out on vital learning (and will suffer mental anguish at the prospect of having a two-hour class on international economics cancelled - the horror!) and I may infect other professors and staff at OSU. The multiplier effect of my getting the flu means I would be a super-infector spreading influenza far and wide across the OSU campus. Surely the cost to OSU of all of this is more than the $20 they are charging me for the flu shot - so why oh why don't they give it to me for free.

Students: I did shell out the $20, so you can thank me now. No worries about me cancelling those two-hour international classes at 8am!

(NB: I have been made aware that Alex Tabarrok at Marginal Revolution has a similar post - see the list of 'Economics Blogs'. OK, but I am sure I thought of it first!)

Oregon and the Bottle Bill

Recently, the Oregon Bottle Bill was expanded to include more types of bottles, including plastic water bottles like those in the picture. The original bottle bill was the first of its kind in the nation and has been credited with greatly reducing litter and with giving the recycling movement a huge boost. All of this is nice, but it also imposes a cost on consumers and retailers and may lead to lower sales for beverage manufacturers. So, is it good public policy?

How I think about this problem is first by focusing on the market failure: externalities. Litter despoiling our landscape, excessive amounts of garbage filling our landfills and excessive use of raw materials (aluminium for cans, say) are all real and not unimportant costs that we all pay when bottles and cans are not recycled - economists call these social costs. However, the costs paid by any one individual disposer of a beverage container is very small, especially compared to the social costs. Thus, this activity has a negative externality associated with it: the private costs are smaller then the social costs. In these cases (where negative externalities exist) the individual incentive to refrain from excessive use and disposal of containers is too small relative to what is optimal for society. This is a classic case for government intervention - similar to the case for government regulation of pollutants from industrial activity. So I buy that there is a strong case to be made for regulation, but at what price? Is this problem worth the cost of the solution?

Here we have to veer off into the realm of conjecture, but it seems clear to me that a $0.05 refundable deposit is a very small cost (the true cost is the time value of the money - i.e. not being able to earn interest on your nickel - and the expense and effort of redeeming the containers) for consumers. For retailers, with the emergence of automated container collection points, it appears that the cost to them has been reduced quite a bit as well. But it is not insignificant: the up-front cost of the machines, the space needed to house them and the expense and effort of handling the used containers are all real. However, I do not notice a large difference in the price of beverages between stores in Oregon and Washington, for example, so I conclude that it is probably not a terribly significant expense.

Finally, there is the question of the recycling itself. Critics argue that recycling uses more resources than it saves. I cannot judge the veracity of this statement, but I will say that with non-renewable resources and toxic pollutants, I think that it is an argument that is not terribly convincing. Even if true however, the motive for the bottle bill is not only energy resource conservation but litter control as well.

So, in the end, my opinion is that the market failure is real and serious, the remedy relatively cheap and painless and thus a very good example of sound policy. One of the things I like most about the policy is that I can choose to pay the extra five cents and dispose of the bottles in my own recycling rather than have to redeem them. Few economists would argue with my description of the market failure, but many may quibble with my analysis of the costs and benefits of the remedy. This is true of most economic policy issues, economists tend to agree on the fundamentals, but disagree on the costs and benefits.