Tuesday, February 28, 2006

L.A.'s Four-Stroke Solution

Leaf blowers create a classic example of what economists call a negative externality. Negative externalities occur when we do stuff that's bad for other people without compensating them for the inconvenience. Let's walk through the typical suburban landscaping transaction to get a better idea of how leaf blowers create negative externalities.

Your neighbor--the one whose social status is tied up in his lawn--hires an army of landscapers every couple of weeks to preen and primp his precious turf. The landscapers arrive with an arsenal of gas powered implements, including leaf blowers, and get to work. Your neighbor gets a nice lawn, the landscaper gets a check, and everyone else in the neighborhood gets a bountiful dose of noise and air pollution. The raging, spewing yard machines confers benefits to both your neighbor and the landscaper but impose costs on people in the surrounding area--costs for which nobody receives compensation. Neither the landscaper nor your neighbor take the external costs of air and noise pollution into account when dispensing or buying lawn care services. Economists view the unaccounted-for-costs as inefficient--when landscapers and home owners do not pay external pollution costs, too many gasoline intensive lawn makeovers will take place.

A bit of prudent government intervention can reduce leaf blower externalities. But how? Read this New York Times article to find out how an air quality agency in Los Angeles approaches the problem.

1. What incentive does the program provide for owners of leaf blowers with dirtier two-stroke engines to obtain cleaner blowers with four-stroke engines? What type of leaf blower user does the program target?

2. How much pollution can a single two-stroke blower emit each year? How many two-stroke leaf blowers are there in the L.A. area?

3. Why might a ban on leaf blowers create more costs than the current externalities? Can you think of alternative policies that would encourage landscapers to buy cleaner leaf blowers? A tax? A system of tradable emissions permits among landscapers?

4. Gas powered yard work generates some negative externalities. But a well maintained yard also confers positive externalities. When neighbors walk by lush lawns, trees, and flowers they benefit from the pleasant experience without paying for it. Better yet, when your neighbor keeps a nice yard, he makes living close by more desirable. As a result, he inadvertently adds a few dollars to the value of your home--much more so than if the only things he planted in his yard were a rusted Chevy and empty beer cans.

Leaf blower and lawn mower trade-ins aim to reduce negative externalities. Might the programs cancel out the positive externalities associated with well-maintained yards?

Topics: Negative externality, Corrective policy, Positive externality

The Traffic Congestion Index

There are lots of economic indicators out there: GDP, CPI, PPI, the unemployment rate, housing starts, labor productivity, FDI--the list goes on and on. But perhaps the most telling indicator of how a particular regional economy is doing is traffic.

In a column in the San Jose Mercury News, commentator Mike Langberg documents the fall and rise of traffic in Silicon Valley over the last five years. At the height of the dot-com boom, traffic was horrible, but according to one person quoted by the article, "everyone was making so much money they tolerated the interminable delays." After the bubble burst, traffic dropped by more than 30% over three years. Last year, it started to get slightly worse, and it's projected to get worse still as the economy continues to recover. As traffic worsens, CEOs in the area worry that congestion makes it more expensive to do business.

The rise and fall of traffic over the business cycle is a nice metaphor for the rise and fall of inflation. When an economy heats up, there's inflationary pressure because people are making so much income that they're willing to pay higher prices for goods. However, the higher prices mean workers demand higher wages, just as longer commutes make jobs less appealing to workers. As a consequence, the cost of doing business increases, cooling the economy off.

In a macroeconomic model, the most reliable way to increase output in the long run is through technological progress. Not surprisingly, especially for Silicon Valley, Langberg suggests a technological solution to the traffic problem: more telecommuting from home or from "drop-in" centers. These solutions can allow the regional economy to grow, while helping to contain traffic congestion--just as technological advances can allow a national economy to grow while helping to contain inflation.

1. What other aspects of daily life rise and fall with the business cycle?

2. Are hours worked from home and hours worked in an office perfect substitutes for each other? Why or why not?

3. Can you think of another technological advance that has helped increase productivity while not increasing inflation? How has it been able to do so?

4. The article says that the employees of one company who telework "give 60 percent of their saved commute time back to the company." Do you think that's high or low? Why?

