Are restaurant awards a negative signal?

I've been thinking about this for some time. If you are at a restaurant, and you spy a bunch of award certificates on the wall, should this give you confidence that this is a good restaurant? Many people would say 'yes, of course'. It is an award-winning restaurant, so of course it is a good restaurant. I'm not so sure, and in fact I think that in many cases a bunch of restaurant awards on the wall might be a negative signal, or no indicator at all. Let me explain why.

First, let's consider why restaurants need to signal at all. Restaurant quality is what economists call private information. The restaurant operators know whether their restaurant is high quality or not, but the patrons do not know (at least, not until they have eaten there). Restaurant meals are an experience good - the quality of the restaurant (an experience characteristic) is only known to the patron after they have experienced the restaurant meal. This information asymmetry between the restaurant operators and restaurant patrons creates an adverse selection problem. If high-quality restaurants can't distinguish themselves from low-quality restaurants, then the restaurant patron will assume that every restaurant is a low-quality restaurant (this is a pooling equilibrium). If this was to happen, then high-quality restaurants would probably start to close down (because they won't be able to get enough additional patrons to pay for their higher costs), and we'd be left with only low-quality restaurants left.

Of course, that scenario doesn't play out in most cities. Restaurants have found ways to make their quality known to patrons. When the informed party (the party that doesn't know the private information) tries to credibly reveal the private information, this is what economists call signalling. [*] In order for a signal to be effective, it needs to meet two conditions. First, it must be costly. And second, it must be costly in such a way that the low-quality restaurants wouldn't want to attempt the signal.

Now, let's consider the signalling value of award certificates. Is an award certificate costly? Yes, getting an award certificate is costly for a restaurant. The restaurant operators would have to work hard on quality of food and ingredients, and the quality of service, in order to win a certificate. [**] Is an award certificate costly in such a way that the low-quality restaurants wouldn't want to attempt the signal? A low-quality restaurant is low quality because of poorer quality food and service (and whatever other criteria are considered in the awarding of the certificate). If the low-quality restaurant operators were willing to pay the costs of higher quality food and ingredients and higher quality service, then they would do so (and they would be a high-quality restaurant, not a low-quality restaurant). So yes, the low-quality restaurant operators wouldn't attempt the signal, and so it does appear that award certificates are a good signal of quality.

However, not every high-quality restaurant can win an award certificate every year. So, what if the certificates on the wall are five or ten years old? Is that still a good signal of quality? I look at those ancient certificates (more than five years old), and I see a restaurant that is past its peak. It's on a downward slide into oblivion. It's not signalling high quality to me today, it's signalling that the restaurant used to be high quality, but not any longer.

There are two reasons why a restaurant would keep ancient award certificates on the wall. First, they are genuinely on the downward slide, but they want patrons to think that they are still high quality. But, if they were genuinely still high quality, they would still be winning award certificates. Given that they are not winning, then they are really signalling to patrons that they haven't maintained their previous quality.

Second, maybe the award certificates are given out in such a way that multiple winners are excluded. Call this the 'give everyone else a chance' effect. In that case, the award certificates are not such a great signal of quality, since they are not awarded to the highest quality restaurants, but to the highest quality restaurants that haven't been excluded for winning too many times. The quality of the signal is lessened, and patrons shouldn't pay as much attention to the award certificates.

So, a real high-quality restaurant, that hasn't won an award for several years, would probably be better off taking down their ancient award certificates, if they don't have any recent ones, then leaving those ancient certificates on the wall. Ancient restaurant award certificates are a negative signal of quality.

Changing tack now, I have a bunch of ancient award certificates myself - my teaching awards (six of them in total). I've been thinking about hanging them on my office wall. However, I haven't won an ward since 2020. Now that I've thought about restaurant signalling, I'm reconsidering whether I should hang those teaching award certificates on my office wall. Would they just signal that I'm on a downward slide? On the other hand, I continue to be nominated every year, and by multiple students every year. Maybe my lack of award winning is just the 'give everyone else a chance' effect at play?

[HT: Inspired by this Tyler Cowen post from December last year]

*****

[*] The patrons (the uninformed party) can also try to reveal the private information about restaurant quality. When the uninformed party (the party that doesn't know the private information) tries to credibly reveal the private information, this is what economists call screening. 

[**] If that wasn't the case, then the certificate provides no signalling value at all.

Tourist levies and tourist spending

The New Zealand Herald reported earlier this month:

An international tourism levy charged to visitors to New Zealand will increase to $100 – a jump of almost 200% – in a decision the Government believes will help boost economic growth and support conservation.

But it has some in the sector concerned the increase will be a barrier to visitors coming to New Zealand.

The International Visitor Conservation and Tourism Levy (IVL) is currently set at $35 and is charged to most tourists, people on working holidays, some students and some workers coming to New Zealand.

The IVL acts as a form of two-part pricing (which you can read about here). A firm uses two-part pricing when it splits the price into two parts: (1) an up-front fee for the right to purchase; and (2) a price per unit. If the consumer wants to buy any of the product, they must first pay the up-front fee. In the case of the IVL, it isn't a firm that's using two-part pricing, it is New Zealand as a whole. Tourists to New Zealand, if they want to buy any tourism experiences in New Zealand, must first pay the IVL.

The effect of the IVL on tourist spending is shown in the consumer choice model diagram below. In this case, the consumer is a tourist. They can spend their income (M) on either of two goods: NZ goods (as a tourist) with price Px, or overseas goods with price Py. The tourist's budget constraint with no IVL is the black line. The highest indifference curve that they can reach is I0, and they will buy the bundle of goods E0, which includes X0 NZ goods, and Y0 overseas goods. Now consider the impact of the IVL. The IVL takes income away from the tourist, but they don't receive any NZ goods in exchange for it (they just receive the right to buy NZ goods, as they can enter the country). That shifts the tourist's budget constraint inwards to the blue line (note that the end points on the budget constraint now have income (M-F), where F is the amount of the IVL). The tourist cannot buy the bundle of goods E0 anymore, as it is outside their budget constraint (it is outside the feasible set). The highest indifference curve that they can reach is now I1, and they will buy the bundle of goods E1, which includes X1 NZ goods, and Y1 overseas goods.

Now consider what this means for the government and for tourism operators in New Zealand. Overall, the tourist is spending more money in New Zealand now. We know this because they are buying fewer overseas goods (Y1 instead of Y0), and since they are still spending all of their income, they must be spending less on overseas goods (because the price of overseas goods is still Py), and more in New Zealand (made up of the IVL and what the tourist spends on NZ goods). The government might see that as a good thing.

On the other hand, the tourist is now buying fewer NZ goods (X1 instead of X0). That clearly isn't a good thing for New Zealand tourism operators, because tourists are spending less on NZ goods. It is little wonder that tourism operators are not happy about the IVL increasing. [*]

It gets worse for NZ tourism operators though, when we consider heterogeneous tourists. The diagram below shows two different consumers - a high-demand tourist (who spends a lot on NZ goods) shown in blue, and a low-demand tourist (who spends very little on NZ goods) shown in red. After the IVL is introduced, the high-demand tourist moves from buying bundle EH0 to bundle EH1. This means that they buy fewer NZ goods (XH1 instead of XH0), but spend more in NZ in total (just like the previous diagram, because they are buying less overseas goods - YH1 instead of YH0). However, the low-demand tourist's best affordable choice after the IVL is introduced is to stop buying any NZ goods at all, and not pay the IVL at all. They would consume the bundle EL1, spending all of their income on overseas goods (and buying no NZ goods at all instead of XL0).

