Tuesday, June 30, 2009

There's a difference between health and health care

Brad DeLong had this to say about Mankiw and Becker (Lucas and Barro, too), specifically about their thoughts on health care reform:

To me, the thing to note about the economists--the Mankiws, the Lucases, the Beckers, the Barros, and all the rest--who have pledged allegiance to the Republican Party this year is how much they hagve [sic] stopped thinking like economists. When an economist thinks about American health care, he or she begins with what we give up and what we get: we give up $1 trillion dollars in real resources a year relative to other countries, and we get... what?... not much. But this is not how Mankiw or Becker approach it. [...]
Contrary to what DeLong's strongly-worded rant suggests, economists do not think in such simplistic terms. Yes, economists like to compare what we give up to what we get, but good economists compare the additional costs we pay to the additional benefits we get. That's called thinking on the margin, or marginal analysis. And, it is precisely what Becker and Mankiw do in their original posts on health care.

Let's examine the post that started the Krugman-based DeLong rant against Mankiw and Becker. Here's the quote that sums up Mankiw's point beautifully:

There is another, flawed argument floating around that also needs debunking--that Americans pay more for healthcare but don't get anything for it, as measured by, for example, life expectancy. The problem with such international comparisons is that there are a lot of differences among nations beyond their health systems. To make comparisons in health outcomes, you need to control for other variables. Without such controls, the simple correlations have little meaning.

He's right. Life expectancy is a terrible measure of how American health care is doing if we Americans have a strong propensity to destroy our health by eating cheeseburgers. We can be less healthy, but receive better health care. Maybe if it weren't for our superior health care, Americans would die much earlier.

Is there a way to obtain a better comparison than life expectancy? If so, how does the American health care system fare? Here's Becker, as quoted by Mankiw:

[...] the US fares poorly on many life style indicators, such as incidence of overweight and obese men, women, and teenagers. To get around such problems, some analysts compare not life expectancies but survival rates from different diseases. The US health system tends to look pretty good on these comparisons.

Now, that's clever. We Americans might be unhealthy because we make really bad health decisions, but that does not imply that our health care system is worse. As Becker points out, if you compare similar procedures in America and Europe, the US option "looks good." In other words, the health care system does a better job with the same problem. Isn't that the right comparison to make?

Maybe the American system is not much better; it probably isn't. Maybe the additional expenditures are not worth it; they're probably not. Maybe there's a better way to organize health care provision; there probably is. But, a good economist compares the marginal benefit to the marginal cost.

Making this comparison takes work, but it is precisely what Becker and Mankiw are telling us to do. That's what I like to call thinking like an economist. It's unfair to label such careful thinking as politically-biased. Yes, they took their side in these particular posts, but they used sound economic reasoning to reach their conclusion.

Moreover, both Becker and Mankiw make a very specific point: In America, we spend more and get more from our health care. Mind you: Their conclusion is not that "everything is wonderful with American healthcare." You can also debate about how much more we get from our additional expenditures. But, at least, there's a debate to be had. There's also a lesson in their logic: don't use life expectancy comparisons to make the case for health care reform. Maybe some people have thought about this, but it's worth a reminder if others have forgotten.

Monday, June 29, 2009

U of I Clout: On the performance of clouted students

Like most people, I am troubled by the University of Illinois clout scandal, but when I came across this passage in a recent Chicago Tribune article, I had to cringe:
Admissions dean Paul Pless reported that the school admitted at least 24 "SI," or special interest, students during a four-year span. He said they had lower grades and standardized test scores than the general applicant pool and they lagged behind their classmates once admitted. On average, they maintained a 2.86 grade point average during their first year compared with the 3.2 grade point average for the overall class, he said. One faced "formal disciplinary charges" and left the school.
From the article, it sounds like the clouted students are doing significantly worse than those people who would otherwise be admitted. After all, their GPA is 0.34 below the average student in their class. That's a B- in every class instead of a B. There's clearly a difference, but one could question how important that is.

But, the small difference between the clouted students and the average is not what concerns me. I am more concerned that the Law School and the Tribune make the wrong comparison. Who really expects the students who were bumped from the university in favor of a clouted student to be average? Those who were excluded from the law program in favor of the clouted students were excluded for a reason: they weren't as good as the other legitimate students in the program.

Their application credentials may have looked better than the clouted students' credentials, but the students who were bumped were not just randomly selected. Should we expect those students to obtain the average GPA? If we're really interested in how the clouted students performed, we should compare their performance to the 25th percentile. As a crude approximation, that's a much better comparison group, and it would actually tell us something about how unqualified the clouted students were compared with their actual alternative. Comparing to the average just stacks the deck.

To be fair, this is a messy scandal, and there's no justification for letting political influence sway admissions decisions at a public university. On the supporting points in the story, we don't need to stretch the truth with inappropriate statistical comparisons. The scandal looks bad enough without exaggeration.

Sunday, June 28, 2009

Companies Tony Loves: ING Direct

Raise your hand if you enjoy balancing your checkbook. Not many hands up out there? I didn't think so. No one likes balancing the checkbook. Maybe once you sit down to do it, you say rationalize it by saying "it is nice to be in touch with our finances," but the truth is that balancing one's checkbook is an exercise in tedious math. Wouldn't it be nice if your checkbook balanced itself? Now, it can... if you bank with this week's Company I Love, ING Direct.

ING Direct is an online bank that gives customers the whole array of options that any bank should (checking, savings, CDs, mortgages, stocks, etc.). Their rates on savings accounts and certificates of deposit are consistently better than average. Moreover, their rates are competitive, but not suspicious. ING exploits not having many bricks-and-mortar locations to decrease administrative cost; they pass some of the savings on to customers.

These other services are great, but ING Direct's Electric Orange checking is the best service ING provides. On account of Electric Orange, ING Direct is not just a company Tony likes, it is a Company Tony Loves. Why is it so great? Here are a few reasons to love Electric Orange checking.

1. Electric Orange does the checkbook balancing for you. There's no need to enter your debits and credits into the ledger. When you log into the website, Electric Orange tells you precisely how much money you have available. They leave the tedious math to the computer.

2. Electric Checks. With Electric Orange, you can feel like an international finance guru by paying your debts electronically. ING Direct allows you to "write" Electric Checks (i.e., transfer your funds electronically) to whomever you wish to pay. Not only do you feel like a rock star when paying your debts, but it is also surprisingly easy.

3. Paper Checks. If you are afraid of getting shocked by an electric check, ING also allows you to "write" paper checks. You use the same online interface, giving the address where you want the check sent. ING prints the check and then mails it for you. What's even better? They'll pay for the stamp. ING saves on the postage because they are able to do bulk mailings with all of the paper checks being written by other ING customers.

As a side benefit, ING will not waste paper on paper checks if they don't have to. If they can find a way to pay your bill electronically, ING will send your paper check by wire. ING Direct minimizes the paper and saves you a stamp. That's a win for the environment and your account balance.

4. The Debit Card. For those payments you can't make at your desktop or laptop, ING provides you with a debit card with a crazy cool orange logo. I haven't used this option much, but it is comforting to know that you can make all of your payments through one account.

5. They'll pay you. ING Direct is currently running a promotion where they'll pay you $25 for opening an Electric Orange account. What's the catch? You have to know someone who has an ING Direct account; A current account holder has to refer you. Fortunately for you, I have an ING Direct account and I'm willing to refer the first 25 people who e-mail me (thisyoungeconomist AT gmail.com).

Of course, ING Direct is giving me my own incentive to refer anyone who will listen. But, I was planning on doing a Companies Tony Loves segment on ING Direct anyway. They're a wonderfully innovative bank, which provides great service. That's a win for anyone involved. We have been with ING Direct for almost two years now and we're glad we switched. Won't you join the Orange Revolution?

Saturday, June 27, 2009

Poll: Do police make you feel safe?

I caught this quote at the Chicago Breaking News Center about the security measures at the annual Taste of Chicago:
Today Weis would not say how many officers would be staffing the event. "Folks will feel very safe because they're going to see a police officer on almost every block, and in some instances 20 feet, so we're going to have a very hard presence in terms of letting people know we have a lot of officers in place," Weis said.
My first instinct upon reading the article was to recoil. A police officer on almost every block? Yikes! I didn't feel safe reading that. The presumption that "more cops makes people feel safe" used to seem very strange to me. After all, the primary purpose of a police officer in Bozeman, MT is to issue traffic tickets around the MSU campus.