Topics: Business Cycles, Inflation, Congestion

Friday, February 24, 2006

Leisure, Labor, and Leisure-Labor

A person can divide his or her time between one of three pursuits: leisure--hanging out with friends, riding a bike, watching a movie; labor--working for pay; or leisure-labor--non-market work like mowing the lawn, washing the dishes, and cleaning the gutters.

With that in mind, think about the progression of American working women since the 1960s. In the early '60s many women devoted their energy entirely to non-market work. Over time, more and more women entered the labor market, taking paid work alongside men. A research paper by economists Erik Hurst and Mark Aguiar chronicles the change in women's work habits from 1965 to 2003. Early on, women felt the pinch on their leisure time as they tried to balance non-market work at home with paid work outside of it. As women continued to enter the paid workforce in the '70s, '80s, and '90s, their amount of leisure time changed. What does a 21st-century woman's time allocation between leisure, labor, and non-market work look like? Read Virginia Postrel's New York Times commentary to find out.

1. Does the average American work more hours for pay than he or she used to? How do economists define leisure? What definition of leisure do Hurst and Aguiar use in their research?

2. How much more weekly leisure time did the average American have in 2003 compared to 1965?

3. Where did most of the increase in men's leisure time come from? Where did most of the increase in women's leisure time come from?

4. What happened to the amount of time women devote to non-market work--like house cleaning and cooking--between 1965 and 2003? What happened to the demand for microwaves and restaurant take-out?

5. Men with low educational attainment work a lot less than they did in 1965. How are they spending their time?

Topics: Labor, Leisure time, Women in the workforce

Wal-Mart Ate My Baby!

Okay, I don't have a baby and Wal-Mart would do nothing of the sort. But the alarmist tone of the title isn't far from the tone of the Wal-Mart debate in the United States. Some feel the retailer's expansion is an economic salvation, others see it as a scourge. Until recently, little in the way of actual economic research underpinned the Wal-Mart hullabaloo. A recent piece in the Economist summarized the findings of several research papers about the economic effects of Wal-Mart. How does Wal-Mart affect the retail sector and employment in local communities? What do Wal-Mart stores do to the average local wage? What's the retailer's effect on local consumers? Read the commentary to see what issues the latest economic research raises.

1. Wal-Mart argues that its arrival in a local market is good for the health of local retailing. Here's a quote from Global Insight's press release concerning its Wal-Mart research:

The study shows that with the opening of a typical 150-350 person Wal-Mart, retail employment increases by an average of 137 jobs over the near-term and levels off to a 97-job increase over the long-term. It also leads to net job losses in food stores, and apparel and accessory stores, and net job gains in building materials and garden supply stores, and general merchandise stores. According to the study, while Wal-Mart does appear to displace other retail establishments in a county, it also serves to stimulate overall retail sector development.

What does the Economist's piece say about this result? Does the correlation between a Wal-Mart opening and strong retail job growth prove causation? What factors might motivate Wal-Mart's decision to open a new store?

2. According to research by the Public Policy Institute of California (PPIC), what effect does a new Wal-Mart have on joblessness in local communities? According to PPIC research, what is Wal-Mart's effect on the incomes of retail workers?

3. According to University of Missouri economist Emek Basker, how do new Wal-Marts affect consumer prices in local communities?

4. I, for one, have "delicate sensibilities" and prefer the local co-op to Wal-Mart. Do I still benefit from Wal-Mart's presence? According to economists Hausman and Leibtag, how much does a local shopper save on grocery bills as a result of Wal-Mart's presence?

Topics: Competition, Job churning, Correlation versus causation

Wednesday, February 22, 2006

I'm Imposing a Negative Externality on You Right Now.

OK, fess up. You've sent an e-mail you later came to regret. Maybe not much later. Maybe even a split second after you hit "send." And maybe to a professor or T.A.

The cost of communication has never been lower, and as a result, lots of things get sent--e-mails, instant messages, text messages, you name it--that wouldn't be sent otherwise. An article in the New York Times discusses the frustration many professors feel when their students e-mail them about matters related only tangentially to class. One student at UC Davis, for example, asked a professor whether they should buy a binder or a subject notebook.

Students are aware that e-mail allows them to pester professors with requests that would not otherwise be worth making. The article quotes Cory Merrill, a student at Amherst, as saying "If the only way I could communicate with my professors was by going to their office or calling them, there would be some sort of ranking or prioritization taking place…Is this question worth going over to the office?"

