Wednesday, November 21, 2012

Give Thanks for Markets

In honor of Thanksgiving tomorrow, I thought I would share this beautiful passage from Leonard Read's classic essay I, Pencil.
There is a fact still more astounding: the absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. This is the mystery to which I earlier referred. 
It has been said that "only God can make a tree." Why do we agree with this? Isn't it because we realize that we ourselves could not make one? Indeed, can we even describe a tree? We cannot, except in superficial terms. We can say, for instance, that a certain molecular configuration manifests itself as a tree. But what mind is there among men that could even record, let alone direct, the constant changes in molecules that transpire in the life span of a tree? Such a feat is utterly unthinkable! 
I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree. 
The above is what I meant when writing, "If you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing." For, if one is aware that these know-hows will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand—that is, in the absence of governmental or any other coercive masterminding—then one will possess an absolutely essential ingredient for freedom: a faith in free people. Freedom is impossible without this faith.

As far as what I am thankful for: I ordered a garment bag on Amazon yesterday, and it is slated to be delivered on Friday (for no extra charge, Amazon Prime).  Before calling me trite, just imagine the legions of tiny know-hows that had to come together to make that happen.  Markets are impressive.

Update: It actually arrived today (Wednesday).  In one day!

Saturday, November 17, 2012

Price Gouging and the Demand Side

John Cochrane recently had a contest in the comments of his blog to come up with ways in which price gouging laws were making the situation worse in the wake of Hurricane Sandy.  He proceeded to take all of the low-hanging fruit to his question of "What would happen if price gouging laws were lifted and the price of gasoline went to $25 per gallon?" [bold emphasis mine]
  • People would voluntarily stay home.
  • Rather than allocating gas to people with time on their hands to wait in line, gas would go to people who are really busy. 
  • People would voluntarily form carpools. Better, they would advertise for paying carpool mates on Craigslist, and the minivan owner running it would be able to get gas. 
  • People who have emergencies, like wife needing to go to the hospital to deliver a baby, could get gas to do so. 
  • Ditto emergency services, fire, ambulances, cops
  • Gas stations would have bought generators, so they could pump and sell gas at a big profit when the power goes out.
  • Gas stations would buy said generators now. (We need to get rid of gouging laws on the generators too, so that gas stations needing generators can pay through the nose to get them, instead of someone who wants to recharge his iphone.)
  • People who don't have to go anywhere would siphon their gas and sell it neighbors. Or second-car gas. 
  • They'd siphon their lawnmowers too.
  • People would rent tanker trucks, drive around the northeast, buy gas and resell it in NY.
  • Actually, people might get a bunch of gas cans and drive the gas in from rural areas in the back of pickups. Not sure if this is a good idea, especially for smokers, but it would improve gas supplies.  
  • Exxon would have spent the money for more storage tanks in NJ, ready to sell gas at high prices in an emergency. 
The reason I bring this up in a blog post is because Cochrane's list is -- by and large -- a very good and standard summary of the likely effects of price gouging laws, except for the statements in bold.  The reason is that price gouging laws do not guarantee a lower effective price of obtaining gasoline, a fact that contrary to popular intuition.

In fact, because price gouging laws discourage the voluntary supply of gasoline, we could expect a higher equilibrium effective price of gasoline (including the monetary price and opportunity cost /hassle of waiting in line or gaming the system) under price gouging than under no price gouging.  If this is the case, you would expect that more people would voluntarily stay home under price gouging, not less, and more people advertising for carpools on Craigslist, not less.

There is a sense in which a simple supply and demand diagram illustrates this intuition, and I wrote about this before.

Under price gouging laws (plus strict no black market enforcement), only the gasoline willingly brought to market by producers at price Ps will be traded (that is, Qs will be traded even though consumers want Qd).  As I discussed in my previous post on price caps, we shouldn't stop by saying that Qd>Qs if we hope to understand what happens when there is a shortage.  Threatened with a shortage, consumers will bid for the gasoline by showing up earlier or by side deals or some other unforeseen mechanism.  Regardless, these bids have costs, which should be accounted for in the full notion of the price.

How much in these ancillary resources will people bid?  That's a somewhat complicated question, but if you assume that no one has a comparative advantage non-price bidding (and no black market, so Qs is all that is supplied), the marginal non-price bid will be Pd - Ps, so that the full price is Pd.  The main point is that price gouging can make the effective price higher.  Higher still than the equilibrium price if price gouging laws were not put into place.  In response, it is possible that more people will stay home.

There is a lot more to allocating resources in a market when the government imposes price caps.  Black markets are important.  On the supply side, bundling of related services can be important too: $50 car washes with a free tank of gas (or should it be $100?), but that's the topic of another post.  For an excellent perspective on this, check out A Theory of Rationing by Waiting by Yoram Barzel.

Monday, November 5, 2012

Patterns of Entry and Entry Deterrence

Here is a video that (unfortunately) I could not embed in my job market paper:


The blue crosses indicate locations of established casinos (existing casinos prior to March 2003), and the red dots indicate locations of entry plans that I observe (March 2003 - August 2012).  Apart from being a cool illustration of the graphing features of R, I think the video shows quite a bit about the pattern of entry in the casino industry over the last decade.

My paper is about how those incumbents at the blue crosses respond to entry plans at the red dots, and the extent to which preemptive investments by incumbents can deter entry.  Here's the abstract:
Using a novel data set on entry plans into the American casino industry, I find that incumbent firms respond to the threat of entry by expanding capacity, and that these strategic investments are effective in deterring actual entry. Specifically, a standard deviation increase in incumbent casino capacity leads to 47 percent more failed plans for entry, ceteris paribus. To quantify the benefit of entry deterrence using a stock market event study, I estimate that a failure of an entry plan increases the equity value of incumbent firms by 10.4 to 13.3 percentage points. Additionally, I find that incumbents that increase capacity during a rival’s planning stage retain a larger share of loyal customers. This finding suggests that strategic investments by incumbents can increase patron loyalty, which increases the likelihood that the entry attempt will be deterred. Apart from providing credible evidence on entry deterrence and its form, this paper provides new empirical evidence on how the capital structure of firms relates to economic activity. In particular, incumbents that are highly leveraged tend to expand capacity less in response to a entry plan by a potential entrant, which suggests that highly leveraged firms engage in less aggressive strategic behavior.
For more on my research (including a pdf of this paper), check out my research page.