Book review: Lives of the Laureates

During my travels in Europe, I managed to get through reading Lives of the Laureates, which includes autobiographical accounts written by Nobel Prize winners in economics. The source material is an ongoing lecture series hosted by Trinity University in Texas, who invite recent Nobel laureates from US institutions to reflect on their 'evolution as an economist'. The lectures are collected together in this volume.

The first edition of the book was published in 1985. I read the sixth edition, which was released in 2014. However, I note that a seventh edition was published last year. The difference between the editions is the selection of economists whose lectures are included. I was a little disappointed to find out that earlier editions included lectures by Arthur Lewis and Ronald Coase, among others. The seventh edition adds many more recent Nobel laureates, including Amartya Sen, Michael Spence, and Alvin Roth, as well as adding back in the earlier lectures that were missing from the sixth edition.

Each lecture is a standalone autobiographical account written by the laureate. However, each lecture is quite idiosyncratic, as each laureate takes a different approach to their task. Some present what is essentially an extended timeline of their research work, while others present a much more personal account. I much preferred the latter, for the additional insights into the people behind the Nobel Prizes. The lectures by Douglass North, James Heckman, and Thomas Schelling were particularly interesting to me. For instance, I learned that Schelling wrote a review of Peter Bryant's book Red Alert, which drew the attention of Stanley Kubrick and eventually became the movie Dr. Strangelove. I also got to learn a lot about the Nobel Prize winners that I didn't know much about before, including Lawrence Klein, Eric Maskin, and Peter Diamond.

There were also a number of interesting anecdotes, such as this from Franco Modigliani, about the research that introduced the now-famous Modigliani-Miller theorem:

This paper has since become quite well known, and it has been assignment to students in business and finance all over the world... this paper was never meant for students. The paper was meant to upset my colleagues in finance by arguing that the core issue that receive most attention in corporation finance, namely finding out what exactly is the optimum capital structure, was not really an issue. It didn't make any difference.

On a similar note, I hadn't appreciated just how negative the reaction to Gary Becker's work was from within economics, at least initially. For example:

The negative reaction to my work on discrimination, coupled with Frank Knight's hostility toward my article on democracy, made it clear to me that using economic analysis to discuss social and political issues was not going to be welcomed with open arms by most economists... I was surprised that the main hostility toward my work, at least as it was explicitly stated, came from economists, not non-economists.

Although the lectures are quite different, there are nevertheless some common themes, which the final chapter of the book attempts to draw together. One that stood out to me while reading was:

...the role of luck... The laureates often use the term "luck" to mean the unpredictability or unplanned path through which their career evolved. each can readily imagine some alternative turn taken early in life that would have set them on an altogether different path.

And finally:

One cannot come away from these lectures without an appreciated for the critical role of teachers, the intellectual environment, the search for rigor and relevance, and the role of happenstance in the evolution of modern economic thought.

I really enjoyed this book, and I recommend it to anyone who wants to learn a little bit more about the history of economic thought, from a variety of different perspectives to those found in traditional textbooks or more general books on the topic.

This week in research #90

This week I attended the European Regional Science Association (ERSA) conference in Athens. The ERSA conference is the largest regional science conference (surprisingly, larger than the RSAI International Conference), and this year had 930 attendees from over 50 countries. Not many would have travelled further than the small contingent of New Zealanders. However, as always, the conference was totally worth the long trip, and I've come away inspired and re-energised in my research. With such a large programme, it was impossible to attend all of the sessions that I wanted to. Nevertheless, here are some of the highlights I found from the conference:

• Nikolaos Terzidis (abstract on page 181 of the abstract book) showed that trade exposure has shifted voting patterns to the right (decreases in voting for radical left parties, and increases in voting for radical right parties) in Greece, with no apparent increase in polarisation
• Anna Lewczuk (abstract on page 540 of the abstract book) showed that exposure to the war in Ukraine (proxied by proximity to the Poland-Ukraine border) increased voting for Eurosceptic parties in Poland
• Pedro Fierro (working paper here) showed that bonding social capital (social capital within groups) was positively associated with Donald Trump's 'margin vote' in the 2020 Presidential election, while bridging social capital (social capital between groups) was negatively associated with the 'margin vote'
• In an interesting session organised by The Regional Science Academy, Nobel Prize winner Paul Krugman described the US as becoming "a hermit kingdom"
• Lukáš Makovský (abstract on page 304 of the abstract book) showed that higher house prices and construction constraints impede migration in England and Wales, and that the impacts are larger for lower-skilled households than for higher-skilled households (this research also has high relevance for New Zealand)
• Daniel Ruiz Palomo (abstract on page 411 of the abstract book) showed that Spanish municipalities that experienced a one-minute lower relative average travel time due to high-speed rail grew three percentage points more in population over a 30-year period (and I learned that Spain has the second largest high-speed rail network, behind only China)
• Jacques-François Thisse gave a wonderful and wide-ranging keynote lecture on the development of regional science and spatial economics (but was, in my view, a little unfair to economists, who hadn't totally ignored developments in regional science in the 1970s and 1980s)

Aside from the conference, here's what caught my eye in research over the past week:

• Allen and Webber (open access) test the 'wisdom of the crowd' by looking at predictions of final rank positions in the English Premier League, and find that experts and bookmakers outperformed a crowd of prediction game players
• Arrondel, Duhautois, and Laslier (with ungated earlier version here) develop a theoretical model that shows that football clubs that include not only profit but also sporting performance in their objectives end up generating more profit than others who purely maximise profit
• Hanedar, Göktan, and İnce (with ungated earlier version here) find that investors anticipated the outbreak of World War I, with bond prices following a continuously downward trend from 1911

Dame Peggy Koopman-Boyden, 1943-2025

I was really saddened to learn this week of the passing of Professor Dame Peggy Koopman-Boyden. Peggy was a long-term collaborator of mine, as I noted in this post from 2017, on the occasion of her being made a Dame Companion of the New Zealand Order of Merit.