The article says students are often unaware of the negative impact that trivial e-mails can have. Sending an e-mail imposes a cost on the receiver. We all know the cost of receiving spam. But even an e-mail from a friend, student, or professor places a demand on our time. An e-mail that requires a response or some kind of action imposes an even higher cost.

We can analyze the effect of easier communication, and the negative externalities that accompany it, using a simple demand model. Consider student demand for professor insights. The longer it takes to request something from a professor, the lower the student demand for insights. Time acts like a price in this model. We can plot student demand for a professor's time as a function of the amount of their own time it takes to place a request. For example, suppose getting an answer from a professor involves going to office hours, which takes 15 minutes of a student's time, but sending an e-mail only takes five minutes of a student's time. Then the ability to send e-mails effectively lowers the cost of getting a response from a professor from 15 minutes to 5 minutes. This increases the number of requests a professor gets--say, from 40 to 60 per week.

Now suppose that any student request, whether by e-mail or in person, takes up 10 minutes of a professor's time. The total cost per request is the amount of time it takes the student to make the request, plus 10 minutes of the professor's time. When students had to walk to a professor's office, only 40 requests per week were made--a total of 400 minutes (the area of the orange rectangle). With e-mail, requests are less expensive for students to initiate and the professor spends an additional 200 minutes per week responding to requests (the area of the green rectangle is 600 minutes). Making matters worse for professors, the new requests are those which weren't worth the students' time before, and are therefore lower-priority requests that often reflect the poor judgment or rudeness mentioned in the article.

1. The article mentions several things that professors were doing in the wake of the increased communication, from not answering e-mails to requiring students to reply to professors' e-mails. What market-based solutions to this problem might help reduce the number of requests professors get, and ensure that professors see and have the chance to respond to the most important requests?

2. Who owns the rights to professors' time--students, the professor, or the university? Is there any way to establish a market for professors' time? What if each student were given an allotment of professors' time at the beginning of the semester, and could sell their access rights to other students? Would such a system improve efficiency?

3. Can you think of another example in which something becoming cheaper led to undesirable results? (One that comes to my mind is a drop in gasoline prices leading to traffic congestion, but there are many others.) What solutions to that problem were proposed? Would a similar solution work in this case? Why or why not?


Tuesday, February 21, 2006

Your Child is Worth Every Penny

The first chapter of almost every economics textbook assumes that humans are rational beings. Every decision that a person makes in his or her life goes through a rigorous cost-benefit analysis that might take seconds, days, weeks, or months to make. The conclusion is simple and elegant: if the benefits outweigh the costs then do it, but if the costs outweigh the benefits then do not do it.

However, does cost-benefit analysis apply to one of life's most important decisions: whether or not to have and raise a child? MP Dunleavey, a columnist for MSN money, wrote an article about the costs and benefits of having and raising a child. The financial costs of having and raising a child are staggering. A family could spend $269,000 to raise a child from birth to 17. Not included in the cost estimates are the cost of college tuition, the opportunity cost of a career break, health and lifestyle cost of pregnancy, costs of prenatal care, the cost of stress, and the many sleepless nights of caring for a child.

Despite these costs, people still have kids. This leads an economist to believe that, for the most part, the benefits of having and raising kids outweigh the costs. However, Dunleavey goes on to argue that the net benefits of having and raising a kid are, at most, ambiguous. There are emotional and psychological benefits (i.e. fulfillment and familial bond) to a child, but these benefits also carry emotional, psychological, and financial costs of their own. Dunleavey concludes that "whoever suggested that we humans are economic creatures was dead wrong."

It appears easy to write off 200 years of economic thought with statistics and numbers on costs and benefits. However, even Dunleavey admits that "when I plug those lines into my mental spreadsheet next to the under funded retirement account and the skyrocketing cost of college, that little voice trumps them all." Hence, having a child does satisfy the cost-benefit analysis criteria because most of the benefits of a child are intangible and can only be measured through the love of the human heart and not dollars.

