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Archive for February, 2009

Economists have many hypotheses to describe how consumers consume. Some suggest we consume based primarily on our current income. Others say we also care greatly about keeping up with the Joneses. Still others allege we decide how to spend money by considering what our financial situation will be from here to eternity.

A key feature of the last one, dubbed the permanent income hypothesis, is that people smooth their consumption. In times of plenty, they will save and use this money and/or debt during times of want. In this way, they can maintain a constant and (for most) gradually improving lifestyle. This hypothesis may or may not be the best one for describing consumption generally, but for my money it’s spot-on in describing how people diet.

I see people as having a set amount of calories they consume on net. Because of smoothed consumption, all dieting does for most is increase volatility without changing that net number. We hear dieters describe this all the time in decidedly moralistic terms: “Yes I can eat that cheesecake because I was good yesterday” or “I was naughty at dinner, so I’d better run a few extra laps tomorrow.” The fact that Activity X burned 1,000 calories doesn’t mean my net calorie intake goes down for the week, it just means now I can treat myself to dessert! There’s nothing wrong with this, but it won’t result in a reduced figure (mmmm, puns).

So if weight loss is the goal, why the self-defeating smoothing? My preferred explanation tastes of Hanson: dieting and exercise is ostensibly about fitness, but it’s really about signaling and self-deception. Going to the gym or using fat-free dressing communicates something about ourselves both to us and other people, and we enjoy this narrative too much to let truth get in the way.

My homemade chocolate amaretto cheesecake gets in the way sometimes, too.

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One of my more disruptive habits is watching a lot of interviews, debates, and lectures online. Many’s the time when work or bed was delayed because of some 8-part video on YouTube that grabbed me and refused to let go. In the past week, this habit led to the curious coincidence of seeing two Charlie Rose interviewees use economic logic to discuss something about their professions, which of course I got a kick out of.

Marc Andreessen, who pioneered the web browser (and who has appeared on this blog before), spoons out his serving 39 minutes in.

ANDREESSEN: Silicon Graphics was a fantastically successful computer company in the late ‘80s and early ‘90s that actually got put out of business by the PC. The engineers got freed up as a consequence of SGI being put out of business by the PC, went to work, and among other things are now at companies like Nvidia and ATI, that make these graphics chips and pose a significant challenge to Intel. Right? And so the cycle repeats.

The key thing happening there is innovation happened, right, and somebody — in that case, right, somebody benefited, somebody got damaged. But the process of damaging right at that point, Silicon Graphics, was a tragedy as far as Silicon Graphics was concerned, but it freed up those brilliant engineers to go on and create the next generation of technology.

(…)

And it’s that level of sort of, you know, turnover and dynamism and spin-offs and start-ups and venture capital that keeps the whole thing going.

It’d be hard to get a better example of creative destruction than that.

In the second interview, Conan O’Brien claims we’re in a “Golden Era of TV” (11’30”)*.

ROSE: Why do you think that is?

O’BRIEN: I think–the competition…There’s so much more television now, and I think to stand out, the writing had to get better.

And I think there’s a freedom in television that a lot of people aren’t finding in the movies. So, I’ll watch a Lost episode–I don’t know what’s going to happen. I really don’t know who’s gonna to live, who’s gonna die, I don’t know what they’re going to find. You watch an episode of 24, you watch an episode of House, and I think the overall quality of the ideas is a lot higher sometimes than what you see in the movies.

And I think it might be because there’s more competition, and I think clearly increased competition has been good for late night shows as well. There are more late night shows and there’s more comedy on television, and it’s forcing all of us to work harder than we probably would have.  If I had a monopoly on late night shows, I don’t know that I’d be working as hard as I do.

Straightforward stuff straight from Smith, but wait, there’s more (16’25”)!

ROSE: Do Jon Stewart and Stephen Colbert represent anything new? A trend, or a direction?

O’BRIEN:…[I]t’s the degree to which you can specialize now, do you know what I mean? I think in a three network world, it was hard to specialize to that degree. Now, these different shows–you know, Jon’s done it brilliantly and Stephen Colbert has done it brilliantly–they can specialize. There used to be shows that could comment on the news but then had to do other things as well. You really feel like well now they have the freedom to just take, in a half-hour, take that to a further degree than it’s been taken before.

