Friday, July 29, 2011

The Learn Microeconomics Tab

Not long ago, I discovered that Blogger added tabs and pages to its list of features. I was elated to try this out because I wanted to have a place with links to all of my YouTube videos (in an outline form, with the logical structure). Hence, the Learn Microeconomics tab on this blog was born (and you can find a pretty good outline for a basic microeconomics course under that tab). Maybe you noticed it already?

Today, I added a new section to this outline of topics: Blog Articles Related to Microeconomics, where I link to articles I write on this blog about basic microeconomics. As I often blog about how basic microeconomics applies to real-world situation, this new feature will give these posts a permanent and easily-searchable home.

In case you're interested, here is the list of past posts I selected to put under this section. As I write more microeconomics-course-relevant posts, I will link more articles in this section. My hope is that this new feature will be useful to economics students as a learning tool.

Netflix Economics II: The difference between free and fee. Imperfect Competition.
Children: Normal or Inferior? Consumer Theory.
Negative Exernalities in Picture Form. Market Failure.
A First Lesson on Producer Theory. Producer Theory.
Commitment. Game Theory.
Subgame Perfect? Not bad. Game Theory.
An example of price discrimination (Costco). Pricing.
Why online education won't replace classroom education. General.
Preferences and Economics Nobel Rankings. Consumer Theory.
Price Discrimination and Car Rentals. Pricing.
When does it pay to burn money? Game Theory.
Pondering complements. Consumer Theory.
Price Discrimination Everywhere: Baseball Edition. Pricing.
What does economics say about setting a price? Pricing.
Why rising house prices and rising home prices are different. Endowment Economies
What is math? General.
Diamonds and Water. Welfare Analysis.


Thursday, July 28, 2011

Mothers and Daughters

According to Tyler Cowen:
There is a mother and a daughter, and the mother wants the daughter to clean her room. Cleaning the room doesn’t take long, but it does involve the daughter getting out of bed at some positive cost.

The mother can come and threaten to beat the daughter with a broomstick. That will induce a rapid-enough cleaning (or a good enough start), but the mother would prefer to achieve the end of a clean room without such drastic measures. That said, the mother will wield the broomstick if that is the only means of getting the room cleaned. The daughter has a slight preference not to be threatened with the broomstick, ceteris paribus.

Time passes and for a while nothing happens. What is the equilibrium?
Read on to see Cowen's take. The first comment on the post is also worth a read.

Wednesday, July 27, 2011

Elderly Employment Versus Unemployment

In an intriguing follow up to his previous post on the topic, Casey Mulligan produced exactly the graph I wanted to see upon reading his previous post, which pointed out that elderly employment has gone up since before the recession. It turns out that unemployment has gone up too:

Mulligan's present post is a response to a post from Dean Baker of the Center for Economic and Policy Research, which takes a different tack:
There is a simple way to try to test this story. We can look at patterns in wage growth since the downturn. If Mulligan's story is right then we might expect to see the wages of older workers rise less rapidly than for younger workers. (These are nominal wages.) The idea is that the desperate older workers are willing to take big pay cuts to keep or get a job, while the young whipersnappers (sic) would rather lounge around on the couch watching TV.

Baker follows this up with a chart that plots wage growth over 2007-2011 by age group. It turns out that elderly individuals have had higher measured wage growth than non-elderly individuals.

As with any simple test, the simplicity might mask other interesting effects. To see one possible labor-supply-side effect behind this chart, suppose that the only thing that happened on account of the recession is a halving of housing prices.

Such a shock would disproportionately affect the moderately-well-off who own houses more than not-so-well-off who do not. Faced with a sharp decline in household wealth, elderly with wealth tied up in housing would stick with their jobs for longer than before (Mulligan's supply story). Because their income is higher than the not-so-well off group, this effect makes it look like incomes of elderly have gone up when we compare the income of the 2007 elderly to the income of the 2011 elderly. But, I just told a story about supply, not demand.

With the right data, one can test for this story. Just produce a bar chart like Baker's bar chart but just using data on individuals who do not own houses (and wouldn't necessarily have the same impetus to stay in the labor market into their golden years). It isn't a clean test -- some elderly had retirement portfolios decline in value -- but it is a rather simple test.

Monday, July 25, 2011

Netflix Economics II: The difference between free and fee

A while ago, I linked to an interesting in-depth analysis of Netflix and pointed out some interesting things they had to say. Basic point: It seems that it is more costly to offer streaming content than it first appears.

But, the article had some flaws, which makes me think that the author doesn't really understand the Netflix business model. Exhibit A is this graph, which is supposed to be an indictment on the selection that Netflix offers.

There is a similar graph for streaming TV shows, but the basic point remains. Netflix does not have the wide selection that other services offer. Look at the graph. What do you think? Should Netflix change its business model? Is change inevitable?