When I saw a police car in Bozeman, it didn't make me feel safe, but in Chicago, I understand how more police can enhance the safety of an event. Maybe a cop every 20 feet is overkill, but police in Chicago generally make me feel safer.

On the other hand, maybe the abundance of cops is a signal that I should be concerned for my own safety. Honestly, I don't know what to think. In either case, I don't think that more police always means that ordinary people feel safer. That brings me to the the question of the week: When you see a police officer, do you feel safer?

A simple Yes or No answer is great, but if you have comments on the issue please share in the box below. The poll is on the sidebar, so please vote early and often. Tell your friends and local police officers to vote. That is, if you're not too scared to talk to them. The poll is open for a week. I'm interested in hearing what you have to say.

Friday, June 26, 2009

The Elements of Style: Thanking you in advance...

In the Elements of Style Series, I relay helpful hints for good writing from the classic book, The Elements of Style by William Strunk Jr. and E.B. White.

This week's advice from The Elements of Style is more than just writing advice; it is advice in how to deal courteously with other people. In Section V on Words and Expressions Commonly Misused, Strunk and White advise writers against using the phrase "thanking you in advance."

Their reasoning goes beyond writing well. Strunk and White point out that it is improper to thank someone in advance. More directly, just thank them. Don't imply that you won't thank them later. Put another way, they want us to strike this phrase from our writing because it is impolite.

I agree, but I want to take their advice off of the written page. It is good life advice to show gratitude. If you want to thank someone, thank them. If you want to thank them again, thank them again. People can't get enough of well-intentioned gratitude -- and, for good reason. Our world is presently starved of gratitude. A genuine expression of gratitude is refreshing.

If you don't believe me, ask yourself how frequently you say "thank you" to the server at the coffee shop. Worse still, how often do you say thank you to your bus driver? They don't hear it often enough. If "thank you" does not fit your purposes, try "have a nice day" or a similar friendly comment.

Try to go through an entire day by greeting and thanking the people who help you along. It might not seem like much, but a simple demonstration of gratitude can transform your day.

The next installment of the Elements of Style Series will appear on this blog on Friday, 3 July 2009. I will continue this series each Friday until I run out of interesting topics in grammar, style and writing.

Thursday, June 25, 2009

A public option with private alternatives?

Here's a recent quote from President Obama on offering a public health care option:

OBAMA: Why would it drive private insurance out of business? If private insurers say that the marketplace provides the best quality health care; if they tell us that they’re offering a good deal, then why is it that the government, which they say can’t run anything, suddenly is going to drive them out of business? That’s not logical.
I found this quote via Paul Krugman's blog where he cites Matthew Yglesias as catching "President Obama making sense on the public option." That quote made me wonder: How exactly is Obama "making sense"?

As Obama concedes in the next paragraph in the transcript, there are "some legitimate concerns on the part of private insurers that if any public plan is simply being subsidized by taxpayers endlessly that over time they can’t compete with the government." In other words, a public option is capable of driving the private alternatives under. Moreover, this possibility seems logical and Obama calls it "legitimate."

But, didn't he just call private insurers' position illogical? I have to disagree with Krugman. Obama's statement, "that's not logical" makes no sense at all.

Private insurance companies reasonably distrust a government competitor for two related reasons.

First, a public option will attract business away from private companies. How? Offer high benefit insurance plans at a low price. Lower prices and better insurance benefits are politically attractive; they might even get more funding and a clever name for the program. Such attractive policies lure more customers to the public option. Now, that's fewer people who buy private insurance. Logically, private insurance companies can't like that.

Second, a public insurance option will create new bureaucracy. Bureaucracies tend to expand, sapping taxpayer resources. Supposedly, we need a public option to discipline private insurance companies. I wonder who is going to discipline the government insurance company. If you say the regulator, I ask who disciplines the regulator? If you say Congress, I ask who disciplines Congress? If you say voters, there's a collective action problem: voters might all be dissatisfied, but it's hard to coordinate collective dissatisfaction.

A competitor who cannot be disciplined is surely a threat, right? My point is that there are plenty of reasons to fear a government competitor, and they don't have to be "Oh no. The government is going to make me better." That's the last thought I'd expect insurance companies to have.

More generally, government companies have incentive problems. Votes are the motive of politicians who fund a program; jobs are the motive for bureaucrats. From the perspective of anyone with control over a public insurance company (politicians or bureaucrats), more money to spend is a good thing. These incentives won't be fixed by a "healthy debate" because they are tangled up in the nature of bureaucracies. Expanding your domain is a perfectly natural temptation for a bureaucrat. No wonder private insurance companies see a public competitor as a threat.

To be fair, our current system for health care provision is a train wreck. Even Milton Friedman recognized this eight years ago. The Friedman article is a fascinating read on health care costs (Greg Mankiw linked from his blog). If you care to know more, read the Friedman article. Then, ask yourself: If our current "private" health care provision is a train wreck, what would adding a public option do to the mess we have on our hands? If your answer is "clean it up," I'm interested in hearing how you plan to keep the bureaucrats in check.

Wednesday, June 24, 2009

How to take a great outdoor picture -- A guest post

Today, we welcome a fabulous guest poster -- Shanna Cookson. Shanna is the most beautiful person I know. Eight years ago, we met in high school; now, we're married. That's evidence that Shanna is a very patient person. In addition to being beautiful and patient, Shanna is quite talented, especially with our camera. In her first guest post, Shanna demonstrates how to take a good outdoor photo. Here's Shanna:

How to Take a Great Outdoor Picture by Shanna Cookson

In Chicago, it’s fun to relax at Lake Michigan, whether to spend an entire day or just a few minutes. Whether sunbathing, picnicking, or reading the latest scoop on Jon and Kate Gosselin, Lake Michigan is the place for you. My personal favorite way to enjoy the lake is to take pictures of it in all its glory. I want to capture the way the light glistens on the waters, the way the trees sway in the breeze, and the way a child laughs as he squishes his feet into the wet sand.

All of this sounds picturesque, right? But, if you are like me, you have taken a few too many pictures that do anything but capture the mood of the moment. Maybe you snap a jillion pictures hoping that one, just one, picture will turn out. Or, even worse, you forgo shooting the Kodak moments for fear they will look like something out of a horror flick. Worry no longer. Here are a few helpful tips for taking a fabulous outdoor picture.

1. You ‘framed’ me! Take a look at the perimeter of the image, and ask yourself how the image is being framed. Is their any foliage that would help frame the subject? If I showed this picture to someone, what do I want them to look at? Are there objects framing the picture that do not fit with the mood I am trying to capture?

2. Take advantage of trees. When taking an outdoor picture, I like to look for foliage that will help frame my subject. If trees are present, take advantage of ‘em! In this picture, we can see that the leaves beautifully frame the Chicago skyline.

3. Texturize and Volumize. Nature is abundant with varying textures and sizes, and it is to your advantage to notice these details. In these images taken in Montana, we can almost touch the jagged edges of the rocks. We can also see the vastness of the cliffs.

4. Practice those shots. In today’s high-tech world, digital cameras are everywhere. We no longer have to endure the process of purchasing film, loading film into the camera, taking the film to the nearest Osco, and waiting from days to weeks to view the photographs. We now have the luxury of viewing our shots instantly. If you take a bad shot, just delete and start over. Trying new things doesn't cost you a dime.

So there you have it, a few tips on how to take a great outdoor picture. Your pictures will be framed, texturized, and more volumized. Keep taking pictures on a regular basis, and you will reap all the benefits your camera has to offer.

Tuesday, June 23, 2009

Why are there no tire stores in Hyde Park?

Last Sunday, we got our first flat tire in Chicago. We used Fix-a-flat on the tire and aired up. Then, we looked around our neighborhood for a tire store to repair our tire, but there was not a single tire store in sight. Keep in mind that Hyde Park, our Chicago neighborhood, is home to 44,000 people. In disbelief, we came home and conducted a Google search for nearby tire stores. Here's a Google map of Hyde Park and Kenwood where I did a search for tire store.

You might get excited about marker B because it is in Hyde Park, but if you look closely, that's the University of Chicago bookstore, a tiresome place. They have no tires there. The other two listings, 350 E. 43rd St. and 6250 E. Evans Ave., are not in Hyde Park, but in locations I avoid on account of crime reports or just not knowing what's there.