Tourism operators might console themselves that while there will be fewer tourists, the remaining tourists are those that buy a lot of NZ goods. However, high-demand tourists could even end up spending less in NZ overall, as shown in the diagram below. In this diagram, I only show the high-demand tourists (for simplicity). Notice that in this case, once the IVL is introduced the high-demand consumers move from buying bundle EH0 to buying bundle EH1, and they end up buying less NZ goods (XH1 instead of XH0), but more overseas goods (YH1 instead of YH1). Since they are buying more overseas goods, they must be spending more on overseas goods (because the price of overseas goods is still Py), and therefore spending less in NZ overall (even when you add the IVL plus their spending on NZ goods).

Which of these scenarios will play out? Will consumers end up spending more overall (combining the IVL and spending on NZ goods)? Low-demand tourists will stop visiting, but how many will do so? Will high-demand tourists spend more overall, or less? These are all relevant questions that it would be worthwhile to answer. And the New Zealand tourism industry really needs some answers, because it will be really consequential for their revenue and profits.

*****

[*] Note that the diagram doesn't show the effect of increasing the IVL. However, comparing IVL with no-IVL is qualitatively the same as comparing smaller-IVL with larger-IVL.

This week in research #42

Here's what caught my eye in research over the past week:

• Yotov (with ungated earlier version here) presents a historical overview of the gravity model (used in trade and migration studies, and I love that the concluding section is titled "Gravity is endless fun")
• Bokhari et al. (open access) use UK data to show that minimum unit pricing of alcohol was remarkably effective and well‐targeted in reducing demand for cheap alcohol during the pandemic lockdowns, with minimal spillover effects, and consumers overall buying and spending less
• Reilly, Williams, and Das find that Office of Civil Rights (OCR) investigations of colleges and universities in the US are associated with lower recorded sexual assaults at private and public research schools and private baccalaureate schools, but not at public baccalaureate schools (so context matters)
• Heutel argues that theme park rides are Giffen goods, noting that when the price of a ride increases (that is, the wait time increases, then the probability of riding it increases (I'm not convinced, and I don't find the results that establish that rides are inferior goods convincing - if people have more time in the theme park (an increase in 'income' in Heutel's model), and holding wait times constant, are there rides that they would ride less as a result?)

Adrian Katz on public sector discounting

This week, my ECONS102 class has been covering the economics of education. One of the key aspects of the topic is the introduction of discounting. This is important in the private education decision (about how much education to invest in), because the benefits of education come in the future, while the costs (including opportunity costs) happen now. In order to make an effective decision, we need to discount the future benefits so that they can be compared with the present costs.

Discounting is also important in public sector decision-making, such as decisions on funding healthcare (and my ECONS102 class will turn its attention to health economics next week), transport and other infrastructure, environmental policy, and many other decisions where there are long-term benefits (and/or long-term costs).

So, I was interested to read this post on the Asymmetric Information substack yesterday by Adrian Katz (senior economist at NZIER), who gives a quick run-down on public sector discounting:

The public-sector discount rate plays a central role in determining which government interventions get the green light, and which stay on red...

The Treasury currently recommends a discount rate of 5.0% for most projects. The Treasury’s CBAx guidance also suggests an alternative rate of 2.0% but does not explain how this should be used.

Some government agencies use different discount rates. For example, NZTA uses a rate of 4.0%, and Pharmac uses 3.5%. Having different discount rates for different government organisations is at odds with the Treasury’s current approach and makes it harder to compare different types of government spending.

Katz then briefly outlines the debate over how the discount rate should be set. It is worth reading that debate if you want to understand more about how the discount rate is set currently. Katz then concludes that:

Arguments about the discount rate are often motivated by political views about the role of government in society or ethical views about what we owe to future generations. Policy advisors face difficulties in making these judgements on behalf of society without clear evidence of New Zealanders’ views on these complex issues.

The choice of discount rate can make a big difference to evaluating the present value of future costs and benefits. The Treasury recommendation of a 5 percent discount rate would discount an amount in 20 years' time by 62.3 percent (=1-[1/(1+0.05)^20]), and an amount in 50 years' time by 91.3 percent (=1-[1/(1+0.05)^50]). In contrast, using the Pharmac rate of 3.5 percent would discount those amounts by 49.7 percent (=1-[1/(1+0.035)^20]) and 82.1 percent (=1-[1/(1+0.035)^50]) respectively. So, $1000 in 20 years' time would have a present value of $377 using the Treasury rate, but $503 using the Pharmac rate. And $1000 in 50 years' time would have a present value of $87 using the Treasury rate, but $179 using the Pharmac rate.

With a lower discount rate (like Pharmac) more alternatives with long-term benefits and near-term costs would have benefits that are greater than costs (that is, a benefit-cost ratio greater than one). As a result, the government would have evidence in favour of investing in more infrastructure, more climate change mitigation, more education and more healthcare. Discount rates matter.

Why study economics? The website edition...

I've had a long-running series of posts on this blog titled "why study economics" (see the links at the end of this post). So I was interested to find out that there is a whole website devoted to the question, why study economics? [Note: The website isn't protected by https, so you might have to click through a browser warning to get to it].

The website is UK-centric, so many of the details won't apply to New Zealand students. However, it still has interesting sections on: (1) what is economics; (2) whether economics would be a good choice for you (your ambitions); (3) what to expect during your studies; and (4) what to expect after you graduate. In the third section, there is a particularly comical page entitled "A day in the life of an Economics student" (although it does require one translation: what they call a 'seminar' in the UK, we call a 'tutorial' in New Zealand).

Anyway, there is lots of good information on the site for prospective economics students, and the 'After you graduate' section is especially helpful. It includes a 'careers cloud', which shows the types of industries that economics graduates go into:

I think I'll probably use this in my mini-lecture presentation on Open Day next year. If you're thinking about studying economics, then definitely take a look at the Why Study Economics website.

[HT: The book How to Be a Successful Economist, which I am reading right now, and will review sometime next week]

Read more:

• Why study economics?
• Why study economics? NZ graduate earnings edition
• Why study economics? Sheepskin effects edition
• Why study economics? It could make you rich...
• Why study economics? PhD edition...
• Why study economics? Even if you won't be an economist edition...
• Why study economics? AEA video edition...
• Why study economics? Tech firm jobs edition...
• Why study economics? More on jobs in the tech sector edition...
• Why study economics? Law and economics edition...
• Why study economics? More tech sector jobs edition...
• Why study economics? Understand the world edition...
• Why study economics? Economics and computer science edition...
• Why study economics? Better than operations research and computer science edition...
• Why study economics? Uber data scientist edition...
• Why study economics? Economists in tech companies edition...
• Why study economics? Amazon edition...
• Why study economics? Uber edition...
• Why study economics? Improve your analytical skills edition...
• Why study economics?  Return on investment edition...
• Why study economics? It causes higher incomes...
• Why study economics? Wizards of the Coast edition...
• Why study economics? Tech firms want you edition...

