Consumer surplus is one of those things which is really, really, difficult to measure. This paper is one of the few that’s able to give us a hard number. But what it is is, really, “how much I would have been willing to pay but didn’t have to?” Say that we’re out and you’re thirsty and I’m not very. You suggest we have a Coke. You’re really interested in this, you’d pay $2 for one, I’m, well, meh, I’d only pay $1 for one. Obviously, the Coke seller (no, not the coke one, that’s different) doesn’t know this so he charges us the same price – $1 each. I’ve gained no consumer surplus I paid a buck for something I value at a buck, you gain $1 of surplus because you would have paid $2 but only paid that buck.
In one manner the consumer surplus is a result of mass manufacturing and marketing. We’re pumping out millions of whatever it is, we’ve got to have a “market price” and some people will value it, whatever it is, at more than that. That greater valuation is that consumer surplus. Without a producer knowing what your individual demand curve is they cannot charge you the full value you ascribe to it.
Of course, they try as hard as they can to do so. This is what brands and product differentiation are all about. VW and car brands for example – there’re SUV models built on roughly the same platform in the Skoda, VW, Audi and Bentley ranges. Oh yes, they’re different cars alright. But perhaps not $300,000 different, which is the price gap between the top and bottom there. Some of this (but please note, only some of this) is because there are people who will pay a fortune to swank around in a Bentley and there are many more who will not, thinking a Skoda is just fine (I do a little work for the company and the new Skoda SUV is indeed very fine but then I would say that, wouldn’t I?). That’s product differentiation.
Another example is what used to happen in old fashioned English pubs – in the public bar and the saloon. The latter had carpets and comfy chairs, the former very definitely not. Beer was 10% more expensive if you wanted the comfy chair experience – very simple and remarkably successful product differentiation. Being able to charge different prices to different groups for much the same thing. Or as it often used to work out, different prices to the same person on different occasions. Dates were in the saloon bar….
Tim Worstall, “Freakonomics’ Steven Levitt On How Inefficient Uber Really Is”, Forbes, 2016-09-20.
July 11, 2018
QotD: Measuring consumer surplus
June 29, 2018
QotD: What is a discount rate?
It is not the 20 percent savings you got by buying a new washing machine on Black Friday last year. A discount rate is a way of accounting for the fact that dollars in the future are not quite the same as dollars you have right now.
You know this, don’t you? Imagine I offered to give you a dollar right now, or a dollar a year from now. You don’t have to think hard about that decision, because you know instinctively that the dollar that’s right there, able to be instantly transferred into your sweaty little hand, is much more valuable. It can, in fact, be easily transformed into a dollar a year from now, by the simple expedient of sticking it in a drawer and waiting. It can also, however, be spent before then. It has all the good stuff offered by a dollar later, plus some option value.
Even if you’re sure you don’t want to spend it in the next year, however, a dollar later is not as good as a dollar now, because it’s riskier. That dollar I’m holding now can be taken now, and then you will definitely have it. If you’re counting on getting a dollar from me a year from now, well, maybe I’ll die, or forget, or go bankrupt.
The point is that if you’re valuing assets, and some of your assets are dollars you actually have, and others are dollars that someone has promised to give to you at some point in the future, you should value the dollars you have in your possession more highly than dollars you’re supposed to get later.
The rule for establishing an exchange rate between future dollars and current ones is known as the “discount rate.” Basically, it’s a steady annual percentage by which you lower the value of dollars you get in future years.
All you need to remember is two things: the longer you have to wait to get paid, the less that promise is worth to you today. And the higher the discount rate you apply, the lower you’re valuing that future dollar.
Megan McArdle, “Public Pensions Are Being Overly Optimistic”, Bloomberg View, 2016-09-21.
June 7, 2018
QotD: Profit and loss
It is necessary for people, most especially politicians and those who campaign for them, to understand that economics is not an optional aspect of our universe. We really do have scarce resources and we really do want to optimise our allocation of those resources. One implication of this is that activities which make losses should not happen. And if an activity starts to make losses then we want that activity to stop happening. This is because a loss is the universe’s method of telling us the alternative uses of those scarce resources would be a better use of those scarce resources.