There's more to this puzzle. Hyde Park seems to be one of the few neighborhoods without a tire store. Here's the same Google map, but zoomed out to show the tire stores throughout the entire city of Chicago:

The red dots indicate tire stores. Here's what I get from the map:

Neighborhoods with tire stores
Lakeview, Lincoln Park, Wrigleyville, Albany Park, Roscoe Village, Bucktown, Hermosa, Little Italy, Back of the Yards, Archer Heights, Garfield Ridge, Chicago Lawn, Gatewood, South Shore, downtown Chicago and most suburbs.

Neighborhoods without tire stores
Hyde Park, Kenwood, Oakland, Humboldt Park and West Town. There may be others; it's harder to use a map to identify what neighborhoods do not have tire stores. Also, if these markers represent other tiresome bookstores, there might be more neighborhoods without tire stores.

Quibble with the map all you will. It's still clear that there are no tire stores in Hyde Park and at least four options if you live in the Wrigleyville-Lakeview-Lincoln Park area. And, call my perspective biased, but it also looks like tire stores are fairly uniformly distributed throughout the city, except for Kenwood and Hyde Park.

All of this begs the question: Why are there no tire stores in Hyde Park? I see three related reasons to expect a dearth of tire stores in any particular neighborhood: lack of demand, sorting/locational choice, and high cost of doing business (i.e., low supply).

Lack of demand. People demand tire repair as part of the cost of driving. If you drive enough to warrant buying a car, you will eventually get a flat tire. Flat tires need repairing and tire stores are made for this job. As more people own and drive cars, we should expect to see more tire repair options. This is common sense.

In this story, low demand for driving means low demand for tire repair. If you live in a city, there's a good chance your demand for driving is less than if you live in Montana. That's because there are plenty of other transportation options (busses, trains, cabs, etc.) and the cost of driving is higher (rude drivers, high price of parking, more potholes, etc).

Returning to the number of tire stores, we should already expect fewer tire stores per capita in Hyde Park than Montana, but that's not a puzzle. It is a puzzle that Hyde Park residents not have a tire store, but Wrigleyvilleians have four options nearby. If Hyde Park had better public transportation options than Wrigleyville, that might explain it. But, the Red Line goes straight from Wrigleyville to downtown, whereas Hyde Park's best train option is the Metra, which comes less frequently and costs more.

Neighborhood Sorting. Another potential explanation for seeing few tire stores in a neighborhood was put forth in a classic and widely-cited paper by Charles Tiebout in 1956 (A Pure Theory of Local Expenditures). The Tiebout idea is that municipalities compete with one another by each offering a menu of public services, amenities and a cost structure for living in that particular place. People rationally choose among the menus, sorting into their preferred places.

Tiebout applied his concept to local governments with taxing authority: the idea is that if you're someone who likes public services, you might not mind paying the higher taxes to provide them. By making the choice to move to the high tax/high service area, you're essentially voting for consuming those services and paying those taxes. In this view of the world, local governments cannot get away with offering awful public services with high taxes because people will just move away, and the local government won't have any tax base. In the real world, governments are still constrained by this effect, but less so because moving is costly.

Back to the tire store problem... Applying the Tiebout theory to Chicago neighborhoods, a potential reason there are no tire stores in Hyde Park is that each of the Chicago neighborhoods offers a menu of services for potential residents, and most people who do not mind being far from a tire store picked Hyde Park, whereas the tire-loving fiends of Wrigleyville also picked their preferred neighborhood (for your econ-fiends, this is a separating equilibrium in a screening game. What might a pooling equilibrium look like?)

That's possible, but there are two key problems with this explanation. First, I doubt people sort on the proximity of tire stores. Although flat tires happen to everyone who drives, getting a flat tire is a rare event. People are more likely to sort on proximity of parks. Second, the Tiebout story only makes sense if the neighborhood or some neighborhood authority is deciding on whether to allow tire stores. With local ordinances, this might be true, but I suspect the market determines whether tire stores come or go.

High cost/ low supply. As I don't believe the demand-side story or the sorting story, I had to look to another explanation. What if it is really expensive to provide tire services in Hyde Park relative to other neighborhoods? In this case, we would surely see fewer tire stores because higher cost means lower profit, all else the same.

There are several reasons to believe there is a higher cost of repairing tires in Hyde Park:

1. Labor cost. The local laborers, many of whom are University of Chicago students, are good at math but really unskilled in tire maintenance. To stock a store with labor, you would have to port people from surrounding neighborhoods whose comparative advantage is tire repair. That makes the labor cost a little higher.
2. Rent. Compared to the surrounding neighborhoods, it costs quite a lot to have a place to change tires in Hyde Park. Compared to Wrigleyville, however, rent is probably lower in Hyde Park.
3. Raw materials. If raw materials for a tire store must come by an 18-wheeler, it is a real pain to get those materials to anywhere on 55th street. That's because someone messed with the Chicago grid and put a huge kink in it right near Lake Park and 55th street. I would imagine that trucks have trouble navigating that curve. Therefore, we don't see many businesses, let alone tire stores along 55th street.

But, there are other streets in Hyde Park that would be fine locations for a tire store: 55th isn't the only street. For example, why isn't there a nearby tire store on 47th or 53rd? Both of those streets have businesses, and a tire store would fit in beautifully.

Needless to say, our tire is still flat and I'm still searching for a good explanation for why there are no nearby tire stores. It looks like I'll be putting the spare tire on the car and driving to Back of the Yards. Wish me luck!

Monday, June 22, 2009

Should we tax the tall more than the small?

Greg Mankiw and Matthew Weinzierl -- both at Harvard -- co-wrote an interesting article on the theory of optimal taxation entitled Do you really want to tax ability? In this article, the authors argue that according to standard theory, it is optimal to tax tall people more than short people. As a budding economist, I found it to be a fascinating read. For those of you who are budding non-economists, here's a layman's breakdown:

Why tax tall people more? Mankiw and Weinzierl describe well-established economic theory on optimal taxation that dates back to Edgeworth (1897) and owes much to Vickrey (1945) and Mirrlees (1971). What's optimal? If we can observe innate productivity, tax it so that everyone ends up with the same wealth after the tax. In the real world, we never observe actual productivity, but some mix of effort and productivity. And, that complicates the picture.

In a nutshell, the optimal taxation literature tells us to tax whatever individuals cannot influence. That way, the tax does not distort individual incentives. Couched in this framework, Mankiw and Weinzierl (2009) suggest that we tax height. Here's why: It's really hard for someone to change his height, and wealthy people tend to be tall. Therefore, if we want to efficiently transfer resources to the unlucky ones (as Edgeworth suggested we do), we should tax tall people more than short people. It won't affect marginal incentives to work, but it will flow money from rich to poor.

The authors break the population into three groups: tall (6 ft 1 or taller), medium (5 ft 10 inches to 6 ft) and short (5 ft 9 inches or shorter). I'm not going to measure the shortcomings of these height cutoffs, but they do seem to be arbitrary choices. Mankiw and Weinzierl compute that an optimal redistribution program would tax tall people at 7.1 percent, medium people at 3.8 percent and that would provide enough money to give short people a 13 percent subsidy.

Caveats. The authors give three caveats to why we might not want to implement the so called optimal tax. These are:
  1. The tax is discriminatory or may lead to other discriminatory tax schemes. In their words, "some might fear that a height tax would potentially become a 'gateway' tax, making taxes based on demographic characteristics more natural."
  2. The tax is not fair after the fact: "it may be hard to explain why a tall person has to pay more than a short person"
  3. Taxing to redistribute money impinges on liberty. Mankiw and Weinzierl quote Milton Friedman on this point: "I find it hard, as a liberal, to see any justification for graduated taxation solely to redistribute income. This seems a clear case of using coercion to take from some in order to give to others..."
All three of these objections rely on changing the terms of the debate. All of these objections are of the form, "Yes. If you value efficiency, you're right that taxing tall people is the way to go, but I value xxxx. If you value xxxx, the natural conclusion is to not tax tall people more than short people." These are useful critiques, but I think a more incisive critique can be applied -- one that takes seriously the time cost of administering a height tax relative to other tax schemes.

Why might time cost matter? Just like Mankiw and Weinzierl do in their analysis, I still take efficiency as my objective. Whenever we propose a tax policy, it is worth thinking how one could implement the tax. In particular, here is a set of questions a government should ask before implementing a new tax scheme:

Do we have all of the required information? If not, how would we go about obtaining the required information? How can we prevent evasion of taxes? Compared with the alternative, how much time will all of this take? How should we value such time?

As Freidrich Hayek taught us, information and "knowledge of particular circumstances of time and place" make the economy go around. Government policies that are made without regard for the flow of information are very costly. Hayek made this comment with special regard to communism's command-and-control directives versus the free market's price system, but we can apply Hayek's information-conservation principle to compare alternative tax schemes.