1. What are some other decisions where most of the benefits are intangible?

2. If a benefit is intangible, then is it still appropriate to use cost-benefit analysis?

3. Are people rational? Why or why not?

Friday, February 17, 2006

Traffic Jam

According to Steven Levitt, the economist behind Freakonomics, Gary Becker is "…probably the world's greatest economist alive." A Nobel prize winner, Becker's groundbreaking research employs economic ideas to explain social topics such as crime, discrimination, family interaction, and drug addiction. But research alone doesn't lead to such lofty proclamations as "world's greatest." Becker's popularity stems from his ability to communicate economic ideas to non-economists. Whether you agree or disagree with Becker's views, you'll be able to clearly follow the economics behind his arguments. Good for us, then, that he publishes blog posts on a weekly basis.

In a recent blog post, Becker used microeconomic ideas to tackle one of life's everyday problems: traffic congestion. As Becker points out, rush hour drivers fail to account for the costs they impose on other people, such as increased congestion and pollution. How to curb excessive driving and congestion? Read the blog post on traffic congestion to see what he thinks.

1. According to Becker's rough estimate, what cost did Americans incur from the extra time and fuel spent during traffic jams in 2005?

2. According to Becker, how can city governments compel drivers to take account of the congestion they cause to other drivers? How would efficient traffic congestion management change with the time of day or weather conditions?

3. How does London's traffic congestion program work? How did Londoners respond to the new program? What happened to the speed of bus trips within London after the program took effect?

4. How do you think the program affected air pollution around London? Do you think people around London drive less as a result of the program? Or do you think they drive the same amount or more by avoiding trips into London?

5. What does Becker mean by a revenue-neutral driving tax? In what ways does traffic congestion impose a tax?

Topics: Negative externalities, Pigouvian taxes, Hidden taxes

Thursday, February 16, 2006

Water, Water, Everywhere

A water molecule consists of two hydrogen atoms and an oxygen atom. As such, you would think it satisfies the economic definition of a homogeneous good.

You would be wrong.

There are now hundreds of brands of water in the United States. Many contain lots of things other than water--indeed, many are chemically indistinguishable from flat diet soda. Still, the water industry in the U.S. brought in billions of dollars of revenue last year.

This article in the New York Times details the history of the water industry in America, from its origins in the Perrier craze of the 1970's to today's vitamin-saturated marketplace.

1. Do the consumers in the article consider different brands of water to be of different quality? Do you think they would really be able to tell the difference in a blind taste test?

2. Suppose two companies produce water, and each product tastes identical. Why might each company try to differentiate its product? Is it profitable to do so?

3. When one considers the market for water, how broadly can that market be analyzed? Is the market for all bottled water one market? What about carbonated bottled water? How would an analysis of demand for all types of water differ from an analysis of demand for small bottles of lemon-flavored sparkling water?

Wednesday, February 15, 2006

Variable Pricing at the Box Office

Most movie theaters price discriminate--that is, theaters charge various prices for the same product based on willingness to pay. Suppose you, your parents, and your grandmother go to an evening showing of Curious George. By checking IDs, the theater separates your family into three distinct groups: students, adults, and seniors. Since students and seniors are typically willing to pay less than adults, you and grandma get a discount and your parents pay the full price of admission. By charging several different prices, the movie theater attracts more moviegoers and captures more revenue.

Movie theaters also use variable pricing to account for peaks and lulls in demand for tickets. Willing to see a mid-day matinee? You'll pay less than the horde of evening moviegoers. As competition heats up in the market for cinema, movie theaters find new ways to implement variable pricing. In a recent New York Times article, David Leonhardt describes some subtle pricing tactics the theaters use to sustain revenues in the face of competition from the proliferation of entertainment substitutes like TiVo and Netflix.

1. How does National Amusements use variable pricing to separate its high willingness to pay customers from its low willingness to pay customers?

2. Individual theaters do not yet charge different admissions for different recent releases. Leonhardt suggests that variable admission prices might send moviegoers the wrong message: lower-priced movies are duds.

Suppose Mega-Super-Cineplex charges $9 for Final Destination 3 and $12 for Curious George. By setting a lower price for Final Destination 3, might the theater actually influence consumer tastes and shift the demand curve for tickets? Or would this strategy simply reduce the wait (quantity demanded) for Curious George tickets and fill vacant seats (increase quantity demanded) in showings of Final Destination 3?