Student strikes and teenage pregnancy in Chile

In 2011, university and high school students in Chile undertook a massive protest against the government (known as the 'Chilean winter'). Thousands of students participated in these strikes, refusing to attend classes or even taking over school buildings, and demanded a new framework for education. Given the widespread nature of the strikes, and the fact that they would affect non-participating students as well (who wouldn't be able to attend a school that had been taken over by protestors), it is worth asking what the consequences of the strike were.

That is the question that this new article by Pablo Celhay, Emilio Depetris-Chauvin (both Pontificia Universidad Católica de Chile), and Cristina Riquelme (University of Maryland, College Park), published in the Journal of Development Economics (ungated earlier version here), seeks to answer. Specifically, they focus on teenage pregnancy as an outcome, defined as a birth to a 15-17-year-old woman, backdated based on gestational age of the baby on the day of birth.

Celhay et al. don't have individual-level data though, so they look at the relationship between the number of births, at the municipality level, and a measure of 'strike intensity', which measures how likely a female student living in a given municipality was exposed to the student strike. It is based on the proportion of schools in a municipality that were on strike, and the length of the strikes overall. In Chile at that time, births were a good measure of conceptions, because abortion was illegal.

Celhay et al. find that:

A municipality with an additional exposure of 10 percentage points, signifying a ten percentage point increase in the number of resident high school female students attending schools on strike, witnessed a monthly rise in conceptions during the strike period ranging from 10% to 11%. For a more straightforward interpretation, consider that a municipality with an average proportion of students on strike (26% according to the combined measure) experienced a 2.7% increase in teenage pregnancies during the strike period.

I guess that tells us what some students were spending at least some of their spare time doing during the strike period? Importantly, this effect was concentrated among women aged 15-17 years, with no statistically significant impact on other age groups. That provides some confidence that the results are specific to school-aged women, and not a general increase in pregnancy and births across the whole population.

However, perhaps more importantly, Celhay et al. then find a more enduring effect on human capital development. Specifically:

Before the strike, schools that eventually experienced strikes were similar to non-striking schools regarding dropout rates and college admission test take-up. However, a significant increase in dropout rates and a decrease in college admission test take-up is observed in the year when the strike occurred. The effects are similar if we disaggregate outcomes by gender. In particular, the schools that took up strikes experienced an increase of 0.7 percentage points in their dropout rate. This represents a 20% increase in dropout rates in comparison to the average level of dropouts in the year 2010 (3.4%)... 

The results show a drop of approximately 20% in the number of students taking the test to be admitted to college during the strike year.. Furthermore, our study reveals that it takes approximately two to three years for dropout rates and college admission test take-up to return to pre-strike levels. This indicates a gradual recovery process after the disruption caused by the strike, as the educational system and student engagement stabilize over time.

I guess one way to interpret those results is that, when students don't attend school, they tend to drop out and don't sit the college admission test. That seems somewhat obvious. What is less obvious is that this impact remains for more than two years after the strikes subsided, and that should be a worry. It is also somewhat consistent with the long recovery of the education system, and student engagement, following the pandemic.

Celhay et al. interpret their results as showing:

...the potential benefits of policy interventions such as sexual education and counseling within schools, as well as initiatives that promote access to contraception among teenagers.

I think that interpretation oversteps, as they didn't actually look at the impact of sex education or counselling, or initiatives that promote contraception. It would be interesting if there was variation in those activities between schools, because then they could have looked at the impacts, but didn't. Nevertheless, I do agree with Celhay et al. that:

...we can interpret the observed effects as primarily related to reduced time spent under adult supervision. 

This week in research #41

Here's what caught my eye in research over the past week:

• Isaksson (open access) finds that,  in Sweden, a reduction in alcohol licences in a precinct is associated with a 3.7% increase in support for the populist Sweden Democrats political party
• Bonney et al. find that AI use is having a much greater impact on worker tasks than on employment levels at the firm level, with about 27% of firms using AI reporting replacing worker tasks, but only about 5% experiencing employment change due to AI use

New from the Waikato working papers series:

• Zhang and Gibson use China's census data for 2000, 2010, and 2020 to test predictive accuracy of four popular gridded population data products, and find that gridded population data are accurate cross-sectional predictors at all three spatial levels (county/district, prefectural city, and province), with less than five percent of variation unexplained, but that predictive performance of gridded data for population changes has fallen substantially in the last decade

Sweet treats are going to cost a bit more

The New Zealand Herald reported earlier this week:

Chocolate prices could be set to rise further as the cost of cocoa keeps pressure on...

Chocolate manufacturer Whittaker’s said in a statement that there had been “significant ongoing cost escalation of cocoa” driven by supply constraints.

It said there would be an impact on the future price of all chocolate.

The supply constraints for chocolate are being caused by "aging cocoa trees, diseases, and fluctuating weather patterns", which have reduced cocoa yields. The effects of reduced cocoa yields on the markets for cocoa and chocolate can be easily analysed using the supply and demand model that my ECONS101 class covered a few weeks ago. This is shown in the diagram below. Think about the market for cocoa first. The market was initially in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of cocoa traded of Q0. Poor yields reduce the cocoa harvest, decreasing supply to S1. This increases the equilibrium price of cocoa to P1, and reduces the quantity of cocoa traded to Q1.

Now consider the market for chocolate. The costs of producing chocolate have increased. That leads to a decrease in the supply of chocolate. The diagram for the market for chocolate is the same as that for cocoa, with the equilibrium price increasing, and the quantity of chocolate traded decreasing.

From the consumer's perspective, this means that chocolate is now more expensive. Some consumers will start to look for alternative sweet treats. What will happen in the market for those other sweet treats. That is shown in the diagram below. Since the price of chocolate has increased, other sweet treats are now relatively cheaper than chocolate, so some consumers will switch to other sweet treats. The effect on the market for other sweet treats is shown in the diagram below, where the market is initially in equilibrium with a price of PA, and a quantity of other sweet treats traded of QA. This increases the demand for other sweet treats from DA to DB, increasing the equilibrium price of other sweet treats from PA to PB, and increasing the quantity of other sweet treats traded from QA to QB.

So, it seems that consumers can't avoid higher prices by switching to other sweet treats, because higher price chocolate is likely to lead to higher prices for other sweet treats as well.

Finally, let me address this quote from Brad Olsen from the New Zealand Herald article:

“It might be more difficult for chocolate to increase in price, being a “nice to have” rather than a necessity as households are more careful with their money but chocolate for households is the necessary luxury so willingness to buy chocolate might remain pretty high despite higher prices.”

I guess this is the sort of quote you get from an economist who is caught on the hop by a journalist's question that they were not well prepared for. If chocolate is a luxury good, then ceteris paribus (holding everything else equal), it will tend to have more elastic demand. That means that consumers are more responsive to a change in price than for other goods that are necessities rather than luxuries. Of course, being a luxury is only one of many factors that determine how responsive consumers are to a change in price, and the other factors (like the number of substitute goods for chocolate, and the proportion of income that consumers spend on chocolate) will matter more. Nevertheless, a "necessary luxury" is not something that exists.