I don't think it is. I look at this graph and think about all of the reasons why I do not watch on Comcast OnDemand, which has a free movies section. With Comcast, the selection is better than Netflix if you count the $5 movies, but most of the time, the only movies worth watching are the ones that cost $3 to $5. Even if I really want to watch that movie, I can wait a few months and see it for free on Netflix.

That's the thing about Netflix. The selection of movies is surprisingly good if you make an apples-to-apples comparison to a similar service. Moreover, I am willing to conjecture that most people who use Netflix either don't mind waiting for a movie to come out later or enjoy older movies.

The rest of this post is what Paul Krugman would call "wonkish"

Setting aside the issue of the selection that is offered, I think it is worth understanding the difference between the $5/movie rental model and the rent-all you want model. To a first approximation, the following graph has everything you need to know about this.

A rental company will set the price such that marginal revenue equals marginal cost. Relative to open competition, they'll jack up the price to make profit. This will decrease quantity, but the decrease in quantity is worth it. For the $5 rental company, profit is illustrated as the green rectangle. Not bad for the rental company. And, the consumer gets the pink triangle in surplus.

What does Netflix do differently? They give away all of their movies for free if you sign up for the monthly fee. To a consumer, this service provides great value (value equal to the big triangle; pink, brown, green, grey and yellow areas). If there is no competition, this big multicolored triangle is how much Netflix could charge for the free-at the margin service.

In this case, Netflix makes a killing. Profit equals "pink + green + yellow - red." If the red triangle is smaller than the pink and yellow areas, the Netflix model makes more profit. Now, that isn't a foregone conclusion because economics art isn't always drawn to scale, but there's a good chance that Netflix makes more profit in this story.

There was a big "if" in my description of the Netflix pricing. No competition. That doesn't sound right. Well, what if Netflix faces competition from someone like Comcast who prices like a monopoly? In this case, Netflix can't charge the full multicolored triangle to each customer. It has to leave consumers at least the pink triangle of surplus in order to attract them to the monthly service. So, the monthly fee is slashed somewhat to "green + brown + yellow + gray" and Netflix profits are equal to "green + yellow - red." Result: Netflix makes more profit if the red triangle is smaller than the yellow one.

Again, the way it is drawn, Netflix seems to be winning the battle of profits (but economics art is not drawn to scale). What I can tell you is that as marginal costs (the costs of producing another unit) decline, the Netflix model looks more attractive because the yellow triangle increases in size while the red triangle shrinks.

There's more to this, but it is far from a foregone conclusion that Netflix is backed into a corner. That said, the one surefire way to put pressure on Netflix is to slap on a healthy per-screening fee. That raises marginal cost (which increases the size of the red triangle). For more background and a quick intro to the topic, check out this YouTube playlist (an hour and 11 minutes of joy)

Saturday, July 23, 2011

Adverse Possession

Via Philip DeFranco, here is one way to obtain a $300,000 house for $16.

This is an interesting case in what it actually means to own something. In case you're interested, here's more on adverse possession from Wikipedia:

Adverse possession is a process by which premises can change ownership. It is a common law concept concerning the title to real property (land and the fixed structures built upon it). By adverse possession, title to another's real property can be acquired without compensation, by holding the property in a manner that conflicts with the true owner's rights for a specified period. For example, squatter's rights are a specific form of adverse possession.

Friday, July 22, 2011

When More Employment is a Bad Thing

Casey Mulligan has an interesting post where he discusses this graph:

My takeaway from this graph is that the employment of the elderly hasn't fallen on account of the recession and that's not necessarily a good thing. To understand why, here's a quote from Mulligan's original take on the graph:
Many elderly people, for example, saw the market values of their homes and retirement assets plummet in 2008 and feel they can no longer afford to be retired. Naturally, many of them react by looking for work.

The blue and green lines in the chart show that the elderly have been much more successful than the general population at obtaining and retaining jobs.
Rather than being an indicator that times are swell for the elderly, this graph indicates to me that many elderly individuals put off retirement on account of the poor economy. The elderly are clearly worse off on account of the recession (this is using Mulligan's description of this graph). In fact, this is an excellent example of when more employment is a bad thing.

When trying to measure our well being, consumption opportunities do not tell the whole story. Leisure activity is important, just ask The Onion (in all seriousness). This is to say that one needs to be careful when talking about macro aggregates like employment. There are plenty of reasons why employment might rise -- most of the time greater employment means better opportunities, but this example is not one of those times.

For additional reading on this topic and graph, here is Mark Thoma's take.

What's a Sordid Lynx?

Click here to find out. For some inspiration behind this post, check this out.

Monday, July 18, 2011

A Click Worth 24 Cents

I received a rather puzzling e-mail from Netflix today. Here is the text:

We're sorry you had trouble watching instantly

Recently you may have had trouble instantly watching movies or TV episodes due to a technical issue on our end.

