You hear them daily: advertising pitchmen exclaiming on radio and TV that this jewelry store or that furniture retailer “saves you money by bypassing the middleman!”
Seems sensible, doesn’t it? Wholesalers and other middlemen don’t work for free; they must be paid. So if a retailer “bypasses” or “eliminates” the middleman, that retailer has “savings” that it can “pass on to you.”
But if middlemen only raise retailers’ costs, why does anyone ever use such parasites to begin with?
Simply to ask this question about middlemen is to cast doubt on the widespread myth that the dominant effect of middlemen is to raise the retail costs of goods.
It’s true that middlemen must be paid for their services. These services are valuable, however, because they reduce the final prices that consumers pay at retail.
Middlemen who fail to reduce the final price go bankrupt; these middlemen are “bypassed.” But middlemen in general reduce the costs that consumers pay at retail.
To see the value of middlemen, it’s helpful to realize that retailers themselves are middlemen. The furniture store that brags of “eliminating the middleman” by “buying direct from the factory” doesn’t itself manufacture sofas, beds and dining-room tables. That retailer specializes in acquiring inventories of furniture and assembling these inventories in locations that are convenient for you to visit (such as the strip mall down the street).
If it were generally true that middlemen raise consumers’ costs, you’d be foolish ever to buy furniture from a retailer — including the one who “eliminates the middleman.” You would be better off going directly to the factory to shop for furniture.
But you almost never do so. You buy furniture from retailers. The reason you don’t “eliminate the middleman” — the retailer — when you buy furniture is that the middleman saves you money.
To “eliminate the middleman” here would require you to rent a large truck and drive it (depending on where you live) hundreds of miles to the nearest furniture factory. The factory owner might be willing to sell to you a nightstand or chair for less money than you’d pay at retail. But this price discount likely isn’t worthwhile. Not only do you spend time and money driving to and from the factory; once at the factory, you can’t easily compare that factory’s offerings with the offerings of competing furniture producers. To make such comparisons, you’d have to get back in your truck and drive to other furniture factories.
By the time you do all this driving around, the price reduction that you get by “eliminating the middleman” won’t be worthwhile. You’ll bankrupt yourself by trying to save money!
Don Boudreaux, “Ode to the middleman”, Pittsburgh Tribune-Review, 2012-02-22.
October 24, 2016
October 19, 2016
Published on Sep 23, 2016
A lot of doom and gloom types say we’re living in dark times. But they’re wrong.
While there are real problems, the world has never been healthier, wealthier, and happier than it is today. Over a billion people have been lifted from dire poverty in just the past few decades.
What has contributed to this improvement of our well-being? The answer can be found in the evolution of economic and policy ideas.
But we can still do better. How will we solve today’s challenges and what breakthroughs will spark change tomorrow?
October 18, 2016
In the 1970s, municipalities enacted new rules that were designed to protect farmland and to preserve green space surrounding rapidly growing cities by forbidding private development in those areas. By the late 1990s, this practice evolved into a land-use strategy called “smart growth.” (Here’s a video I did about smart growth.) While some of these initiatives may have preserved green space that can be seen, what is harder to see is the resulting supply restriction and higher cost of housing.
Again, the lower the supply of housing, other things equal, the higher real-estate prices will be. Those who now can’t afford to buy will often rent smaller apartments in less-desirable areas, which typically have less influence on the political process. Locally elected officials tend to be more responsive to the interests of current residents who own property, vote, and pay taxes, and less responsive to renters, who are more likely to be transients and nonvoters. That, in turn, makes it easier to implement policies that use regulation to discriminate against people living on low incomes.
Sandy Ikeda, “Shut Out: How Land-Use Regulations Hurt the Poor”, The Freeman, 2015-02-05.
October 17, 2016
Fortunately, as Tim Worstall explains, politicians can rarely be believed — especially when it comes to economics:
Hillary Clinton Vows To Slam The Economy Into Recession Immediately Upon Election
This probably isn’t quite what Hillary Clinton intended to say but it is what she did say at a fundraiser on Friday night. That immediately upon election she would slam the US economy into a recession. For what she has said is that she’s not going to add a penny to the national debt. Which, in an economy running a $500 billion and change budget deficit means tax rises and or spending cuts of $500 billion and change immediately she takes the oath. And that’s a large enough and fierce enough change, before she does anything else, to bring back a recession.
Now, what she meant is something more like this. That she has some spending plans, which she does. And she is also proposing some tax rises. And that her tax rises will balance her spending plans and thus the mixture of plans will not increase the national debt. Which is possibly even true although I don’t believe a word of it myself. For her taxation plans are based upon static analyses when we really must use dynamic ones to measure tax changes. This is normally thought of as something that the right prefers. For if we measure the effects of tax cuts using the dynamic method then there will be some (please note, some, not enough for the cuts to pay for themselves) Laffer Effects meaning that the revenue loss is smaller than that under a static analysis. But this is also true about tax rises. Behaviour really does change when incentives change. Thus tax rises gain less revenue in real life than what a straight line or static analysis predicts.
