Monday, March 23, 2009

Digital Distribution Meets the Video Game Market

GameStop and EB Games have always been the major players in the used video game market when it comes to retail sales. Given their level of success, it was only a matter of time before other major players, such as and Toys "R" Us, entered the market. But how does this affect the long-term profitability of retailers, game publishers, and game developers?

The short-term motivation of retailers such as GameStop buying and selling used games is that they share none of the profit with developers of the game. Game publishers and developers only receive a payment for the sale of brand new games and are thus negatively affected by the growing used video game market, especially during bad economic times when sales are already lower than desired. Although buying used games instead of new titles might only save consumers $5-$10, some GameStop stores also allow you to return used games within 7 days if they don’t work properly or you simply don’t like the game, an option unavailable if you pay for a new game.

Incentives play a crucial role in economic analysis. Properly aligned incentives can promote desired outcomes in the short run and long run. From the perspective of video game developers, the lost revenue from video games trading hands multiple times in the used market is evident. As an increasing number of retailers realize the gains from entering this market, video game developers will experience decreasing gains from the production of new games.

This provides publishers with the incentive to consider other mediums of distribution, in particular digital distribution. The video game market is not the first entertainment industry to delve into a more technical solution. In the music industry, CDs are being replaced by iPods and MP3s thanks to Apple's iTunes. In the movie rental industry, we have gone from renting at our local store to mailing in movies through services such as Netflix or Blockbuster to downloading movies directly to our TV through the internet or cable services.

Therefore, it is not surprising that the video game market is heading in this direction, especially with the growing popularity of the used video game market. Since its inception, the Nintendo Wii has offered games from older consoles for purchase through the Wii Marketplace. Because the Wii offers free Wi-Fi, Nintendo can bypass the middle man of in-person and online retailers. In addition, Microsoft has begun to experiment with this option by offering smaller-scale, arcade-like games for purchase using Microsoft points that can be purchased in the Xbox Live Marketplace. They also offer free demos of newly released games in hopes of attracting additional sales. The drawback with Microsoft is their Xbox Live internet service is not free, so only users with a paid account can access these services.

Discussion Questions:

1. From the consumer perspective, what would your indifference curves look like for these two goods? Do you believe a used game is equally as good as a new game? How would this affect the demand for used video games?

2. What kind of incentives, if any, could a video game developer provide to GameStop to encourage them to sell new games over used ones?

3. How will the growing popularity of releasing and purchasing video games through an individual console change the market structure of video game retailers? How does this compare to the success of the iPod and MP3s in general?

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Bovine Intervention

A couple of weeks ago, economist Greg Mankiw pointed to an interesting story about so-called cow tax proposals in Europe. The taxes would apply to farmers and ranchers, based on the number of animals they raise—the more cattle in your herd, the larger the tax bill. Thus far, lawmakers in Ireland and Denmark have struck such measures down. The defeated Irish proposal put the tax at €13 for each dairy cow and the Danes were considering a tax as high as €80 per cow.

Why tax livestock? In a word, flatulence. (In two, enteric fermentation.) Cows belch and otherwise discharge their way to about 14% of the world's methane emissions. Like carbon dioxide, methane is a greenhouse gas. Although methane accounts for a relatively small share of all greenhouse gas emissions, it is alarmingly effective at preventing heat from escaping the planet. Compared to carbon dioxide, a little bit of methane goes a long way toward raising the potential for climate change. Reducing methane emissions would help Denmark and Ireland meet their EU climate policy commitments.

Raising livestock generates a negative externality: the costs of methane emissions are born by the general public rather than those directly involved in the production and consumption of meat and dairy. The emissions cause the marginal social cost of producing a pound of beef to exceed the marginal private cost.

The proposed taxes are an attempt to force farmers and ranchers to internalize the heretofore external costs of the methane emissions, bringing the private costs of raising livestock closer inline with the social costs. The tax would raise the costs of producing meat and dairy, reduce the supply of such products, and, consequently, lower methane emissions.

While a tax based on the number of cattle in a herd would undoubtedly reduce farming-related green house gas emissions, it would do so in rather blunt fashion. To see why, consider two ranchers. The first uses specialized cattle feed to reduce the methane emissions of his herd. The second sticks to traditional methods with the typically methane-intensive results. The cow tax, however, is levied equally on each head of cattle, failing to account for the methane reduction efforts of the first rancher.

While the cow tax provides an incentive to cut back on cattle, it doesn't encourage ranchers to adopt any of the promising technologies devised to reduce methane discharge from individual cows. Ideally, climate change policies should focus on the amount of methane emitted rather than the number of cows.

Discussion Questions

1. Can you think of policies to incentivize the adoption of methane-reducing technologies in farming and ranching?

2. Governments in Europe and the United States heavily subsidize the farming and ranching sectors of their economies. How would the removal of such subsidies impact methane emissions in Europe and the U.S.? What about methane emissions from less developed countries?

