Can financial incentives help heavy drinkers stay sober?

Rational (and quasi-rational) decision-makers respond to incentives. If the costs of doing something go up, they tend to do less of it. If the costs go down, they tend to do more. And the reverse is true of benefits. Changing the costs and/or benefits of an activity therefore should be expected to change behaviour.

Does that logic extend as far as behaviours involving addiction and self-control problems? Consider alcohol consumption. Can heavy drinkers be incentivised to remain sober, at least temporarily, by increasing the costs of drinking, or increasing the benefits of not drinking? That is essentially the question addressed in this 2019 article by Frank Schilbach (MIT), published in the prestigious journal American Economic Review (open access).

Schilbach conducted a field experiment over three weeks with 229 cycle-rickshaw drivers in Chennai, India. In the experiment, the drivers were randomly split into three groups. The first group received a financial incentive to remain sober (the 'Incentive group'). The second group were paid an unconditional payment of similar magnitude (the 'Control group'). The third group got to choose between the sobriety incentives and the unconditional payment (the 'Choice group'). To receive their payment, the study participants had to report to the study office and submit to a breathalyser test. Schilbach was really interested in the effect of alcohol consumption on savings behaviour, so each research participant was offered the opportunity to save money at the study office each day. He was also interested in the effects on labour market participation and earnings, which were determined using surveys of the research participants.

The results reveal a number of important things about rational behaviour among heavy drinkers. First, the group that was given the choice between sobriety incentives and an unconditional payment demonstrated a strong demand for sobriety:

One-third to one-half of study participants chose sobriety incentives over unconditional payments, even when this choice entailed a potential or certain reduction in study payments...

One-third of the participants in the 'choice group' were willing to give up as much as 30 percent of their study earnings in order to be given the sobriety incentives. Schilbach isn't able to definitively determine why there was such high demand for sobriety, but he does note that:

First, study participants had significant experience with alcohol consumption and the potentially resulting self-control problems. The average study participant had been drinking alcohol for over a decade and many of them had been drinking (almost) daily...

Second, individuals perceived the costs associated with their drinking as significant. Many individuals expressed a strong desire to reduce their drinking in surveys and informal conversations. These men had spent substantial income shares on daily alcohol consumption for many years before participating in the study. Compared to these expenses, the forgone study payments due to the commitment choices may have appeared relatively small to individuals, especially if they implied a positive (perceived) chance of reducing subsequent alcohol consumption in the longer run.

So, the research participants may have perceived the experimental setting, and the money on offer, as a way to commit themselves to sobriety, at least for the period of the study. Did the incentives work, though? Schilbach finds that they did:

In the pre-incentive period, about one-half of the individuals in each of the three groups visited the study office sober. This fraction gradually declined in the Control Group to about 35 percent by the end of the study... In contrast, with the start of the incentivized period, sobriety in the Incentive and Choice Groups increased by about 10 to 15 percentage points. Subsequent sobriety at the study office also declined in these two groups, but the difference to the Control Group remained roughly constant.

Regression models confirm that the Incentive and Choice groups were approximately 13 percentage points more likely to visit the study office sober than the Control group, and the average breath alcohol content (BAC) was 2 to 3 percent lower for the Incentive and Choice groups than for the Control group (conditional on visiting the study office). Schilbach notes that the effect was largest on daytime drinking and not overall alcohol consumption, suggesting that many study participants simply shifted their drinking to later in the day (after visiting the study office).

Did sobriety affect labour market outcomes? Schilbach finds small and statistically insignificant effects on labour supply, hours worked, and earnings. As for savings, Schilbach found that the intervention increased savings, with the Incentive and Choice groups saving about 50 percent more than the Control group over the study period. Schilbach interprets this as showing that:

...increasing sobriety reduced self-control problems in savings decisions. An alternative interpretation could be that alcohol is a key temptation good for this population such that reducing alcohol consumption mitigates the need for commitment savings. However, given that the intervention only moderately reduced overall alcohol consumption and expenditures, this channel is unlikely.

My takeaway from this paper is that many heavy drinkers recognised their own self-control problems and were willing to give up some income for a commitment device that would help them remain sober. The commitment device increased the costs of drinking (or, equivalently, increased the benefits of not drinking). So, the drinkers who chose the sobriety incentives were acting rationally in response to a change in incentives. The research participants who shifted their drinking to later in the day were also acting quite rationally. By shifting their drinking to later in the day, they could receive the benefits of the sobriety incentive, while continuing to drink (albeit later in the day). In other words, the incentive changed behaviour, just not necessarily in the way it was intended to.