That is, as I say, probably what she means. But that’s not actually what she said. She said she’ll not add a penny to the national debt. Which means that immediately on taking office she’s got to either raise taxes by $500 billion and change or reduce spending by that amount. Because the budget deficit is that $500 Big Ones and change at present and the deficit is the amount being added to the national debt each year. The problem with this being that that’s also some 3.5% or so of GDP and an immediate fiscal tightening of that amount would put the US economy back into recession.
Published on 1 Oct 2016
Giant stones sunk under the sea? Cows? Cowrie Shells? What do they all have in common? They were all money. Find out how we got from exchanging these things to doing 8 hours of work for a stack of paper that takes 2 seconds to print on The History of Paper Money.
October 5, 2016
I agree that most people are troubled that the likes of Tom Brady and Jennifer Lawrence earn far higher pay than does any firefighter or school teacher. But this reality reflects not people’s correct understanding of a failing economy but people’s incorrect understanding of a successful economy. It reflects also a failure of economists to better teach basic economics to the general public. So let me ask: would you prefer to live in a world in which the number of people who can skillfully fight fires and teach children is large but the number of people who can skillfully play sports and act is very tiny, or in a world in which the number of people who can skillfully fight fires and teach children is very tiny but the number of people who can skillfully play sports and act is large?
I’m sure that you’d much prefer to live in a world in which skills at fighting fires and teaching children are more abundant than are skills at playing sports and acting. Precisely because saving lives and teaching children are indeed far more important on the whole than is entertainment, we are extraordinarily fortunate that the numbers of our fellow human beings who possess the skills and willingness to save lives and to teach children are much greater than are the numbers who can skillfully play sports and act.
The lower pay of fire fighters and school teachers simply reflects the happy reality that we’re blessed with a much larger supply of superb first-responders and educators than we are of superb jocks and thespians. Were it the other way around, then while we’d be better entertained with more top-flight sporting events and movies, all but the richest amongst us would suffer significantly greater risks of being unable to educate our children and of dying in house fires and from other mishaps.
Don Boudreaux, “Thinking At the Margin: It’s Revolutionary”, Café Hayek, 2016-09-01.
October 1, 2016
The same world poverty data, presented as absolute or relative levels of poverty:
H/T to Rob Fisher at Samizdata for the link.
Thinking at the margin is much more crucial than it seems to non-economists when it is first explained to them. Only by thinking at the margin can we correctly understand, for example, why the wages of life-saving first-responders are lower than are the wages of NFL players and of Hollywood starlets and why this fact is a good thing for society. Only by thinking at the margin can we understand the error of those who assert that firms that have lots of money stashed away in reserve, or that are currently earning higher-than-normal profits, will respond to a hike in minimum wages simply by raising the pay of all of their affected workers. And only by thinking at the margin can we come close to fully understanding why there is no objectively correct minimum standard of drug safety, workplace safety, food safety, or of any other kind of safety.
Don Boudreaux, “Quotation of the Day…”, Café Hayek, 2016-08-30.
September 20, 2016
Another land-use regulation that makes space more expensive is municipal requirements that establish a minimum number of parking spaces per housing unit.
According Donald Shoup’s analysis, parking requirements add significantly to the cost of housing, particularly in areas with high land values. For example, in Los Angeles, parking requirements can add $104,000 to the cost of each apartment. Parking requirements limit consumers’ choices and increase the cost of housing even for those who prefer not to pay for parking.
Developers typically build only the minimum amount of parking required by law, which indicates that those requirements are binding. That is, in a less-regulated environment, developers would devote less land to parking and more land to living space. A greater supply of living space will, other things equal, lower the cost of housing.
Sandy Ikeda, “Shut Out: How Land-Use Regulations Hurt the Poor”, The Freeman, 2015-02-05.
September 15, 2016
Published on 23 Sep 2015
In this video, we discuss asymmetric information, adverse selection, and propitious selection in relation to the market for health insurance. Health insurance consumers come in a range of health, but to insurance companies, everyone has the same average health. Consumers have more information about their health than do insurers. How does this affect the price of health insurance? Why would some consumers prefer to not buy health insurance at all? And how does this all relate to the Affordable Care Act? Let’s dive in.
September 9, 2016
Megan McArdle explains why some Apple fans are not overjoyed at the latest iPhones:
You’ve probably been thinking to yourself, “Gee, I wish I couldn’t charge my phone while also listening to music.” Or perhaps, “Gosh, if only my headphones were more expensive, easier to lose and required frequent charging.” If so, you’re in luck. Apple’s newest iPhone, unveiled on Wednesday, lacks the familiar 3.5-millimeter headphone jack. You can listen to music through the same lightning jack that you charge the phone with, or you can shell out for wireless headphones. The internets have been … unpleased with this news.
