Month: December 2005

I’m finishing an MA in Economics at Boston University right now, and am also the author of "PSX: The Guide to the Sony Playstation" which is being released this week.  In the course of research for the book, I interviewed a number of VPs at Sony about why they priced at 299 when the PS2 came out.  The waits for the PS2, in fact, were much longer than those for the Xbox360, and still no rise in prices.

Here’s my understanding of the pricing situation:

1) Console prices are announced months in advance of the system release, unlike many other products.  There is a general consensus that a price above 299 (or 399, perhaps, which is the true price of the 360) will be unsuccessful.  In the mid and late 90s, a huge number of consoles bombed by announcing prices of 400-1000 (Sega Saturn, cd-i, 3DO, Amiga CD32, etc.). Third party developers are essential to a system’s success (a system without games, after all, does nothing), and in order to have games ready for a system, they evaluate a system a year before launch.  A high price would discourage developers -> discourage games -> lessen demand.  Given the competitiveness of the console game market, I have no doubt that major third-party game producers (Activision, Ubisoft, Square, EA, etc.) would balk if Microsoft were to raise prices, fearing, justly or not, that system sales two years down the road (when their games are ready) will be lower. For the 500-pound gorillas (EA in particular) there might even be contractual stipulations with MS about the system price.

The other reason is the one Alex gave – The $700 consoles on ebay represent the highest WTP on the demand curve, not the average.  Personally, I don’t think MS would’ve sold 500k Xboxes at $500.  Why MS didn’t auction off "limited edition" systems early, as you said, remains a mystery though. Nintendo has done exactly that with some items (in charity auctions, however).

In any case, the basic pricing structure is no mystery at all.  MS needs to satisfy both end-users AND third-party developers, not just end-users. They’re selling a *platform* more than a product.

Gift-giving advice today…

Do not buy gifts for nieces, nephews or grandchildren. Send money if you must, but other gifts will be spectacularly incompetent. Using questionnaires, the Joel Waldfogel famously revealed (in an article entitled ‘The Deadweight Loss of Christmas’ – JSTOR) that the typical $50 gift is valued at between $35 and $43 by the ungrateful recipient, but that gifts from grandparents, aunts and uncles were even less welcome. If you are content to spend $50 to provide $35 worth of pleasure to your distant relatives, then next time please use me as your middleman.

It’s the thought that counts. His detractors rarely admit this, but Professor Waldfogel explicitly asked his subjects not to consider sentimental value. Sentimental value might indeed outweigh the waste of a poorly-chosen tie, but the cheaper the tie the more likely that is to happen. A $50 tie valued at $40 by the recipient is still a good gift if it also creates $15 worth of warm fuzzy feelings. But think how much better it would be to give a $5 tie valued at $4, which still created the same $15 of fuzzy feelings: this is a much more efficient way to produce a smile.

Actually, maybe it’s better if you don’t give anything at all. Steven Landsburg reminds us that one of Christmas’s greatest philanthropists was Scrooge. His miserly refusal to eat a Christmas turkey, year after year, meant one more turkey that someone else could afford. His capacious bank account meant that money was available to lend out to entrepreneurs and kept interest rates low. There’s nothing wrong with spending money if you’re going to enjoy it, but if it’s going to be frittered away on chintz then you couldn’t ask for a better role-model than Scrooge.

Tomorrow: making those New Year resolutions stick, surviving the sales, and why Alan Greenspan should replace that soft fool Santa Claus.

Why are Cuban cigars good?  It’s not as if communist economies are known for producing quality goods so why the exception for Cuban cigars?  I have a few hypotheses:

1. Cuban cigars are not good.  The contrary impression is due to rememberances of things past and the sex appeal of the forbidden fruit.  (Testable hypothesis: Are Cuban cigars as highly prized in countries where they are not banned?)
2. The Cuban "terroir," the soil, climate and environment are unique.   (Maybe but Communists destroy good terroir – see Zimbabwe, the Ukraine etc. – all the time.)
3. Castro puts a huge amount of resources and incentives into producing cigars because a) he likes to smoke and b) exporting cigars and doctors is good for the brand image.  Cuban cigars are like Soviet chess.
4. Castro has basically privatized the cigar industry allowing for significant market incentives.

Comments are open for those who know more about cigars and the Cuban cigar industry.

…conservative commentator Philip Oppenheim…argued recently that in
Britain, it’s supermarkets that profit most from fair trade sales. They
charge a premium for fair trade bananas, for example, while a
"minuscule sliver ends up with the people the movement is designed to
help"…

Here is more.  In case you don’t know, fair trade sells a product at a premium price, under the promise that the workers are treated better and paid more.  But will that improve living standards?  Hmm…this sounds like a problem in tax incidence theory.  To make the best possible case for fair trade, I will assume the promise of good treatment is credible.