So, if you wanted to roll out a broader intervention based on changing incentives for heavy drinking, it might be better to measure sobriety at multiple times of the day. However, in this context even the later drinking may have reduced some of the potential alcohol-related harm, since there may have been fewer drunk-driving cycle-rickshaw drivers on the streets of Chennai (although, to be fair, the study doesn't actually show that there was less drink-driving).

It would be interesting to know how much of these study results are context-dependent, and whether a similar intervention would work elsewhere. If you tried to incentivise heavy drinkers in a high-income country to reduce their consumption, would they respond in a similar way? That question will have to wait for future research.

Egg prices will rise in New Zealand, even without a major avian flu outbreak

Last year, I posted about avian flu in the US and the impact on egg prices, noting that prices will rise. Thankfully there hasn't been a major outbreak of avian flu in New Zealand as yet, although it seems likely there will be soon. Domestic birds, such as chickens, are at risk, and as I noted in that earlier post, that affects the supply of eggs. And New Zealand egg suppliers are acting now, as the New Zealand Herald reported earlier this week:

It comes as New Zealand’s largest egg supplier Mainland Poultry, accounting for nearly 40% of the country’s eggs, is putting hundreds of thousands of free-range chickens into lockdown after the deadly bird flu virus was detected in the country last week.

Putting free-range chickens into lockdown will raise the costs of production for free-range eggs. The effect on the market for free-range eggs is shown in the diagram below. Before the chickens were locked down, the free-range egg market was in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of free-range eggs traded of Q0. The lockdown increases the costs of producing free-range eggs, which decreases supply to S1. This increases the equilibrium price of free-range eggs to P1, and reduces the quantity of free-range eggs traded to Q1.

Free-range eggs and colony eggs are substitutes. Once free-range eggs become relatively more expensive, some consumers will switch to colony eggs. The effect on the colony eggs market is shown in the diagram below. Before the change in the price of free-range eggs, the market for colony eggs was in equilibrium, where demand DA meets supply SA. The equilibrium price was PA, and the quantity of colony eggs traded was QA. Since some consumers switch to the relatively cheaper colony eggs, that increases the demand for colony eggs from DA to DB, increasing the equilibrium price of colony eggs from PA to PB, and increasing the quantity of colony eggs traded from QA to QB.

Overall, eggs are going to cost more, regardless of whether they are free-range eggs or colony eggs. And even without a major outbreak of avian flu. If avian flu does take hold in New Zealand, the price of eggs of both varieties will go up even further.

Are men's and women's soccer complements or substitutes?

Both my ECONS101 and ECONS102 classes touched on the subject of complementary and substitute goods this week (in different model contexts). Two goods are complements if consumers tend to consume them together. In that case, a decrease in the price of one good would increase the quantity that the consumer buys of both goods. Two goods are substitutes if consumers tend to consume one or the other. In that case, a decrease in the price of one good would increase the quantity that the consumer buys of the now-cheaper good, but decrease the quantity that the consumer buys of the other good (which is now relatively more expensive).

Often, it is easy to tell if goods are complements or substitutes. However, sometimes it is not straightforward. Consider the example of men's and women's soccer matches. Are they complements, or substitutes? If, when faced with the choice of whether to attend a men's or a women's soccer match, or both, fans tend to choose one or the other (and not both), then the matches are substitutes. On the other hand, if fans tend to go to both, then the matches are complements. Another way of thinking about this is that, when the price of one of the matches goes up, what happens to attendance at the other. So, if the ticket price for a men's soccer match increases and attendance at women's matches goes up, then they are substitutes, whereas if attendance at women's matches goes down, then they are complements.

Ultimately, whether men's and women's soccer are substitutes or complements is an empirical question. Fortunately, this 2025 article by Galila Nasser and Christian Deutscher (both Bielefeld University), published in the Journal of Sports Economics (open access), provides us with an answer. Or rather, they provide us with an answer in one particular context, which is German soccer.

Specifically, Nasser and Deutscher use data from the 2009/10 to 2018/19 seasons of the Frauen-Bundesliga, and look at the impact on match attendance when a Frauen-Bundesliga match is played on the same day as a men's Bundesliga match. They also consider whether the effect is larger when the overlapping men’s and women’s matches involve teams belonging to the same club. Their dataset contains 1,256 Frauen-Bundesliga matches, including 851 played on the same day as a men's Bundesliga match and 118 played on the same day as a match involving the men's team of the same club.