As I noted in that 2017 post, Peggy and I may have collaborated a lot, going back to 2006, but we only published one research paper together - this 2015 working paper entitled "Labour Force Participation, Human Capital and Wellbeing among Older New Zealanders" (co-authored with Matthew Roskruge at Massey University). I won't reiterate my other comments from that 2017 post. However, in recent years, Peggy and I served together on the governance board of the Institute of Healthy Ageing, a collaboration between the University of Waikato, Health New Zealand, and other organisations.

Peggy made a number of contributions to the community as well as to academia. This Waikato Times article provides a great overview. Peggy continued to contribute widely until relatively recently, when poor health started to intervene.

I saw Peggy only a few times over the past couple of years. I'll most remember her for her ready smile, her keen intelligence and wisdom, and her frequent witty remarks. I'll miss those moments when she would ask what I had been working on, and then quip that I spent too much of my time on research that was unrelated to population ageing. It is somewhat fitting then, that the presentation I will be making at the European Regional Science Association conference tomorrow is on subnational population ageing (in Australia).

Peggy is a great loss to the New Zealand community. I am very surprised that, as yet, there are no obituaries of her online. She will be greatly missed.

This week in research #89

Here's what caught my eye in research over the past week (a slow week, while I've been travelling):

• Matthews (open access) interviews Anne Krueger (Johns Hopkins University, past president of the American Economic Association, and Chief Economist of the World Bank in the 1980s)
• Hassan et al. (open access) explore the use of text as data in economic analysis, with lots of examples and use cases

Tim Harford on unintended consequences

In the Financial Times last month, Tim Harford (who is always an interesting read) had a good piece on unintended consequences (paywalled, but available ungated on his website). It covers a number of examples of unintended consequences, including the (possibly apocryphal) 'cobra effect':

It describes an attempt by the British Raj to rid Delhi of its cobras by paying a bounty for each cobra skin, thus encouraging a thriving cobra-farming industry.

However, Harford devotes more attention to a more recent example that is definitely not an urban myth, where:

...the Straits Times and Climate Home News recently reported on a striking scheme in Melaka, Malaysia, where locals were selling cooking oil that would eventually be used to supply European producers of aviation fuel. The underlying idea of turning a waste product, used cooking oil, into something that can be blended into aviation fuel seems as appealing as getting the cobras out of Delhi. Cooking oil starts tasting bad after being used for frying three to five times, but as an input to aviation fuel, used oil is perfectly good.

At this point two intriguing forces intersect: European governments are demanding that airlines use more biofuels from sustainable sources — used cooking oil being one — while the Malaysian government subsidises cooking oil. This means that in Malaysia buying fresh oil is cheap and selling used oil is lucrative. If you run a food stall or restaurant in Malaysia, you can buy subsidised fresh oil, fry food a few times, then sell the waste oil at a profit. It’s a nice side-hustle.

The trouble is, writes financial journalist Matt Levine, “If you don’t run a restaurant, you can buy fresh cooking oil for $0.60, not use it to fry food any times, and then say, ‘Oh, yeah we totally used this oil,’ and sell it to a refiner for $1.” That seems a simpler and more scalable way to proceed. It certainly cuts out the precarious, time-consuming hassle of actually running a restaurant. It is hard to know how much fresh oil is being resold this way, but fraudsters have both the motive and the opportunity. Climate Home news notes that Malaysia collects an astonishing volume of “used” cooking oil: more per person than anywhere else, and two and a half times as much as second-placed Singapore.

You can real the original stories on this on the Straits Times and Climate Home News. Incentives matter, and it is incentives that can create unintended consequences. When a policy like this goes wrong, it is often a failure to consider the incentives.

However, just because the consequences are unintended, that doesn't mean that they need be unanticipated. Policies should be subjected to a careful consideration of the incentive effects that they create, and importantly, how entrepreneurial folks might try to game the policy. Software developers have a practice of 'red teaming' new software (like generative AI tools) to test whether they can be hacked or used for no good. Perhaps governments need to start red teaming policy?

This week in research #88

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

• Peña finds that older male Oscar nominees are more likely to win that younger nominees, while there is no effect of age among female nominees
• Elizalde and Kampanelis (open access) find a strong and positive relationship between pre-colonial institutions and contemporary economic development among Latin American countries
• Cummins (open access) uses the change in compulsory schooling in England in 1972 to investigate the effect of education on age at marriage and marital fertility, finding that an extra year of education at age 15 or 16 may have raised age at marriage, but had no causal effect on marital fertility
• Ackermann, Bradley, and Cameron (open access) find that digital piracy complements box-office revenue for “spectacle”-oriented films (where the value of the good is linked to in-theatre viewing), but that piracy displaces box office sales for “story”-oriented films (where the value is inherent, that is, unenhanced by in-theatre viewing)

Scott Sumner on the Lerner Symmetry Theorem

My ECONS102 class covered international trade this week (hence the flurry of posts on the theme of trade this week). One aspect that we briefly touch on is the Lerner Symmetry Theorem, named for the American-British economist Abba Lerner, which suggests that a tax (tariff) on imports is exactly equivalent to a tax on exports. As luck would have it, Scott Sumner posted yesterday on exactly that topic:

Fortunately, there is a way of making this deeply counterintuitive concept much more intuitive. You may recall from Econ101 that a tax has an identical impact regardless of whether it is legally placed on the seller or the buyer. If Congress writes a law imposing a 23-cent tax on gasoline, it makes no difference whether Congress specifies that the tax is to be paid by the retailer, or whether they specify that the tax is to be paid by the consumer. If you are confused by this distinction, think about the difference between gasoline taxes (paid by the retailer and incorporated into the sticker price) and sales taxes (paid by the consumer and not incorporated into the sticker price.) Either way, the result is the same.

Now imagine that international trade is actually, you know . . . trade. That is, imagine a system of barter. Countries give up valuable goods and in return receive other valuable goods from other countries. In that case, both a 10% import tariff and a 10% export tax are simply two methods of taxing international trade. They represent a 10% tax on the transaction of exchanging one good for another. It makes no difference whether the tax is formally imposed on the importer or the exporter, just as it makes no difference whether a gasoline tax is formally imposed on the seller or the buyer.