Let’s say the supermarket has some market power and would have liked to price discriminate on coffee sales.  Now you can buy either normal coffee or fair trade coffee, and the richer,
more conscientious people are willing to pay more for the latter.  Some people can be charged lower prices, while others pay higher prices.  Fair trade will likely increase coffee output, relative to a world with no fair trade.  Profits will go up.  But what happens to input prices?  Will wages of Rwandan coffee producers rise?

It depends on the alternative to market segregation.  It is possible that if only a single kind of coffee can be sold, the market would opt for the more expensive coffee, involving better treatment of all workers.  Even if you don’t expect this today, it might happen in a few years’ time.  If McDonald’s can improve the treatment of all the chickens it buys, maybe Starbucks or some other force will force the coffee sector to clean up its act.  So development optimists should be suspicious of fair trade.  It could diminish long-run general progress by giving the conscientious an outlet for their charity.  By splitting up the market, we are institutionalizing especially poor treatment for one class of workers.  Furthermore the high profits from price discrimination imply that
producers will be keen to continue such segregation rather than end it.

How about a genre called "Exploitation Coffee"?  You pay less, and they promise to treat the workers especially poorly.  That wording is a less effective marketing ploy, but that is what quality differentiation and indeed "fair trade" boils down to.

It is well known that price discrimination can either raise or lower the average level of prices, but it does increase price dispersion.  We can expect it to increase wage dispersion as well.  It is harder to predict whether price discrimination will raise or lower wages at the bottom level of the scale. 

By increasing output, fair trade can bid up wages for coffee producers.  But fair trade also diverts some drinkers from Exploitation Coffee.  If the switching effect is large, wages for producers of Exploitation Coffee can fall.  Just as we have created two classes of market prices, so have we created two classes of market wages.  If you believe that coffee producing firms have some degree of monopsony power, this is  sustainable and again will increase profits but possibly worsen human misery for the poorest.

These are all "existence theorems."  I would not be surprised to learn that current benefits from fair trade are positive.  But since I am a development optimist, I have reservations about the institution in the longer run.

Exam question: How much of this analysis also applies to free-range vs. factory-farmed chickens?  Hint: not all of it (why not?)  Comments are open…and might you know of empirical work on how fair trade influences wages?

Burn your Christmas card list. Deep down, we all know that many Christmas card exchanges are more like vendettas than expressions of seasonal goodwill. Is your yearly card from former neighbors Mr. and Mrs. Grinch a genuine effort to keep in touch – or does it reflect the fact that they’ll be damned rather than be the first to stop? Thomas Schelling argues for a bankruptcy procedure in which all lists should be burned and people could start again, motivated only by genuine good-will. Take his advice and you’ll be doing yourself a favor, not to mention releasing all those near-strangers you inflict cards upon. (Read more.)

Take your children to a good fire-and-brimstone Christmas service – but make it brief. Robert Barro and Rachel McCleary have investigated the connection between religion and economic growth, with two notable results. First, belief in heaven and hell is good for business, presumably because it generates trust and substitutes for expensive legal proceedings. Second, time spent in church is not time well spent: presumably you make some contacts but could more profitably seek them elsewhere. To ensure successful offspring, send them to a church that instills the fear of God into them without demanding too much face time. Shop around.

Establish firm property rights over the TV remote. I can’t stress this one too much. Ronald Coase taught us that disputes over shared resources can always be resolved, provided the costs of negotiation are low and property rights are clearly established. Arguments only happen because it’s not clear who has the right to name the channel. Therefore, somebody must be given the control of the TV remote and should auction off the right to choose the channel to the highest bidder, perhaps in half-hour slots. It doesn’t matter much who the owner of the remote is – the choice of programming should be the same. Still, in our household I’ve always been in favor of giving the job to the paterfamilias.

Further advice to follow tomorrow.

The usual explanation, a shortage generates hype, doesn’t make much sense.  First, as Tim Harford also points out hype can be generated by high prices as well as by shortages.  Very high end luxury items, for example, like Lamborghini’s are difficult to obtain but also very expensive.  Second, it’s implausible that a shortage
now could generate such greater sales later as to be worthwhile this is especially true given that Christmas is the peak selling season.  You want
hype before not during Christmas. 

Here is a new paper on culture and economics, destined for the Journal of Economic Perspectives, hat tip to the New Economist blog.

Imagine economics is no longer built around the dual of preferences and constraints.  We would instead have the following starting points:

1. Priors.  Without differing Bayesian priors, there is neither trade nor disagreement.  Your priors depend on your cultural background.

2. Beliefs. What model of the economy — and more importantly of yourself — lurks in your mind?

3. Peers. Which people do you accept as your relevant peer group?  This often determines the working model for your beliefs.

4. Stories. What stories do you tell yourself about who you are?

Arguably these analytical categories are more fundamental to human behavior than utility maximization.  Combine them with evolutionary biology, and a bit of neuroscience, a marriage with sociology and social psychology, and we have the foundations for a revolution in economic science.  Fifty years or so from now, that is.