Controlling for the day of the week, week of the season, the weather, whether a UEFA Champions League match was also being played that day, and a variety of variables capturing the popularity of the match, Nasser and Deutscher find that there is:

...an approximately 15 percentage points decrease in attendance when women’s games coincide with men’s games on the same day.

A minor quibble with the paper is that when they say a 15 percentage points decrease, they really mean a 15 percent decrease. And the effect for matches played by the same club on the same day is somewhat larger, with attendance lower by about 16 percent. So, these results are consistent with men's and women's top-league soccer matches in Germany being substitutes (fans tend to go to men's or women's games, and not both). However, we can't conclude this for certain as the results are based on observational data so they are correlations, not causal. Nevertheless, Nasser and Deutscher conclude that:

For matches on the weekend, it is essential for clubs that have both men’s and women’s soccer teams in the first Bundesliga to avoid scheduling their matches on the same day.

Given that the seasons overlap substantially, and clubs in both leagues understandably want weekend matches, another option might be to make joint attendance at both men's and women's matches more attractive. Clubs with both men’s and women’s teams could offer a combined ticket covering matches played on different days, or even arrange occasional double-headers. As I note in my ECONS101 class, this sort of bundling can be an effective pricing strategy when there is heterogeneous demand across multiple products. Provided the variation in fans' willingness to pay for the ticket to the combined event is lower than the variation in fans' willingness to pay for the tickets separately, then bundling has the potential to increase total revenue overall. And that higher total revenue can then be shared between the men's and women's teams. Whether that would work here is another empirical question. Perhaps Bundesliga clubs could indulge us by running the experiment?

Farmers can't avoid high synthetic nitrogen fertiliser prices by switching to organic fertiliser

The New Zealand Herald reported yesterday:

New Zealand farmers face hefty increases in the price of fertiliser this spring as a result of the escalating US-Iran conflict and the war in Ukraine.

The Middle East plays a big role in the global fertiliser market because of its supply of natural gas and mineral resources.

Russia is also a major supplier of fertiliser.

Renewed hostilities in the Persian Gulf – and the virtual closure of the Strait of Hormuz – have driven oil prices up to about US$90 ($154) a barrel for Brent crude, the international benchmark.

Synthetic nitrogen fertiliser is generally manufactured from ammonia created using the Haber-Bosch process. This requires hydrogen, which is often derived from natural gas (mainly methane). Since the Middle East is a major supplier of natural gas, a lot of nitrogen fertiliser is manufactured in the Middle East. The current conflict in the Middle East is constraining the transport of nitrogen fertiliser from the Persian Gulf, reducing the supply of nitrogen fertiliser.

The effect of this on the market for nitrogen fertiliser is shown in the diagram below. The market was initially in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of nitrogen fertiliser traded of Q0. The Middle East conflict reduces shipping of nitrogen fertiliser, which decreases supply to S1. This increases the equilibrium price of nitrogen fertiliser to P1, and reduces the quantity of nitrogen fertiliser traded to Q1.

Can farmers avoid the higher price of nitrogen fertiliser by switching to an alternative product, such as organic fertiliser (compost, or manure)? Not really. Consider what happens in the market for organic fertiliser, shown in the diagram below. Before the change in the price of nitrogen fertiliser, the market for organic fertiliser was in equilibrium, where demand DA meets supply SA. The equilibrium price was PA, and the quantity of organic fertiliser traded was QA. Since nitrogen fertiliser and organic fertiliser are substitutes, and nitrogen fertiliser is now relatively more expensive (as shown above), farmers switch to the relatively cheaper organic fertiliser. That increases the demand for organic fertiliser from DA to DB, increasing the equilibrium price of organic fertiliser from PA to PB, and increasing the quantity of organic fertiliser traded from QA to QB.

So, the effect overall is that the price of both nitrogen fertiliser and organic fertiliser increase. Farmers cannot easily avoid high fertiliser prices. We can expect that to flow through into higher prices for farm produce, as well as lower profits for farmers.

Why rising honey prices may increase kiwifruit orchard costs

This week, my ECONS102 class covered rational behaviour, one aspect of which is the cost-benefit principle: that when evaluating mutually exclusive alternatives, a rational decision-maker will choose the alternative that offers the greatest net benefit (the greatest difference between benefits and costs). So, it was interesting to see a good example of this in The New Zealand Herald just last month:

There’s growing competition for beehives as honey prices sweeten again and kiwifruit orchards continue to grow...