I have two other ways that I explain the Lerner Symmetry Theorem to my class. The first explanation comes from Henry Hazlitt's book Economics in One Lesson (which I reviewed here). This explanation goes like this: If a New Zealand exporter exports goods in exchange for foreign currency, then they end up with a handful of foreign currency. They can't spend that foreign currency in New Zealand. The only thing they can then do with that foreign currency is to buy goods overseas (now, or in the future, or trade the currency to someone else who will buy goods overseas now or in the future). If they buy goods, then they end of with a bunch of goods overseas, and in order to consume those goods they would need to import them. If they trade the currency for New Zealand dollars, then those New Zealand dollars must have come from someone overseas who had sold some goods to a New Zealander in exchange for New Zealand dollars (that is, imports). Either way, those earnings from exports get effectively spent on imports. Similarly, if a New Zealand importer buys goods overseas, then people overseas now have New Zealand dollars. The only thing they can then do with those New Zealand dollars is to buy New Zealand exports (now, or in the future, or trade the currency to someone else who will buy New Zealand exports now or in the future). If they buy New Zealand goods, then they end of with a bunch of goods in New Zealand, and in order to consume those goods they would need to export them. If they trade the New Zealand dollars for foreign currency, then that foreign currency must have come from someone in New Zealand who had sold some goods to a foreigner in exchange for foreign currency (that is, exports). Either way, those earnings from New Zealand imports get effectively spent on New Zealand exports.

The second explanation comes from this post last year by Kimberley Clausing and Maurice Obstfeld (both from the Peterson Institute for International Economics). The explanation goes like this: If a trade barrier makes imported goods more expensive, domestic firms in that industry will produce more. Those firms demand more labour, making labour more expensive in that industry, but also in other industries, including export industries. More expensive labour therefore raises the costs of production in export industries, which decreases supply and the quantity of exports.

So there you have it. There are several ways that we can explain intuitively how the Lerner Symmetry Theorem could hold - by noting the equivalence with a domestic excise tax, by explaining what happens with the currency, or by thinking about what happens in the labour market.

Sumner's post explains the Lerner Symmetry Theorem in a bit more detail, and I did appreciate the shout-out to the robustness of the demand and supply model to a violation of the strict assumptions of perfect competition (which is a point that I make in my other class, ECONS101).

[HT: Marginal Revolution]

Sorry US tomato growers, consumers will be worse off from of the anti-dumping duty on Mexican tomatoes

The Financial Times reported last week (paywalled):

In July, President Donald Trump sided with Florida farmers, imposing a 17 per cent anti-dumping duty on Mexican tomatoes and accusing producers of selling at less than the cost of production. US growers see the levy, which took effect in July and is separate from broader trade tariff negotiations, as a lifeline for their declining industry...

Mexico supplies more than 60 per cent of the fresh tomatoes consumed in the US, a stark example of how the country has won market share across sectors to become the US’s top trading partner since the North American Free Trade Agreement came into effect in 1994.

That has also made it a prime target for Trump since his first presidential campaign. The duty is part of a glut of allegations of trade violations he has thrown at Mexico, alongside broader pressure on security and migration.

The tomato duty, which uses a different legal instrument to regular tariffs, is the first Trump trade levy to directly target a fresh food staple...

Price data has not been released for the period after the new duties were imposed. US growers say farm-level prices could rise, which would eat into retailers’ and distributors’ profits but would not necessarily affect regular Americans. But Mexico’s National Agricultural Council said the consumer would pay, predicting prices would go up 11.5 per cent.

Gándara said if US companies want to produce more, it would require large investments in expensive land and technology, which inevitably would lead to higher prices.

The US growers are not correct here. Regular Americans will be paying more as a result of this anti-dumping duty (which has the same effect as a tariff). This is shown in the diagram below, which shows the American market for tomatoes. With no international trade in tomatoes at all, the market would operate at equilibrium, with a price of P0, and Q0 tomatoes would be traded. However, the domestic price of tomatoes (P0) is higher than the world price (PW). This means that the US has a comparative disadvantage in producing tomatoes. In other words, other countries can produce tomatoes at lower cost (specifically, lower opportunity cost) than the US. One of those countries with a comparative advantage in producing tomatoes is Mexico. If the US allows international trade in tomatoes, US consumers will realise that they can buy tomatoes much cheaper from Mexico than from domestic US tomato growers. The price for tomatoes in the US market will drop to be equal to the world price PW. At this lower price, US consumers will buy more tomatoes (QD0). However, US tomato growers will only be willing to supply QS0 tomatoes at this lower price. The difference between QD0 and QS0 is satisfied by imports of tomatoes.

Now consider what happens if an anti-dumping duty (or a tariff) is imposed. If consumers want to buy tomatoes from the international market, they must now pay the world price PW plus the tariff. The price for tomatoes in the US market will increase to PW+T (where T is the per-unit size of the anti-dumping duty). At this higher price, US consumers will buy less tomatoes than without the tariff (QD1), but US tomato growers will be willing to supply more (QS1). The quantity of tomato imports decreases to the difference between QD1 and QS1. This was the purpose of the anti-dumping duty, of course - to keep a lot of Mexican tomatoes out of the US market.

However, who pays the cost of the tariff? We can work this out by thinking about the areas of economic welfare. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, at the equilibrium price and quantity (without trade), consumer surplus is the area AEP0. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, at the equilibrium price and quantity, consumer surplus is the area P0ED. Total welfare is the sum of the two areas (consumer surplus and producer surplus), and is equal to the area AED.

With international trade (but no import tariff), the consumer surplus increases to the area AFPW. Producer surplus decreases to the area PWGD. Total welfare is the combined area AFGD. Notice that US tomato consumers are better off with trade, but US tomato growers are worse off. As a whole, US society is better off, because total welfare is larger (by the area EFG - this is a measure of the gains from trade).

Now consider what happens when the anti-dumping duty is applied. Consumer surplus decreases to the area ABK. Producer surplus increases to the area KCD. The government gains tariff revenue equal to the area CBJH (this is the per-unit amount of the anti-dumping duty, multiplied by the quantity of imports subject to the duty). Total welfare is all three of these areas added together, which is the area ABCD+CBJH. In other words, the anti-dumping duty makes US tomato growers better off (higher producer surplus), and makes the government better off (due to the duty revenue). However, the import tariff makes US tomato consumers worse off (lower consumer surplus), and US society as a whole worse off (lower total welfare). The loss of total welfare is equal to the areas BFJ+CHG - this is the deadweight loss of the import tariff.

