Month: September 2003

Here is one excerpt:

WIRED: Who deserves the most blame for the crash?
STIGLITZ: I identify three or four culprits. The deregulation movement went too far, too fast. Then I have to give some blame to the Fed. Greenspan gave the “irrational exuberance” speech but didn’t do anything about it. And there was the bad accounting framework, which emphasized stock options and created a series of perverse incentives. Wall Street and Silicon Valley conspired to maintain those bad standards.

Now this bit will enrage some people I know:

STIGLITZ: I don’t like the word deregulation. I like to say “finding the right regulatory structure.”

From Wired.com.

Read this good article on the difficulties of maintaining the Eurozone. Here are some of the big problems:

France and Germany, which have the biggest economies of the 12 countries that use the euro, are breaking the strict budget rules governing the currency by running huge public-spending deficits. Growth continues to sputter in the euro zone, while the United States is showing initial signs of recovery. Unemployment has risen to 12.5 million. And the near-record-high value of the currency is hurting competitiveness by dampening exports. Last week voters in Sweden overwhelmingly rejected adopting the euro in favor of keeping their national currency, the krona.

Ever wonder why product quality often comes in threes? (Basic, Regular, Premium. Bronze, Silver, Gold. Third, Second, and First Class etc.) When there are only two product qualities consumers are torn between two “extremes,” either of which makes them uneasy. Add a third quality and you create a happy medium. Simonson and Tversky (the cite is in the link below) report that when offered a low-end and a midrange microwave oven consumers chose the midrange 45% of the time. But when offered the same two ovens plus a high-end oven they significantly increased their purchases of the midrange. Even when few consumers buy the premium product the mere fact that it is offered can increase sales of the midrange product. Hal Varian calls this Goldilocks pricing (see discussion beginning at p.10).

There is a right way to do it and a wrong way. Brad DeLong gives low marks to the recent performance of Treasury Secretary John Snow. Rather than merely talking the dollar down to where it “ought to be,” he has also made the dollar appear riskier, thus discouraging future investment. Also see Brad’s earlier post on the same topic.

Nature reports this new article on the stock market, which purports to show that trader behavior might simply be random. I haven’t read the whole piece yet, but I worry when it characterizes the mainstream view as suggesting that all traders are fully rational. I don’t consider myself an advocate of the efficient markets hypothesis, but the notion is more modest than that. Still, anything published in Nature is newsworthy.

Click here, here (scroll through, their archives aren’t working), and here to read some responses to my earlier post on why we do not see more price gouging.

I agree gouging should not be illegal, the question is why the refusal to gouge persists when gouging is legal. Here are some possibilities:

1. People are just irrational, gouging would be an improvement over shortages.

2. Gouging would violate fairness constraints, break down our trust in business, and lower the overall gains from trade.

The above links discuss these options. Last night I was pondering another hypothesis, to be sure it has some holes, but since the absence of gouging is often a puzzle, let us look more closely.

3. Non-gouging is a form of price discrimination that raises long-term profits, for reasons that have nothing to do with fairness constraints.

I was first pondering the case of airlines. It is sometimes argued that airlines keep coach quality low deliberately, to raise the demand for business and first class tickets. I don’t know if this is true, but an analogous argument can be made in the intertemporal context. If flashlights are scarce when a storm comes, the pre-storm demand for flashlights will rise. Conversely, if the flashlight market clears when a storm comes, fewer people will stock up on flashlights in the first place.

Assume that right now flashlights cost $5 (laugh at this number if you want, I haven’t bought a flashlight in ages). If prices cleared the market every period, flashlights might cost $20 when there is a storm, and $4 otherwise. Both the wealthy and the careless might hold off on flashlight purchases, knowing they can always get one at the last minute, if they need to. So fewer flashlights are sold up front. By keeping flashlights scarce during a storm, the store forces people to invest in a flashlight now as a form of insurance against not being able to get one later. This might raise the overall demand for flashlights. In similar fashion, perhaps sports arenas (another classic venue for non-market-clearing prices) may not wish to give everyone the option of showing up at the last moment to purchase tickets.

What are some of the holes in this argument? First, the store must have some market power (but note that most plausible explanations of sales and coupons require this same assumption). Second, the numbers need not work out in favor of keeping the price steady. Third, why would this effect hold for flashlights and not for all commodities? Fourth, I can think of gouging cases where this argument would not apply. I recall a peanut butter shortage about twenty years ago, and the market did not clear, it is hard to imagine that this encouraged people to stock up on peanut butter.

Still, the absence of price gouging is a puzzle, and we need to look at all available explanations. Intertemporal considerations might be part of a broader understanding of the phenomenon. Perhaps market-clearing prices don’t boost profits as much as we would otherwise expect.

Addendum: Gary Leff offers an instructive post on the pricing of airline seats, more generally check out his excellent travel blog.