The economics of Netflix

Lately I’ve signed up for Netflix.com. You pay $20 a month and you get mail order DVDs, free shipping, and you can keep them as long as you want. The limit is three to a customer. Once you return what you have, you can order some more. This is a big business and Wal-Mart is entering the market.

I am finding that Netflix changes what I watch. Service is prompt but there is a lag between ordering and viewing. The only late fee is the rather abstract opportunity cost of not being able to order more films. So I can order a DVD and not watch it for a week or even a month. I can engage in a kind of artistic deficit spending. I find myself ordering more movies that I feel I “ought to watch,” but won’t necessarily enjoy. After all, the consequences of my decision lie further in the future. I find myself especially altruistic toward my wife, and what she wants to watch. I am more willing to order long movies. I could never bring myself to rent The Shawshank Redemption, which is compelling yet sappy and well over two hours long, but now I have seen it.

Netflix reminds me just the tiniest bit of democratic voting. I order films to feel good now about my ordering, and not necessarily to watch them. Overall Netflix has improved my movie viewing and induced me to experiment more. Fortunately it is a supplement to other ways of choosing movies. When it comes to what I really want to see, nothing beats getting in the car and driving there, pushing through the yellow light to make sure I don’t miss the previews.

Does free trade lead to insufficient diversification?

The theory of comparative advantage, and the theory of increasing returns, both predict that free trade brings specialization. Michigan and Tennessee produce automobiles, but Delaware does not. I have heard free trade critics suggest that regions end up especially vulnerable and overspecialized.

Yes in economics virtually everything is possible, once you recognize that Giffen goods and upward-sloping demand curves cannot be ruled out. But I am not so worried about free trade leading to excess specialization.

First, individuals can buy equities from multiple regions or countries. There does appear to be an inefficient “home bias” when it comes to investing, but surely free trade is not at fault here. If anything, free trade should encourage investors to think more globally and to diversify more.

Second, individuals specialize, in response to trade, because specializing brings higher returns. When investors expand a firm or line of business they internalize risk-return trade-offs.

Third, we must consider global risk. Let us say that protectionism helps a country avoid a declining industry. The world as a whole does not gain. Those economic problems are simply shouldered by another country, and in a less efficient way, relative to free trade.

Fourth, risk is borne by individuals, not by countries per se. Having many different industries in a country does not by itself create safety for individual investors or workers. Who cares if France has its own movie industry, if you are losing your job in computer software? Contrary to what Dana Rodrik suggests, it is not necessarily economically safer to live in a large country.

I can see a potential political version of the argument. Free trade, by inducing specialization, might make tax revenue more volatile in a country. Still, tax revenue should be higher in absolute terms. And if revenue volatility is a problem, I would prefer fiscal responsibility over protectionism as the proper medicine.

I am indebted to Randall Parker and Arnold Kling for sharing some of their email correspondence on this topic with me.

The culture that is French

Concern over France’s diminishing importance in world cuisine has prompted the government to create a gourmet university, which it yesterday promised will be nothing less than the “Harvard for the art of French cooking”.

The university will open in October in Reims, in the heart of Champagne country, and admit 70 French and 30 foreign students in its first year, according to Renaud Dutreil, minister for small business and consumption.

And why is French haute cuisine in crisis?

The suicide of Bernard Loiseau, France’s best-known three-star chef, drew attention to the difficulties the best restaurants experience in reconciling innovative menus and silver service with the commercial realities of high wages and massive fixed costs.

Mr Loiseau’s suicide coincided with widespread frustration at international criticism claiming that French chefs have failed to move on from nouvelle cuisine and have fallen far behind Spanish, Italian, American and even British rivals.

… many restaurateurs have been frustrated by the government’s failure to lower VAT on sit-down meals.

The election pledge by Jean-Pierre Raffarin, prime minister, to reduce the rate to 5.5 per cent from the current 19.6 per cent is facing German opposition in Brussels.

Did you get that right? London is now a more interesting dining spot than Paris. The core problems involve an overregulated French labor market and excessively high French taxes. Here is the full story.

On a related note, it is now the case that 35 percent of all French movies are shot outside of France, most commonly in the Czech Republic. French filmmakers are asking their government to set up a specially subsidized studio complex, to restore French cinematic competitiveness. It is time we start realizing that government regulations involve an aesthetic price, not just an economic burden.

Addendum: Here is additional commentary on relative French culinary decline, with useful links.

