Industrial Organization Puzzle

In IO theory we teach our students that price discrimination requires monopoly power and monopoly power allows the firm to make above-normal profits. So why don’t the industries that practice a lot of price discrimination seem especially profitable? Airlines, movie theatres, universities – all classic examples of users of price discrimination yet none seem especially profitable. There are examples of profitable industries that use price discrimination, pharmaceuticals for example, but there are also profitable firms that don’t use a lot of price discrimination. If we graphed use of price discrimination against profits would we find a positive slope across the economy as a whole? I doubt it, yet this is what the theory would seem to predict. Send me your thoughts.

Secondary consequences

Substitutes are everywhere, and the do-not-call list appears to be reviving door-to-door salesmen:

“I think companies are looking for new distribution channels for their products,” said Amy Robinson, a spokeswoman for the Direct Selling Association, a Washington, D.C.-based trade group. “Direct selling has traditionally been undervalued by Wall Street, but many realize its strength. It’s a niche market, but $28.7 billion in sales last year make it nothing to scoff at.”

Here is the full story. No, there does not appear to be a one-for-one substitution, but I’ll take an unwanted phone call over a knock on the door anyday. Let’s also not forget about spam, which threatens to cripple the use of email, as an additional unwanted substitute.

Man vs. machine

Tomorrow (Tuesday) Kasparov plays his first match game against X3DFritz, another chess-playing computer. The four-game match will be covered by ESPN television; chess has not received this much media attention since Fischer-Spassky in 1972.

The betting odds make Kasparov a slight favorite. Humans have perhaps the best chance in a short match. They do not lose their stamina, and can play to draw, hoping to elicit positional mistakes from the machine. Humans, of course, cannot beat the machines when it comes to computation and pure tactics.

Man vs. machine games often run a typical course. The human grandmaster carries a significant advantage out of the opening or early middle game, where it is harder for the machine to calculate all relevant possibilities and positional judgment is at a premium. But as the game progresses, the machine plays perfect defense and the human cannot convert the advantage into a win. If any tactics arise at all, the human usually is doomed. So it often feels as if the humans are “blundering” and letting advantages slip mysteriously away. The reality is that it is hard to beat a perfect opponent, once the early positional mistakes are over.

I was surprised to see Kasparov favored. Once he lost to Deep Blue, the last big match (Kramnik vs. Deep Fritz) was a draw. I know it is not as simple as Moore’s Law, but hey, don’t these machines improve their game more rapidly than the human players do? Stay tuned for more.

Oenophiles love global warming?

According to a report in Scientific American:

Gregory Jones of Southern Oregon University and his colleagues analyzed data from 27 of the top wine-producing regions worldwide from the last 50 years… The scientists studied Sotheby’s vintage rating…and compared the trends to climate records. Overall, they found an average temperature increase of two degrees Celsius for the wine regions and higher vintage ratings for their products. “There were no negative impacts,” Jones notes.

Armchair economics makes me suspicious
. The “top wine-producing regions” should be located in places where the weather is optimal for grape growing. If higher temperatures are better, why weren’t the top wine regions located further to the South to begin with? Higher temperatures could make previously inhospitable areas good for wine-making and even raise wine quality on net but the best regions ought to be made worse by climate change. I suspect the authors did not control well for other factors that are improving wine.

Gasoline and market power

Having just visited New Jersey, I am reminded once again that service stations in New Jersey are full service only. That’s right, self-serve is against the law. My wife wonders what a public choice explanation could possibly be, I postulated a kind of “full employment act” for the undereducated, the public rhetoric once claimed that without full-service stations the supply of auto repairman would dry up, although that hardly seems plausible. Here is a summary of a recent New Jersey debate, the piece notes that NJ gas prices are not especially high.

The real puzzle, for me, is precisely that full-service gasoline in New Jersey is typically no more expensive than the typical self-service prices in Virginia. (I am writing from a Kinko’s in Manhattan and don’t have the exact numbers handy.) Yet full-service gas in Virginia is much more expensive than self-service in Virginia, often thirty, forty, or fifty cents a gallon more, at least.