We are sorry for the inconvenLinkience this may have caused. If you attempted and were unable to instantly watch TV episodes or movies yesterday, click on this account specific link in the next 7 days to apply your 3% credit to your next billing statement. Credit can only be applied once.

Ready to start watching again? Browse our selection.

Again, we apologize for any inconvenience and thank you for your understanding. If you need further assistance, please call us ....

It's true. I had trouble watching instantly yesterday, but I wasn't expecting Netflix to apologize for it. How generous of them to be giving me 3% back on my $7.99 monthly subscription.

Update: In case you think that this is a new policy, here is a forum discussion on exactly the same topic from about 3 months ago at the widely respected forum Shroomery.

Update 2: Also, three months ago. An interesting discussion of Netflix customer service. For some reason, the people at the Motley Fool used the same language as I did. I just realized they wrote about this. I'm ... puzzled. But, the e-mail is truly puzzling.

For status or for wealth

Xan has an interesting post on this question. Here is his conclusion:
More generally, for most anything which correlates with higher status, we systematically tend to overestimate the degree to which people are pursuing it for the sake of status alone. Making more money boosts both absolute welfare and relative status, but we are more likely to notice the people who hold their wealth over us, not the ones who blend in quietly. On average, the rich are probably less obsessed with their riches than we imagine.
Or, perhaps, the rich are more obsessed with obtaining and enjoying their riches and less obsessed with being among the rich than we imagine.

Sunday, July 17, 2011

Netflix Economics I: The Cost of Going Streaming

Here is an excerpt from a rather long, but generally very interesting analysis of the Netflix business model.

Netflix's customers have responded by rapidly switching: in its most recent quarter (Q3), the company said that 66% of its subscribers watched instantly more than 15 minutes of a TV episode or movie compared to 41% for the same period of 2009, and 61% for the second quarter of 2010. In Q4, a majority of Netflix subscribers will watch more content streamed from Netflix than delivered on DVD.

So many of Netflix's 16.9 million customers are streaming videos, in fact, that they account for 20% of all internet traffic during a typical evening, according to Sandvine, which makes network-monitoring equipment. (We find this number hard to believe, but anything close to it is still very substantial.)

From a casual standpoint, it just seems cheaper to stream movies and television directly to your existing TV, over your existing internet connection rather than troubling the postman to deliver it. Plus, with streaming, there is no plastic DVD waste created as a byproduct.

But, there's more to the DVD-streaming tradeoff than meets the eye. What is cheaper -- accounting for 20 percent of Internet traffic or mailing hoards of DVDs through the mail -- is not as obvious as it first appears. On the scale that Netflix uses America's bandwidth, there is a real cost to going streaming. Netflix doesn't currently pay for this cost, not even indirectly through customers who have to pay more for more intensive usage of bandwidth.* According to the article, this may change soon.
Another major threat to Netflix is internet providers starting to charge for high usage rather than offering unlimited downloading for a flat rate. It goes without saying that streaming video is very bandwidth intensive and, as noted earlier, Netflix may account for as much as 20% of all internet traffic during a typical evening. Such high usage by Netflix's customers is slowing down the internet for everyone and is one of the reasons why Cisco predicts that internet traffic will triple by 2014. To accommodate this, carriers like AT&T and Comcast will have to invest billions of dollars - and will of course look for a return on this investment, most likely by shifting to a pay-for-usage model that would make Netflix's streaming content much more expensive.
There are a lot of other points to pick apart in this analysis. Not all of them are right. For the sake of focus, I'll leave my comments on those ideas to another post. For now, have a read. It is an interesting perspective.

*This was a big issue in late 2010 when new guidelines were released to govern how Net Neutrality applies to competition between Internet Service Providers like Comcast and content delivery services like Netflix. Here is what I had to say back then (and here is what Jeff Ely had to say, which is a hundred times more comprehensive and detailed).

Thursday, July 14, 2011

The $13 Trillion Question

From Jacob Goldstein at NPR's Planet Money, Here's an interesting description of the larger picture surrounding the U.S. budgetary debate:

That $13 trillion figure is based on CBO's "alternative fiscal scenario," which CBO says "incorporates several changes to current law that are widely expected to occur... ."

For example, under current law, marginal tax rates on middle-class families will rise in in the next few years, and Medicare payments to doctors will fall sharply. The alternative fiscal scenario assumes that Congress will intervene — as it has in the past — to prevent those things from happening.

As the CBO says, "Many budget analysts believe that the alternative fiscal scenario presents a more realistic picture of the nation's underlying fiscal policies" than estimates based solely on current law.

I quite enjoy Goldstein's Planet Money Indicators, which are featured on the Planet Money podcast.