Australia may have passed peak craft beer, but that could just be the start of a new cycle

I've written a couple of times about the craft beer industry and how, as many new craft breweries had entered the market, prices and profits would be falling, and eventually firms would start to exit. This is a type of market dynamic that I discuss with my ECONS101 class.

It appears to be playing out in Australia as well. As the National Business Review reported last month (paywalled):

For beer lovers, the craft brewing industry is like beer nirvana.

So many cool brands to sample, so many varieties, so many hip brewery venues to visit.

For a time, around a decade ago, it seemed the industry was unstoppable as a flood of new breweries with clever names and unique flavours posed a threat to the established players.

If you were a serious beer fan, why would you take a can of plain old VB when you might try something really exotic, like a Sydney dark ale called Motor Cycle Oil or a Juicy Banger from Byron Bay?

On the production side, a craft brewing startup was an inspiration to a younger generation of entrepreneurs who could create a unique beer and sell it in a trendy destination venue, often with live music and ‘designer burgers’. It was not just beer, it was marketing a lifestyle.

And, if you got lucky, there might be a big payday if one of the major brewers came calling with a cheque book.

Like so many exuberant business cycles, however, the craft brewing industry in Australia is enduring a painful reality check, with multiple business failures and an uncertain outlook. These are not just growing pains or over-investment. There are some significant economic headwinds that have emerged for craft brewers...

There are about 700 craft breweries in Australia, with the industry growing by 80% or so in the past eight years. It’s a market worth A$160m and, according to the Independent Brewers Association (IBA), it contributes A$1.93 billion to the economy and employs about 10,000 people.

In the past 18 months, however, about 30 breweries have folded and there are predictions that a new wave of failures is on its way.

The problem here is the over-enthusiasm of craft brewers. In the 2010s, the industry was flying high, with (relatively) high prices and profits. The problem was that, with the advent of contract brewing (where craft brewers contract out their brewing operations, and therefore don't require a large investment in brewing equipment), the barriers to entry into craft brewing fell. So, many more brewers could enter the market. And that's exactly what happened in Australia and New Zealand.

This increase in market entry increased the supply of craft beer, which has decreased the price as well as the profits to be made from brewing. Many of the brewers are closing down. I described these dynamics in this post in 2017.

However, all is not lost. This market is cyclical. After the market shake-out is complete, and prices and profits are low, there may be an opportunity for new craft brewing entrepreneurs to get in early on the next wave of the cycle. The smartest of these entrepreneurs will try to pick the bottom of the cycle, just when consumers have become frustrated with the faux-craft offerings of the major brewers and the decrease in quality of the craft products that they have bought out. It is bound to happen. The only question is when.

However, it is not easy to pick the bottom of a cycle, and an entrepreneur who gets in too early is likely to lose big. That is part of the challenge of the 'hit-and-run' strategy - trying to pick the bottom of the cycle (and hit the market). The other part of the challenge, of course, is trying to pick the top of the cycle (and run from the market, probably by selling out to one of the major brewers).

As I predicted in that 2017 post, many investors in craft brewing have lost big. However, it won't be long before the profit opportunities for new entrepreneurs in this market rebound. This will be an interesting market to watch in the next few years.

Read more:

• The rise and fall of craft beer?
• Are we reaching peak craft beer yet?

The Commerce Commission and the Foodstuffs merger

This week, my ECONS102 class covered monopoly. As part of that topic, we look at competition policy, and in particular whether a government competition or antitrust agency (in New Zealand, that's the Commerce Commission) should allow two (or more) firms to merge. In theory, the government should allow a merger if that merger would make society better off - in other words, if economic welfare were higher than without the merger.

However, as I noted in this post back in 2021, that isn't the remit of the Commerce Commission, which is expected to oppose any merger that 'substantially lessens competition'. As I noted then:

The wording "substantially lessening competition" comes from Section 27 of the Commerce Act, which is the legislation that the Commerce Commission exists to enforce (among other things). However, I think that wording is problematic, because lessening competition is not necessarily the same as decreasing total welfare. In fact, it is entirely possible for a merger between two firms to increase total welfare, while at the same time substantially lessening competition.

Anyway, this year's example comes from the supermarket sector, where Foodstuffs' North Island and South Island operations are looking to merge (they are currently separate companies). As the New Zealand Herald reported back in July:

Foodstuffs (both North Island and South Island) maintain that the merger is aimed at improving efficiency in their businesses, and that reducing costs - such as duplicate overheads across the likes of head offices and key supply-chain functions - will help to drive prices lower than they otherwise would have been (though perhaps not lower in an absolute “before and after” sense, given the significant other variables).

Chris Quin, head of Foodstuffs North Island and the proposed head of the merged entity, has also pointed to the freshly erected guard rails of the new regulatory regime as a reason to allow the merger to proceed.

The commission does not appear to share his view. The latest statement noted that the new regulations: “are designed to address some of the competition issues brought about by the existing high levels of concentration in the grocery sector. They are not intended to, and would not, mitigate the structural loss of competition in relevant upstream and retail grocery markets that would result from the Proposed Merger.”

It is interesting that the Commerce Commission does appear to be considering competition as it relates to suppliers, and not just consumers. And it is also interesting that Foodstuffs are pushing the idea that this merger will lead to efficiency and ultimately to lower prices (and therefore higher economic welfare, as shown in my 2021 post).

The Commerce Commission is due to make a final determination on 1 October. It will be interesting to see what their determination is.

Read more:

• The Commerce Commission, competition and total welfare

This week in research #40

Here's what caught my eye in research over the past week:

• Barron et al. (open access) look at the impact of alcohol prohibition during Covid in South Africa, and find that it reduced injury-induced mortality by at least 14%
• Lapré and Palazzolo (open access) find that, over the period 2002–2021, NFL teams that made better trades (trading less valuable for more valuable picks) had a higher probability of reaching the playoffs
• Petrusevich finds that an intervention in Russia that restricted the hours when alcohol sales were allowed improved children’s physical health, with younger children being more affected
• Vasileiou et al. (open access) find that positive feelings are associated with wine and beer consumption, while negative feelings relate to spirits consumption, in Italy
• Burgi and Gorgulu (open access) show that, for a measure of spatial population concentration, the largest relationship with economic growth is found for a radius of 25 kilometres, implying that regional policies such as infrastructure projects that influence population density should strategically target areas based on a 25km radius
• Lanzara et al. (with ungated earlier version here) find that, over the period from 1948 to 1992, the identity of the bishop in office explains a significant amount of the variation in the vote share for the Christian Democracy party in Italy, and that the bishop's political culture, and their interaction with the population matter most for this

Finally, Statistics NZ has released a new paper investigating the technical feasibility of transforming the New Zealand census to a model based primarily on administrative (admin) data supported by surveys. This will feed into one of the big debates heading towards the 2028 Census. This quote in particular is going to get a lot of population and other social science researchers quite worried: "It indicates Stats NZ’s readiness to shift towards an admin-data-first-based approach". There will be more to come on this.

