Leggo My Eggo! Really!

It’s hard to miss the barren shelves in grocery stores due to a pending Eggo Waffle shortage. The recent run on the popular breakfast food is one of the few times when a very clear-cut piece of microeconomics hits home enough to capture the attention of people without an economics background. What fascinates me the most about this story is how people with no interest in economics still have the shortage on the tips of their tongues. I believe there are two different microeconomics concepts at play here: one covered in nearly every introductory economics class and the other a deeper assumption that deserves more discussion than it normally gets.

First, the shortage in stores essentially comes from Kellogg’s self-imposed price ceiling. It seems that Kellogg has decided to continue selling Eggo Waffles at the same manufacturer’s suggested retail price (MSRP) rather than raising it to reflect a decrease in supply since two of their four production plants are out of commission. By leaving the price where it is, there is a shortage in the market because more people would like to buy at the MSRP than Kellogg wants to serve. This decision seems odd to economists because it introduces inefficiency. The price ceiling creates a shortage in the market which leads to the inefficiency. On the corresponding graph, you can see the minimum amount of deadweight loss (DWL) in the market for Eggo waffles given this shortage; the DWL could be larger if those consumers with a lower willingness to pay are the ones who end up buying the existing waffles. One possible reason for the price ceiling is that Kellogg does not want to appear like it is trying to profit off of its own misfortune (the Atlanta plant closed due to heavy rain) and planning (the Tennessee plant closed for repairs).

Operating under typical economic assumptions, unless Kellogg or individual stores decide to raise the price, the shortage in grocery stores should continue. This means that some consumers who would be willing to pay more than the MSRP will be unable to get waffles. Which customers end up with the waffles will only be a matter of timing and luck, and it is very likely that some people who are unable to purchase waffles will value them more than others who buy a box they find on the shelves. One common explanation economists offer about how this situation will be resolved is the emergence of a secondary market or black market. USA Today interviewed Joey Resciniti, a shopper who bought one of the last boxes, who said, “I told my husband that maybe I need to put them on eBay." In secondary markets, people who are lucky enough to buy the boxes at the MSRP are able to turn around and sell them to an unlucky person who is willing to pay above the sticker price but was unable to buy any waffles in the store, exactly what Ms. Resciniti suggested.

The second economic concept at play here is the competitive hypothesis. The classic supply and demand analysis used above rests on some core assumptions of economics, such as rationality of agents, complete information, and the competitive hypothesis. When any of these assumptions are broken, we need a different model to understand what will happen in the world. The competitive hypothesis can be summed up by the assumption that a consumer believes that if they decide to buy a product they can afford, they are able to get it. For example, if I worried that the gas station near my house would run out of coffee before I get there in the morning, I might behave much differently. The same can be said of Eggo Waffle consumers. In the USA Today article, Ms. Resciniti also said, "We have eight of them, and if we ration those—maybe have half an Eggo in one sitting—then it'll last longer.” If consumers believe they will have a hard time finding an item they want to buy, they may instead chose to change what they want to buy. If for example, Ms. Resciniti does start to ration her waffles, then she may need to buy more oatmeal or fresh fruit for breakfast on other days. If consumers start rationing because the competitive hypothesis does not hold, a more complicated model is needed to correctly determine equilibrium behavior.

Discussion Questions:

1. What should the shortage of Eggo Waffles do to the demand for other brands of waffles? What about the demand for maple syrup?

2. Think of some secondary markets you are familiar with, like eBay, ticket scalpers, or craigslist. How are prices determined in these markets? If a secondary market for Eggo Waffles forms, what can you say about the equilibrium price?

3. If a black market for Eggo Waffles did emerge, who would be worse off at the equilibrium? Would anyone be better off?

4. Think of some other real-world examples where the competitive hypothesis is violated. What would need to be added to the basic supply and demand model to accurately predict what people do when they aren’t sure if the store will have the goods they want in stock?

On Income Caps and the Market System

Yesterday morning on a local radio station, a few callers discussed a silly idea. The question posed to listeners was this: "Should there be a law against anyone earning over $1 million per year?" One caller talked about the celebrity Kim Kardashian, and how it is not right that she earns so much money. That is absurd. The market is rewarding Kim because of her looks, her connections, and because in recent years her public persona has been well-managed. If companies want to pay her ridiculous amounts of money for her various "talents" because people enjoy being entertained by her, then so be it. It might not be fair, but neither is life. On the bright side, we have a progressive income tax system that will tax such extravagant incomes at higher rates than the rates faced by ordinary Americans. A much better idea would be to raise marginal income tax rates on the highest tax brackets to help limit our budget deficits and get a fair amount of tax revenue from those whom our market system has allowed to earn enormous amounts of income in our nation.

Yet, how could economists ridicule a ban on excessive income when they support President Obama's limits on executive pay for firms that seek government assistance? The reason is that such firms were mismanaged, and as a result, they got pummeled by the market, forcing them to sheepishly seek government bailout funds. In this situation, executive salary caps are a brilliant proposal. If the firms do not like the caps, they could try getting bailed out by the market, but they will find that the market will most likely not come to their rescue. The market system will allow the firms to go bankrupt because of their poor performance. That is what the market system does to firms that perform poorly. Obama's limit is set at "only" $500,000 per year and lasts until the bailout funds are fully repaid by the firm.



The argument against the salary caps proposed by Obama is that these firms will lose good executives because they can be paid more elsewhere. But is this necessarily a problem? There are undoubtedly many capable people with better understanding of risk management and liquidity who would be happy to work for these firms for $500,000 per year. If the firms find that they cannot retain the best executives, then they will find themselves with a greater incentive to refund the taxpayer money that much sooner. If the executives who are running these firms want to earn more than $500,000 per year, they will have to get their firms back in shape and earn enough profit to repay the bailout money. An argument can be made that shareholders can oust poorly performing executives and limit executive pay by changing a corporation's board of directors. This argument is a diversion, as can be seen in an article named Shareholder Power from the Christian Science Monitor.