[Beekeeper Liam Gavin] said renewed confidence in honey production is seeing some pivot away from pollination.

“I sort of describe it as the tug of war between honey and pollination.

“Both are needing more beehives. So which one, where are they going to go? And that’ll all be down to, like, region-specific [stuff], and what people like to do in terms of how they beekeep.”...

With honey prices coming back up, [New Zealand Kiwifruit Growers Incorporated chief executive Colin] Bond expected more beekeepers would prioritise honey over pollination, which would create a challenge for kiwifruit growers.

Beekeepers can position their hives primarily to generate income from honey production, or primarily to generate income by providing pollination services. Thus, for a particular hive at a particular time, honey production and paid pollination are mutually exclusive alternatives.

A rational beekeeper, applying the cost-benefit principle, would compare the expected net benefit from using their hives for pollination with the expected net benefit from using them for honey production. That comparison would include pollination fees, expected honey revenue, transport and feeding costs, risks to hive health, and other relevant costs and benefits. As honey prices increase, the opportunity cost of committing hives to pollination increases. Ceteris paribus (holding all else constant), as honey prices increase fewer hives will be offered for pollination.

So, if kiwifruit growers (and other farm and orchard businesses that depend on pollination) want to secure enough hives for pollination, they will probably need to offer higher pollination fees. That would raise their pollination costs and, consequently, their overall orchard operating costs.

Spark's new overseas roaming charges and price discrimination

I've just gotten back home from three weeks in Europe. One irksome but necessary aspect of travelling is mobile phone roaming. While I was away, Spark introduced new roaming charges, and their new options both increase the price per day of roaming for most overseas trips, and price discriminate so that those staying overseas for longer pay a higher price for roaming. As the New Zealand Herald reported:

Spark customers travelling overseas for the school holidays face new charges to stay connected, with the telco scrapping its cheapest $25 fortnightly roaming pack.

The company is overhauling its roaming plans, with the new charges taking effect this Friday, including an automatic $10-a-day fee if customers don’t turn roaming off...

Previously, pay monthly customers could use 2GB of data on one of the provider’s 14-day roaming packs, priced at $25 and $30...

Three new packs will replace the old plans, alongside a new daily roaming option.

A $30 14-day pack will still be available to prepaid customers.

The other options will provide travellers with 20GB to use over 30 days, a change the company believes will make roaming simpler and more predictable.

“This helps our customers to stay connected for longer, with fewer top-ups, less uncertainty, and greater confidence about what they’ll pay.”

While the $50 and $65 packs have a higher upfront cost, customers would receive five times more data to use than under the previous plans, the spokesperson said.

If you look at the price per gigabyte of data, the new roaming packs are clearly much better value. Customers are paying twice the price, but getting ten times the data. So, high data users are likely to be better off under these plans. I want to focus instead on travellers who are not using large amounts of data (and for simplicity, I'm going to focus on the data-only packs, not the more expensive packs that include roaming calls and texts). For those travellers, when you look at the cost per day of roaming, the new packs are far more expensive. This is illustrated in the diagram below, which shows the costs for up to 30 days of roaming. The bold green line shows the existing pricing for a 14-day data-only roaming pack ($25 for each 14-day period). The light blue dashed line shows the cost using the new $10 daily roaming rate. The orange dashed line shows the cost for the new 30-day data-only roaming pack ($50 for each 30-day period).

For a Spark customer roaming for one or two days only, the new daily roaming pack is the cheapest option. So, if you're travelling to Australia for a day or two of shopping or to attend a concert or a sporting event, the new option is a better deal than what was previously on offer. With the new options, daily roaming is lower cost than buying a 30-day pack for up to four days of roaming, and the same cost as the 30-day pack for five days of roaming. Beyond that, you would be better off buying the 30-day roaming pack, even if you are only roaming for seven days.

The comparison between the old 14-day roaming pack and the 30-day roaming pack makes it clear that anyone roaming between five days and 14 days will now be paying twice as much as before. From 15 to 28 days, the cost of roaming with the new packs is the same as for the old packs. For someone like me, who typically goes overseas for a conference and might be away for 10-14 days at a time, this is clearly going to increase the cost of roaming.