So, it turns out that US consumers do end up paying part of the anti-dumping duty. They pay a higher price (PW+T instead of PW), and they lose some consumer surplus (their consumer surplus is smaller by the area KBFPW). US tomato growers may want to claim that tomato consumers will not be made worse off by the anti-dumping duty, but the growers are clearly not right about that.

International trade and the domestic price of butter in New Zealand

If you're in New Zealand, you probably couldn't avoid the news over the last six months about the price of butter. In case you missed it though, this New Zealand Herald article from January explains:

The price of butter has topped $9 for a 500g block in some shops and one analyst is warning prices could stay high for months due to global butter supply shortages...

A spokesperson for New World and Pak’nSave operator Foodstuffs said any change in supplier pricing had a direct impact on the price for customers.

“The price of butter on our shelves is primarily influenced by the broader dairy market and the wholesale costs set by our suppliers,” the spokesperson said.

“Over the past 18 months, global butter commodity costs have risen by around 43%...

ANZ agricultural economist Susan Kilsby said butter prices had lifted by 24% over the past year in the global markets.

“Demand for cream [which is used to make butter] does tend to peak over the Christmas holiday period which tightens supply available for butter,” Kilsby said.

“Butter has been in short supply in some parts of the world, as dairy production is relatively stagnant in many markets, whilst demand continues to lift.”

Unfortunately for Kiwi consumers, Kilsby expected butter prices to stay relatively high for the next three to six months.

Let's unpack what's going on with the price of butter. First, let's consider the impact of international trade. This is shown in the diagram below. New Zealand is an exporting country, which means that New Zealand has a comparative advantage producing butter (and other dairy products). That means that New Zealand can produce butter 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 butter (PD) would be below the price of butter on the world market (PW0). Because the domestic price is lower than the world price, if New Zealand is open to trade there are opportunities for traders to buy butter in the domestic market (at the price PD), and sell it on the world market (at the price PW0) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW0). In other words, there are incentives to export butter. The rest of the world is willing to buy as much butter as we are willing to supply. [*] So, the demand curve in the domestic market for butter becomes D+exports (the red line in the diagram). The price in the domestic market is determined by the intersection of that demand curve and the supply curve, which is the price PW0. The domestic consumers end up having to pay the price PW0 for butter, since they are competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW0 instead?). At this higher price, the domestic consumers choose to purchase Qd0 butter, while the domestic dairy farmers sell Qs0 butter (assuming that the world market could absorb any quantity of butter that was produced). The difference (Qs0 - Qd0) is the quantity of butter that is exported.

In terms of economic welfare, if there was no international trade in butter, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic timber consumers) would be the area AEPD, the producer surplus (the gains to domestic dairy farmers) 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. So to summarise, exporting butter makes domestic butter consumers worse off (lower consumer surplus), domestic dairy farmers better off (higher producer surplus), and society overall better off (higher total welfare).

Now consider how the increase in worldwide demand for butter (as noted in the article) affects the world market for butter, as shown in the diagram below. World demand has increased from DW0 to DW1, and that increases the equilibrium world price from PW to PW1.

Now, let's go back to the New Zealand domestic market for butter. The world price has increased from PW to PW1, as shown in the diagram below, and demand including trade has moved up from D+exports to D+exports1. Now, the domestic consumers have to pay the higher price PW1 for butter, since they are still competing with the world price (and the world price is now higher). At this higher world price, the domestic consumers now choose to purchase Qd1 butter, while the domestic dairy farmers now sell Qs1 butter (still assuming that the world market could absorb any quantity of butter that was produced). The quantity of exports is now (Qs1 - Qd1). That means that more butter is now being exported.

What does that mean for economic welfare? With the higher world price, the consumer surplus decreases further to AGPW1, the producer surplus increases further to PW1HF, and total welfare increases further to AGHF. In other words, the increase in the world price of butter makes domestic consumers worse off, but it makes domestic dairy farmers better off, and society overall better off.

While we might like dairy farmers to sell us butter at a lower price than they can receive from the world market, there is little incentive for them to do so. New Zealand butter consumers must pay the world price of butter. The world price has increased, so the domestic price of butter must increase as well. That higher butter price makes dairy farmers (and society overall) much better off. However, that will come as cold comfort to households that must pay a small fortune to butter their toast.

*****

[*] This assumes that the domestic market for butter in New Zealand is a small proportion of the total world market, such that domestic supply and demand do not affect the world price. For butter, that is unlikely to be true, as New Zealand exports a substantial proportion of global butter supply. However, for the purposes of this analysis, it doesn't have a big impact since we are not considering changes in domestic market conditions.

Price discrimination (or not) at Parisian restaurants

The Telegraph reported last month (paywalled, but you can read it free from the New Zealand Herald):

Hapless tourists in Paris are being charged as much as 50% more than French customers, the city’s leading newspaper found.

After tourists complained online about being overcharged, Le Parisien sent out a bona fide Parisian to a cafe on the Champ-de-Mars near the Eiffel Tower.

It also dressed up one of its reporters as a typical tourist, sporting a T-shirt emblazoned with the tower, trainers, dark glasses and a baseball cap, and speaking in a passable American accent – albeit with a French twang.

They both sat down at the unnamed eatery and ordered the same dish – lasagne – and drinks, a Coke and water, and discreetly filmed themselves doing so.

The clearly French customer was served a can of Coke for €6.50 ($12.65) and offered a carafe of water with his dish. Meanwhile, the “American” was not offered a small can, only a medium or large Coke. When it arrived, it was half a litre and cost €9.50 ($18.50).

As for the water, the “American” received no offer of a carafe, which is free, instead having to fork out a further €6 ($11.60) for a small bottle of Vittel...

The Telegraph spoke to Joseph, a 21-year-old waiter who confirmed that some of the techniques were widespread.

“In one restaurant I worked I was instructed to bring spring water at €7 ($13.60) a bottle unless foreign customers specifically asked for a carafe,” he said.