Let's use Hayek's information-conservation principle to compare a height tax with our current graduated income tax scheme. I pose this discussion in terms of advantages and disadvantages for a height tax.

Advantage: The right marginal incentives. As the Mankiw and Weinzierl make clear, the height tax has the distinct advantage that it does not change individuals' incentives to work. In this respect, a height tax gets the incentives right. Don't discourage people from working if working is worthwhile.

Disadvantage: The costs of measurement. Compared with a graduated income tax scheme, a height tax has significant informational demands. In particular, I doubt there exists a trustworthy database on people's current height, whereas most American payroll departments keep comprehensive records of income payments to their employees. It could be quite costly to build a height database reliable enough to use as a basis for taxes. That's because implementation of a height tax comes with many questions.

For example, would we measure people's heights at a particular age (say 18)? What about late bloomers? What about taxing people younger than the measurement age? Would we measure people's heights every year? If so, who would administer this measurement? Who would monitor slouching? Who would audit the measurements? Who would develop the standards for measuring people? Shoes on or shoes off? Do people take time off from work to get measured? And so on...

A height tax would not just tax our bank accounts, but also our time -- at least the time it takes to get measured. Given that the government cannot spend that time, this lost time is an additional loss to society.

The take home message. You may just say that these are just messy details of taxing a population, but real life is full of messy details that contort what is actually optimal. These information costs affect what's the best way to tax. Given the informational requirements and the costs of administering a height tax, it might just be optimal to stick to a graduated income tax system. We would have to work out the math, but qualitatively, it could go either way.

Furthermore, the government does not exist just to redistribute money among the population; it has very real demands for tax revenue. Moreover, a height tax would not be enough to cover these expenses. As a result, by imposing a height tax, we would not actually save any of the administration cost of the old tax scheme. It would be added cost to get added tax revenue.

That sounds like a bad deal to me, but then again, I am 6 ft 1 -- this tax scheme is out to get me. I hope we never see the day when Uncle Sam, pencil in hand, tells me to stand tall. Although it is nice to think about, when applied to the reality of raising taxes, a height tax just doesn't measure up.

Sunday, June 21, 2009

Companies Tony Loves: Walmart

This week's installment of the Companies Tony Loves Series is on Walmart. "Companies Tony Loves" posts describe why innovative companies and business practices make us all better off, and therefore why they deserve our love. "Companies Tony Loves" is featured every Sunday on this blog.

Last week, I lauded the role of successful small businesses for improving our lives. Using the example of local coffee shops in Bozeman, MT, I argued that small businesses can make any community better off, especially in a market as competitive as Bozeman's coffee shop market. Small businesses -- at least the ones that are still around -- compete by providing better value. This fact makes me love them.

Given my love for small businesses, my admiration for Walmart might surprise you. To many people, Walmart epitomizes everything that is bad for small business. Here's a story you may have heard: Walmart enters a town and drives many of the established local businesses out. Then, Walmart exploits the community. That's the perception anyway.

But, that's not how I see it. Walmart does not force consumers to buy their products. Walmart induces them into the store by offering low prices on everything. That's not bad for consumers; it is great for consumers, even in the long run. My experience with Walmart is that they enter a community with low prices and keep those prices low.

For example, consider the Walmart location in Butte, MT. Here is an opinion article from the store manager in Butte, discussing why Walmart is good for the community -- after 15 years of serving the Butte market. He makes some very good points: Walmart offers low prices, decent service and competitive wages. Scoff all you will at the wages Walmart offers, but before you do, ask yourself what someone doing the same work at a local store would make. I doubt it would be much higher.

There is a strong contingent of Butte locals who have never embraced Walmart, saying that "Walmart only offers low prices until they drive out the competition." After 15 years, the prices are still low at the Butte Walmart. I wonder when the competition will move out of town so Walmart can start raising prices...

After 15 years, there are fewer high-price businesses in Butte, but isn't the Walmart option a much better one? The consumers who switched stores must have thought so. And, those consumers are better off. As last week's EconTalk podcast suggests, the employees are possibly better off as well. And, that's coming from a man, Charles Platt, who took a job at Walmart to write about his experience.

If there really is something irreplacable about the local businesses, they can use that quality to attract customers. That's what distinguishes local businesses I love from the ones I can do without. The coffee shops in Bozeman are so efficient and innovative that they keep the big stores out, whereas Butte's ailing small businesses cannot compete with Walmart except through picket lines and complaining to the local media.

Efficiency and value are deserving of admiration -- entitlement is not. On this measure, the local businesses that cannot withstand Walmart's competition do not stack up. Walmart -- just like the local coffee shops of Bozeman -- provides a great service to its community. Put down your placard. Grab a shopping cart. I assure you that you will find good value inside.

If you have ideas for Companies Tony Loves, please let me know. It could never hurt to have more suggestions!

Saturday, June 20, 2009

Poll: How do you commit to losing weight?

I recently read an article at Economists Do It with Models entitled Be Careful With Those Commitment Devices..., which made the claim (supported by observation and behavioral economics research) that people who tell their friends about their intended diet plans are less likely to lose weight. Based on this conclusion, the article tells us to keep our dieting plans to ourselves if we want to lose weight (a conclusion that makes me wary).

You can see what I think about the article in the article's comments. Also, some of you may have read an article I wrote on my own on commitment device for getting out of bed in the morning. I think commitment devices are a great way to get stuff done. You just have to be careful.

Losing weight is a difficult thing to do. But, if one can find a good way to commit to be fit, we might be able to lose those unwanted pounds. Inspired by the Economists Do It With Models post, my question this week is How do you commit to losing weight?

(a) Use silent willpower
(b) Tell your friends you're on a diet
(c) Sabotage your car (so you have to walk everywhere. i.e., put a screw or nail in your tire)
(d) Write a check to your rival school's athletic scholarship fund. Give the money to a trusted friend who can check on your diet. Instruct him to send the check if you cheat on your diet (Source: The Logic of Life by Tim Harford. A similar contract can be found here).

The poll gives four options (please select one on the sidebar), but I also encourage comments. The most creative way to lose weight wins! I don't have any actual prizes, but you can win public gratitude.

The poll is open for a week. Please vote and tell your friends to vote. I'm interested in seeing what you and your friends think. Heck, tell your enemies to vote. That should make for some interesting discussion.

Friday, June 19, 2009

Elements of Style: 50 years of bad grammar?

This is the eighth installment of the Elements of Style Series where I relay helpful hints for good writing from the classic book, The Elements of Style by William Strunk Jr. and E.B. White.

A couple of weeks ago, I was brainstorming my next Elements of Style post when I came across a scathing review of The Elements of Style, 50 Years of Stupid Grammar Advice by Geoffery K. Pullum. In this article, Pullum says that he "won't be celebrating" the 50th anniversary of The Elements of Style. In fact, he claims that the book has "significantly degraded" American college graduates' grasp of English grammar.

This is a strong claim, which Pullum spends five single-spaced pages supporting. As Pullum is a leading expert on grammar, it's worth breaking down his points to see what we can learn about the applicability of Strunk and White. What's so objectionable about The Elements of Style?

On Strunk and White's style advice. Even though he claims that the style advice is "mostly harmless," Pullum uses the words vapid, tautologous, silly and useless to describe Strunk and White's suggestions. In particular, he identifies the maxims "Be clear," "Do not explain too much" and "Omit needless words" as no-brainer advice.

Is it a no-brainer to avoid being verbose? You bet. Do good writers want to be clear? Sure. What does it mean to "explain too much"? I'm not sure. These are good points if you only read the section headings of Strunk and White, but The Elements of Style is valuable because it gives tangible advice to help writers overcome common bad habits. The concrete and clear advice beneath the headings sets The Elements of Style apart.

On the active and passive voice. After discarding the style advice, Pullum turns to Strunk and White's discussion of active versus passive voice:
What concerns me is that the bias against the passive is being retailed by a pair of authors so grammatically clueless that they don't know what is a passive construction and what isn't.

If you need one, here's a translation: Strunk and White are clueless about the passive voice. They're idiots who cannot distinguish between passive and active.