That is, if we use some thing (whatever, labour, capital, land, buildings, electricity, just whatever) and pay market price for it and then make a profit from selling what we create from using it then we have added value. Profit is the value of the output over and above the value of those inputs in their alternative uses. Losses, equally obviously, mean that we are subtracting value from those inputs. Or, as we can also put this, losses make us all poorer in aggregate, profits make us all richer in aggregate.
For, as it shouldn’t be necessary to point out, that gross domestic product, GDP, that everyone likes to talk about is just the aggregate value added in the economy. Something which profits increase and losses reduce.
Tim Worstall, “Things That Make Losses Are Things That Stop Happening – Aetna Edition”, Forbes.com, 2016-08-17.
June 3, 2018
QotD: Price controls just make things more expensive in real terms
One of the perennial, and pernicious, political ideas is that if things are “too expensive” then we can fix that by just passing a law to make them less expensive. We see this just about everywhere and its sadly not limited to the more idiot sector of the left. Although of course it thrives there. Venezuela is a complete and total mess because Hugo Chavez and Nicolas Maduro thought they would make life cheaper by limiting prices by law. Payday lending doesn’t exist in certain states because people like Elizabeth Warren insist that interest rates should not go “too high”. Those usury laws mean that interest rates are infinite – as the lending simply isn’t available at all. And yes, people over on the right have made the same sort of mistake – Nixon tried to fix gas prices after all.
Price fixing just always leads to things getting more expensive. As David Friedman explains:
The result – that price control results in a cost to the consumer, pecuniary plus nonpecuniary, higher than the uncontrolled price – does not depend on the details of the [supply and demand] diagram. Consumers cannot consume more gas than producers produce, so the nonpecuniary cost must be large enough to drive quantity demanded down to quantity supplied. Quantity supplied is lower than without price control, so cost to the consumer must be higher.
Tim Worstall, “Memo For Would Be Price Fixers – Price Controls Always Make Things More Expensive”, Forbes.com, 2016-08-16.
May 30, 2018
QotD: Microeconomics
… I sincerely believe – believe to the point that I can say that I know – that principles of microeconomics is the most important economics course any student can ever take. Ever. By far. If taught properly, and learned with an open and critical and attentive mind, a principles of microeconomics course will impart to the student more understanding of the operation of economies than will all other economics courses combined – and I include here even well-taught PhD econ courses.
Too many academic economists, in my experience, are bored with microeconomic principles. Such principles are so basic. No genius is required to understand them or to teach them well. Teaching microeconomic principles provides no opportunity to showcase great cleverness or to push out the frontiers of understanding. It is, instead, to repeat timeless verities – and verities the majority of which have been known and understood by wise economists for nearly 250 years, and nearly all of which have been known and understood by wise economists for the past 50 years.
[…]
My goal in teaching Principles of Microeconomics is not to launch my students on a path to earn a doctorate in the subject, or even for them to become econ majors. While I’m always pleased when a student, after taking my class, switches his or her major to economics, I teach the course as if it is the only economics course these students will ever take. (Empirically, this assumption of mine is true.) So unlike many other intro-econ courses, I do absolutely no mathematics; I even draw no cost curves. I define a handful of esoteric terms (such as the “law of diminishing marginal utility”) but never mention many others (such as “perfect competition” or “marginal rates of substitution”) that are typical fare in many other principles-of-microecon courses. I wouldn’t even dream of doing indifference-curve analysis in such a course.
I open the course with some economic history. (“Have you any idea how materially prosperous you are compared to the vast majority of your ancestors?!”) I spend a lot of time on supply and demand. I devote two whole sections to international trade, another to public choice, and one to public goods and taxation. (Each section is two-and-a-half-hours long. And I cover some other topics in addition; I mention these only to give a flavor of my course.)
My goal – by teaching basic, foundational, principles of microeconomics – is to inoculate students against the bulk of the common economic myths that they’ll encounter throughout their lives – myths such as that the great abundance of goods and services available to us denizens of modernity is the result of a process that can be easily mimicked or understood in detail by smart people or planners – that the market value of goods or services can be raised by price floors (such as a legislated minimum wage) or lowered by price ceilings (such as rent control) – that benefits can be created without costs – that government is an institution capable of rising above the realities that ensure that private institutions never perform ‘perfectly’ – that intentions are results – that destruction of property is a source of prosperity – that exchange across political boundaries differs in economically meaningful ways from exchange that takes place within political boundaries – that the only consequences that occur or that matter are those that are easily anticipated and seen.
