Category: Economics

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.

I survived hurricane Isabel, but couldn’t buy a flashlight or the right size batteries, the night before the storm was to come. Merchants let supply run out rather than raise the prices. C.C. Kraemer at TechCentralStation.com tells us that half of all states have anti-gouging laws. More significantly, merchants fear that customers will resent price increases during times of trouble. The testable prediction is that wandering “umbrella merchants,” as I have encountered in Manhattan, will raise their prices when it is raining. They have little reason to fear long-run negative effects on their reputation. I have found this to be true but can cite only two data points in its favor. Twice, when it was raining, I bought umbrellas for $10 rather than for the usual price of $5.

Kraemer suggests that we should allow price gouging in times of emergencies. This policy conclusion need not follow. Since supply is constant in the short-run, higher prices won’t give more flashlights to more people, although in the long run the economy will stand readier with emergency flashlights. Higher prices will allocate flashlights to those people most willing to bid for them, but at the cost of all buyers feeling gouged. After all, not wanting to be gouged is a preference too. And the subsequent decline in trust will eliminate other potential gains from trade.

Arguments by N. Gregory Mankiw and George Akerlof suggest that small costs of changing prices can have large macroeconomic effects. They focus on cases where prices remain too high and output is restricted as a consequence. In contrast, if a firm refuses to raise its prices, presumably it feels that the resulting “resentment costs” are higher than the extra revenue it would reap. First, the price changing costs are not small. Second, if the firm had initial monopoly power, as the Mankiw argument requires, keeping prices lower will not in general lower consumer welfare. (It is a tricky intertemporal problem, there can be cases where contrived ex post shortages pump up ex ante demand for the good, to the benefit of the monopolist and to the detriment of social welfare.)

I would repeal the anti-gouging laws, on libertarian freedom grounds, but I don’t welcome more price gouging as a means of making us better off. Markets are quite willing to gouge us in a wide variety of instances, just try hearing a good jazz show on New Year’s Eve. We should take it seriously when markets are not willing to gouge us. We can also ask whether people would be better off if they had weaker fairness norms, or better fairness norms, that is the next relevant question for assessing the costs and benefits of price stickiness. Just keep in mind that our current norms help keep our suppliers in line and limit their ability to defraud us.

Addendum: I’ve made some slight re-edits in the interests of clarity.

Remember Tom Peters? The 1996 Guinness Book of World Records listed him as the world’s most highly paid management consultant. His In Search of Excellence was one of the earliest mega-hits among management books, you might recall that he flirted with various Hayekian ideas about the market as a discovery mechanism. Today’s Financial Times looks at Peters today and asks, quite literally, whether he has lost his mind. It describes a Tom Peters seminar as “a combination of Billy Graham and Sid Vicious.” Peters admits to being proud of the inconsistencies in his thoughts, but to my mind the FT evinces no evidence of real craziness. Several years ago Fortune magazine raised the same issue, I cannot find an on-line copy but again I am waiting for the smoking gun.

Make up your own mind, visit Tom’s web site. Be warned that not all of it is rigorous, consider the following:

An Aussie reporter asked me recently about the origins of “Re-imagine.” I answered in terms of war & peace & commercial effectiveness alike. The following leapt from my lips, and I was intrigued by what I’d said. Dangerous, I well know; and it may wear off. But herewith, not a bad rationale, at the highest level of abstraction, for what we’re about and the possible importance thereof…

Tom admits that he was overoptimistic about Silicon Valley — at least he will admit he was wrong — and says that the increased difficulty of valuing intangible assets is behind the recent corporate scandals.

Devah Pager’s article in the latest American Journal of Sociology demonstrates an important relationship between race, criminal record and employment. She sent out pairs of black and white young men to apply for entry level jobs, gave them similar records except that one was randomly selected to have a criminal background. She then analyzed who was called back for an interview and got some interesting results:

1. Unsurprisingly, for both blacks and whites, reporting a criminal record drastically reduced the chances of a call back.

2. Black men *without* the criminal history were less likely to be called back than white men *with* criminal records.

3. Having a criminal record is more damaging for black applicants than for white applicants.

This, I think, is a nice challenge to the whole statistical discrimination thesis, where employers use race as a proxy for other unmeasured variables. The Pager study shows that even when employers have full information on their applicants, they often prefer a white ex-convict than a similar black man without a criminal record.

Update: Dmitri Masterov writes to tell me about point #2 – Pager showed that the difference between the two groups was not statistically significant.

If workers are paid their marginal product its difficult to understand why some CEOs are paid such high wages. But think of the CEO’s wage as a prize. Valuable prizes make everyone else work hard in order to become the CEO. With this model, the tournament model (JSTOR) of Lazear and Rosen, it may even make sense that CEO wages go up as profits go down. After all, shouldn’t prizes be set highest when motivation is most required? No doubt, some will see this argument as more proof that economists are just shills for the capitalist class.