This sounds a lot like price discrimination, which occurs when a firm charges different prices to different groups of consumers for the same good or service (and where the difference in prices does not arise from a difference in cost). Price discrimination comes in three forms: (1) first-degree price discrimination (or personalised pricing), which involves setting a different price for every consumer; (2) second-degree price discrimination, which involves the consumer paying a declining price for each additional unit that is purchased; and (3) third-degree price discrimination (or group pricing), which involves setting different prices for known groups of consumers.

As I noted in yesterday's post, one form of third-degree is menu pricing. Menu pricing is where the firm offers the consumer different options (that the firm knows appeal to consumers with different elasticities), and consumers select their preferred option. On the menu, items that the firm knows will appeal to consumers with less elastic demand (consumers who are less sensitive to price) are priced with a higher markup (over marginal cost) than items that the firm knows will appeal to consumers will more elastic demand (consumers who are more sensitive to price).

In the case of Parisian restaurants, tourists tend to have less elastic demand for meals and drinks than locals. There are several reasons that we could use to argue this. First, tourists have likely travelled a long way, at considerable cost, to visit Paris. The price of a meal (or some water) at a Parisian restaurant is a very small proportion of the total cost of their holiday. When price is a small proportion of the total cost, demand tends to be less elastic. Second, tourists may have higher income than locals. That means that the price of a meal (or some water) will take up a lower proportion of a tourist's income than a local's, making demand from tourists less elastic. Third, tourists may not know the area well, and are less aware of substitutes (other nearby restaurants), although Google Maps, TripAdvisor and other apps have reduced the impact of this factor. When a good has fewer substitutes, it has less elastic demand. For any or all of these reasons, we may expect tourists to have less elastic demand, and firms that price discriminate would charge them a higher markup (and a higher price).

Now, the Parisian restaurants aren't practicing menu pricing as typically described, because they are essentially removing options from the menu that tourists get to see. The locals, with more elastic demand, are offered cheaper options than the tourists, with less elastic demand. The tourists are generally unaware that there are other options available that would be cheaper (like a carafe of water).

This reminded me of my several trips to Thailand (first during my PhD, and then subsequently), where tourists tend to pay higher prices for visiting various attractions than locals do (a point I mentioned in this 2014 post). The tourist attractions in Thailand hide this fact from the tourists by putting the price for locals in Thai script, so that only those who can read Thai know that the cheaper option exists. Now, the Parisian restaurants have made me wonder about various times in Thailand and China and elsewhere, where I've visited restaurants and received a menu in English (sometimes poorly translated). It's likely that the prices on the English menu are far higher than on the menu in the local language.

All of this suggests that, when we are tourists, we should be a bit savvier about our buying behaviour. The best option is to have local friends who can identify the opportunities for saving, although this won't apply to 'friends' of the type that hang out outside airports or hotels and offer to be a guide. At restaurants or attractions, ask a generative AI app to translate a photo of the local menu or price board, rather than simply accepting the English version. At the very least, we should observe what the locals are ordering and do the same (probably this is good advice generally). Price discrimination is pervasive. That doesn't mean that as tourists we need to just accept it.

Delta Air Lines moves from group pricing to personalised pricing

In my ECONS101 class last week, we covered price discrimination: where a firm charges different prices to different groups of consumers for the same good or service (and where the difference in prices does not arise from a difference in cost). Price discrimination comes in three forms: (1) first-degree price discrimination (or personalised pricing), which involves setting a different price for every consumer; (2) second-degree price discrimination, which involves the consumer paying a declining price for each additional unit that is purchased; and (3) third-degree price discrimination (or group pricing), which involves setting different prices for known groups of consumers.

Airlines typically engage in price discrimination (as I discussed here), in the form of group pricing. Specifically, they engage in a type of group pricing known as menu pricing. As I noted in this post:

Airlines don't quite have a menu. However, they do offer a range of options to consumers. Some consumers will buy a ticket close to the date of the flight, while others buy far in advance. That is information the airline can use. If you are buying close to the date of the flight, the airline can assume that you really want to go to that destination on that date, and that few alternatives will satisfy you (maybe you really need to go to Canberra for a meeting that day, or to Christchurch for your aunt's funeral). Your demand will be relatively inelastic, so the airline can increase the mark-up on the ticket price. In contrast, if you buy a long time in advance, you probably have more choice over where you are going, and when. Your demand will be relatively elastic, so the airline will lower the mark-up on the ticket price. This intertemporal price discrimination is why airline ticket prices are low if you buy far in advance.

Similarly, if you buy a return ticket that stretches over a weekend, or a flight that leaves at 10am rather than 6:30am, you are more likely to be a leisure traveller (relatively more elastic demand) than a business traveller (relatively more inelastic demand), and will probably pay a lower price. 

Menu pricing is an imperfect form of price discrimination. The ultimate form of price discrimination would be for a firm to sell to every consumer for exactly the maximum that they are willing to pay. This is a perfect form of personalised pricing (first-degree price discrimination). However, this is difficult for firms to achieve in practice, as consumers don't typically volunteer information on how much they are willing to pay. Nevertheless, firms would still really like to do this, and so estimating consumers' willingness-to-pay is important to firms. If they can achieve that, then the next step is to charge every consumer a different price.

And that brings me to this article in The Verge last month:

Delta Air Lines is leaning into dynamic ticket pricing that uses artificial intelligence to individually determine the highest fee you’d willingly pay for flights, according to comments Fortune spotted in the company’s latest earnings call. Following a limited test of the technology last year, Delta is planning to shift away from static ticket prices entirely after seeing “amazingly favorable” results.

“We will have a price that’s available on that flight, on that time, to you, the individual,” Delta president Glen Hauenstein told investors in November, having started to test the technology on 1 percent of its ticket prices. Delta currently uses AI to influence 3 percent of its ticket prices, according to last week’s earnings call, and is aiming to increase that to 20 percent by the end of this year. “We’re in a heavy testing phase,” said Hauenstein. “We like what we see. We like it a lot, and we’re continuing to roll it out.”

Obviously, Delta thinks that it has enough information about its customers to make this work. It was inevitable that firms would eventually start using artificial intelligence and machine learning to estimate the maximum willingness-to-pay for each of their consumers. This is likely to be just the beginning of a wider trend, given the potential for greater profits for firms. As I note in my ECONS101 class, there is no possible pricing strategy that could be more profitable than perfect personalised pricing. Delta's approach probably isn't perfect, but it is likely to be more profitable than the regular airline group pricing strategy.