The cost of new drugs

In 2003, Joseph DiMasi, Ronald Hansen, and Henry Grabowski published an important paper in the highly-regarded Journal of Health Economics that estimated that the average cost of developing a new drug was around $805 million dollars. Hal Pawluk at Blog Critics repeats some nonsense from Public Citizen to claim that high research costs for pharmaceuticals are a myth and that this paper in particular is part of a conspiracy of pharmaceutical companies to raise prices. Frankly, the comments of the critics are laughable but not everyone sees the joke so I will explain.

Here is the number one criticism, the “major flaw,” in the DiMasi et al. study according to the critics.

1. The $802 million included $400 million that had nothing to do with bringing drugs to market. It was an estimate of how much the drug companies could have made by investing in some other way. This is an imaginary number that the drug companies do not pay.

(See also, Public Citizen who say these are “theoretical costs that drug companies don’t actually incur.”)

Firms spend on R&D from the day the development process begins up until the day the drug is approved for marketing which may be a decade or more later. But a dollar spent early in the process could have been earning interest in the bank for years before marketing approval is achieved. Recognizing this, DiMasi et al. calculate the cost of the drug as if all the money had been spent on the day the drug was approved.

Is this unreasonable? Well, suppose you lend me $5000 – how much would you want back in a year, in 2 years, in 10 years? The longer the loan period the more you would expect back when the loan came due, right? This is exactly the same calculation performed by DiMasi et al.

I challenge anyone who thinks this is imaginary money to lend me $5000. I guarantee to repay them the same return as they recognize as legitimate for the pharmaceutical companies.

Do only smokers benefit from moderate drinking?

Richard Ippolito says yes:

This paper uses data from the Health and Retirement Survey to measure the effects of alcohol on the incidence of morbidity and death. The study is able to reproduce the implied benefits of engaging in moderate levels of alcohol consumption, even after controlling for a large number of independent variables not usually available in health data sets. In fact, the controls work in the direction of supporting the benefits of engaging in even higher dose levels than conventionally recommended. It turns out, however, that smokers and quitters enjoy most of the benefits of unusually high alcohol consumption. Non-smokers evince modest benefits that are completely captured at very low dose levels. In general, the results suggest that studies of alcohol intake on health need to pay more attention to the characteristics of users. It may be that alcohol is especially beneficial for populations that are deficient in their health for other reasons like smoking or poor eating, whereas populations who follow good diets and do not smoke benefit very little from alcohol use.

Smokers should drink even more than we had thought, or quit smoking. Non-smokers won’t benefit much from drinking. Thanks to Newmark’s Door, one of the most useful yet underrated blogs, for the pointer.

Barter clubs and monetary theory

When I was a kid my father belonged to a barter club. He sold advertising space in his magazine, published for a chamber of commerce, in return for free restaurant meals. The system involved a county-wide network, involving trading stamps and pledges to supply real-valued goods to other members. Being a Jersey boy, I had many a veal piccata this way.

More generally barter clubs expand in deflationary times. They were prominent in the 1930s, during the Great Depression, and very common after the Argentinean financial crisis.

I can think of at least three reasons for such arrangements:

1. They may offer tax advantages, not always legally.

2. They serve as a form of price discrimination. Some people won’t pay the full cash price, but you will accept a bartered service for some of your wares.

3. Barter clubs expand the real supply of money, when monetary policy is bad. This is why we see them in times of financial crisis. Prices can be sticky downwards. If the government won’t maintain the real supply of money, to some extent the private sector will issue scrip to make up the difference.

Bernard Lietaer thinks that scrip is an important monetary institution for the future. Irving Fisher had a fascination with related ideas, as did the German monetary economist Heinrich von Rittershausen.

My view: Scrip will remain limited in economic importance and may even decline in use. Scrip allows you to issue your own money, backed by the goods you sell. But the more effective financial intermediaries become, the less such monies are needed. It is no accident that scrip picks up in times of depression. As for the price discrimination motive, growing resale opportunities (e.g., ebay) should diminish this over time.

Thanks to Carnival of the Capitalists for the pointer.

Facts about lightning

1. On average lightning strikes one hundred times per second.

2. From 1959 to 1994 an average of 363 Americans are struck a year, 90 are killed.

3. The annual odds of being struck are about 576,000 to 1. The annual odds of being killed are about 2.32 million to 1. In other words, one in 87,000 bolts hits someone, one in 345,000 bolts kills someone.