Don Boudreaux, “Teach the Timeless Verities”, Café Hayek, 2014-08-26.
May 14, 2018
QotD: Words and ideas matter
The way we talk and write – the words we use – what we say and what we don’t say – matter. Of course, the process of articulating thoughts helps each of us who articulates (and that is every human being) to better form thoughts that are otherwise fuzzy and amorphous. More importantly, what we express to others not only informs others of facts, instructions, and perspectives that they would not learn were we not to express our thoughts to them, our talking also expresses and, in doing so, reinforces specific ethical values.
Each and every time you say with a smile “thank you” to the supermarket cashier who tallies your order you add a little more dignity to that person’s life and occupation – and to the social estimation of that and related occupations. Each and every time you tell a homophobic or anti-immigrant joke, you detract from the social valuation of homosexuals or of immigrants. Through our talk we humans are constantly raising the social valuation of some peoples and things and lowering the social valuation of other peoples and things. Your words, individually, might have no detectable impact, but by signaling to your hearers or readers what you regard to be acceptable and unacceptable – honorable and dishonorable – important and insignificant – productive and unproductive – polite and crude – true and false – good and bad – you influence their perceptions and evaluations, if only ever so slightly. If, for example, you express admiration for a hard-working entrepreneur and do so with no trace of envy of that entrepreneur’s monetary success, your audience (be it one person or a million people) becomes a bit more inclined to regard entrepreneurs favorably and to not suppose that successful entrepreneurs’ profits are to be envied.
Obviously, the relation of the speaker to the audience matters. The effect of a mother’s words on the attitudes of her young child is greater than the effect of those same words, spoken by the same woman, to some other-woman’s child. The effect of words about widgets spoken by someone publicly regarded to be an expert in widgetry is greater than is the effect of words about widgets spoken by someone who is not regarded as having expertise in widgetry.
Ideas and attitudes matter. They matter greatly. And ideas and attitudes are transmitted chiefly by words. It is this reality above all that causes me distress when I hear or read someone with a degree in economics (or who is otherwise regarded to be expert in economics) get fundamental economics wrong. When some economist asserts that a country’s growing trade deficit destroys jobs, that’s simply wrong – but the expression of that false notion, especially by an “economist,” contributes to the public’s fear of international trade. When some other economist says that “[t]here’s just no evidence that raising the minimum wage costs jobs,” that, in this case, is not only indisputably wrong but is almost certainly an outright lie – but this economist’s lie contributes to the public’s false belief that hikes in minimum wages are all gain with no risk of loss for low-skilled workers. When economists talk and write, as they too often do, as if government officials possess superhuman capacities to care about strangers and to know enough to intervene productively into those strangers’ affairs, that’s wrong – but such talking and writing gives more phoolish credence to the false notion that state power is an especially trustworthy cure for life’s ailments, large and small.
Don Boudreaux, “Quotation of the Day…”, Café Hayek, 2016-08-01.
April 25, 2018
QotD: The “white magic” of the market process
Leonard Read explained what he called the “white magic” of the market process in his justly praised article “I, Pencil.” No one knows how to make an ordinary pencil; no one can ever know how to make a pencil. And yet pencils are produced in such huge quantities that they are virtually free for the taking. We have pencils not because some one person planned from the beginning the cutting of cedar trees, the mining of graphite, alumina, and bauxite, the extraction of petroleum and clay, or the organization of transportation to get supplies to pencil factories and pencils to retailers. When you contemplate the enormousness of all the tasks that are required to make a single pencil, you understand that no one can know how to do more than a tiny fraction of these tasks.
We have pencils (along with indoor plumbing, electric lighting, microprocessors, disposable diapers, camcorders, concert halls, …) only because for each of the countless tasks required for the production and distribution of each good there are a few people who specialize in knowing how to perform these tasks. But no one knows — or can know — how to perform all of the tasks required to produce even the most commonplace of goods. The free market works as well as it does because, when property rights are respected and fully transferrable, the resulting prices tell each of the producers at the innumerable different production “sites” just what (and how much) to produce and with what particular combination of resources.