[HT: Marginal Revolution]

Read more:

• Price discrimination and airline tickets

This week in research #87

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

• Núñez et al. (open access) perform a meta-analysis based on 1595 estimates (from 223 studies) of the price semi-elasticity of wine quality ratings, and find a price elasticity of 0.05-0.06, and that quality ratings are more influential in the context of red wines, and less important in the case of sparkling and organic wines
• Tripodi et al. (open access) analyse data from over 12,000 researchers across 15 disciplines in the US, and find that publication rates typically increase sharply during the tenure track and peak just before obtaining tenure, although academics increasingly produce novel, high-risk research after securing tenure, but that research has less impact, with post-tenure research yielding fewer highly cited papers

Even if they are provided by local government, not all of the 'three waters' are public goods

This week, among other things, my ECONS102 class covered public goods. Public goods are goods that are non-rival (where one person using the good doesn’t reduce the amount of the good that is available for everyone else) and non-excludable (where the good is available to everyone if it is available to anyone). Just because a good or service is provided by the government, or you think it should be provided by the government, that doesn't make that good or service a public good. To be a public good, it must be both non-rival and non-excludable.

Which brings me to this article from the New Zealand Herald from earlier this year, about water services in Gisborne:

An overwhelming 90% of Gisborne submitters are in favour of keeping the region’s water services in council hands, with ring-fenced funding and targeted rates...

Previous Mayor Meng Foon was among those who submitted, writing in his submission, “water is a public good” and it should stay in public hands to prevent exploitation.

In general, water is not a public good (as I have noted before, here and here). However, the context here is a little different from the context in those posts, because the 'water' that is being referred to in the article is actually three different water services that are often bundled together and provided by local councils: (1) water supply; (2) wastewater; and (3) stormwater. That is the 'three waters' that had many people losing their minds under the previous Labour government.

Now, as much as Meng Foon may wish it to be so, the three waters are not all public goods. To see why, let's consider each of them in turn.

First, water supply is not a public good. It is a rival good, because one household (or other user) using water from the municipal water supply leaves less water for everyone else. Water supply is also an excludable good, because the consumption of water can be separated into the consumption by Household A, the consumption by Household B, the consumption by Household C, and so on. That means that it is feasible to exclude any of those households from access to the water supply. The council simply turns off the tap that runs to their house. So, water supply is a good that is both rival and excludable. By definition, that makes water supply a private good, not a public good.

Second, and in contrast to water supply, wastewater is probably a public good. Unless the wastewater system is at capacity, it will be a non-rival good, since one household flushing a toilet won't stop other households from doing so (if the wastewater system is at capacity though, then wastewater might be a rival good). Wastewater is also a non-excludable good because, unlike water supply, there is no tap to turn off to exclude a household from the wastewater system (as far as I am aware). If the wastewater system is available to anyone, it is available to everyone. So, unless the wastewater system is at capacity, [*] wastewater is non-rival and non-excludable. Wastewater is a public good.

Third, stormwater is almost certainly a public good. It is non-rival, since one household benefiting from the stormwater system doesn't prevent other households from benefiting from it as well. And it is non-excludable, because if it is available to anyone, it is available to everyone. Stormwater is non-rival and non-excludable. Stormwater is a public good.

I guess that makes Foon two-thirds correct, if we can agree that wastewater and stormwater are public goods. Water supply is clearly a private good though.

Now, even though water supply is a private good, rather than a public good, that by itself doesn't mean that it shouldn't be provided by the government. The government provides many goods and services that don't meet the definition of a public good, including healthcare and education.

The question of whether a good or service should be provided by the government is necessarily normative, and your preferred answer likely depends on your ideological position. However, as noted in my ECONS102 class, there are a number of principles that apply when deciding whether a particular good or service should be provided by the government or by the private sector. One of those principles is that the government can almost always raise large amounts of money more cheaply than the private sector. That's because governments are low-risk borrowers, so tend to pay lower interest rates than private sector borrowers. This is likely to be somewhat less true of local government than it is of central government, but nevertheless the point is valid. Foon clearly understands this point:

At the hearings, Foon spoke on his submission, supporting the council’s recommended option to retain water services under council control...

“Even though it’s a CCO, your private organisation cannot borrow money as cheaply as the council.”

This is quite relevant, because water services are very costly to establish and so the initial establishment of the infrastructure for water services is likely to be funded by borrowing. To minimise the cost of that borrowing, you want to borrow at the lowest possible interest rate, and governments can better achieve that than the private sector.

However, this particular argument in Gisborne might actually be missing the point somewhat. The argument discussed in the article was about whether to have a council-controlled organisation (CCO) run water services in Gisborne, like Watercare Services does in Auckland. A CCO is not a privatisation at all, since the CCO is fully owned and controlled by the local government. It may make operational decisions at arms-length from the local government, but that doesn't make it wholly a private sector entity. And even if water services are provided by local government, whether directly or through a CCO, that doesn't make all water services public goods.

*****

[*] If wastewater is rival and non-excludable, that makes wastewater a common resource.

Why the accommodation supplement does little to help low-income tenants

In an article in The Conversation earlier this year, Edward Yiu and William Cheung (both University of Auckland) discuss New Zealand's accommodation supplement for low-income renters:

New Zealand’s unaffordable housing market has left many low and middle-income families reliant on the accommodation supplement to cover rent and mortgage payments.

But our new research has found the scheme, which costs the government almost NZ$2 billion a year, might not be an effective tool in addressing the country’s housing affordability crisis.

Introduced in 1993, the accommodation supplement is a weekly, means-tested payment designed to subsidise part of a household’s rent or mortgage. The supplement is calculated using the actual rent or mortgage payments a client is paying.

But our study looking at data from Auckland between 2019 and 2023 found accommodation supplement rental subsidies were not delivering meaningful improvements in affordability for renters.