Despite being unclear and using too many words, Pullum is right that Strunk and White misdiagnose their chosen sentences as passive. Maybe I did too. After all, Pullum co-wrote a handbook on grammar. Does that mean Strunk and White's suggestions on what they call active and passive sentences are bad advice? I'm not sure. Pullum ridicules the Strunk and White example sentence:
There were a great number of dead leaves lying on the ground.
as not passive. He insinuates that this sentence is fine. In his words, the sentence "has no sign of the passive in it anywhere." Then, should we leave it be? Here's Strunk and White's suggested alternative:
Dead leaves covered the ground.
In my opinion, Strunk and White's phrasing is punchy and clear -- just what a good writer wants. Maybe it was a misguided example to illustrate passive construction, but the Strunk and White version is better writing.

Pullum challenges the internal consistency of The Elements of Style. In particular, he notes places where Strunk and White violate their own rules. Here's Pullum again:
And then, in the very next sentence, comes a negative passive clause containing three adjectives: "The adjective hasn't been built that can pull a weak or inaccurate noun out of a tight place."

That's actually not just three strikes, it's four, because in addition to contravening "positive form" and "active voice" and "nouns and verbs," it has a relative clause ("that can pull") removed from what it belongs with (the adjective), which violates another edict: "Keep related words together."
Pullum is right again. Strunk and White messed up and violated their own rules. Oops. Pallum calls this "sheer ignorance." Maybe it is. On the other hand, writing is difficult. I have heard stories of E.B. White struggling for an entire afternoon over a page-long column. Yet, White was a wonderful writer. The best writers struggle, not with form or technicalities, but with the best way to communicate ideas.

Pullum criticizes other elements of Strunk and White's grammar. In particular, he takes the instruction from Strunk and White: "With none, use the singular verb when the word means no one or not one." Pullum criticizes this advice for being at odds with established literary practice at the time "when Strunk was teaching and when White was a boy." Pallum searches a database of books that were published around 1900 for the phrase "none of us."

In this so-called "experiment," Pullum describes three instances where the word none is used only in plural form: Oscar Wilde's The Importance of Being Earnest (1895), Bram Stoker's Dracula (1897) and Lucy Maud Montgomery's Anne of Avonlea (1909). Pallum then says "Is an intelligent student supposed to believe that Stoker, Wilde, and Montgomery didn't know to write? Did Strunk or White check even a single book to see what the evidence suggested?"

That's a scathing criticism, but I think it is unfounded. The Elements of Style is designed to correct common writing errors. It pays little attention to things that most people get right, dealing with difficult and commonly misunderstood topics. If you're in the business of exposing common mistakes, you have to recognize that even good writers mess up. The more common the mistake, the more likely it is that a good writer makes it.

Another point: on the use of none, some of the instances Pullum cites are quotes in works of fiction. Aren't phrases in quotes exempt from grammatical scrutiny? If we are not allowed to scrutinize them in their original context, how can we place these quotations on the pedestal of grammatical purity? Would we dare to do the same with George Bernard Shaw's Pygmalion? If so, "I washed me face and hands before I come, I did." is wonderful grammar.

Yes. I believe that Stoker, Wilde and Montgomery knew how to write, but I also believe that they were human. Human beings make mistakes and we tend to make the same errors when something is difficult. But, make no mistake, clear writing is difficult. On writing clearly, The Elements of Style is still the best advice around. It might not be perfect, but it does the best a little book can.

The next installment of the Elements of Style Series will appear on this blog on Friday, 26 June 2009. I will continue this series each Friday until I run out of interesting topics in grammar, style and writing.

Thursday, June 18, 2009

Who pays for Chicago's fireworks?

Last Saturday, my wife and I went on a fireworks boat tour while entertaining friends who visited us in Chicago. We paid $23 each for two hours on a mini cruise boat. Our fee bought a river tour of the skyscrapers, a view of the skyline from Lake Michigan, and a spectacular view of the twice-a-week Navy Pier fireworks show. If you ever visit Chicago, the fireworks tour is definitely worth the price of admission.

If you don't have sea legs, you can view the fireworks display from plenty of places downtown: by land, by bridge or even by skyscraper. No doubt, other people watched the show. Furthermore, almost no one who viewed the show paid for the show directly. Even we did not pay for the fireworks directly: the tour would have been worth the price even without a fireworks display.

On our trip back to the dock, while everyone else was hearkening back to the brilliant fireworks display, I couldn't help but wonder: who paid for the fireworks? Silly ole economist me, I had to do some math to figure it out.

Our boat had a capacity of 130 passengers and it was not quite full. Out on the lake, I noticed only four other boats like ours on a similar tour de fireworks. At 100 people per boat, that's 500 people who paid for the show. If $10 of our $23 fare went to the fireworks budget, that's only $5000 with which to pay for the spectacular fireworks display.

That's a good load of cash, but the fireworks display we witnessed was a good one. Even though fireworks displays start at $3000, good ones can cost more than $20,000. In fact, the July 3rd fireworks show in Butte, MT perpetually puts Butte Celebrations in debt exceeding $10,000. Our show was better than the yearly July 3rd celebration in Butte. So, if better fireworks means it is more expensive, our show cost more than $10,000.

That's more than the revenue captured, so it seems that the show is a money-loser for the organizers. From an economic perspective, this shouldn't be surprising. After all, fireworks displays are what economists call a public good. Public goods have two features that distinguish them from ordinary goods like pizza or computers.

  1. My use of the good does not diminish or preclude your use of the good. With the fireworks, my viewing of the show doesn't dim the lights or dampen the booms for you. A good with this feature is called non-rival.

  2. People can enjoy the good even without paying. In our example, someone on the Michigan-Wacker bridge didn't pay a cent, but gets a great show. A good with this feature is called non-excludable.

Because public goods are non-excludable, it is very difficult to make a living producing them. Even though everyone wants the good produced, no one wants to pay because they can enjoy the good without paying. Therefore, no one wants to produce them. Standard Econ101 tells us that the government can help us over this non-excludability hurdle by taxing the beneficiaries and providing the good.

Now, that's not to say that government is the only solution. In fact, you should be skeptical whenever an economist tells you that the government can (or will) fix a problem. Yes we can provide public goods with public money, but government solutions are laden with legislation and pork. Is it possible for individuals and private groups to solve the problem? That's the question I asked myself as our boat raced back to the Chicago skyline.

Private solutions. For some public goods, there are some promising private alternatives for overcoming the public good problem. For example, our tour bundled a fireworks show with other amenities that made the whole package worthwhile. As a result, we paid for a substantial portion of the show. Bundling is a common way for companies to overcome the non-excludability of public goods. Television and radio programming, as well as most services on the Internet bundle public goods (broadcast programming, information, knowledge, etc.) with advertising.

As my story above shows, sometimes bundling does not make the good profitable enough. Another way for private entities to raise fireworks revenue is to form a coalition of interested parties to provide the good. For fireworks in Chicago, a coalition that makes sense is a group of downtown businesses. If some organization can solicit them to pitch in some money to finance the fireworks show, that might raise sufficient revenue.

And, local businesses have an interest in pitching in. On account of the twice-a-week shows, people visit downtown and frequent the downtown businesses. That extra business is worth paying for, leaving open a couple of revenue sources: people who want an extra special view (like us) and businesses that want to attract extra patrons. Put the two together and it just might be profitable to provide the service privately.

What does Chicago do? The theory behind public goods is nice, but how does it match with how Chicago actually finances the fireworks shows? It turns out that the Metropolitan Pier and Exposition Authority (MPEA) puts on the fireworks shows as part of its managing of Navy Pier. MPEA is a municipal corporation with the express purpose of "strengthening the local economy." To that end, the municipal corporation acts as an extension of local government; it is not expressly profit-seeking.

This is not a private solution, but there are elements of economic efficiency to it. The fireworks boat tours induce people who want the best view to pay the lion's share of the firework show. The businesses at Navy Pier capture some extra revenue drawn in from the crowds who come to watch. Other downtown businesses pay taxes, but in return, get spillover benefits from the fireworks shows. Patrons pay taxes and most get a free fireworks show in return.

In the end, the provision of Chicago's fireworks shows is a government solution to a public goods problem, but from the perspective of someone who likes private solutions, it isn't half bad. Having fireworks shows twice per week is just another perk that makes me happy I am living in Chicago. Sure we have 10.25 percent sales tax, but did you see that finale?

Wednesday, June 17, 2009

Marijuana: How to convince someone on legalization

For the past month, I have been reading what ordinary people say about why marijuana should be legalized (i.e., the comments at the bottom of Digg articles on marijuana legalization). Some of these comments are interesting and have changed my perspective, but others have terrible logic.

If you favor legalization for a good reason, why should you care if others use bad logic to also favor legalization? Simple. Their support makes your arguments seem less valid. This is not fair because you probably have some good points. But, this is the cost of a bad argument.