4. Florida is the most dangerous state for lightning. In per capita terms New Mexico is the most dangerous state.

5. Alaska and Hawaii are the least dangerous states, with zero reported lightning deaths.

6. July is the most dangerous month.

7. 3 p.m. is the most dangerous time of day, it is five times more dangerous than 9 a.m.

8. Men account for 84 percent of lightning deaths. Can we be that stupid? Yes.

9. Golfer Lee Trevino has been struck by lightning twice.

These facts are from LIfe: The Odds (And How to Improve them), by Lee Baer.

Here is a color-coded map of where lightning is most likely to strike. Here is an association of lightning survivors. Here is a medical description of what happens to you if you are struck.

Happy golfing!

How to improve meetings

Reader Robert Ayres relates the following:

Heard about this at General Electric’s Missile and Space Division, back in the 60s. (I did not actually see it in use.)

As you enter the meeting room, you privately enter your annual salary (thousands) on the telephone dial (pad). A little computer (a one-off then, a PDA now) continually computes the total running-cost of the
meeting, in terms of (sum salaries) meeting-duration.

So the chair can at any time announce, “OK guys, we’ve spent $1500 of the company’s money, have we reached any conclusions?”

For other ideas, see my earlier post.

Markets in prediction, revisited

You can now bet on future developments in the tech sector. The questions include the following:

1. When will Google have an IPO?

2. Will SCO be awarded damages? [in its lawsuit against IBM at the District Court in Utah]

3. When will there be a commercially available electronic device using ultrawideband technology?

4. Will Oracle acquire PeopleSoft Inc?…before March 31st, 2004.

Here is the website. There are no cash prizes, but it is not just for pure play either. The top ten winners receive prizes from Circuit City. If you are wrong about everything, you lose nothing.

My take: I’ve long been intrigued by the idea futures concept. One central question is whether they can perform some function that current asset markets do not already satisfy. I’ll say no for this version of the idea. For instance some of the other predictions involve the future value of the NASDAQ index. Many of the others can be satisfied, albeit with noise, by betting on the relevant companies. Note also that Circuit City wins publicity for sponsoring the contest, which points to another truth about idea futures. In financial terms they are a zero-sum game for the investors, so a sponsor may need an external incentive, such as publicity value, to market the idea. If idea futures have a breakthrough use, it may well be within companies, such as to evaluate competing R&D proposals.

Thanks to Daniel Akst for the pointer to the link.

The evolution of proverbs

First-graders were asked to complete the first halves of proverbs and they came up with the following:

“Better to be safe than punch a fifth-grader.”

“Don’t bite the hand that looks dirty.”

“A penny saved is not much.”

“Don’t put off till tomorrow what you put on to go to bed.”

“You can lead a horse to water, but how?”

All, I might add, appear to show a familiarity with economic reasoning, with the possible exception of number four, which to my mind makes no sense whatsoever.

Here is the full story. My colleagues David Levy and Daniel Houser have recently started designing some economic experiments about the evolution of proverbs. Proverbs, like prices, aggregate information. One question is whether proverbs evolve to demonstrate the wisdom embodied in some weighted notion of “average opinion”, the opinion of the median member of the language community, or the most frequently expressed opinions at the mode.

Electronic newspapers and human electronic billboards

…after years of unabashed hype and dashed hopes, truly flexible displays are at last being ramped up to commercial production. Among the uses that manufacturers foresee are electronic newspapers that can be folded or rolled when not in use and then opened to display the latest news; flexible strips for store shelves that display constantly updated price and product information; and watch bands or bracelets that offer streaming news or other information.

Some companies are even considering working the technology into lines of clothing. Forget those low-tech embroidered Gap or Gucci logos on your shirts, said Barry Young, vice president and chief financial officer for Austin-based DisplaySearch, a market research company that tracks the flat panel display industry. We’re talking about a Times Square-style news crawl moving across your chest: G . . . U . . . C . . . C . . . I.

“Now we’ll have to pay to be a billboard,” Young quipped.

Flexible-display blouses are still some years off. But a more modest rollable display — the first to be truly mass-produced — is now being churned out at the rate of 100 per week and may reach production levels of 1 million a year by the end of next year…

Here is the full story. Just think, you could read your favorite blogs on your MarginalRevolution T-shirt.

Thoughts on steroids

Professional sports face the unusual problem of trying to manufacture dominance and competitive balance at the same time. On one hand, the race to the title cannot be too lopsided, or fans of the lesser teams will lose interest. Revenue-sharing and salary caps are common (but not universal) in major league sports. On the other hand, stars and superlative performances draw fans. Most NBA fans look back with nostalgia to the days when the Lakers and the Celtics were the dominant teams, meeting each year in a dramatic showdown at the end of the season.