As predicted, the 'regulated grocery retailers' scheme is failing, but there is an alternative worth considering

The supermarket sector in New Zealand has been in the news a lot recently. Bryce Edwards' Political Roundup column in the New Zealand Herald last week did a great job of summarising the media coverage. The column is worth reading in its entirety, but I want to focus on just one bit:

Grocery Tsar Pierre van Heerden made it clear this week how unimpressed he is with the duopoly he’s trying to regulate. He says he proposes further regulatory reform to the Government.

The first proposal is to reform the failed “regulated grocery retailers” scheme to make it mandatory that Foodstuffs and Woolworths treat rival retailers equally in providing them with wholesale groceries. However, commentators have been less than convinced by this. The supermarket reform advocates, Grocery Action Group (GAG), have called this proposal “tinkering in a market that has structurally failed”. And the Post’s business journalist Tom Pullar-Strecker suggested that the supermarkets might treat such regulations in the same way that electricity gentailers have managed to game the system: “If the supermarkets do need to supply rival retailers on the same terms and prices as their own stores, one question will be what might stop them making those prices high and shifting their profits from their retail to their wholesaling arms.”

It should be no surprise to anyone that the 'regulated grocery retailers' scheme has failed its objectives, and that further tinkering wouldn't make much difference. In fact, I predicted as much in this post in 2022:

Finally, the supermarket firms are not just retailers, but wholesalers. By itself, this proposal on retail prices would need to be carefully designed. Otherwise, the supermarkets will simply route around it by separating out their wholesale operations into a different business, which sets the wholesale prices, upon which the retail prices (cost-plus wholesale) will be based. Then the supermarket profits will simply back up one step as wholesale, rather than retail, profits... This might be one way that the supermarkets will respond to the Commerce Commission's recommendation that the supermarkets be required to offer wholesale supply to other grocery retailers (see here) anyway.

Why isn't the scheme working? It's more-or-less as I predicted (from Edwards' column):

According to the report, the scheme hasn’t been working as intended. Although former Prime Minister Jacinda Ardern claimed the regulation would “unlock the stockroom doors” of the duopoly to smaller players, instead, Foodstuffs and Woolworths had found a way to jack up the wholesale prices.

The report said: “In our analysis we found that as many as 54% of the products offered by RGRs (regulated grocery retailers) in wholesale could be purchased cheaper at retail”. It seems that the duopoly had managed to exclude competitors from gaining access to the various trade discounts from an array of rebates, payment arrangements and special deals.

So, rather than the scheme resulting in supermarkets and their competitors all facing the same wholesale price, the supermarkets have been giving trade discounts or rebates to their own stores (and presumably not to their competitors' stores). So, while the list price may look the same for everyone, in practice the supermarkets' own stores end up paying a lower wholesale price. And so the big supermarkets continue to profit because the higher wholesale price that their competitors pay ensures that the big supermarkets profit margins are not competed away.

The Grocery Commissioner's proposal to reform the scheme is also doomed to failure, as I noted in my 2022 post and Tom Pullar-Strecker has also pointed out. One solution, which no one seems to have suggested so far, and which might be worth considering, is to regulate wholesale grocery supply to operate under a cooperative model. Under this model, all grocery retailers would be 'members' of a single national wholesale cooperative, with ownership shares in proportion to their wholesale purchases. This is essentially a form of structural separation. Grocery retailers would all receive the same prices and special terms from the wholesale cooperative, which might be prohibited from offering quantity discounts (to prevent the big supermarkets from simply using those discounts to continue to receive lower wholesale prices than their competitors). This would also prevent the big supermarkets from simply shifting high prices to the wholesale level and continuing to profit overall, since the whole sector would now receive the same wholesale prices, whether they are high or low. It's not a perfect solution, and the wholesale cooperative will have a huge amount of market power over its suppliers (even more than the current supermarket duopoly does). But in terms of opening the path to more competition, it is a solution that is certainly worth thinking about.

Read more:

• Supermarkets are not natural monopolies, and should NOT be regulated as public utilities

Book review: A Herstory of Economics

Books that outline the history of economic thought tend to look, from the outside perspective, like a history of white male social scientists. A few key female economists' names may get a mention, such as Joan Robinson, or Elinor Ostrom. An enthusiastic chronicler of the history may even include Jane Marcet, Harriet Martineau, or Harriet Taylor Mill (the latter in conjunction with her husband John Stuart Mill). Otherwise, these histories mostly ignore the role of women in the development of economics.

Filling this void in our understanding of economic history is important, and is part of the goal of A Herstory of Economics, by Edith Kuiper. As she explains:

This book tells the larger history, or perhaps better, the herstory of economic thought. It tells the story of women, a long line of women who wrote about economic topics, theories, insights, and their experiences - the story of women economic writers and women economists and their work. Because they were women and because they wrote about women, their work was ignored and left to gather dust.

The book is incredibly well-researched, and well-written, albeit in quite an academic style. Kuiper had a lot to share, and I definitely learned a lot. Some of the things I learned were relatively benign, such as the fact that 'home economics', as taught in high schools (and until relatively recently, in many universities, before it was renamed 'family and consumer sciences') had the same academic roots in antiquity (oeconomicus) as did the political economy of Adam Smith or David Ricardo. Other things were somewhat more profound, such as this description of the reality of work in a pin factory (which contrasts with the complete lack of a gender lens in Adam Smith's description of a pin factory in The Wealth of Nations), referencing the work of Charlotte Elizabeth Tonna:

Tonna uses Smith's example as she describes how one would enter the pin factory and find the men in the first room. Walking on, however, one would find young women and children in terrible circumstances doing their work, practically in the dark, in the back of the building:

We enter at once a new scene - the interior of a pin manufactory. It is winter, the chilliness of a November day ... We proceed through several departments of busy employment: in one there are children winding slender wire, which, being passed through a machine by steam-power, is drawn out by men. Here, the boys work, generally under their fathers; and whatever we may think of their close, protracted confinement, the labour itself is not severe. In the next room we find many little fellows, more fatiguingly employed, being perpetually on foot, walking to and fro, assisting their seniors by the operation of straightening the coiled wire furnished by the drawers, which the men cut into length and point. ... Hitherto, we found no girls, nor very little children; but enter the next department, and the scene will change. Here is a room, if we can call it by that name ... and here, seated before machines unlike any that we have yet surveyed, are about fifty children, of whom the eldest maybe thirteen, but the general age is less, much less - they are mere babes...

This description sits uneasily beside the more straightforward description that Adam Smith provides, of how specialisation and division of labour enable the workers in a pin factory to be much more productive than are individual craftsmen making pins (see the third paragraph of Chapter 1, Book 1, of The Wealth of Nations here).

As in the quote above, Kuiper draws out many of the important contributions that women economic writers have made. Many of those contributions are hidden, because they were not written in scholarly books or journals, but rather in novels, in poetry, in trade magazines, in translations of books, or in other forums. There is a lot to be learned from these sources that have mostly been overlooked by the mainstream history of economic thought. For example, I believe it would be worthwhile for more people to explore the criticism of Adam Smith's Theory of Moral Sentiments by Sophie de Grouchy de Condorcet, who was the first to translate Smith's book into French.