As I dislike bad logic, I was elated to find the following exchange in the comments on a popular marijuana article from Digg:

Stop throwing innocent people in jail because they have a plant on them. Most people that don't smoke don't realize how serious an issue it is, people are literally being sent to jail and prison because they have a PLANT on them! Imagine you were arrested because they made cotton illegal and you were wearing a T-shirt? [NightC]
Silly, right? Here's my favorite response:

Look, I'm all for legalizing pot, but please stop trying to support it by posting your reasoning, and I use the term loosely, because horribly simplified arguments like that are not helping. [egoideal]
I could not agree more. If you have a good point, why ruin it by adding a bad argument into the mix? Yet, that's what the pro-legalization camp looks like: For every 10 arguments, there are only one or two good ones. Someone who might be persuaded by a good argument won't listen to your good points if you also throw senseless garbage at him.

Of course, if all you have are bad arguments, your best strategy is to spray them anywhere and everywhere. Maybe someone will believe you if only you contact enough people. As of right now, I'm just a casual observer, waiting to be convinced.

Tuesday, June 16, 2009

Reputations and stealing don't mix

Last month, I was the victim of content theft: A company named Palluxo stole my article on why I love Apple-the-company while still detesting Apple-the-product. They posted my words to their web site without linking to my original source. Why am I bringing this up again? My previous post on how Palluxo stole my stuff should convince you that content theft is wrong. This post makes a stronger claim: content theft is bad for business.

This past week, the shady dealings of Palluxo were exposed to the Mac community by Phillip Elmer-DeWitt, author of the Apple 2.0 blog on CNN.com. It turns out that Palluxo not only steals original content, but the company also spreads false rumors about Steve Jobs. The post sparked a debate in the comments. Here are two opposing views. First, from Simon Turner:
If the story is so silly – which it obviously is – why are you dignifying it by repeating it? I would have expected Fortune to be above the usual “having it both ways” media BS. Disappointing.

Second from Dan Butterfield:
By calling BS on a site for consistently lighting these matches, PED [Philip Elmer-DeWitt] is alerting readers, blogs, journalists, news services, et. al. that they’re being played by Palluxo. “Consider the source” is a journalism golden rule. PED’s post is a clarion call for other news organizations to do just that … consider the source, and if you’re being played call BS.

So, what should we do? Lay silent and let silliness be, or proclaim that we've been scammed by a false media organization? Because of the role of reputations in doing business, I strongly encourage crying foul. In fact, Palluxo is a great example for how crying foul can work.

In online news, the reputation of your news source is as important as the content on the site -- at least for initially visiting a site. If you see a source you distrust, you don't listen to it, you don't click through to the next level and you do not take that source seriously. Reputations are important. This is why many people read the New York Times -- it's a source people trust. The Times has a well-established reputation and that reputation is valuable.

So, what can emerging news organizations -- ones without well-established reputations -- do to grow their audience? Palluxo's ill-advised strategy was to publish headlines that no one else would dare to publish. Doing so would garner attention. The more shocking the headlines, the more attention the headline grabs. The trouble is that these headlines were made up.

By consistently publishing false rumors and stealing original content, Palluxo developed a reputation for shady dealings. As this reputation spreads, fewer people will click on links that say Palluxo because Palluxo is a synonym for false or stolen information. If we just let silliness be, people will discover more slowly that Palluxo does not actually provide expert commentary. And, Palluxo will get more traffic in the long run.

When ordinary people are in the dark about a company's intentions, that company can get away with lying and cheating. Subversive companies like Palluxo thrive on this darkness and the lack of a well-formed reputation. That's why one of the best remedies is light. Let people know who scammed you. If they do the same, everyone will be scammed less frequently.

If you are an emerging news organization, know this: your actions today will determine your reputation tomorrow. You have a choice over what reputation you cultivate. Don't be the next Palluxo.

Poll Results

This post documents (in reverse chronological order) the results of the Weekly Empirical Poll. As new results come in, I'll update this post. For now, here are the questions and the results:

What is your Michael Jackson ticket reservation price? 11 said $0, 8 said $25, 1 said $50, 2 said $100, and 2 said greater than $1000.

What's your reaction to University Market closing? 5 said "good riddance," 3 said "this is horrible," 12 said "no downside," and 5 said "I'm puzzled."

Poll: What would you choose? 5 said Trick, 5 said Snickers, 2 said Kit Kat, 2 said Smarties.

Poll: How much cash do you keep on your person? 1 said $5, 10 said $25, 3 said $75, and one said $200.

Poll: What is your reaction to President Obama's Peace Prize? Two said "Proud," 11 said "Confused," 7 said "Hopeful," and 3 said "Angry."

Poll: What do you trust? Four said "individuals," Two said "government," 12 said "incentives," and one said "the media."

Poll: Would you refund your textbook royalties to your students? 10 said "no," 6 said "yes."

Poll: Have you ever ordered at a restaurant only to discover you forgot the money to pay? 8 said "no," 9 said "yes." It's more common than I thought (at least among the people who responded).

Poll: What is this video to you? 4 said "inspirational call to service," 2 said "thought-provoking public service announcement," 1 said "harmless enviro-fluff," and 17 said "leftist propaganda."

Poll: What do you do when a friend asks for help moving? 15 said "help him," 2 said "get out of it", and 2 said "lecture him"

Poll: What would you do? Do you tell your sales associate about a misapplied discount if silence benefits you $25? 23 said no; 14 said yes.

Poll: Willis or Sears Tower? If you went to the tower, what would you say? 15 said Sears Tower; 4 said Willis Tower; And, 5 said "lost my glasses."

Poll: What's your favorite popular economics book? 8 said Freakonomics; 2 said More Sex is Safer Sex; One said The Logic of Life; One said Create Your Own Economy. My favorite is The Logic of Life. It's worth a read.

Poll: Is there such thing as a free lunch? 36 said no; 16 said yes.

Poll: Mankiw versus Krugman. Who would win in a joust? 576 voted for Mankiw, 143 voted for Krugman.

Poll: How much should the President make? Two said $1, six said $400K, four said the median household income and no one said it should be tied to performance.

Poll: Where did I read this? 13 said Chicago (2009), 4 said South Africa (1999) and none said either Soviet Union (1989) or China (1979). Most of you were right.

Poll: Why turn down $25? 3 said scam, 6 said hassle, 2 said sounds like a good idea, and 4 said I already have an ING Direct account. It's not a scam, but I can understand why someone would think that.

Poll: Do police make you feel safe? 9 said Yes; 7 said No. Close call.

Poll: How do you commit to losing weight? 7 said "use silent willpower," 2 said "tell your friends," 4 said sabotage your car, and one said post a bond. Kristi had the best (and only) comment.

Poll: What attracts you to Chicago? 7 readers said "go to the ballpark," 5 said "explore downtown," 3 said "explor the museums," and one said "enjoy the lake."

Poll: Seatbelts -- What's your policy? Do you wear a seatbelt? Why or why not? 11 readers said "Yes. Belting up saves lives," two said "Yes. To avoid tickets," and three said "No. I rationally choose not to buckle up."

Climbing a tree for a nut: I asked where I read a passage about climbing a tree to get a nut. Six of you got it right that I read that in a top economics journal, two thought I read it in a children's book, and one thought I made it up.

Can time travelers change history? Inspired by Lost, 8 people said Yes, 7 people said no.

What do you do when it rains? Run from place to place won with 5 votes, grab an umbrella got 3 votes, and put on some raingear earned 2 votes.

How often do you do laundry? Every two weeks won with 6 votes, followed closely by "when the underwear runs out" with 5 votes. Weekly got 3 votes and no one voted for doing laundry daily.

Were you surprised, enchanted, humbled, or troubled? by Barack Obama's response to the same question. Four were troubled, one was humbled, two were surprised, none were enchanted.

Where is the better place for a carriage ride? Chicago (9 votes) defeated Montana (8 votes)

Monday, June 15, 2009

Drinking, taxes and menu costs

In a post entitled The Economics of Cocktails and Taxes, Jodi Beggs at Economists Do It With Models gives an interesting set of predictions regarding the effects of a recent sales tax increase on the price of cocktails. She used three models (Econ101, drunken irrationality, and menu costs) to assess the effects of a tax on the market for drinking.

In last Thursday's post [link], I described why I don't like the drunken irrationality argument. Here I give a more complete explanation of what menu costs have to do with the effect of the tax.