3. Other kinds of firms also use variable pricing. American Airlines was the first airline to use a yield management system to implement variable pricing. How did American Airlines first separate business travelers from leisure travelers?

4. According to the article, why did Coca-Cola's variable pricing strategy backfire? Suppose theaters adopt a similar strategy by charging more for Friday and Saturday night shows than for weeknight shows. Might the value moviegoers place on fairness exceed the costs they incur by waiting in line at a crowded theater?

Interested in movie pricing? George Mason University economist Tyler Cowen offers several explanations of flat movie pricing on his popular blog, Marginal Revolution.

Topics: Price discrimination, Variable pricing, Consumer perceptions of fair pricing

Wednesday, February 08, 2006

Incentives and School Attendance

In microeconomics, we learn that people respond to incentives, especially monetary incentives. The U.S. tax code is about 17,000 pages long, in part because politicians often try to achieve policy goals by enacting specific taxes or giving special tax breaks. An article in the New York Times this week highlights the use of money incentives in an unusual situation: some schools are offering incentives for student attendance. As a father, I have to admit that I offer my three-year-old son cash bribes with some frequency. (Though that "dollar" I promise him for helping to clean up his room is admittedly on a wildly fluctuating exchange rate with the U.S. dollar.)

To what extent are we comfortable offering cash incentives to encourage behavior that people "should" do on their own? High school attendance is mandatory, after all, so offering cash for perfect attendance may seem redundant. Plus, cash incentives are only one kind of incentive. For example, at one of the schools in the article, students were offered a $25 reward for perfect attendance. But the penalty for missing school was relaxed at the same time. According to the article, "Students were no longer getting grade-point reductions for unexcused absences or having grades withheld if they had more than two unexcused days per quarter." As a result, attendance rates actually dropped from 90% to 85%. Said one student about the cash: "It's $25. I mean, almost nobody cares."

Think of some public policy problem--global warming, the war on terrorism, low school attendance, poverty, anything. Ask yourself some questions about it:

1. Does the problem arise because incentives are misaligned, or because of some other reason?

2. Who is in the best position to fix the problem? A single person, or lots of individuals? What could provide them with an incentive to act differently?

3. How would that person or group of people respond differently to cash incentives, as opposed to other kinds of incentives (legal restrictions, punishments, shame, pride)?

4. If you were able to change that person's or group of people's behavior, how would other people's behavior change in reaction? (For example, if you got all the students at one school to have perfect attendance, would that help teachers teach? Or would it just mean a bunch of rowdy delinquents are now disrupting class instead of skipping school?)

Friday, February 03, 2006

A Happy Coincidence?

Oil prices, already rising before Katrina, shot up further after the hurricane destroyed oil refining capacity in the Gulf Coast region. Oil price shocks affect both the supply side and the demand side of the economy. On the supply side, oil is an important input to the production of goods and services, and rising oil prices translate into higher production costs and lower output. On the demand side, gasoline expenditures make up a significant portion of consumer budgets and consumers may react to increasing gas prices by curtailing overall spending. Given the negative impacts on producers and consumers, you might expect rising oil prices to put the brakes on economic growth. Yet, the U.S. economy experienced strong growth even as oil prices increased during 2004 and 2005. Why have rising oil prices and economic growth coexisted so nicely?

Martin Feldstein, an economist at Harvard, sees a happy coincidence: a mortgage refinancing boom came along at just the right time, boosting consumption even as oil prices increased. Read his Financial Times column to see how refinancing might explain recent growth and why Feldstein is less optimistic about the economy weathering future oil price spikes.

Note: A mortgage is just a home loan. The collateral that secures the loan is the house itself--if you default on mortgage payments, the bank gets your house. Refinancing allows a homeowner to take advantage of a drop in interest rates by paying back his original high-interest loan with money from a new, low-interest loan. For example, suppose a homeowner borrowed $100,000 at 10% interest to buy a house, so he was paying about $10,000 per year in interest. If interest rates drop to 5%, they could take out a $100,000 loan from another bank at 5% interest, use that money to pay off the first loan, and thereby cut their interest payments to $5,000 per year.