I do have a couple of small quibbles with the book. First, because Kuiper is quite exhaustive in her sources, I often found myself thinking that I wished she had written more about some of the women economic writers that she references. For instance, the work of Sadie Tanner Mossell Alexander, the first African American women to obtain a PhD in economics, was only given the merest of mentions. Of course, by providing hints about the value of writing by previously under-rated women economists and economic writers, Kuiper is inviting the reader to look further on their own, and she cannot be faulted for making those invitations quite inviting. Second, because the book is written in quite an academic style, it may not suit all general readers. I found many of the stories of great interest, but that reflects my own background and interests. A general reader might prefer if the stories of these women economic writers could 'come alive' on the page a little more. However, perhaps that is best left to a more mainstream treatment.

Overall, I quite enjoyed this book, as complementary to existing histories of economic thought. It would be good to read alongside Robert Heilbroner's excellent book The Worldly Philosophers (which I reviewed here) for example. For someone wanting to see a more rounded view of the history of economic thought, that doesn't mostly ignore that women also thought about economic issues, this book is to be recommended.

Rent controls make many tenants worse off in the Netherlands

Rent controls have created shortages of housing, every time and in every place that they have been tried. In the latest futile attempt to create working rent controls, the Netherlands has worsened its housing shortage. As Bloomberg reported recently (paywalled, but try this alternative link):

Two years ago, Nine Moraal and her two children moved into a one-bedroom flat near the Dutch city of Utrecht, a comfortable spot close to family and friends. Although she had only a two-year lease, she expected to be able to extend it and stay until she could get one of the Netherlands’ many rent-controlled apartments.

But last spring, her landlord told her she’d have to move out in November, because renting the flat was no longer profitable. Despite “frantic efforts on social media, phone calls, visits to realtors and housing agencies,” the 33-year-old educator says she hasn’t found anything. “The cost isn’t the problem, but a real shortage of housing is.”

Moraal is among the growing number of Dutch people struggling to find a rental property after a new law designed to make homes more affordable ended up aggravating a housing shortage. Aiming to protect low-income tenants, the government in July imposed rent controls on thousands of homes, introducing a system of rating properties based on factors such as condition, size and energy efficiency. The Affordable Rent Act introduced rent controls on 300,000 units, moving them out of the unregulated market...

For the past year, Shahmy Wahabdeen has been renting a house in The Hague for €1,400 a month. After the new rules kicked in, his landlord decided to sell, leaving Wahabdeen scrambling to find new digs for his family of four. “I’m feeling completely hopeless and am seriously considering sending my family back home,” says the 34-year-old software engineer from Sri Lanka. “I don’t know what else to do.”

Coincidentally, I covered rent control with my ECONS101 class in the lecture today. I could see some sceptical faces around the class when I described the negative impacts of rent control on the market, and especially the negative impacts on tenants. However, there is lots of robust evidence on these negative effects, and the Netherlands example is just one more example of how rent controls often fail to help the very people that they are designed to help. A tenant who has nowhere to live isn't going to thank the government for cheap rent.

In fact, my most recent post on this topic was titled "There should be no debate at all about rent controls", and that's because any debate should be over before it begins. When it comes to bad policy, rent control ranks near the top. It certainly isn't a way of fixing the cost of housing. If a government is concerned about the cost of housing, they should build more housing.

[HT: Marginal Revolution]

Read more:

• Why rent controls have worse effects over longer time horizons
• The deadweight loss of rent control
• The deadly consequences of rent control in Mumbai
• Rent control and inequality in San Francisco
• Rent control and the redistribution of wealth
• Rent control and vacant properties in India
• Rent control according to Seinfeld
• There should be no debate at all about rent controls

Information asymmetry, adverse selection, and large language models

In an article in The Conversation earlier this week, Nicholas Davis (University of Technology Sydney) wrote about information asymmetry as it relates to large language models (like ChatGPT):

A lack of skills and experience among decision-makers is undoubtedly part of the problem. But the rapid pace of innovation in AI is supercharging another challenge: information asymmetry.

Information asymmetry is a simple, Nobel prize-winning economic concept with serious implications for everyone. And it’s a particularly pernicious challenge when it comes to AI...

AI creates information asymmetries in spades. AI models are technical and complex, they are often embedded and hidden inside other systems, and they are increasingly being used to make important choices.

Balancing out these asymmetries should deeply concern all of us. Boards, executives and shareholders want AI investments to pay off. Consumers want systems that work in their interests. And we all want to enjoy the benefits of economic expansion while avoiding the very real harms AI systems can inflict if they fail, or if they are used maliciously or deployed inappropriately.

Davis is generally talking about information in relation to AI safety, but I want to take this post in a slightly different direction first, about AI quality. I will return to AI safety at the end.

When we consider AI quality, information asymmetry will cause a problem of adverse selection, ultimately causing the market for high-quality large language models to fail. So, let's consider how this market fails. There is information asymmetry in relation to the quality of large language models. AI firms know whether their large language model (LLM) is high quality or not, but users do not know. The 'quality' of a large language model is private information. Because of this information asymmetry, a LLM user should assume that any LLM is low quality. This creates a pooling equilibrium, where the user is only willing to pay however much they value access to a low-quality LLM. AI firms with high-quality LLMs, which are more expensive to train and run, will not be willing to accept users who are only willing to pay a small amount. These AI firms with high-quality LLMs drop out of the market. The only AI firms that are left will be those with low-quality LLMs. The market for high-quality LLMs fails.

A key part of the problem here is that LLMs may be experience goods. Experience goods are goods where the consumer doesn't know the quality (or some other important attribute) until after they have consumed it (they are called experience goods, because consumers don't find out what they have really bought until they have experienced it). The quality of a LLM isn't revealed to the user until after they have used it, and seen what the LLM outputs in response to a given prompt. However, users are not experts, and they might not even know the quality of the output after they receive it. That would make LLMs not experience goods, but credence goods (goods where some of the characteristics, the credence characteristics, are not known even after the good has been consumed). It seems likely that for most non-expert LLM users, LLMs will be a credence good.

So, how can the adverse selection problem be solved for LLMs? In other words, how can we move from the pooling equilibrium to a separating equilibrium (where LLM users can separate the high-quality LLMs from the low-quality LLMs)? There are two options: (1) screening; and (2) signalling. Screening involves the uninformed party (the LLM user) trying to reveal the private information (the quality of the LLM). This is unlikely to work well, because the LLM user typically isn't an expert. The only way that they can reveal the quality of the LLM themselves is to try it out, but if LLMs are actually a credence good, then even trying them out won't reveal their quality.

That leaves signalling, which involves the informed party (the AI firm) credibly revealing the private information. Only an AI firm with a high-quality LLM would want to attempt signalling, to try and reveal that their LLM is high quality (and AI firm with a low-quality LLM is unlikely to want to reveal that their LLM is low quality). In order for a signal to be effective, it needs to meet two conditions. First, it must be costly. And second, it must be costly in such a way that the AI firms with low-quality LLMs wouldn't want to attempt the signal.