It may be that Spark has determined that the new pricing options better reflect actual customer usage. That is what a Spark spokesperson argues in the New Zealand Herald article. However, it is also clearly an example of price discrimination in action. Travellers going overseas for a few days likely have more elastic demand for roaming than travellers going overseas for a longer time. That's because of the availability of close substitutes. If you go overseas for a few days, you could make use of free hotel and airport WiFi, or be prepared to just switch off mobile data for the time you are away, rather than paying for roaming. So, travellers who go overseas for a few days are likely to be relatively price sensitive. Travellers going overseas for a longer time are less likely to be able to switch off mobile data for that length of time, making them less price sensitive. The optimal pricing therefore is to set a higher price for travellers going overseas for a longer time than for those going overseas for a few days.

Price discrimination is very common in practice. In this case, Spark is using price discrimination and that will likely increase their profits. And that means that many travellers who are not high data users, myself included, will be paying more for roaming in the future.

Turkish inflation drives consumers to incur extreme shoe-leather costs

Inflation imposes costs on people. One of the costs of inflation is that it gives people strong incentives to spend time and effort avoiding higher prices. They can do that by reducing their cash holdings, searching harder for low prices, or, in extreme cases, travelling to shop elsewhere. When inflation is high, and prices are increasing rapidly, consumers have a strong incentive to spend a lot of time doing these things. Economists call these shoe-leather costs, because when consumers have to walk around a lot of stores in order to compare prices, their shoes wear out. At least, that's a literal explanation of the term. In an age where prices are published online, the actual act of 'walking around to compare prices' is a lot easier on the shoes. Or is it? An extreme example has been playing out recently, as reported in Bloomberg last November (paywalled, but you can find an ungated version here):

Almost every month, Cihan Citak gets into his car, passport in hand, and sets off from Istanbul to Alexandroupolis, a Greek seaside city 40 kilometers (25 miles) from the Turkish border. After a roughly four-hour drive, he walks the crowded aisles of the local supermarket, filling his cart with wine, cheese and other groceries that cost a fraction of what they do back home...

Cross-border retail has become routine for many who found that Turkey’s surging food prices and stronger lira make Greece a cheaper alternative for everyday purchases. The trend, while not new, is accelerating: 6% of all Turks crossing the border to Greece in the first nine months of the year were on a shopping run, the highest share of overall travelers since at least 2012, data from the country’s statistics agency show.

When inflation causes people to drive four hours in order to find lower prices, you know the shoe-leather costs must be high. The inflation rate in Türkiye is over 30 percent. That isn't hyper-inflation, but it is very high. For comparison in New Zealand, the inflation rate spiked at about 7 percent just after the pandemic, but that was the highest it had been in over 30 years. Inflation more recently has been between 2.5 and 3.5 percent, which is higher than the Reserve Bank's mandate to keep inflation between one and three percent in the medium to long term.

All of that is to say that Türkiye’s much higher inflation creates much stronger incentives for consumers to incur shoe-leather costs to avoid higher prices than is currently the case in New Zealand

[HT: New Zealand Herald, also paywalled]

My 18-month detour through second-degree price discrimination terminology

When I was composing this post about price discrimination last month, I was drawn into a discussion with ChatGPT about second-degree price discrimination. ChatGPT, which I mostly use for checking for inconsistencies and grammatical errors in my draft blog posts, told me that I should refer to menu pricing as a form of second-degree price discrimination. I replied that wasn't correct, because second-degree price discrimination, as defined by Arthur Pigou in the early 1920s, involves offering a declining price for each additional unit that the consumer buys. ChatGPT responded that indeed, Pigou had defined second-degree price discrimination that way, but that in much current industrial organisation usage, second-degree price discrimination includes cases where consumers are offered different options and sort themselves into groups that have different price elasticities of demand (or different willingness to pay) for the good.

That discussion made clear that I had been on an 18-month detour in how I described the degrees of price discrimination. Only last year, I changed the definitions of the degrees of price discrimination in my ECONS101 class to match those that Pigou uses, and therefore moved menu pricing into the definition of third-degree price discrimination (or group pricing). I've held off on posting about my exchange with ChatGPT until now, because I didn't want to confuse my students in this trimester's class about what did, and did not, fall under the different degrees of price discrimination before they were tested on it (and, as it turns out, I didn't test them on that specific aspect of the topic in any case). [*]

This appears to be one of those situations where terminology changes meaning over time, and is a cautionary lesson in making sudden changes to definitions on the basis of reading about the history of economic thought. The issue here is that I had come across Pigou's definitions in one source, and initially dismissed it as it was inconsistent with the way we taught that topic. But then I read The Economics Book by Niall Kishtainy and co-authors (which I reviewed here), which made me more certain about Pigou's definitions. To be clear, I'm not blaming Kishtainy et al. They were perfectly correct in terms of Pigou's definitions. I should have checked some other sources for more current usage. One example is the excellent book Information Rules, by Carl Shapiro and Hal Varian (which I read in 2023 and reviewed here), which made the definitions used in industrial organisation clear (although Shapiro and Varian preferred to use the term 'versioning', rather than second-degree price discrimination).