The mortgage refinancing that Feldstein refers to in the article is called cash-out refinancing. Cash-out refinancing allows the homeowner to refinance for more than they currently owe on the house, and take the difference as a cash loan. For example, that same homeowner could have taken out a new loan for $120,000, used $100,000 to pay off the original loan, and kept $20,000 in cash. Their interest payments ($6,000 per year) would still be less than the original interest payments they were making, and they're able to increase their consumption by $20,000.

1. Saving is the portion of after-tax household income that is not consumed. When a household saves, it contributes current income to its stock of wealth. When a household borrows, it incurs a debt that reduces its stock of wealth. You can think of household borrowing as dissaving. How did the mortgage refinancing boom affect household saving? How did it affect household consumption?

2. How did most households use the cash they borrowed from mortgage refinancing? How did mortgage refinancing counteract the effect of higher oil prices?

3. What role did monetary policy play in the mortgage refinancing boom? How do the Fed's recent interest rate policies affect America's appetite for refinancing?

4. How does Feldstein describe today's global energy market? How do you think the U.S. economy would respond to another oil price shock?

Topics: Aggregate demand and supply, Oil price shocks, Monetary policy, and Mortgage refinancing

It's in the (Used) Game

Aplia is just down the road from the Electronic Arts (EA) headquarters in the San Francisco Bay Area. For the non-gamers out there, EA makes video games. Around here, you'd know an EA engineer if you saw one--they're the guys in the Starbucks queue sporting varsity jackets with logos from the latest video games. If corporate schwag indicated profitability then you might guess that business is booming at EA.

It's not.

As a recent New York Times article points out, the profitability of video game publishers like EA is particularly weak compared to profit margins in two other sectors of the video game industry: online subscriber gaming and game exchange stores. Read the article to see why.

1. How does the recent Xbox 360 shortage affect the demand for the latest games from Activision and EA? How does subscription-based online gaming affect the demand for games from American publishers like EA?

2. What is GameStop's profit margin on used games? According to an executive at GameStop, the used game market actually helps game producers like EA. How might resale or trade-in opportunities affect the demand for new games?

3. What would happen to the supply of used games if game publishers began electronic distribution of games directly to players?

4. In what ways does the video game industry resemble the textbook industry? Does the used market for textbooks cannibalize new textbook sales? How do textbook publishers mitigate potential losses from the used book market? Think about the re-issue of new editions and the more recent trend of digital textbook delivery.

Topics: Interaction between primary and secondary markets

Wednesday, February 01, 2006

Negative Saving Rate

In 2005, the U.S. personal saving rate fell to -0.5%--the lowest personal saving rate since the Great Depression! Some facts about the negative personal saving rate are presented in this Associated Press article. What does a negative personal saving rate mean and what does it imply for the U.S. trade deficit?

The personal saving rate is the percentage of real GDP saved by households within a given year. A negative personal saving rate implies that households consumed more than they earned by using their current stock of savings or borrowing money.

Saving becomes loans to U.S. businesses that use the funds for investment spending--the purchase of new capital.

So does a decrease in the personal saving rate mean that the investment rate, too, must shrink? Not necessarily. In a closed economy, the investment rate is equal to the national saving rate. However, in an open economy, this need not be true, because American firms can borrow funds from overseas. A negative personal saving rate means that not only are American firms borrowing from overseas to finance investment--American consumers are also borrowing from foreigners to finance consumption of foreign goods and services. In effect, one of the U.S.'s biggest imports is foreign saving.

This importing of foreign saving has an important implication for the U.S. trade deficit. Think about what happens when Chinese financial investors buy U.S. treasury bonds--in effect, lending money to the U.S. government. In order to do so, they must have U.S. denominated assets (dollars). In order to get those dollars, China must export more than it imports--that is, the Chinese must sell more of their goods and services to the United States than they buy from the United States. The leftover dollars can then be lent to the U.S. government or American firms.

The graph above shows that a decrease in the national saving rate causes the trade deficit as a share of real GDP to increase if the investment rate stays at (I/Y)*.

Discussion Questions

1. Why are foreign financial investors willing to lend to the United States?

2. If foreign financial investors refuse to continue lending funds to the United States, how would this affect the U.S. investment rate?

3. In the 1930's, the saving rate was negative because incomes were so low that people had to dip into prior savings in order to survive. But the United States is prosperous now. Why, then, do you think the U.S. saving rate is so low?

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