Adam Smith claimed the division of labor as one of the primary sources of the wealth of nations. If I’m better at milling wood and you’re better at milking cows, we will be more productive by specializing in what we’re good at and trading for the rest rather than aiming for self-sufficiency.  This wealth-creating division of labor is, however, “limited by the extent of the market.” If you and I are the only people on earth, in other words, it’s unlikely I’ll be earning my keep as an art critic.  Conversely, a large market allows for large degrees of specialization, just as hundreds of cable channels allow for more specific shows.

Conan later wonders whether TV will continue such that “everyone is working a certain very specific niche.” It’s not clear how he feels about that proposition, but Adam Smith did fret about a worker so specialized he only performed “a few simple operations” for his job. This man, says Smith, “has no occasion to exert his understanding or to exercise his invention” and “naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become.”

Yeesh!

*I couldn’t agree more. Movies rarely strike my fancy these days, but there are many TV shows I enjoy tremendously.

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Bazaar Pricing

Followup to: Price Caps

For someone running a rug shop in a Turkish bazaar, knowing the maximum price each customer is willing and able to pay for a given item would be a boon to his business. Since haggling is the hallmark of a bazaar, he could easily engage customers individually and use this knowledge to extract every last  kuruş from the consumer surplus and maximize his profits. Economists call this perfect price discrimination.

A skilled haggler can still do well without this perfect knowledge, however. Price discrimination–charging a different price to customers for the same thing–relies on the ability of the seller to separate the market and deal with customers individually.  Physical separation is endemic to a bazaar, but not so in Western retail, where most things come with set prices.  Western firms have therefore devised a multiplicity of methods to reap the benefits of price discrimination within a different market structure that does not see much individual interaction.

One ubiquitous method is through a sort of Dutch auction. Sellers introduce goods at a high price, and then lower the price over time in order to draw more people in the market (usually this is done through sales or specials). In this way, the customers reveal their personal demand–and are separated–by when they choose to make the purchase.  Apple did this very thing with the iPhone, which had its price cut $200 several weeks after its launch (much to the chagrin of early adopters, who presumably would hate shopping in a bazaar).

Sellers can also separate the market by making certain items hard to obtain or by making them eligible only to certain customers. Tim Harford, for instance, claims that Starbucks has an unlisted smaller-size cappuccino, which one can only get if it is asked for by name. This ensures that only price-sensitive and cocksure customers will go for the smaller size, while most everyone else will take the larger, more expensive brew.  Fast food places offer “kid’s’ meals” and discourage adults from eating them. Store loyalty cards (think grocery stores) aren’t so much about loyalty as they are about being able to charge a higher price to people too indifferent to apply for a discount.

Branding also allows for discrimination. Put a different logo on otherwise identical sweaters and one can command a higher price for one over the other, even if sold side by side. Sellers also separate in more creative ways, such as was highlighted on the Freakonomics blog:

Price discrimination may always seem devious, but it does tend to benefit–aptly enough–the more discriminating among us; airlines and iTunes make good examples. On my recent flight to Pennsylvania, I had to pay $15 dollars to check a bag. Some people grumble about this, but they do so under a strange assumption that this expense is new. But what’s new isn’t the expense, it’s the fact that the expense can be avoided–I might forgo even the peanuts pretzels if it would lower my ticket price! Similarly with iTunes, I no longer have to buy a bundle of songs in the form of a CD, but can pick and choose only the songs I like at a lower cost.

And did I mention the fact that my hair has never looked better?

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Price Caps

Walking near the Hagia Sophia in Istanbul a few years back, I decided to haggle with one of the many locals peddling fez-like hats. As I recall, the initial quoted price was somewhere around $10, but after a few moments of tense negotiation I had whittled down the price to about $3-4 and made the purchase. Feeling quite satisfied with myself—especially since I am not one who suffers hagglers gladly—I went on my merry way, cap on head.

When I ran into someone else I knew wearing a similar cap later that day, I, confident in my newfound prowess, asked him how much he had paid for his hat. As he answered that he had paid half of what I did, the smug swirling about me quickly wafted away, and I ruefully realized that I had been gotten the best of.

But had I been, well, had? The transaction after all was voluntary, so unless I had not been of sound mind, I wouldn’t have bought the hat unless I thought its value to me was higher than the cost. Thus, even the discovery that a better deal could have been made didn’t alter that I was better off than I would have been sans fez. Nonetheless, I couldn’t help being in a minor funk because I realized someone else had gotten a better value than I had.

Sportin' fezessess in Istanbul.

Sportin' fezessess.