Now I'm left with the task of combing through my past posts, to ensure that I update my terminology, or revert it to the original text in the few cases where I went back and made changes. I don't want to risk confusing future students, which is a risk given that I refer them to my posts for further detail and examples on topics that we discuss in class.

*****

[*] I didn't perfectly achieve this goal, because one very alert student picked up the error through her own conversations with Harriet, our ECONS101 AI tutor, an irony that was not lost on me.

David Oks on the bad business economics of airlines

Airlines are a strange business. They seem to have huge numbers of passengers, and yet we routinely hear about airlines struggling financially, entering administration, or shutting down. For example, in 2024 in Australia, Bonza collapsed, while Rex withdrew from major intercity routes after entering vountary administration (see this post for more on those examples). The most recent example is Spirit Airlines in the US, which shut down this month, after its second bankruptcy process in less than two years.

I just discovered David Oks's Substack, which has overnight become one of my favourites. The post that first attracted me was this one titled 'Why airlines are always going bankrupt', inspired by the Spirit Airlines story. Another recent post titled 'Why ATMs didn’t kill bank teller jobs, but the iPhone did' is also excellent, as is 'How funerals keep Africa poor'.

Oks's airline post has a huge amount of depth, so is difficult to summarise without losing part of the story. However, I'm going to try (but I really recommend that you read his entire post, as it is truly excellent).

Oks first notes that airlines are not just badly managed, they are structurally vulnerable and often fail to earn a positive return on capital. He then turns to the game theory of airlines, noting that there is an 'empty core' problem, meaning that there isn't any subset of the airline industry that can form a stable coalition, because some part of the coalition would always be able to make themselves better off by breaking away from the coalition. In other words, no group of airlines and routes is stable for long, because whenever capacity is tight and fares are high, another airline has an incentive to add seats. However, once those seats are added, the market can quickly become unprofitable.

The 'empty core' arises because airlines have high fixed costs, low marginal costs, volatile demand, weak product differentiation, and large minimum efficient scale. All of that means that adding one extra airline on a route, or one extra aircraft, can swing a market from being undersupplied and profitable to being undersupplied and unprofitable. So, what happens in the airline industry is that when there are few airlines, they are profitable and happy, but that encourages new airlines to enter, after which profits decrease until one or more of the airlines shuts down. And then the cycle starts over.

As you can see, there is a lot to unpack from Oks's post. Again, I encourage you to read the whole post. But the key points are, first, that airlines are always going bankrupt because the nature of the airline industry lends itself to a boom-bust cycle when airlines compete with each other.

Second, from the perspective of airline consumers (and, probably, governments as well) there is an uncomfortable trade-off. We want low fares from competition between airlines, and we also want airlines to be financially stable, but it may be difficult to have both. The pursuit of low fares can set off the cycle described above, with competition pushing fares down, leading to falling profitability, and eventually one or more airlines exiting the market. Airline financial stability, on the other hand, probably requires some limit on competition between airlines. One way of achieving this is to regulate airlines more closely, closer to the equilibrium that existed before deregulation in the late 1970s and early 1980s, when regulators had much greater control over fares, routes, and market entry. Airlines segmented the market, flew fewer routes, and were profitable in part because they were not actively competing with each other. The other alternative is to recognise that airlines can diversify into other markets. Oks’s most striking example of this is Delta:

...the most profitable airline in the United States, which started a fruitful partnership with American Express in 1996 and launched a co-branded card with them in 2008. Annual spending on Delta-branded American Express cards comes out to about 1 percent of U.S. GDP. In 2025, this produced about $8 billion in revenue for Delta, accounting for more than the entirety of its profit. That means that without the American Express partnership, Delta would be operating at a substantial loss. In effect, Delta’s aviation business is a loss leader for a much more profitable credit card partnership. So to the extent that Delta is now a good business, it is because it escaped the basic instability of the airline industry by becoming less of an airline.