To be fair, there are design reasons for doing this. As David Pogue writes, the old-fashioned jack is an ancient piece of technology. It’s been around for more than 50 years. “As a result,” says Pogue, “it’s bulky — and in a phone, bulk = death.”
Getting rid of this ancient titan will make for a thinner phone or leave room for a bigger battery. Taking a hole out of the phone also makes it easier to waterproof. And getting rid of the jack removes a possible point of failure, since friction isn’t good for parts.
For people who place a high value on a thin phone, this is probably a good move; they’ll switch to wireless earbuds or use the lightning jack. But there are those of us who have never dropped our phones in the sink. We replace our iPhones when the battery dies, an event that tends to occur long before the headphone jack breaks. There are people in the world who take their phones on long trips, requiring them to charge them while making work calls, and they won’t want to fumble around for splitters or adapters. Some of us do not care whether our phone is merely fashionably slender or outright anorexic. For these groups, Apple’s move represents a trivial gain for a large loss: the vital commodity that economists call option value.
Option value is basically what it sounds like. The option to do something is worth having, even if you never actually do it. That’s because it increases the range of possibility, and some of those possibilities may be better than your current alternatives. My favorite example of option value is the famous economist who told me that he had tried to argue his wife into always ordering an extra entree, one they hadn’t tried before, when they got Chinese takeout. Sure, that extra entree cost them money. And sure, they might not like it. But that entree had option value embedded in it: they might discover that they like the new entree even better than the things they usually ordered, and thereby move the whole family up to a higher valued use of their Chinese food dollars.
September 6, 2016
Other things equal, the larger the lot, the more you’ll pay for it. Regulations that specify minimum lot sizes — that say you can’t build on land smaller than that minimum — increase prices. Regulations that forbid building more units on a given-size lot have the same effect: they restrict supply and make housing more expensive.
People who already live there may only want to preserve their lifestyle. But whether they intend to or not (and many certainly do so intend) the effect of these regulations is to exclude lower-income families. Where do they go? Where they aren’t excluded — usually poorer neighborhoods. But that increases the demand for housing in poorer neighborhoods, where prices will tend to be higher than they would have been.
And it’s not just middle-class families that do this. Very wealthy residents of exclusive neighborhoods and districts also have an incentive to support limits on construction in order to maintain their preferred lifestyle and to keep out the upper-middle-class hoi polloi. Again, the latter then go elsewhere, very often to lower-income neighborhoods — Williamsburg in Brooklyn is a recent example — where they buy more-affordable housing and drive up prices. Those who complain about well-off people moving into poor neighborhoods — a phenomenon known as “gentrification” — may very well have minimum-lot-size and maximum-density regulations to thank.
When government has the authority to restrict building and development, established residents of all income levels will use that power to protect their wealth.
Sandy Ikeda, “Shut Out: How Land-Use Regulations Hurt the Poor”, The Freeman, 2015-02-05.
September 5, 2016
Published on 8 Jan 2015
George Akerlof, a Nobel Prize-winning economist, analyzed the theory of adverse selection – which occurs when an offer conveys negative information about what is being offered. In the market for used cars, Akerlof posited that sellers have more information about the car’s quality than buyers. He argued that this leads to the death spiral of the market, and market failure. However, the market has developed solutions such as warrantees, guarantees, branding, and inspections to offset information asymmetry.
August 24, 2016
Published on 26 Jun 2015
In this video, we take a look at common goods. Common resources are nonexcludable but rival. For instance, no one can be excluded from fishing for tuna, but they are rival — for every tuna caught, there is one less for everyone else. Nonexcludable but rival resources often lead to what we call a “tragedy of the commons.” In the case of tuna, this means the collapse of the fishing stock. Under a tragedy of the commons, a resource is often overused and under-maintained. Why does this happen? And how can we solve this problem? Like we’ve done so many times throughout this course, let’s take a look at the incentives at play. We also discuss Nobel Prize Winner Elinor Ostrom’s contributions to this topic.
August 21, 2016
Of the numerous and occasionally contradictory techniques used to ration demand and supply [when monetary prices are not used], perhaps the most common is past behavior: persons already in apartments are given preference under rent control, or past acreage determines current allotments under agricultural price support programs. Another common technique is queuing or first come – first served: taxicabs, theater tickets, medical services, and many other goods and services are rationed in this way when their prices are controlled. Of course, discrimination and nepotism are also widely used; the best way to get a rent-controlled apartment is to have a (friendly) relative own a controlled building. Other criteria are productivity – the least productive workers are made unemployed by minimum wage laws;…. collateral – borrowers with little collateral cannot receive legal loans when effective ceilings are placed on interest rates.
Each rationing technique benefits certain groups at the expense of other groups relative to their situation in a free market. Price controls are almost always rationalized, at least in part, as a desire to help the poor, yet it is remarkable how frequently they harm the poor.
Gary Becker, Economic Theory, 1971.