Maybe the discussion of menu costs seemed incomplete because I recently took a final exam in my graduate macroeconomics course that covered, of all things, menu cost models. The key to applying menu costs sensibly is to relax the law of one price.

Economists often like to assert that only one price prevails in a market because it makes the math easier, but in a world with menu costs, different producers charge different prices. This is true, in part, because there really is no such thing as perfect competition that equalizes all prices. The competitive model is a useful caricature of the messy economic forces at work, but there still are messy economic forces at work.

Why are there different prices for different places? Some bars adjusted their prices last week, whereas others adjusted their prices ten weeks ago. The out-of-date prices are more likely out of line with current supply and demand. This means, in econo-statistical jargon, the prices have a distribution.

Every firm would love to be at the optimal price, but it is costly to keep the price pegged there. It also doesn't hurt too badly to have a price that misses the target price by a little bit, but as the price drifts downward relative to other firms, profit margins dwindle. If the price increases relative to other firms, customers leave causing profits to fall. With menu costs, bars don't change their prices unless they are very far from the optimal price. But, once the bar decides its price is far enough from its target price, the owner changes prices and by a lot.

Notice that if there is a distribution of prices, the implications change. Not every bar is right near the optimal price. Some have prices that have drifted down relative to everyone else. Some have just changed their menu. When we hit the entire market with a sales tax increase, the effects are different for different bars.

When there are menu costs, a bar really has to benefit from increasing or decreasing its price. With this in mind, here are the predictions:
  • If the target price decreases, bars with the highest prices are most likely to decrease their prices (and by a lot), whereas the bars with already low prices get less gain from changing prices, and so they don't.
  • If the target price increases, the menu cost model predicts the opposite: low price places really raise their prices, whereas high price bars keep the prices as they were.

So, what happens when the market for cocktails is slapped with a moderately hefty sales tax (say 6 percent)? What do bars want to do with their prices? If the tax is not figured into the price (but lumped on top, like here in Chicago), bars want to decrease their prices to attract customers from home who said "Boooo" to the tax. As the analysis above illustrates, the bars that were relatively overpriced will be the first to cut prices. When they do, they will really adjust prices.

If the price is inclusive of the tax, the high price bars will "eat the tax," while the relatively underpriced bars will redesign their menus. That's what menu cost models say anyway, and I think the story is encouraging for what we learn in Econ101. The Econ101 story tells us qualitatively what happens to the target price. The menu costs tell the rest of the story.

Sunday, June 14, 2009

Companies Tony Loves: The Leaf N Bean

This week's installment of the Companies Tony Loves Series is on the Leaf N Bean, a local coffee shop in Bozeman, MT. "Companies Tony Loves" posts describe why innovative companies and business practices make us all better off, and therefore why they deserve our love. "Companies Tony Loves" is featured every Sunday on this blog.

Small businesses are everywhere, and they are a big part of our lives. Successful local companies earn our business with hometown charm, good service and good value. I love successful small businesses for all of their innovation and charm. In this era of chain restaurants and Big Box stores, the small businesses that remain have a competitive spirit that is great for customers and their product cannot be replaced. And, that's why this week's company I love is the Leaf N Bean, a local coffee shop in Bozeman, Montana.

Having lived in Bozeman for seven years, I noticed one very peculiar fact about the place -- there are zero Starbucks coffee shops in Bozeman. There's plenty of demand for espresso in Bozeman, a vibrant young community that is home to Montana State University. With nearly 40,000 people, Bozeman is even a large town by Montana standards. Yet, there is no Starbucks in sight. There are no Dunkin' Donuts locations in Bozeman either. Corporate coffee is mysteriously vacant from the college town.

This fact should make you marvel at the local coffee shops in Bozeman. Starbucks would not do well in Bozeman: not for lack of coffee demand, but for abundance of competition. I have personally visited over 20 Bozeman coffee shops, and I have not seen them all. Even though Starbucks is one of the fiercest competitors on the planet, it is no match for the local coffee shop market in Bozeman.

How can this be? What is so great about Bozeman coffee shops? Take the example of the Leaf N Bean, which has two locations in Bozeman. The Leaf N Bean has a full set of amenities that welcome visitors and encourage them to come back. The comfortable chairs and tranquil music make it a great place to study while sipping some coffee or tea. There are board games for people who want to hang out in the shop. There's even a playroom for children to play while mothers sip coffee and have conversation.

So far, the place sounds like the quintessential coffee shop, complete with hometown charm. That it is, but the downtown location is more than that in the evenings. The Leaf N Bean on main street hosts live music several evenings out of the week. People are drawn to all of these amenities, and the service is always great. I have never entered a Leaf N Bean coffee shop without being greeted with the friendliest smiles.

All in all, the Leaf N Bean has small town charm and provides high quality service in a way that corporate coffee cannot. That's a good reason to love them and an even better reason to support them.

If you have ideas for Companies Tony Loves, please let me know. It could never hurt to have more suggestions!

Saturday, June 13, 2009

Poll: What attracts you to Chicago?

If you live in Chicago, you know it's that time of year. It's time to entertain visitors. Chicago is a great place to visit in the summer. We have the lake, two professional baseball teams, the Magnificent Mile and loads of museums. That's just scraping the surface. With so many options for things to do in Chicago, it makes me wonder: What would you do if you could visit Chicago for one summer day? Here are some options to consider:

1. Enjoy the lake. You can easily fill a day enjoying the lake. For 35 dollars ($17 if you caught the Groupon), you can take a guided bike tour of the lakefront. The lake also has numerous beaches: some charge for access, others don't. You can also take a lakefront cruise, sipping champagne and enjoying the warm breeze. Afterwards, you can walk along Navy Pier, and of course, there's no charge for walking.

2. Explore downtown. The Magnificent Mile is... well... magnificent. There are all sorts of high-end stores and boutiques. And, you don't have to spend money to have a good time. It's fun to go around looking at art galleries and marveling at the high price tags on particular pieces. You can also shop at Macy*s, Bloomingdales, and Nordstrom while you're at it. A last, highly-recommended attraction is the John Hancock Tower. They have an observatory that costs $12, but the Lounge on the 95th floor of the Hancock has the same view (albeit behind glass) and you get to enjoy it while sipping a drink for the same $12.

3. Go to the ballpark. Of course, Chicago has the Cubs and the White Sox. On many summer days, you have a choice between watching a Cubs game at historic Wrigley field versus watching the southside Sox at much-newer U.S. Cellular field. Cubs games are a little more expensive, but both teams are fun to watch. There's nothing like having a loaded Chicago-style hot dog while watching some afternoon baseball.

4. Explore the museums. You can fill an entire week with all of the museums Chicago has to offer. At the Museum of Science and Industry, you can tour a real-life German U-Boat, which was captured during WWII. There's also the Adler Planetarium and the Shedd Aquarium, which are great places for kids. I would be doing Chicago museums a disservice for not mentioning the Art Institute and the Museum of Contemporary Art. Our current neighborhood of Hyde Park has about 10 museums in addition to the Museum of Science and Industry.

There are lots of other things to do in Chicago, but it would take an entire travel brochure to mention them all. This week's question of the week asks you to select among the four options I listed. Even if you live in Chicago, pick your favorite attraction. I'd be interested to see what Chicago attractions are most popular.

The poll is open for a week, so please vote early, vote often, encourage your friends to vote and encourage your visitors to vote. The poll will close at 1 pm Chicago time on 20 June 2009.

Friday, June 12, 2009

Elements of Style: Positive Writing

This is the seventh installment of the Elements of Style Series where I relay helpful hints for good writing from the classic book, The Elements of Style by William Strunk Jr. and E.B. White.

Rule 12 in Strunk and White is "Put statements in positive form." This rule is straightforward. Its application comes down to two sub-rules:

1. When negating a word or phrase, use its antonym. Avoid the word not.

Strunk and White give several examples where an antonym leads to better, more direct writing. My favorite is did not have much confidence in versus distrusted. This sub-rule goes hand-in-hand with picking a word that is right for the purpose. Appending not to an idea usually takes zest out of your sentence.

This is because the construction "not xxxx" usually leaves several interpretations of what you mean. This is especially true if xxxx is an all-inclusive word like everything or everyone. Instead of just negating the all-inclusive idea, it is better to write what you mean. For example, the sentence "Not everything about economics fascinates me." can be replaced by one of the following sentences (without contradicting the original sentence):

- I am fascinated by law and economics, industrial organization and transaction costs.
- No field of economics fascinates me.