Let the Kim Kardashians of the financial sector go seek out new firms to mismanage!

Discussion Questions

1. Do you agree with this author's viewpoint about bans on enormous salaries? How about his viewpoint on Obama's executive pay cap plan? Is there inconsistency in his views? Is there inconsistency in yours?

2. How do you feel about America's progressive income tax system? If you were in control of the federal government, what would you do to change it, if anything?

3. What do you think about the concept that government should stay out of the free enterprise system? Do you believe that government involvement has made the global financial crisis worse, or has it helped moderate its severity?

4. Suppose that the U.S. did enact a law against anyone earning over $1 million per year. What would the corporate CEOs, celebrities, athletes, and other top earners do in response? Would they leave the country? What other complications might arise from such a law?

And You Think Low Prices Are Always Best?

With persistent hyperinflation, money has become worthless in Zimbabwe. The official inflation rate in May was 4,500%, but according to estimates, the real rate had already reached 9,000%. In response to the continuously rising prices, President Mugabe of Zimbabwe ordered the prices of all commodities be cut by at least half. This type of price control by the government is referred to as a price ceiling, with the selling price set below the equilibrium price. Let's examine the effect of a price ceiling using the supply and demand diagram to the right.

Let Pe and Qe be the equilibrium price and quantity of a commodity. A price ceiling that regulates the commodity to be sold at Pc leads to an increase in quantity demanded to Qd. At the same time, producers reduce the supply of the commodity at Pc, thereby lowering the quantity supplied to Qs. Hence, there will be excess demand, or shortage (Qd – Qs) for the commodity. This is exactly what the Zimbabweans are experiencing in the wake of Mugabe’s price cuts. Many commodities were swept from the shelves and disappeared from sale as producers refused to supply more at the regulated price.

The story does not end here, though. From the supply and demand model, we see that at Qs, some people are willing to pay as much as Pb to obtain the commodity. Therefore, informal markets emerge with people buying and selling commodities at prices much higher than the regulated or market equilibrium prices.

Read Chris McGreal’s article in The Guardian to learn more.

Discussion Questions

1. According to the article, what might be the reasons behind President Mugabe’s price cuts?

2. Who stands to benefit from the price controls in Zimbabwe? Who stands to lose?

3. What could the Zimbabwean government do to save the economy?

Net Neutrality

The Internet presents a challenge for economic thinkers. Because it's new and changing rapidly, economists struggle to draw substantive conclusions based on data. As a result, they are largely left to argue over which of the economic models designed to describe the "old economy" are most appropriate for examining the "new economy."

The economic question stirring the most debate right now has to do with network neutrality, or "net neutrality." (Someone asked a ninja recently about it. Someone also asked Greg Mankiw. The ninja had an answer, and Mankiw didn't.) In a neutral network, internet service providers (ISPs) give equal weight to all websites. Suppose AT&T provides your internet service. AT&T recently merged with SBC, which has a partnership with Yahoo. Under the current neutral network, you can conduct searches with Yahoo or Google, and neither Yahoo nor Google have to pay AT&T for delivering their content to you.

Suppose, though, that AT&T could charge websites for the speed of content delivery. If Google doesn't agree to pay for faster delivery of its search results, videos, and other content, AT&T might make the Yahoo site--a business partner--load up a lot faster than Google. Does it have the right to do so? A bill working its way through Congress would give it that right; this has led to a revolt among Internet users and Internet companies like Google.

The opposing sides of the debate use different economic models to support their respective positions. According to supporters of the legislation, sites offering content that uses lots of bandwidth, like youtube.com, currently use ISP-maintained infrastructure for free, and such sites should have to pay for that bandwidth. Because bandwidth is scarce (or becoming scarce as the Internet becomes more congested), the argument goes, allowing ISPs to charge for it will ensure that bandwidth goes to those who can use it most profitably. For example, Robert Litan of the Brookings Institution, argues that using the Internet to deliver health care to disabled people would amount to nearly $1 trillion of cost savings--but only if doctors can be sure that the data they get is uncorrupted by, say, a video broadcast of "Ask a Ninja." Without a market for broadband, those kinds of cost savings will not be realizable. Similarly, Robert Hahn and Scott Wallsten argue that "mandating net neutrality, like most other forms of price regulation, is poor policy." All of these economists treat broadband access as a private good, subject to the usual laws of supply and demand.

Opponents of the legislation are organized on http://www.savetheinternet.com/. They claim the more appropriate model is that of monopoly or oligopoly: ISPs are so large that they would have market power and charge excessively high prices for broadband in order to maximize their profits. Consequently, the number of websites would dwindle, and the Internet would be a much less varied place. More insidiously, this would have a cascading effect on other Internet innovations: the fact that access to Internet users has been relatively cheap up until this point has allowed a myriad of new Internet startups to take risks by creating or entering new markets.

1. Which economic models that you have studied are most applicable to the market for broadband? Why?

2. Hahn and Wallsten argue that as long as the market for ISPs is competitive, the market for broadband will be as well. They suggest that the better way of fostering competition is to ensure that the market for ISPs is indeed competitive. Is this reasonable?

3. Both sides of the debate argue that their position is better for innovation. What kind of innovations might not occur if net neutrality is maintained? What kinds of innovations might not occur if a market for broadband were to exist? Is there any way of weighing the pros and cons of those kinds of innovations?