Allowing airlines to operate in a cartel-like equilibrium, as airlines effectively did prior to the 1980s, doesn't strike me as a very positive solution, especially from the perspective of consumers. Having airlines shut down at short notice, cancelling thousands of flights, is clearly not good for consumers either. Perhaps then we need to tolerate airlines that try to sell us financial services, or unbundling the airline package and separately selling seat selection, checked baggage, meals, and so on (see this post about Jetstar's business practices, or this one).

The economics of castles

When I'm in Britain or Ireland, one of my favourite sightseeing trips is to visit medieval castles. Even the ruined ones are fun to visit. Actually, maybe the ruined ones are more fun to visit, because you get to imagine what they would have looked like in their heyday. Britain and Ireland are full of castles, many of which were built by and housed local nobles. In fact, in relative terms there were very few royal castles, which the literature in history and economic history has interpreted as a sign that centralised states were weak.

However, this recent article by Desiree Desierto and Mark Koyama (both George Mason University), published in the journal European Economic Review (ungated earlier version here) challenges that view. They instead show that there was an economic logic to the proliferation of private castles.

Desierto and Koyama develop a game theoretic model of medieval states, which first recognises that the monarch cannot rule alone but must rely on a coalition of local lords or barons. Each lord agrees to join the coalition, and pledges resources to the monarch in exchange for a (however small) share of control of the kingdom. The monarch can renege on the agreement, taking the resources without offering a share to the lord. However, the lord would then rebel, leaving the coalition. What allows the lord to leave the coalition, and gives them bargaining power, is the presence of their own castles, since they can retreat to their castle when they rebel against the monarch. Without a private castle, the lord would have little bargaining power, and would anticipate the monarch reneging on any agreement, and so they would not join the coalition in the first place. In economic terms, the castle gives the lord an outside option. 

So, the monarch tolerates private castles held by the lords, because the presence of those castles gives the lords the feeling of security they need to join the kingdom. And, in turn, the presence of those castles disciplines the monarch. Rebellions are more costly to suppress when the lords can retreat to a well-defended private castle. The lords' outside option increases the feasibility of rebellion and ensures that the monarch mostly keeps to their agreement with the lords.

In short, the private castles induce an equilibrium where the kingdom is larger and more stable than it would be without them. Notice that this is the opposite of the conventional view that private castles represent a sign that a state was weak.

Desierto and Koyama support their argument with descriptive evidence, noting that:

In Norman England after the Conquest, castles were built across the country: by 1154 there were 225 baronial castles (compared to 49 royal castles) in England... Baronial castles allowed the Dukes of Normandy to extend their authority over the far larger territory of Anglo-Saxon England. Similarly, in the twelfth century Angevin rule expanded over much of France as semi-independent lords in Gascony accepted the lordship of Henry II.

Desierto and Koyama also note that powerful medieval monarchs did not act to systematically eliminate private castles, and in fact the monarchs often gave away their own castles to local lords. And the power of the lords did keep the monarchs in check - a lord's probability of rebelling against the monarch was positively correlated with the number of private castles in the lord's family network. That last point might sound contradictory, but since castles make rebellion by lords a more credible threat, this can deter monarchs from reneging and reduce the number of rebellions overall. However, when rebellion does occur, lords connected to more castles were more likely to participate in the rebellion.

So, if private castles were so important for the stability of medieval states, why did private castles eventually disappear? Desierto and Koyama note that:

The answer is military technology, not the rising power of the state. Technological changes and the associated ‘‘military revolution’’ that took place beginning in the late Middle Ages reduced the value of medieval fortifications. The main technological innovation was the introduction and improvement of gunpowder weapons, which began in the fourteenth century but only really began to have a serious impact in the fifteenth century with the introduction of iron cannonballs.

This is not a new insight, but it does align well with their model. However, it somewhat reverses the logic of the conventional view, which is that greater state power, along with military technology, reduced the prevalence of private castles. Instead, in Desierto and Koyama's model, the rise of gunpowder reduces the ability of lords to retreat to a well-defended castle in the event of a rebellion (because the castle could not be as well-defended against cannons). This reduced the lords' bargaining power, giving the monarch and the centralised state greater power. As a result, the state should become less stable. In support of this, Desierto and Koyama use the Wars of the Roses in England as an example:

England experienced a large number of rebellions and civil wars between 1450 and 1500. These conflicts are conventionally grouped under the label of the Wars of the Roses (1455–1485), but the period of weak state capacity and frequent rebellion extended from Jack Cade’s uprising in 1450 through Perkin Warbeck’s invasion and the Second Cornish Uprising in 1497. The causes of these rebellions were complex, multifaceted, and varied across cases. Nonetheless, the frequency of civil war during this period is consistent with our model’s prediction that a decline in the military value of castles would destabilize feudal realms.