That the accommodation supplement doesn't deliver improvements in affordability for renters is consistent with a simple model of the market for rental housing, as shown in the diagram below. This is the stylised version of this market that I use in my ECONS102 class, and is based on the rental market for land. In this market, the supply curve is very inelastic (very steep), and starts at a positive quantity (meaning that if rent falls to zero, there is still a positive quantity of land that is made available to rent). That's because of two reasons. First, this market includes owner-occupiers. They would rent land to themselves, even if the rent falls to zero (that explains the positive quantity when the rent is zero). Second, the quantity of land supplied doesn't respond very much to the rent - landlords can't suddenly make more land available - as Mark Twain once noted: "The thing about land is, they aren't making it anymore". Twain isn't quite correct, as land can be reclaimed from the ocean. However, landlords are unlikely to be very responsive to changes in rent, making the supply curve very inelastic.

Now, consider this market operating at equilibrium (with no accommodation supplement). The market operates at the point where supply meets demand, at a rent of R0, with Q0 housing (technically, land) rented. The accommodation supplement acts as a subsidy, paid to the tenants. We show this on the diagram with a new curve, D+subsidy, which lies above the demand curve D. It acts like an increase in the demand for rental accommodation. The price that landlords receive for housing increases to RL. That is the rent that tenants pay to the landlords. However, once the accommodation supplement is subtracted, the effective rent paid by the tenants decreases to RT (the difference between RL and RT is the amount of the accommodation supplement).

But notice the difference in the rents with the accommodation supplement to the equilibrium rent. The rent that landlords receive increases by a lot (from R0 to RL). The effective rent paid by tenants is barely affected (decreasing from R0 to RT). Landlords benefit the most from the accommodation supplement, with tenants barely benefiting at all. That is because the side of the market (supply or demand) that is more inelastic will always capture most of the gains from a subsidy. In this case, the supply is very inelastic (and certainly more inelastic than demand), so landlords stand to gain most from the subsidy.

It gets worse though. The increase in rents that landlords receive also affects rents paid by tenants who don't receive the accommodation supplement at all. These higher-income tenants pay higher rents as well, because they have to compete with the subsidised tenants for housing. However, the government doesn't provide them with any subsidy, making them clearly worse off as a result.

So, it should be no surprise that the accommodation supplement does not deliver meaningful improvements in affordability for renters. It barely has any effect on the effective rent paid by tenants who receive the accommodation supplement, and raises the rents paid by tenants who don't receive the accommodation supplement.

Are there better options? Yiu and Cheung suggest that:

...mortgage support seems to level the playing field more effectively than rental assistance.

Possibly. If a mortgage subsidy allows some low-income tenants to become owner-occupiers instead, then they will benefit greatly (from capital gains, as well as many other benefits associated with home ownership). If the mortgage subsidy is given to landlords as well, it might help to lower rents. Overall, it could well be more effective than the current accommodation supplement paid to tenants. It is certainly something worth further exploration.

This tax lawyer doesn't understand the deadweight loss of taxes

A regular reader shared with me this 2023 blog post by Tax Policy Associates (in the UK), arguing against removing VAT (Value Added Tax, the equivalent of New Zealand's GST) from sunscreen (and some other goods). The post notes that:

There are currently high-profile campaigns to scrap VAT on sunscreen, and scrap VAT on public electric vehicle (EV) charging. The proposals would waste public money, and fail to achieve their objectives.

The post then goes on to argue against the campaigns, but gets two things very wrong. Here's the first:

There’s a common intuition that a reduction in a producer’s cost (like VAT) will result in the producer lowering its prices. After all – the argument goes – the price of a product is made up of the cost of production plus a profit markup. So if the cost drops, the price will drop. And VAT is a cost, so if we reduce VAT, the price will drop...

But that’s wrong. In a market economy, economic actors charge what the market will bear.

The post uses some data on price changes over a four-year period before and after VAT was removed from e-books and tampons, and shows that the prices of those products did not fall. However, that is not a careful analysis, because it fails to account for all of the other things that might have caused prices to change. Comparing to other products where a VAT reduction didn't happen (which the write did) might be valid, but you would need to be sure that there weren't other factors at play (which the writer doesn't).

We should expect that removing an excise tax reduces the price of a product. To see why, consider the supply and demand model below. If there is no VAT, then the market would operate in equilibrium, with a price of P0 and a quantity of sunscreen traded of Q0. However, VAT, which is paid by the seller, effectively increases the sellers' costs. We represent this with a new curve, S+tax. VAT is an ad valorem tax, which means that the amount of the tax is a proportion of the price of the good. So, the S+tax curve starts off close to the supply curve, and gets progressively further away as the price of the good increases. With VAT in place, the price that consumers pay for sunscreen increases to PC. The producer receives that price from the consumer, and then passes the VAT onto the government, leaving the producer with an effective price of PP (the difference between PC and PP is the amount of VAT per unit sold). With the higher price including VAT, the consumers demand less food (QT), and with the lower effective price after paying VAT, the sellers supply less food (also QT). There is no excess supply or excess demand. Now, removing VAT moves the market from a price of PC for consumers to the equilibrium price of P0 - consumers end up paying a lower price and buying more (Q0 instead of QT). So, it is correct (at least, based on this model), that removing VAT would cause a decrease in consumer prices for sunscreen. The only time that would not be true would be if the demand curve was horizontal (perfectly elastic) - then the quantity would change, but the price would not.

Now, here's the second thing that the Tax Policy Associates post gets wrong:

The UK sunscreen market is worth £169m, implying that a VAT cut would cost about £30m.

Imagine if we could use that £30m to put high SPF sunscreen directly in the hands of the people that should use it, but don’t, and then persuade them to use it. That would be perfectly efficient, with zero “deadweight cost”. Of course real world programme to provide free sunscreen wouldn’t be perfectly efficient, and there would be material deadweight costs as we hand free suncreen [sic] to people that would have bought it anyway. However we would certainly not expect a deadweight cost of £30m.

The deadweight costs of a VAT cut are much more serious. First, a big chunk of the £30m will be kept by retailers, and not passed to consumers – on the basis of the evidence above, that’s probably most of the £30m; approaching a 100% deadweight cost right away. Even if we imagine that somehow all the benefit went to consumers, there would be an immediate £30m deadweight cost as we give a VAT cut to people who were buying sunscreen already. Only when we attract new purchasers are we incurring a non-deadweight cost, and this will almost inevitably be a small fraction of the overall cost of the VAT cut.