For example, if the supply of crude oil falls, the resulting higher price will prompt manufacturers of paint to produce less petroleum-based paints and more linseed-oil or water-based paint. The resulting higher price of petroleum-based paints will prompt pencil manufacturers to paint fewer of their pencils with petroleum-based paints and more of their pencils with paints made of substances other than petroleum. As F. A. Hayek taught, the pencil manufacturer need never know why the price of petroleum-based paint rose; all that is required for this manufacturer to act appropriately is for him to conserve on his use of petroleum-based paint. The higher price of such paint achieves this goal.
Don Boudreaux, “A Pitch for Humility”, Café Hayek, 2016-08-05.
February 16, 2018
Games Should Not Cost $60 Anymore – Inflation, Microtransactions, and Publishing – Extra Credits
Extra Credits
Published on 24 Jan 2018You would think that paying $60 for a game would be enough, but so many games these days ask for money with DLC, microtransactions, and yes, lootboxes. There’s a reason for that.
February 14, 2018
Repost: “I, Rose” and “A Price is Signal Wrapped Up in an Incentive”
Published on 8 Feb 2015
How is it that people in snowy, chilly cities have access to beautiful, fresh roses every February on Valentine’s Day? The answer lies in how the invisible hand helps coordinate economic activity, Using the example of the rose market, this video explains how dispersed knowledge and self-interested actors lead to a global market for affordable roses.
Published on 8 Feb 2015
Join Professor Tabarrok in exploring the mystery and marvel of prices. We take a look at how oil prices signal the scarcity of oil and the value of its alternative uses. Following up on our previous video, “I, Rose,” we show how the price system allows for people with dispersed knowledge and information about rose production to coordinate global economic activity. This global production of roses reveals how the price system is emergent, and not the product of human design.
January 28, 2018
QotD: Protectionism
All protectionism is rooted in the mistaken presumption not only that existing, domestic producers have a moral right – enforceable by the state – to the patronage of domestic consumers, but also that no future domestic producers have such a right as against current domestic producers. This right, were it real, implies that consumers exist to please existing domestic producers; it implies that continued or expanded production of that which is currently produced domestically is the end, while consumption is only the means of encouraging such production.
Only the widespread, if unthinking, acceptance of this presumption gives credence to the demands of domestic producers that some “unfair” practice by a foreign rival or foreign government justifies the imposition by the home government of punitive taxes on domestic consumers who purchase imports. Only a widely shared, if seldom articulated, belief that current domestic producers have a right to some minimum portion of domestic-consumers’ incomes explains the nodding of the heads of many people of all political persuasions when they hear some politician or pundit or preacher demonize foreign producers for selling wares to domestic citizens.
Don Boudreaux, “Protectionism”, Cafe Hayek, 2016-05-27.
January 11, 2018
QotD: Regime uncertainty
Washington’s destructive policies have been dubbed “regime uncertainty” in a strand of innovative analyses pioneered by Robert Higgs of the Independent Institute. Regime uncertainty relates to the likelihood that an investor’s private property — namely, the flows of income and services it yields — will be attenuated by government action. As regime uncertainty is elevated, private investment is notched down from where it would have been. This can result in a business-cycle bust and even economic stagnation. I recommend Higgs’ most recent book for evidence on the negative effects of regime uncertainty: Robert Higgs. Taking a Stand: Reflections on Life Liberty, and the Economy. Oakland, CA: The Independent Institute, 2015.
Steve Hanke, “What’s Killing U.S. Growth?”, Huffington Post, 2016-04-12.
January 4, 2018
QotD: “[G]reedy corporations sacrifice human lives to increase their profits”
The charge that sways juries and offends public sensitivities, and helps explain the large awards, is that greedy corporations sacrifice human lives to increase their profits.
Is this charge true? Of course it is. But this isn’t a criticism of corporations; rather it is a reflection of the proper functioning of a market economy. Corporations routinely sacrifice the lives of some of their customers to increase profits, and we are all better off because they do. That’s right, we are lucky to live in an economy that allows corporations to increase profits by intentionally selling products less safe than could be produced. The desirability of sacrificing lives for profits may not be as comforting as milk, cookies, and a bedtime story, but it follows directly from a reality we cannot wish away.