To avoid miscommunication or confusion, be direct.

2. Make definite assertions.

Writing in positive form focuses attention on what is, rather than what is not. Readers typically want to know the answers to what is questions. A sentence about what is not requires a change in direction (and more thought to decipher the passage). Therefore, it is more natural to read a passage that is written in positive form. As good writers want to make the reader's job as easy as possible, good writers stick to the positive form. Here's an example from Strunk & White:
The Taming of the Shrew is rather weak in spots. Shakespeare does not portray Katharine as a very admirable character, nor does Bianca remain long in memory as an important character in Shakespeare's works.

is in negative form, whereas
The women in The Taming of the Shrew are unattractive. Katharine is disagreeable, Bianca insignificant.
is in positive form. Not only is the first passage difficult to understand, but its use of negative form requires more words. Good writing is clear and direct. The positive form helps us write more clearly and directly. Lesson? Write positively!

The next installment of the Elements of Style Series, "50 Years of Bad Grammar?" will appear on this blog on Friday, 19 June 2009. I will continue this series each Friday until I run out of interesting topics in grammar and writing.

Thursday, June 11, 2009

Drinking, rationality and taxes

In a post entitled The Economics of Cocktails and Taxes, Jodi Beggs at Economists Do It With Models gives an interesting set of predictions regarding the effects of a recent sales tax increase on the price of cocktails. Here are the three models with which Beggs does the question of "What happens to the price of a cocktail when taxes increase?"

1. Econ101 -- Basic supply and demand. Under this model, a tax drives a "wedge" between the price suppliers receive and the price consumers pay. This standard "wedge" theory implies that the producers pass some (but not all) of the tax on to consumers. In this way, the two groups split the check, perhaps unevenly, to be sent to the government (Beggs gives a really nice graph to this effect).

2. Irrationality -- People are drinking, after all. Under this model, drunkards who are consuming cocktails do not pay attention to the costs of their habit. In such a world, people will be too blazed to notice that they pay more at the end of the night. The bar owners can charge their customers the whole of the tax increase.

3. Menu Costs -- Changing the labels on the menu is costly. Under this model, bar owners will worry that the higher price drives away customers. They want to offer discounts to attract more customers, but marking the discounts costs more than it is worth. In Beggs' words, the bar owners "eat the whole cost of the tax" if the menu price includes tax, but the consumers will "eat it" if the menu price does not include tax.

The article is entertaining and well-written, but I can't shake the feeling that this argument is incomplete in its resorting to irrationality. I also think a more complete menu costs model does a better job of explaining what's going on. In this post, I make the argument against irrationality. On Monday, I give my version of the menu costs explanation.

On Irrationality: It might be true that some form of irrationality explains the problem, but as a rule, I make irrationality my last explanation, rather than my first (or second). I don't usually buy irrationality arguments because purported irrationality can explain any phenomenon. Don't believe it? Here are some examples:

Why did people get a mortgage they couldn't afford? They were irrational.
Why do people get married? They are irrational.
Why do people put money in a 401K and not look at it again? They are irrational.
Why does Tony attend University of Chicago, instead of some place that will push him less? He is irrational.

What's the problem with the irrationality explanation? Isn't it still useful to explain what's going on? When using models, we're interested in more than just an explanation -- we want to predict. The trouble with irrationality is that it cannot be predicted. People are irrational for idiosyncratic reasons that depend on context. Change the context and you change the prediction.

Even if we really expect people to be irrational, we'd like to have an explanation that we can apply to other settings. That's why we economists do it with models in the first place: we commit to a simplified version of the world to see if we can get by without resorting to irrationality. If we can get by without too much irrationality, we can trust the predictions more.
With the drunkards, let's try an alternative explanation out for size. People might not care that much about prices while they are at the bar, but when they get home, they realize what they have done. Or, when they contemplate going out on the town, they weigh the costs and benefits. People are foresighted and they also know their own habits better than anyone else.

A drunken night on the town might cost $100. In deciding to go out on the town, a person budgets (either explicitly or implicitly) that expense. We can expect that people will go out on the town less frequently if there is a sales tax, but they still get just as blazed when they do.

People might be fully irrational while drunk, but that need not imply that their drinking behavior be irrational. This is the same logic that led Nobel Laureate Gary Becker to develop a theory of rational addiction: people weigh the costs and benefits of acquiring addictions. Why shouldn't they weigh the cost of going out on the town?

Wednesday, June 10, 2009

Estimating tax revenue from marijuana: five assumptions

My last post on marijuana criticized The Budgetary Implications of Marijuana Prohibition by Jeffery Miron. This is the report that claims that legalizing marijuana will net the government nearly $14 billion in cost savings and tax revenue. As my last post highlights, the report overstates the cost savings because it trivializes the enforcement and judicial costs that remain after legalization (say for users below the cutoff age).

In this post, I highlight five assumptions that the report makes to obtain estimates of tax revenue. To make sense of the policy implications, we need to understand what these assumptions imply the tax revenue that would be collected from a legalize-and-tax policy applied to marijuana.

Here's how the report (found here) estimates the tax revenue from a legalize-and-tax scheme:

Using year 2000 marijuana expenditure levels from the Office of National Drug Control Policy as a baseline, the report makes the following assumptions:

1. Marijuana's demand curve (relationship between price and quantity) is the same before and after legalization. Under this assumption, price and quantity change solely because marijuana becomes more or less costly to produce (i.e., supply conditions).
  • The report then makes the strange claim that it might become more costly to sell marijuana in a legal scheme. This is strange because marijuana suppliers can always exercise the option of returning to the black market. If it really was more costly under a legalized system, producers would just revert back to the black market.
2. The Netherlands is the same as the United States. To be fair, he takes prices in the Netherlands, and in academic language, conveys that these will be the prices in the United States if we legalize. More concretely, this conjecture makes two implicit assumptions: (1) demand conditions are identical in the two countries, (2) our legalization will have the same effects on the supply of marijuana as the de-facto legalization in the Netherlands.

3. The demand for marijuana in the United States is the same as in 1972. Either that or use the demand from Australia. The world is a different place today than in 1972. The quality and potency of marijuana has also changed dramatically enough for some people to claim that it is a "different drug." I'm not claiming that it is a different drug, but if it has different quality attributes, we should expect price responsiveness to be different.

As an alternative estimate, Miron cites a study that used Australian data. Like the Netherlands comparison, using this study makes the implicit assumption that the United States and Australia are the same (i.e., have the same price-quantity relationship). They might be, but they might not.

4. The data represent what's really going on. As the previous three assumptions make clear, the report relies heavily on other marijuana studies. Most of these studies conducted a survey to obtain data. And, there's a big problem with surveys about illegal activity: people lie. Even purchase data are bound to have problems when the act of purchasing the drug is illegal. People hide that they're purchasing illegal drugs. Asking people about their activity and trying to observe their use is going to miss something, and that's going to affect the calculations.

5. Substituting from other goods (alcohol, tobacco, etc.) has modest, negligible effects on overall tax revenue. Miron recognizes the possibility of substitution from other taxed goods to marijuana, but he does not deal with this issue quantitatively. Instead, he dismisses this effect by referring to another conceptually unrelated effect that likely goes in the opposite direction -- that demand increases because punishments no longer apply. It might be that there are no good estimates out there on how people would substitute from alcohol to marijuana, but this is something we need to know (or at least think about more carefully).

As I am still sorting through these assumptions myself, I appreciate reading your thoughts in the comment box below. I have some thoughts, but it is a complicated problem. In particular, I would like to know: What effect do these assumptions have on the tax revenue estimates? Why? The report makes most of these assumptions on account of having inadequate data. Do you see any better ways to get around missing or misleading data? Also, if you have access to data sources that can help me sort out what's going on, I appreciate the input. Next week, I will have a more to say.

Note on Attribution
Since last week, I discovered the Jeffrey Miron has since extended the paper to cover the budgetary implications of legalizing all other currently illegal drugs. In particular, his revised version of the same paper is entitled "The Budgetary Implications of Drug Prohibition." His paper also updated his estimates for marijuana for 2006. After adjusting for inflation, the estimates in the new paper are $1.53 billion higher than the previous paper.

With a research question like this where the data are very noisy, an 18 percent blip in costs is not unheard of. What would be really useful is if Miron computed some measure of the variability in the data. For you statistics nerds, there are few standard errors in the report (though he talks a lot about uncertainty and variability). It would lend more credibility to the report if it quantified the data's variability in some way.

The Budgetary Implications of Drug Prohibition can be found