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Friday, March 13, 2009

The Financial Crisis for Dummies

This is, perhaps, the most engaging and accessible explanation of the current "Great Recession" I have come across. In this 59-minute podcast, Ira Glass and his cohorts at Chicago Public Radio and NPR create an ultra-simplified world of just one eager dollhouse buyer, a would-be banker with $10 in his pocket, and a young man with $90 he wants to put into a savings account to explain the financial mess we find ourselves in. This recording explains why TARP is called TARP, what insolvency is all about, what the term toxic assets means, and why America's biggest banks are afraid to "mark it to market" or re-value those toxic assets.

After listening I have a better appreciation for the state of all things financial but I am left wondering, what's the best way out of this morass?

Discussion Questions

1. Can you point to an underlying cause that precipitated this crisis?

2. Does the government nationalize the banks for a time, robbing banks' shareholders of their investments but allowing banks to start over with a clean slate? Does it help the banks get back on their feet by purchasing toxic assets with taxpayer money at artificially high prices? What are the short and long term effects of these different strategies?

3. Do you think the United States has "learned its lesson"? Will people (and businesses and governments) change their behavior? Or are we doomed to repeat this process?

4. Are there safeguards the government can introduce that will keep this from happening in the future?


Thursday, March 05, 2009


In an earlier post, I commented that I loved Radiohead. And I do, but I LOVE the Beatles. I hope you can appreciate the difference. Think about someone you know who is really obsessed with a band. Now multiply that by 20. That's how much I love the Beatles.

So when I heard about Paul McCartney's intent to play a 4,000-seat venue in Las Vegas this April, one of the smallest public shows since he was backed by Pete Best at the Cavern Club, tears nearly welled up in my eyes. I enlisted the help of friends and family to get tickets online at the moment they became available. Much to my everlasting despair, we were unsuccessful, and I remain ticketless.

Claire, a friend here at Aplia who shares my obsession*, was also trying for tickets that afternoon. She, however, was successful.

There's a book that I recently read that gives good insight on my dilemma: Dan Ariely's Predictably Irrational. In this excellent book, Ariely details his research on what economists call "the endowment effect." The endowment effect states that the value someone places on a good increases when it comes under his ownership. The person would require more to give up a good than he would be willing to pay to receive it. This is in opposition to standard economic theory which would state that these two values should be equal when the good has a functioning market.

Ariely's experiment (PDF) found that students who had won a random lottery for Duke basketball tickets valued their tickets 14 times higher than students who lost the lottery. I found this interesting, and I wanted to see if the endowment effect would hold true for Claire and me, two equally obsessed McCartney fans who were on the opposite side of luck that Saturday afternoon.

How much would I pay for a ticket? Well, I guess it's less than $700, since that is the price on the secondhand market right now, and I haven't made a purchase. Now, how much would Claire require to relinquish her seat to me? See our instant messenger chat below where I asked for the sale:

Knapington: how much would i have to pay you to give up your ticket to Paul, assuming you couldn't re-buy another ticket with the funds?
Claire E: i really don't know if i'd take money--i really want to see paul
Knapington: so if i wrote down $1,000 and handed it to you, you'd say no?
Claire E: I'd say no
Knapington: what if I wrote $5,000
Claire E: nope. it would have to be at least $15,000 - because then i couldn't justify walking away
Knapington: so literally if I wrote a check for $10,000 and offered it to you right now, you'd say no thanks?

So perhaps she was exaggerating a bit—I eventually talked her down to $10,000, but that was as low as she'd hypothetically go. How could two people who at one point equally valued these tickets (each of us said before the sale that we would pay no more than $700 per ticket) hold such different values for the tickets after the fact?

Discussion Questions

1. 2008 was a remarkably bad year for most stocks. If you could sell all of your portfolio of stocks today, would you buy the same stocks again? If not, what keeps you holding on to those that you already own?

2. Think about the recent downturn in the housing market. Many homeowners looking (or needing) to get out of a mortgage they have difficulty affording end up pricing their home at the value they place on the home. Unfortunately, this price is often higher than any reasonable house-hunter would be willing to pay, particularly in current market conditions. How will this affect the homeowner? How will this behavior affect the housing market in general?

3. Can you think of other examples where the endowment effect might keep markets from adjusting as quickly as they otherwise would?

4. Suppose that Ryan is willing to pay $650 for the McCartney ticket while Claire values her ticket at $10,000. How do these figures relate to Dan Ariely's experiment? What if Ryan were willing to pay only $400 for the McCartney ticket?

* After working at Aplia together for some time, we stumbled upon our common obsession, and in our discovery, also realized that we had met each other at a Paul McCartney concert three years prior, and had a 20 minute conversation. Weird.