The reality is scarcity. There are limits to the desirable things that can be produced. If we want more of one thing, we have to do with less of other things. Those expressing outrage that safety is sacrificed for profit ignore this obvious point. For example, traffic fatalities could be reduced if cars were built like Sherman tanks. But the extra safety would come at the sacrifice of gas mileage, comfort, speed, and parking convenience, not to mention all the things you couldn’t buy after paying the extraordinarily high price of a Tankmobile. Long before we increased automotive safety to that of a Tankmobile, the marginal value of the additional life expectancy would be far less than the marginal value of what would be given up. It simply makes no sense to reduce traffic deaths as much as possible by making automobiles as safe as possible.
Dwight R. Lee, “Sacrificing Lives for Profits”, The Freeman, 2000-11.
December 25, 2017
Repost – The market failure of Christmas
Not to encourage miserliness and general miserability at Christmastime, but here’s a realistic take on the deadweight loss of Christmas gift-giving:
In strict economic terms, the most efficient gift is cold, hard cash, but exchanging equivalent sums of money lacks festive spirit and so people take their chance on the high street. This is where the market fails. Buyers have sub-optimal information about your wants and less incentive than you to maximise utility. They cannot always be sure that you do not already have the gift they have in mind, nor do they know if someone else is planning to give you the same thing. And since the joy is in the giving, they might be more interested in eliciting a fleeting sense of amusement when the present is opened than in providing lasting satisfaction. This is where Billy Bass comes in.
But note the reason for this inefficient spending. Resources are misallocated because one person has to decide what someone else wants without having the knowledge or incentive to spend as carefully as they would if buying for themselves. The market failure of Christmas is therefore an example of what happens when other people spend money on our behalf. The best person to buy things for you is you. Your friends and family might make a decent stab at it. Distant bureaucrats who have never met us — and who are spending other people’s money — perhaps can’t.
So when you open your presents next week and find yourself with another garish tie or an awful bottle of perfume, consider this: If your loved ones don’t know you well enough to make spending choices for you, what chance does the government have?
December 22, 2017
QotD: Economic lessons from Christmas toy shortages
Toy marketing on this elite level — Canada should be proud! — creates enraged parents. Hatchimals disappeared from stores altogether many weeks ago, and the high prices commanded in the resale market have created an industry of colorful social-media abuse. Hatchimal hoarders (who can now command C$120-$140 on eBay for one egg) are alleged to be greedy monsters, ruining Christmas for single moms — that is, by making the toy available at a premium at a time when toy stores and the makers of the product are no longer any help. (If the toy had never been invented, or were otherwise unavailable at any price, there would be no cause for complaint.)
What we have here is the familiar operation of a strong human superstition: the belief in an illusory “just price” for a product. It is the same superstition that makes some music and sports fans angry at scalpers. But it is exacerbated in the Christmas-shopping milieu by the innate predicament of the parent, always an emotional hostage to their offspring.
The complainers know perfectly well their kids will survive if they have to wait a couple of months for a Hatchimal. They know they could buy many equally good (and equally ephemeral) toys for half what they might pay a Hatchimal hoarder. They probably even know, if I can play the obtuse childless know-it-all for a second, that an authoritative, confident parent could explain the situation to a child, and make them live with the explanation.
Parents always want Christmas to be just so, but in the people who are castigating Hatchimal resellers, you can hear the hints of desperation, maybe even bad conscience. The problem, angry moms and dads, is not the hoarders. They just saw the real problem coming, and it is you.
Colby Cosh, “How the Hatchimals Christmas craze got me to own up to my irrational baseball complex”, National Post, 2016-12-16.
December 21, 2017
QotD: Milton Friedman’s four types of spending
Economist Milton Friedman famously divided spending into four types:
- I’m spending my own money on myself, in which case, I want to get the best combination of price and quality. This is the sort of spending that middle-aged women do on expensive handbags.
- I’m spending my own money on someone else, in which case I mostly care about price. This is why you get so many books you never read as gifts.
- I’m spending someone else’s money on myself, in which case … WEEEEE! This is the kind of spending that employees do on expense accounts. (Though not, of course, myself. I mean a generic employee with less moral fiber than I have).
- I’m spending someone else’s money on someone else, in which case … ah, who cares?
Megan McArdle, “Republicans Should Save These 3 Unpopular Parts of Obamacare”, Bloomberg View, 2017-01-05.