I suspect that in non-haggle societies, we often forget that there is always a range of prices each of us is willing to pay for a given good, despite there being only one price tag. I might be willing to pay up to $15 for a widget, for instance, while you are willing to pay up to $20. If the price were $10 we would both buy, but I’d have a consumer surplus of $5 while you’d have twice that. You’ve benefited more than I have, but I don’t get upset in this case because I have no idea what your maximum willingness to pay is and indeed probably assume it’s the same as mine. Thus, I don’t worry about it and am content only in the knowledge that I am better off.

Having one non-negotiable price may be good for convenience, but it doesn’t change the fact that individual consumers will still benefit to varying degrees from a given item, just as would happen in a tagless bazaar. Haggling can also make prices less “sticky” than they would be otherwise, meaning that they better reflect market conditions.

Interestingly, haggling in the West is becoming more commonplace with the economy’s downturn. Consumers are beginning to tease out the lowest price for which sellers will sell by asking for freebies or perks. To some extent this is nothing new, however, and is actually the result of firms finding clever ways to engage in price discrimination. More on that in a future post.

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I’d never heard of Maxine Waters, a congresswoman from California,  until 20 minutes ago, but she will stay with me for a long time to come. Here she is questioning several bank CEOs, notably Ken Lewis from Bank of America and Vikram Pandit from Citi:

The whole exchange is sadly funny (surely the Germans have a compound noun for this?), but I literally laughed out loud–several times–at one bit starting at 5’20” in which the following dialogue occurs:

Rep. Waters: I think it’s important for us to understand why you paid yourself fees on the money that we gave you? As a matter of fact Bank of America, you paid yourself $30 million in fees just to accept that TARP money. Citigroup, you paid yourself $21 million in fees. Why do you do that?

Ken Lewis: I…I don’t know what you’re talking about.

Rep. Waters: Do you…do…do…do any of you understand what I’m talking about…?

Keep in mind that Waters is a member of the House Committee on Financial Services. Wall Street bankers aren’t the only ones who have failed to perform due diligence, it seems.

HT: Megan McArdle

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For many in the US, the word “recycling” conjures up images of plastic bins that in many cases do a better job collecting rainwater than anything else. Recycling is thus perceived in the same way as that particular example of it: inconvenient drudgery with altruism as the main motivator. What this misses, however, is that long before recycling bins began lining city streets, striving to turn waste into a resource has been a self-interested effort and the source of much wealth and prosperity.

Gasoline, for example, was considered a waste product of crude oil distillation and discarded until it was discovered to make a good fuel for internal combustion engines. Semi-automatic and automatic firearms came into being only when John Browning, the famous gunsmith, realized that the gases escaping from the barrel after firing could be redirected to operate a reloading mechanism. Today, BMW is working on using the heat escaping from tail pipes to generate electricity and help power the car. Silicon processors generate so much heat IBM has developed a method to cool them with water; the cooling makes the processors more efficient, and now IBM is devising a way to use the heated water to warm its offices and surrounding buildings. Trinidad’s famous steelpans were originally made using empty 55-gallon oil drums from the local oil industry and US naval base. And lest we forget, someone long ago changed agriculture forever by taking note of the fact that the excretions issuing from an animal’s backside made grass grow greener.

These innovations do not occur out of a feeling of guilt or vague altruism; rather, they occur because there are high payoffs for anyone who can figure out a way to turn trash into treasure. Recycling, properly understood, is an integral part of the mechanism of capitalism and enriches modern life.

Now if I could think of some valuable way to utilize rainwater…

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A book I just finished reading:

Worship of money was an old-world trait; a healthy appetite akin to worship of the Gods, or to worship of power in any concrete shape; but the American wasted money more recklessly than any one than anyone ever did before; he spent more to less purpose than any extravagant court-aristocracy; he had no sense of relative values, and knew not what to do with his money when he got it, except use it to make more, or throw it away…The American mind had less respect for money than the European or Asian mind, and bore its loss more easily; but it had been deflected by its pursuit till it could turn in no other direction. It shunned, distrusted, disliked, the dangerous attraction of ideals, and stood alone in history for its ignorance of the past.

p. 328

I liked this book, but found the last hundred pages hard to get through. An autobiography written in the third person, Adams details his lifelong quest for the education he felt he did not get in school ( A schoolmaster is memorably defined as “a man employed to tell lies to little boys.”).

If more people read this book, my post-collegiate decisions would not be so inscrutable to so many; self interest compels me thus to recommend it.

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