You might that the marginal cost of providing service explains this differential, but then why is full-service gas in New Jersey so cheap? More likely, you have gas stations in Virginia, and elsewhere, practicing a common price discrimination, here is some empirical support for such a model. In other words, the stations believe that those who purchase full-service gas are simply willing to pay much more. Such price discrimination, of course, is impossible in a perfectly competitive market. You would think, surely, that the retail gasoline market is very competitive. The product is relatively homogeneous and there are many different service stations in developed regions. Yet it does not appear to behave like a competitive market, and that is the source of my puzzle. Here is a good piece on the use of, and how it serves price discrimination, including in the gasoline market.

Here are Capitalistchicks complaining about full-service requirements in Portland, where they claim that gas prices are especially high, they consider public choice arguments as well.

The final lesson?: You have to look really hard to find a truly competitive market, in the sense defined by the economist’s notion of perfect competition.

Addendum: Gary Leff relates how pulled out of the gas market several years ago. And here are gas taxes by state, though they do not explain the observed price gaps in this case, thanks to David Hartley for the tip.

Underground dining

…securing a seat at Mamasan’s is not easy. The restaurant, which also happens to be Lynette’s apartment, has no sign, and the only way you will ever find it is if someone tells you where it is (a quiet street, a hidden door, up a dark stairwell to the top apartment). Even then, you can’t just show up: you must have an invitation. To get one you need an introduction from a previous guest. This may seem as if it’s a complicated way to get a plate of grilled salmon, but Mamasan’s Bistro is not a legal endeavor. Its kitchen lacks the certificates, permits and inspections required by the city of San Francisco. And although the coconut-mango cocktails flowed, Lynette does not have a liquor license.

Mamasan’s is not, however, an anomaly. Restaurants of dubious legality, where food is cooked in apartments and backyards, abound across the United States. These underground restaurants range from upscale to gritty, and are born from youthful idealism, ethnic tradition or economic necessity. They lack certification from any government agency and are, strictly speaking, against the law.

Many of the new entrepreneurs quite like this arrangement, this quotation is a delight:

I’ve worked at restaurants for years, and dealing with the public is a beast,” Lynette said. ”You don’t get to edit who comes into your space, and it becomes a very sterile exchange of goods. I like knowing who is coming, and whether they understand what I’m doing.”

Lynette describes her restaurant as a kind of ”party” — albeit one that comes with a bill — and many underground restaurateurs harbor similar visions.

In other cases immigrants start these restaurants out of economic necessity. Asking a taxi driver is recommended as a good way to find one. African and Brazilian restaurants in Queens are especially common. Here is the full story, and thanks to co-blogger Alex for the tip.

Yes, the public is a beast, and I suppose that includes me. But if you know a good underground restaurant in the Washington, D.C. area, please write me, and I promise not to publicize it on my Ethnic Dining Guide.

Don’t forget to say thanks

Paul Schervish and John Havens at the Boston College Social Welfare Research Institute have projected that between 1998 and 2052, between $31 trillion and $41 trillion of [American] wealth (in 1998 dollars) will move from one generation to another. They estimate that during this fifty-four-year period, our economy will produce 10.1 million new millionaires.

The stock market crash did not require much of a revision in this estimate, according to an article on Schervish’s home page. Here is the home page itself, you will see that Schervish studies donor behavior. Here is the home page of John Havens.

Of course their numbers are, in some ways, gross underestimates. Let’s not forget the even more important bequests of decent institutions, the American Constitution, science, and technology. The next generation will enjoy something better than Stone Age conditions, not because they are so especially smart, but because of the shoulders they will be standing on.

All of a sudden, I don’t feel so bad about making these people pay for my retirement and the retirement of my baby boom generation.

The above quotation is from The Greater Good, by Claire Gaudiani, a keen treatment of the importance of philanthropy in American life. The author notes that many more people donate to charity than vote. It is also more people than eat fast food or would read a book.

