Sunday, February 26, 2012

Segmented Cheese, Price Discrimination, and Cheese Arbitrage

While at the grocery store today, I noticed a new cheese product in the dairy aisle. Apart from the usual shredded, block and sliced cheese, the store now offers "cheese bars," which is something between a cheese block and a cheese slice.

Upon closer examination of my photo, the store also offers cheese sticks (a skinnier version of the cheese bar) as well. I found myself oddly attracted to these products: I like cheese, I like to snack, and sometimes I like to snack on cheese. At the same time, it is hard to understand the place of cheese chunks in the market -- especially next to the cheese block that consists of exactly the same type of cheese. After all, the only inputs you need to make cheese bars and cheese strips are a knife and a cheese block... and a little time.

It is possible that the very people who would buy cheese bars and strips are those people who place a very high value on their time (or estimate the amount of time it would take to cut the cheese to be very high). Consequently, they're willing to pay a higher markup for segmented cheese.

In economics lingo, segmenting the market by pre-cutting the cheese allows the cheese firm to screen customers into price sensitive (those who would go through the hassle to cut their own cheese) and price insensitive (those who appreciate pre-cut cheese). This is valuable to the firm because it allows for price discrimination. Charge a higher markup on pre-cut cheese (disproportionate to its additional cost) and price discrimination can be profitable.

The one technicality here is that the firm must prevent arbitrage -- resale or repackaging of the blocks into bars and strips. As long as a big enough group of people is unwilling to cut their own bars and strips, cheese arbitrage shouldn't be an issue.

For more on this topic, there's an excellent set of three (1, 2, 3) YouTube videos on Price Discrimination.

Tuesday, February 21, 2012

Words of a Democrat

Via Freakonomics, here is a cool word cloud that visually summarizes words favored by Democrats.

Click through to see the corresponding word cloud for Republicans.

Saturday, February 18, 2012

What I do

In a post entitled What We Do, Greg Mankiw points to an entertaining list of caricatures of economists. For the empirically minded economist, there was one missing panel in his post:

Note: Just in case you think I am cheating on R, Stata's recognizable black background shows up in the photo, but my preferred program (R) looked like a white background with nothing on it.

After Dinner Coffee

One of my hobbies is taking pictures of my food to send to relatives. Indeed, my wife (Shanna) looks forward to my almost-daily lunch photo. This evening, Shanna and I went to Piccolo Mondo for dinner. After dinner, I had a cappuccino that was so beautiful I had to take a picture and share it with the world:

Dinner was great too. Good atmosphere, knowledgeable and attentive waiters, excellent food. My only regret is that I had an appetizer instead of saving room for dessert.

Thursday, February 16, 2012

On my reading list: Private Information and Insurance Rejections

I recently attended a job market seminar by Nathaniel Hendren. Here is the abstract to the paper he presented:
Across a wide set of non-group insurance markets, applicants are rejected based on observable, often high-risk, characteristics. This paper explores private information as a potential cause. To do so, we develop and test a model in which agents have private information about their risk. We derive a new no-trade result that can theoretically explain how private information could cause rejections. We use the no-trade condition to generate measures of the barrier to trade private information imposes. We develop a new empirical methodology to estimate these measures that uses subjective probability elicitations as noisy measures of agents’ beliefs. We apply our approach to three non-group markets: long-term care, disability, and life insurance. Consistent with the predictions of the theory, in all three settings we find larger barriers to trade imposed by private information for those who would be rejected relative to those who are served by the market. For those who would be rejected, private information imposes a barrier to trade equivalent to an implicit tax on insurance premiums of roughly 65-75% in long-term care, 90-130% in disability, and 65-130% in life insurance.
His intuitive summary of the results: from the standpoint of an insurance company, there's one way to be healthy, but many (unobservable) ways to be sick. Based on his presentation and a quick scan of the paper, his paper has a lot of good stuff in it.

Friday, February 10, 2012

A Golden Quote

Here's an interesting article from Warren Buffett:
Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.

Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

What is interesting to me is that we could probably conduct a similarly absurd exercise with the world stock of diamonds in Pile A. Buffett's statement is about the total value of the stock of gold relative to Pile B, but prices in a free market do and should reflect the marginal value. Phrased this way, Buffett exhibits a classic paradox in economics (the diamonds and water paradox). What Buffett means to say -- that the price of gold is too high given the marginal value of the product -- may also be true (and I think it is), but one could prefer Pile B over Pile A and the price of gold could still be "right" at the margin.

HT (Sean "Golden")

Thursday, February 9, 2012

Mark Cuban on Financial Engineering

Today, I am reading the Freakonomics Q&A with Mark Cuban. In response to a question that essentially asked if engineers should go into finance, here's what Mark Cuban had to say:
We have too many bright grads concentrating on “financial engineering” rather than actually making something and contributing to society. I think we will see tax and regulatory policy that will reduce the incentives and increase the friction for those who “hack” the stock market and focus on financial engineering. Which, in turn, hopefully will incentivize you and others to enter other disciplines.
He goes on to say what he thinks should be done about the problem of financial engineers. Whether or not you agree with is ideas on the topic (I'm conflicted), his interview is an interesting read. Plus, he talks about other topics, too.

Monday, February 6, 2012

Deceive Thyself

There's an interesting post on self deception at Cheap Talk:
So, my explanation is really the Trivers’ explanation. I did not lie convincingly. My doubts about the answer manifested themselves somehow to the student. He investigated further and cracked the problem. In previous years, the teachers were convinced the answer was right and never even questioned it. They never had to lie because they truly believed they were telling the truth, just like the Trivers’ thesis on self-deception. Students left convinced. If they had doubts, they stifled them.

Saturday, February 4, 2012

Attention is not Free: Lessons from YouTube

How important is getting your audience's attention? Very. This post provides evidence using YouTube data.

In 2008, I attended a research workshop on institutional analysis put on by the Ronald Coase Institute. At the workshop, one exercise stuck with me more than most. Essentially, can you grab your reader's attention in the first 15 words? Time is scarce, and if you cannot immediately get your reader to care, they're going to move on to the next abstract.

Before the conference, we were asked to submit an abstract of our research project. To drive the point home, the workshop provided us with a list of our own abstracts truncated at 15 words. In 15 words, most abstracts couldn't communicate what the paper was about. Some did better than others (we voted on winners!), but all could have used dramatic improvement. The lesson: To set your paper and ideas apart, make the first 15 words count.

Why did I think of this today? For mostly recreational purposes, I have been pouring over data from my YouTube channel. As part of their Analytics feature, YouTube gives content providers a graphical summary of the fraction of viewers who are still watching at any given point in the video. Here's the performance of my most watched video (Marginal Rate of Substitution and Marginal Utility):

At first blush, this looks pretty abysmal, but it reflects the natural attention pattern of people on YouTube. How do I know? YouTube provides a relative audience retention view to help creators see how their videos stack up compared with videos of the same length. Here's how my most watched video stacks up to the typical video:

That's average. Until YouTube came out with their absolute measure of video retention (just recently), I thought average retention meant people were paying more attention.

Now, the graph is a little hard to read precise statistics. Fortunately, YouTube made the graphic interactive. If you hover over a particular point, it tells the point in the video as well as what fraction of the initial audience is still watching.

After 16 seconds of the video, 27 percent of viewers had left. What had I said in those 16 seconds? Here's the transcript:
In the last video, I explained how and where and why you would want to ever draw indifference curves. In this video, I want to give a little more detail about indifference curves and how to work with them. Specifica.... [cut!]
As an abstract, that's pretty bad. In retrospect, I would have rather said:
Want to learn more about marginal rate of substitution and how it relates to marginal utility? In this video, I show how the two concepts relate using some simple graphical intuition. Come along. It's time to learn.
That might have been better phrasing to keep viewers watching. That this intro had average viewer retention is a useful reminder that attention isn't free. This lesson applies much more broadly than keeping YouTube viewers interested.