What might be good signals for an AI firm with a high-quality LLM? Firms that sell experience goods have come up with a number of options, including free trials, testimonials from other customers, branding or advertising. In this context, a free trial might not work. If LLMs are a credence good, then a free trial won't reveal the private information (and we would expect to see AI firms with low-quality LLMs also offering free trials). So, while free trials are costly (they come with an opportunity cost of foregone income for the AI firm), they don't appear to be costly in a way that AI firms with low-quality LLMs wouldn't want to attempt them.

Testimonials from other customers might be an option, but only if the LLM user can trust those other customers. So, testimonials from acknowledged experts in AI might be worthwhile, but testimonials from other non-expert users might not. Are testimonials costly to the firm? Probably not greatly, but they will be more costly for an AI firm with a low-quality LLM. They might have to pay for a testimonial, whereas an AI firm with a high-quality LLM might receive praise from an expert without payment. The problem here, though, is that a non-expert user may not be able to tell the 'experts' giving testimonials apart, and so may not trust any testimonial.

What about branding or advertising? These are costly to a firm, but it's unlikely that they are costly in a way that would prevent AI firms with low-quality LLMs from attempting them.

All of this is bad news for the LLM user. They can't tell high-quality LLMs and low-quality LLMs apart, they probably can't use screening to help tell them apart, and the AI firms with high-quality LLMs probably can't use signalling to reveal that their LLM is high quality. We're left in a situation where the LLM user just has to assume that any given LLM is low quality (the pooling equilibrium).

So, what's left? Davis suggests that:

Well-designed guardrails will improve technology and make us all better off. On this front, the government should accelerate law reform efforts to clarify existing rules and improve both transparency and accountability in the market.

Of course, this is intended as a solution to information asymmetry about AI safety, not a solution to the adverse selection problem related to AI quality. However, now that we've considered the market failing in relation to AI quality because quality is a credence characteristic, it might be worth considering: is AI safety also a credence characteristic?

If AI safety is a credence characteristic, then safety isn't revealed even after the LLM has been used. Then we end up in a similar situation for AI safety as we do for AI quality, in that there is little that users can do to separate the safe LLMs from the unsafe LLMs. We would have a AI safety pooling equilibrium, where all LLM users would have to treat LLMs as potentially unsafe. Since LLM users would not be willing to pay more for LLMs that are safe (since they couldn't be sure about safety), and because safety presumably costs AI firms more, the AI firms with safe LLMs will start to drop out of the market. That would leave only the unsafe (but regulated) LLMs available, which seems like a suboptimal outcome. This isn't an argument against AI safety regulation, but hopefully provides some food for thought about its possible consequences.

This week in research #39

Here's what caught my eye in research over the past week:

• Aina, Aktaş, and Casalone (open access) look at how the allocation of workload across university courses affects students’ outcomes, finding that reducing the number of courses in a degree, while keeping the total course work unchanged, strongly reduces students’ performance and increases first-year dropout rates, and that the effects are larger for students from less affluent families
• Omberg (with ungated earlier version here) finds that Uber’s arrival to a US city resulted in decline in the unemployment rate by between a fifth and a half of a percentage point
• Taylor and Livingston (open access) show that the minimum unit price for alcohol in Northern Territory implemented in 2018 impacted very few alcohol transactions, as it was set very low (AU$1.30 per 10g of alcohol)
• Huckle, Moewaka Barnes, and Romeo (open access) find that 17 percent of substantiated child maltreatment among Māori from 2000 to 2017 could be attributed to parental hazardous alcohol consumption
• Mikkelsen and Peter (open access) examine a Swedish parental leave reform in 1995 that reserved one month of leave for fathers, and find that the reform increases the probability of doing a maths-intensive programme in upper secondary education among girls whose father was otherwise reluctant to take leave, with no effect on boys

Te Papa Tongarewa embraces price discrimination, but other tourism operators are still missing the trick

Ten years ago, I asked whether tourism operators in New Zealand were missing a trick - why weren't they charging higher prices to tourists and lower prices to locals? In other words, why weren't these tourism operators employing price discrimination?

It may have taken ten years, but finally tourism operators are starting to see the light. As I noted last year, Hamilton Gardens' new fee structure is a form of price discrimination. Now, the national museum Te Papa Tongarewa is going to start charging a fee to foreign tourists (while remaining free for New Zealanders). As the New Zealand Herald reported last month:

Te Papa has announced it will start charging international visitors a $35 entry fee, citing the increased cost of energy, insurance and staffing.

The charge will apply from September 17 to people aged 16 and older. The national museum in Wellington will remain free for Kiwis.

Te Papa needs to raise $30 million annually to stay afloat, on top of the $44m it receives from the Government.

It’s hoped the new charge will raise several million dollars towards the museum’s portion which is currently met through existing partnerships, philanthropy donations, and commercial activities – as a conference venue - and from its cafes, retail stores and carpark.

Price discrimination occurs when a firm charges different prices to different customers for the same good or service, and where the price difference doesn't arise from a difference in costs. It costs Te Papa the same to provide the service to a New Zealander and to a foreign tourist. The difference in price (free vs. $35) is therefore price discrimination.

There are three conditions that must hold in order for price discrimination to be effective:

1. There must be different groups of customers (a group could be made up of one individual) who have different price elasticities of demand (different sensitivity to price changes);
2. The firm must be able to deduce which customers belong to which groups (so that they get charged the correct price); and
3. There must be no transfers between the groups (since you don't want the low-price group re-selling to the high-price group).

Those conditions are generally met in the case of tourist attractions such as Te Papa Tongarewa. Foreign tourists have low sensitivity to price (low price elasticity of demand) for two reasons. First, for a foreign tourist, there few substitutes to visiting Te Papa Tongarewa. In contrast, locals have plenty of other activities they can do rather than visiting the tourist attraction (there are many substitutes) Second, foreign tourists have usually also travelled a long way at great cost to get to New Zealand, so the cost of entry into Te Papa Tongarewa is pretty small in the overall cost of their holiday. For a local, any entry fee for Te Papa Tongarewa would entail a significant increase in the total cost of a visit (since the local doesn't have a high travel cost to get there, compared with a foreign tourist).

For both of those reasons, foreign tourists are relatively insensitive to changes in price compared with locals (foreign tourists have less elastic demand for visiting Te Papa Tongarewa). So, raising the price of entry isn't going to keep foreign tourists away in great numbers. However, raising the price for locals would have a much greater impact on the number of visits. Therefore, keeping the price low for locals, while charging a higher price for foreign tourists, is likely to increase profits for Te Papa Tongarewa.

All of this applies to other tourist operators as well. So, I remain surprised that there isn't a price differential for visits to Hobbiton, Waitomo Caves, or Whakarewarewa (to take just three relatively local examples). Tourist operators could even use price discrimination to paint themselves as friendly to locals. Who would argue against a 'large discount' for New Zealanders to visit iconic tourist attractions? They support the local community! Other than not using that framing, Te Papa Tongarewa has made the right choice. Other tourist operators are still missing this trick.