Roosevelt and the Great Depression

I was amused to see Conrad Black writing with shock:

Jim Powell of the Cato Institute (cited approvingly in a recent column by Robert L. Bartley) argues in a new book that FDR actually prolonged the Depression!

Of course, Powell is correct. Imagine, increasing the power of unions to strike and raise wages during a time of mass strikes and mass unemployment. Imagine thinking that cartelizing whole industries thereby raising prices and reducing output could improve the economy. Not everything Roosevelt did was counterproductive – he did end prohibition (although in order to raise taxes) – but plenty was and worst of all was the uncertainty created by Roosevelt’s vicious attacks on business. (See, for example, the work of Bob Higgs especially this important paper and historian Gary Dean Best’s overlooked classic Pride, Prejudice and Politics.) Business investment failed to recover because business people legitimately feared a regime change like that which had occured in Germany and Italy. Sound extreme? Roosevelt himself threatened/promised this in his first inaugural:

…if we are to go forward, we must move as a trained and loyal army willing to sacrifice for the good of a common discipline, because without such discipline no progress is made, no leadership becomes effective. We are, I know, ready and willing to submit our lives and property to such discipline, because it makes possible a leadership which aims at a larger good… I assume unhesitatingly the leadership of this great army of our people dedicated to a disciplined attack upon our common problems….in the event that the Congress shall fail to take one of these two courses, and in the event that the national emergency is still critical, I shall not evade the clear course of duty that will then confront me. I shall ask the Congress for… the power that would be given to me if we were in fact invaded by a foreign foe.

Microsoft hires bounty hunters

Microsoft has put up “two $250,000 rewards, a total of $500,000, for information that leads to the arrest of the writers of two nasty computer worms — the Blaster worm and SoBig.” I am all for this as those guys sure wasted some of my time. As regular readers will know, I am also a fan of bounty hunters (see my earlier post; and my econometric paper – finding that bounty hunters reduce failure to appear rates and bring back fugitives much more succesfully than the public police).

Greenhouse effect skeptics

Here is an entire web site devoted to skepticism about the greenhouse effect, and whether the burning of fossil fuels is at fault. It offers the latest scientific research on the skeptical side, excellent visuals, and regular updates. I am an agnostic on this issue, and underinformed most of all, but I do feel that this alternative point of view deserves a better hearing.

How to commission music

Why not? And it might only cost you a few thousand dollars.

A doctor in Illinois commissioned a mass from Christopher Rouse. A Twin Cities musical version of the Beardstown Ladies stock club gets together after dinner to talk about movies and family life and which oboe concerto we should commission next.

Read here for more information, including a booklet of commissioning instructions and a phone number for assistance. The bottom line: Patronage today is more active, and more decentralized, than ever before.

Fires and insurance

Why do people put their houses in the path of so many fires? Matt Welch at suggests an answer:

“The frequency and the intensity of the forest fires in the Southern California chaparral are the greatest in the United States, with the possible exception of the wildfires of the New Jersey Pine Barrens,” wrote environmental essayist John McPhee, in his marvelous “Los Angeles Against the Mountains” section of The Control of Nature. “It burns as if it were soaked with gasoline… The canyons serve as chimneys, and in minutes whole mountains are aflame, resembling volcanoes, emitting high columns of fire and smoke.”

Of course, those canyons–at least the ones not owned by the state or federal government–also serve as glorious, high-end residential real estate, eligible for the state-mandated, below-market FAIR insurance. According to Kiplinger’s, the average FAIR policy here costs $350. Part of the reason for the low price is that FAIR plans don’t generally cover theft or personal liability. But another is that there is a two-fisted downward pressure on prices–political desire to keep rates affordable, and the massive disincentive for any private insurers to compete against the heavily backed, low-priced plans.

The bottom line: These people are not paying the full social costs of their real estate decisions. In response we are offering welfare for the wealthy.

Thanks to Instapundit for the pointer, see also his commentary.