Thursday, August 23, 2012

The Fiscal Cliff

John Cochrane has an interesting post on the fiscal cliff.  Here's an excerpt:

As a "standard" economist, I look first and foremost at incentives. Raising marginal tax rates lowers incentives to work, save, invest, start businesses.  That's not good. So I agree that the tax part of the fiscal cliff will drag down the economy. But not because it reduces Keynesian stimulus, but because it worsens incentives.  
The bigger problem with the fiscal cliff is the utter chaos of it all. What serious country decides its tax laws year by year, in one big chaotic crisis during the first few weeks of the year? Will estate taxes be 55% or 0% next year? Who knows? 
Moreover, this last-minute crisis atmosphere is ripe for salting the tax code with little goodies which nobody will notice until it's too late. It's a fiesta for lobbyists, tax lawyers and crony-capitalists of all stripes. 
This is not how any serious country operates, let alone the supposed leader of the free world. And annual tax chaos is certainly not good for GDP. 

The rest is definitely worth reading, but the short version is "incentives matter."

Friday, August 17, 2012

Propane Price Discrimination

I observed an interesting pricing dilemma today while visiting my wife's family.  Our big event of the day was to go to the propane store.  They had an event where they would give away hamburgers and hot dogs, as well as fill up your 20 pound propane tank for $4.88.  For those of you who are not in tune with wholesale propane prices, that's about cost (link 1, link 2).

When we arrived at the event, the parking lot was full and so was street parking for about two blocks (abnormal in Montana).  In addition, everyone there was bringing all of the propane tanks they could muster.  We got in line behind a couple who had 4 normal-sized propane tanks, and as we had just arrived, I thought this was a lot.  As we left, there was someone with 4 JUMBO propane tanks (I'm guessing that each could hold 100 pounds of propane) plus 3 regular sized ones.  I would have taken a picture, but I didn't want to seem too weird.

What could explain this crazy event?

My first thought was that this was great advertising.  The propane shop sells more than just propane.  They also sell fireplaces and grills.  This was a great opportunity to get people into the store to look at this propane-intensive merchandise.  Forgoing your markup for a weekend in order to get a big boost in sales is a great idea.

My second thought was that this is a good way to price discriminate via two part pricing.  Offering wholesale-cost propane is like charging marginal cost for use of the products they're selling.  Moreover, who are you going to attract to this event?  Heavy propane users who very much enjoy grilling.  For more on this pricing scheme and how it relates to price discrimination, there's an excellent video here.

Finally, on the consumer side, how come everyone knew to come with their propane tanks like they did?  After all, it would take a lot of preparation to end up with SEVEN huge empty propane tanks just in time for this event.  While at the shop, I noticed a sign that said this was the 22nd annual propane shop event where they give propane away at cost.  After seeing this happen 21 years prior, I'm sure that people caught on that they could just time their propane tanks for this event (and perhaps, get enough propane to last the whole year?).

This allows for another -- more subtle -- method of price discrimination.  Consumers who have room for seven propane containers will find it less costly to wait for the annual sale on propane (and they'll get more benefit when it comes around).  This ties into the general notion of price discrimination: give discounts to consumers who are sensitive to price hikes  -- here's looking at you, guy with seven tanks -- while everyone else pays regular price (most of the time).

As you can see from this example, there are a lot of reasons why we see the prices we do.  The world is full of entertaining pricing schemes, and this one is no exception.