Read more:

• Are tourism operators in NZ missing a trick?
• Price discrimination in tourism... India edition
• Price discrimination and the Great Walks
• Hamilton Gardens' entry fee for tourists as a form of price discrimination

China's export restrictions on resources for semiconductors

The Financial Times reported last week (paywalled):

Chinese export controls on crucial semiconductor materials are hitting supply chains and stoking fears of shortfalls in western production of advanced chips and military optical hardware.

Beijing’s curbs on shipments of germanium and gallium, which are used for semiconductor applications and military and communications equipment components, have led to an almost twofold increase in the minerals’ prices in Europe over the past year.

China introduced the restrictions, which it says safeguard its “national security and interests”, last year in response to US-led controls on sales of advanced chips and chipmaking equipment.

The FT article focuses on the effect of the export controls on Europe. However, I want to look at the effect of the export controls (an export quota) on the prices of the resources (gallium and germanium) in China. However, let's start by considering why China is an exporter, and the gains from trade for China. This is demonstrated in the diagram below. China has a comparative advantage producing these resources. That means that China can produce gallium (or germanium) at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of gallium (PD) would be below the price of gallium on the world market (PW). Because the domestic price is lower than the world price, if China is open to trade there are opportunities for traders to buy gallium in the domestic market (at the price PD), and sell it on the world market (at the price PW) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW). In other words, there are incentives to export gallium. The domestic consumers would end up having to pay the price PW for gallium as well, since they would be competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW instead?). At this higher price, the domestic consumers choose to purchase Qd0 gallium, while the domestic suppliers sell Qs0 gallium (assuming that the world market could absorb any quantity of gallium that was produced). The difference (Qs0 - Qd0) is the quantity of gallium that is exported. Essentially the demand curve with exports follows the red line in the diagram.

In terms of economic welfare, if there was no international trade in gallium, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic gallium consumers) would be the area AEPD, the producer surplus (the gains to domestic gallium producers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade.

Now consider what would happen if there is an export quota limiting the quantity of gallium exports below (Qs0 - Qd0). This is shown in the diagram below. Let's say that the quantity of exports is reduced to the amount between B and G on the diagram (about half the amount of exports that were previously occurring). Now consider what happens to the demand curve (including exports). The upper part represents the domestic consumers with high willingness-to-pay for gallium. Then there is a limited quantity of exports that are allowed under the export quota, at the world price PW. After that, there are still profit opportunities for domestic suppliers (that is, there are still some domestic consumers who are willing to pay more than what it costs the suppliers to produce gallium). So, the demand curve (including the export quota) pivots at the point G, and follows a parallel path to the original demand curve (i.e. the demand curve including exports follows the red line in the diagram). The domestic price is the price where supply is equal to demand (P1). The domestic consumers choose to purchase Qd1 gallium at the price P1, while the domestic suppliers sell Qs1 gallium at that price. The difference (Qs1 - Qd1) is the quantity of exports of gallium.

Now consider the areas of economic welfare. The consumer surplus is larger than it was without the restricted exports (it is now the area AJP1), the producer surplus is smaller than it was without the restricted exports (it is now the area P1HF). There is a new area of welfare KLHJ, which is the profit that exporters of gallium would receive from exporting, because they can purchase the gallium at the price P1 domestically, and then sell it to the world market at the price PW. This area KLHJ is the licence-holder surplus. Total welfare is smaller than without the restricted exports (it is now the area AJHF+KLHJ). There is a deadweight loss (a loss of total welfare arising from the restricted exports) equal to the area [BKJ + LCH] - these areas were part of total welfare with trade and no restricted exports, but have now been lost. The reduction in exports makes domestic gallium suppliers worse off, as well as society overall (in terms of economic welfare in total). However, domestic gallium consumers benefit in terms of higher consumer surplus, and the export licence holders are a new group that gains from these restrictions.

Now, the model we used above relies on an assumption that Chinese decisions about gallium (or germanium) exports do not affect the world price. In fact, because China produces 98 percent of the world's gallium, and 60 percent of the world's germanium (according to the FT article), this is unlikely to be true. When China restricts exports through the quota, the world price will increase. That has the effect of increasing the surplus for the export licence holders, but otherwise doesn't affect domestic consumers or producers. However, it will make international consumers worse off, since they would now have to pay a higher price for gallium. And that's what the FT article shows. However, now we know that it isn't just the global consumers of these resources who are worse off, but Chinese mining companies, and Chinese society generally, as well.

Taylor Swift tickets and the endowment effect

The Wall Street Journal reported last month (paywalled, but see here for an alternative):

Taylor Swift ended the European leg of her Eras tour on Tuesday at London’s Wembley Stadium, delighting nearly 100,000 cheering “Swifties”—but leaving many who couldn’t snag a ticket disappointed. One reason: the failure of the secondary market in tickets. Swifties have the same mental biases as the rest of us, making them reluctant to sell even at eye-watering prices.

Markets work on the basis of supply and demand setting a price. If there is more demand than supply, the price rises until fewer people are willing to buy and more are willing to sell. The basic problem is that Swifties mostly aren’t willing to sell, so the price soars until demand is destroyed—hitting well over $1,000 for many tickets...

I have firsthand experience: My eldest offspring snagged tickets months ago to take my besequinned wife (but not me) to the latest Eras concert. By this week the tickets were changing hands at more than eight times face value, and both agreed they wouldn’t buy them at such a high price.

Given they wouldn’t buy at this price they ought to be, on traditional economic assumptions, willing sellers. But both dismissed the idea out of hand—and not merely because trading tickets is trickier than trading shares. There probably would be some ludicrous price at which they would have parted with the tickets, but even a quick profit of eight times their outlay in a matter of months wouldn’t do it.

The WSJ rightly offers up loss aversion and the endowment effect as explanations for this behaviour. Loss aversion is the idea that decision-makers value losses much more than otherwise-equivalent gains. The pain of giving something up is worth much more than the pleasure of gaining that same thing. One consequence of loss aversion is the endowment effect. Since giving something up makes people very unhappy (because they are loss averse), people prefer to hold onto the things that they already have. That means that, when a person owns something, like a Taylor Swift ticket, they have to be given much more to compensate them for giving it up than what they would have been willing to pay to get it in the first place.

This applies to lots of things, not just Taylor Swift tickets (although, honestly, Taylor Swift tickets was the exact example that I used in my ECONS102 class earlier this trimester). The original research example that described endowment effects, by Daniel Kahneman, Jack Knetsch, and Richard Thaler, used free coffee mugs to demonstrate the effect. People given a free coffee mug were generally unwilling to exchange it for a pen, and people given a free pen were generally unwilling to exchange it for a coffee mug.

Returning to concert tickets, tickets to the Oasis reunion tour sold out fairly quickly this week - I bet those who have those tickets also wouldn't be willing to give them up cheaply. A further interesting implication of the endowment effect arises in the case of Oasis tickets, since according to this tweet from the band's official X account:

Tickets can ONLY be resold, at face value, via @TicketmasterUK and @Twickets.

If the endowment effect applies, few ticket-holders will be willing to part with their tickets at face value. These secondary markets are unlikely to help many people who originally missed out to secure tickets. I guess we will see.

[HT: Cyril Morong at The Dangerous Economist, for the WSJ article]