There is a really fundamental misunderstanding of deadweight loss here. To see why, consider what they are really saying: removing the VAT on sunscreen makes society worse off. So, applying that logic, increasing the VAT on sunscreen must make society better off, unless the current level of VAT is some magical level that maximises welfare. So, why aren't they arguing for higher VAT? It's because their argument doesn't make sense.

To see why they are wrong, consider again the diagram from earlier, and consider the areas of economic welfare. Consumer surplus is the difference between the amount that consumers are willing to pay (shown by the demand curve), and the amount they actually pay (the price). In the diagram, with VAT in place, consumer surplus is the area ABPC. Producer surplus is the difference between the amount the sellers receive (the price), and their costs (shown by the supply curve). In the diagram, with VAT in place, producer surplus is the area PPCF. The VAT that is collected by the government, which is the per-unit amount of VAT, multiplied by the quantity of food sold) is equal to the area PCBCPP. Total welfare is the sum of the three areas (consumer surplus, producer surplus, and government revenue), and is equal to the area ABCF.

When VAT is removed, consumer surplus increases to the area AEP0, producer surplus increases to the area P0EF, and total welfare increases to the area AEF. Overall society gains total welfare equal to the area BEC, which was the deadweight loss of VAT. In other words, removing the VAT increases total welfare, and decreases the deadweight loss. There is a deadweight gain from removing the VAT. Tax Policy Associates gets this argument completely backwards.

Now, they argue that it is a bad thing that some of the gain goes to the producers. But gains to producers are part of total welfare for good reason. Producers are people too (or, rather, their owners or shareholders are people). Those gains accrue to people, even if not directly. You may not like it, but that doesn't make it wrong. [*]

There are good ways to argue against exempting particular products from VAT (or GST). The best arguments relate to the inefficiencies that would be created in the tax system generally (for example, see here). Lowering taxes does increase total welfare (within that market), but may have other social costs, and that needs to be taken into account.

Lowering an excise tax will almost certainly affect the good's price, and will not increase the deadweight loss (but will instead decrease the deadweight loss). Tax Policy Associates probably has the conclusion correct, but their arguments in support of the conclusion are wrong.

[HT: Huw Davies]

*****

[*] There is at least some consistency in these wrong arguments though. As I noted, if demand is perfectly elastic (horizontal), then there would be no price change from removing the tax. The gain in total welfare would also accrue only to the producers (because there would be no consumer surplus at all with a perfectly elastic demand curve). However, it isn't clear that this is what Tax Policy Associates is arguing. Is demand for sunscreen perfectly elastic? It seems unlikely - the estimates on this site suggest that demand is quite inelastic.

Read more:

• Judge rules that snuggies are blankets, not clothes
• Stephen Hickson on why we shouldn't remove GST from food
• We also shouldn't be debating removing GST from food
• Flapjacks, jaffa cakes, and the quiet simplicity of GST
• Strawberry and cream sandwiches are the new jaffa cakes
• Popcorn (taxed) three ways

Popcorn (taxed) three ways

Popcorn three ways sounds like a weirdly contrived dish at a pretentious restaurant. Instead, it is the way that India taxes popcorn. As the Wall Street Journal reported back in January (paywalled, but you can access an ungated version here):

A seemingly routine ruling by India’s top tax officials went off like metal in a microwave. 

The government laid out a three-tiered system for taxing popcorn depending on if it is packaged or sold loose, carries a brand name or is generic, and is salted or sweet. Caramel popcorn, the government said in December, would be taxed at 18%—nearly akin to a luxury product.

The people weren’t pleased. An explanation from India’s finance minister, chair of the tax council, didn’t help.

“I want to explain the whole background of the popcorn taxes to you: Salted popcorn, caramelized popcorn, plain popcorn,” said Nirmala Sitharaman at a news conference in late December. “When it comes to popcorn’s tax treatment, as long as it is salty, whether it is with salt, spiced, tangy, chilli powder, that’s all 5%. But when it has added caramelized sugar, it is no longer salty.”

But the 5% will apply only if the popcorn is sold loose. Put it in a sealed plastic packet and slap a label on it and the rate jumps to 12%. An accompanying press note explained further that caramel popcorn had transformed into a confectionery, and merited a correspondingly higher tax rate.

I'm sure there are legions of lawyers queueing up to argue cases about whether salted caramel popcorn counts as salty or sweet. Or whether pick-and-mix popcorn counts as a packaged good. These are the sorts of ridiculous arguments that New Zealand avoids by having an incredibly simple GST that applies with an equal rate to all goods and services (with a couple of easily segregated exceptions, including financial services and residential rents). As soon as politicians start to mess with the simple tax, the efficiency of the tax system decreases. Any extra revenue from having a higher rate on some products could easily be eaten away by legal battles over which category goods fall into - for example, the famous Jaffa Cake controversy in the UK involved a legal case over whether a Jaffa Cake was a cake, or a biscuit.

Let's keep our simple GST. We shouldn't mess with it by exempting products. India can fight over its three different popcorn tax rates. We don't need that at all.

[HT: The Dangerous Economist, back in February]

 Read more:

• Judge rules that snuggies are blankets, not clothes
• Stephen Hickson on why we shouldn't remove GST from food
• We also shouldn't be debating removing GST from food
• Flapjacks, jaffa cakes, and the quiet simplicity of GST
• Strawberry and cream sandwiches are the new jaffa cakes

This week in research #86

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

• Street (with ungated earlier version here) finds that during the fracking boom in North Dakota, aggregate crime increased in fracking counties relative to non-fracking counties, but that local residents experience a modest decrease in criminal activity
• Nigai finds that exporting to more unequal countries increases domestic inequality, and that this might explain as much as 4.4 percent and 4.8 percent of the observed levels of Gini coefficients and income shares of the top 1 percent, respectively
• Harris and Mills (with ungated earlier version here) evaluate a randomized trial offering US ninth graders a $12,000 merit-based grant, and find that the program may have increased graduation from two-year colleges but did not affect overall college entry, graduation, employment, incarceration, or teen pregnancy