On net, it appears that leagues would prefer to have more superstars and outstanding performances. NBA fans eagerly embrace high school phenom LeBron James, in the hope he will be the next Michael Jordan. Home runs have been good for baseball attendance.

Now steroids can have one of two possible effects. First, steroids may make it easier to produce spectacular performances. It is commonly charged, for instance, that some of the superlative home run seasons (Barry Bonds?) are the result of steroids and related drugs. If this is so, steroids may make a sport more fun for fans and more lucrative for both stars and non-stars.

A second possibility is that steroids level relative performance. They make all players bigger and stronger, but make it harder for any single player to stand out. In that case a league may seek to ban steroids. The profit-maximizing set-up, of course, is probably a general ban but only loosely or selectively enforced. Some players get the steroids and others do not. Arguably this is what we see. A league will try to ban steroids, but not too hard. Steroids are a relatively cheap way of manufacturing stars.

Note that the Olympics probably prosper more from competitive balance than from a single dominant country. Was it really so much fun for the rest of the world to watch the Soviets win all those medals? This would predict that the Olympics should take special care to ban performance-enhancing drugs, which is indeed the case.

By the way, if you don’t think that economists will apply their discipline to everything, read this, thanks to Roger Meiners for the pointer though don’t expect it to convince your wife.

Do football teams punt too much?

Economist David Romer says yes. Teams would enjoy higher returns if they would try for the first down more often. Furthermore his work has influenced how professional football is played.

The real question is why this mistake was made in the first place. Could it be the economist’s well-known distinction between the seen and the unseen? If you punt, no one sees the first down you didn’t make. If you don’t punt and fail to make a first down, you feel bad and are easily blamed. For agency-related reasons, we might expect coaches to be more risk-averse than players. The coach wants to hold onto his job, whereas a superstar player captures upside returns to a greater extent. The variance of player salaries, especially if you include endorsements, is typically much higher than the variance of coach salaries. So the coach plays it safe to a greater extent, and of course a punting decision is usually in the hands of the coach.

Addendum: Here is further discussion from Nick Schulz.

The evolution of language

On Wednesday, the Agence France Presse news service reported that author Phil Marso has published (on paper) an antismoking novella for teenagers called “Pa Sage a Taba” (Not Wise to Smoke), composed in the jambalaya of abbreviations, slang, and neologisms that teens worldwide use to send each other text messages online and via cellphone. In English, for example, 2moro is “tomorrow” and YYSSW is “Yeah, yeah, sure, sure, whatever.” So in Marso’s book, when a detective asks the villain, “6 j t’aspRge d’O 2 kologne histoar 2 partaG le odeurs ke tu me fe subir?”, what he’s actually saying (in translation) is, “What if I spray you with cologne so you can share the smells you make me suffer?” A glossary of terms is included.

Marso, who admits that his book may “annoy the guardians of the French language,” says he wrote the book as a public service announcement.

Here is the original link. The constraint, of course, is that you wish to send and receive information as rapidly as possible, given your limited typing or punching speed. If you are interested, why not try some Shakespeare?

“Luv Loks Nt Wiv T iis
Bt wiv T Mnd”

Translation: “Love looks not with the eyes
But with the mind,”

William Shakespeare

Or this one?

“2 b or nt 2 b, thts de qn”

r v upset now? I think it’s pretty neat. And to keep you busy, here is a short glossary, TMMV stands for “Your Mileage May Vary,” which refers to different luck, POS stands for “Parents Over Shoulder,” B4N.

New sports and technology blog

Nick Schulz, of TechCentralStation.com fame, has started a new blog on sports and technology, part of the Corante.com group. At the blog you can read Nick on the true meaning of sports, whether better equipment improves your golf game, how to solve the steroids problem, and why sports fans seem to enjoy a lack of competitive balance. John-Charles Bradbury addresses this same topic as well. From Nick’s own TCS, read this account of how NFL Films has driven the popularity of football in America. Here is a related story about how to better measure value in football, using a Bill James-like approach.

My own major sports interest, the NBA, has just started its own blog, though this consists largely of celebrity comments, presumably ghostwritten for the most part. Try also this sports and law blog. Did you know that relocating the New Jersey Nets to Brooklyn might push at least 800 people out of their homes and require eminent domain?

By the way, Nick says the smart money is on the Panthers for today’s game.