Sunday, July 10, 2011

Signaling, Education and Skills

An interesting post by Robin Hanson.
Bottom line: If much of human interaction is signaling, then much of human investment is in ways to better signal. Businesses that signal are also willing to invest in better signals. The fact that attending school seem (sic) to cause changes in students that employers are willing to pay for does not show that school isn’t all about signaling.
From the links in the post, I thought this was an interesting reading list by Tyler Cowen. And, here's an interesting quote from Bryan Caplan's piece on the topic:
But isn't this process productive, broadly defined? At some level, sure. But as always in signaling models, there are negative externalities at the margin. If everyone signals for four extra years, this doesn't improve the quality of our signal; it just waste (sic) four years of time and resources. But that's from a social point of view. Selfishly speaking, "wastefully" signaling for four extra years can still enrich you by making you look better relative to competing workers. It's just like standing up at a concert to see better: You make yourself better off by making everyone else worse off - and burn socially valuable resources in the process.
I find these education-as-signaling arguments compelling, but I think these two quotes take it a little too far. It's true that education has a huge signaling component, but it is far from clear that education is all about signaling.

Take Hanson's example of business school, where students learn how to signal (dressing well, memo writing, presentation giving, etc.). Hanson's post suggests that these skills are mostly self serving, but that's not necessarily true. It depends on the business. Business skills can add value to potential employers, value that is not fully realized by a self-serving employee.

For example, if you go to work in a fundraising office at a hospital, it is important that you present and dress well. Otherwise, your poor signal hurts the company's bottom line (what donor wants to give money to the hospital represented by the unshaven dude in board shorts?). Employers can't have an employee around who cannot give a presentation or who dresses like a slob. In business, that's not just a signal, but because business is all about signaling, it is added value.

Update: 7/10/11 (10 pm) Tyler Cowen makes this point more succinctly than I did.

Wednesday, July 6, 2011

New Ideas

From Scott Sumner, some encouraging advice to young economists about idea generation.
Memo to young economists: Don’t ever think you’ve come up with a new idea. Unless your last name is Coase, you are almost certainly wrong. Everything in macroeconomics keeps get rediscovered with each new generation. I don’t even know if Attwood and Rooke are the first. Of course ideas are continually refined and developed, and I don’t doubt the Mankiw and Reis paper is far better than mine.
Or, in a different context, Tyler Cowen would say, "there's a literature on everything."

Monday, July 4, 2011

Cost of Policing Fireworks

After looking at some of the spectacular private fireworks displays to the south of my apartment in Chicago, I thought I'd see how an old post of mine was doing on the seasonally-popular search for "Chicago Fireworks cost." My post was at the top, but another article at the Chicago Sun Times caught my eye. This year's City of Chicago fireworks display has been cancelled, leaving the fireworking to the twice-weekly Navy Pier display.

One of the reasons cited for cancelling the main fireworks show is the cost of policing it. Here is an excerpt from the article that describes how this went last year:

Instead of having one fireworks show on July 3 that drew more than 1.2 million people and stretched city services to the brink, Chicago held smaller synchronized fireworks shows on July 4: at Montrose Harbor and 59th Street to coincide with the previously scheduled show at Navy Pier.

City Hall hoped to cut security costs by making the switch, but it didn’t quite work out that way.

Policing three fireworks venues cost $756,476, including $251,377 in “regular tour pay,” $444,251 worth of “accumulated compensatory time” and $60,846 in overtime, records show.

To be sure, that's a hefty sum to spend on policing a fireworks celebration, but the number quoted in the article is not the actual economic cost of policing the fireworks. To know the economic cost, we need to know the cost of the alternative. In other words, we need to know how much we would save on policing by slashing the main fireworks show (or even if we collectively save anything, given that MPEA is putting on a replacement show at Navy Pier).

Maybe the savings of putting on a small fireworks show is considerable relative to putting on a large display, but the authorities won't cut extra policing to zero. In fact, I expect many Chicago police officers are working overtime tonight. With or without a large public fireworks display, they should probably be on call when a significant fraction of Chicago residents is setting off fireworks.

Sunday, July 3, 2011


As many Americans associate July 4th with freedom, here is a reminder of an excellent blog post on the economics of freedom by Ed Glaeser:

In the 19th century, John Stuart Mill asserted, “The only freedom which deserves the name is that of pursuing our own good in our own way, so long as we do not attempt to deprive others of theirs, or impede their efforts to obtain it.”

In the last century, Milton Friedman offered “freedom is a rare and delicate flower” and “a society that puts equality — in the sense of equality of outcome — ahead of freedom will end up with neither equality nor freedom.”

Economists, like Friedman, often made the case that freedom had instrumental value — it achieved other aims, including equality and prosperity. But no one should doubt that Friedman and Mill and Smith saw freedom as a fundamental good, a thing to be valued for itself. That is, after all, how freedom is treated at the very heart of economic theory.

May you cherish freedom wherever you are.