And so, as gunpowder reduced the military value of castles, private castles became much less useful as a source of bargaining power for lords. That helps explain why the medieval pattern of widespread private castles gave way to state-controlled castles from the mid-15th Century onwards. Now, I'll be thinking more carefully about the vintage of the castles I visit on my next trip to Europe next month!

Kansas City rent strike rebalances relative bargaining power towards tenants

Today in my ECONS101 class, I covered search models of the labour market. In these models, a matching between a worker and an employer creates a surplus, which is then shared between the worker and employer depending on their relative bargaining power. The greater the worker's relative bargaining power, the greater the share of the surplus the worker will claim, meaning that wages will be higher. The lesser the worker's relative bargaining power, the lesser the share of the surplus the worker will receive, meaning that wages will be lower.

Search models are not just useful for thinking about labour markets though. They can be used in any situation where two (or more) parties are matched together in a way that creates a surplus, which is then shared between them. A joint venture between firms is an example. So is a marriage. In both cases the parties match together, create a surplus, and then share that surplus based on their relative bargaining power. A further example exists in the market for rental housing. Landlords and tenants are matched together. That matching creates a surplus, which is shared between them. And relative bargaining power matters, as this Yahoo!News article from the end of last year (originally published in the Washington Post) demonstrates:

In the two years she has lived at Bowen Tower, Cynthia Barlow’s apartment has flooded, been plagued by mold and been infested with cockroaches. The building’s heat stopped working. When the elevators broke over the summer, emergency workers carried a sick neighbor down 10 flights of stairs.

Meanwhile, Barlow’s rent for the two-bedroom unit increased from $993 per month to $1,213.

Growing frustrated, she hung fliers in the elevators and hosted potlucks, persuading a majority of tenants in the 90-unit building to join the Bowen Tower Tenant Union and stop paying rent until conditions improved. So far, they’ve won a meeting with the landlord, and a judge has knocked thousands of dollars off the rent debt of one resident facing eviction.

“I got tired of being treated the way I was treated,” Barlow said.

The rent strike is part of a strategy that housing activists have started to replicate in midsize cities across the country.

When tenants organise themselves into a tenant union, then ceteris paribus (holding all else equal) that increases the tenants' relative bargaining power with the landlords. If the tenants were to all leave their apartments, then the landlord has to search for new tenants, which is costly. Now, an individual tenant could threaten to move out, but filling one apartment with a new tenant is relatively easy. When an entire block of tenants makes the same threat, the landlord is facing serious disruption. More importantly, a rent strike means that, instead of losing or negotiating with one tenant at a time, the landlord faces coordinated action including withholding rent, legal disputes, repair demands, and public pressure from many tenants at once.

The tenants' increased bargaining power (due to unionising) should result in lower rents and improved maintenance of the apartments. The way this worked in practice was that tenants, feeling more powerful with the backing of other tenants, stopped paying rent. However:

Barlow is scheduled for eviction court in January, and Bowen Tower management hasn’t renewed her lease.

There is only so far that tenants can push their greater relative bargaining power, particularly where alternative affordable housing is scarce and legal protections are weak. However, the Bowen Tower case also shows why collective action may matter. Ultimately, the tenants appear to have prevailed and won substantial concessions. This later article notes that the rent strike ended after four months, when the landlord promised repairs and lower rents, and after tenants had withheld nearly US$110,000 in rent. 

Tenant unionisation does not guarantee success, and the risks to tenants can be substantial. But it does mean that tenant unions can shift the bargaining outcome, and the share of the surplus, especially when they are able to sustain coordination long enough to make the landlord’s alternative more costly than negotiation.

[HT: New Zealand Herald]

Two papers show the bad, and some good, of rent control in San Francisco

I have been talking with my ECONS101 class this week about rent controls, which is a topic that I have blogged about many times before (see the links at the end of this post). Economists really dislike rent controls, sometimes in deliberately hyperbolic terms. In one prominent case, the Swedish economist Assar Lindbeck was quoted as saying:

“Rent control appears to be the most efficient technique presently known to destroy a city—except for bombing.”

Lindbeck's statement is based on the evidence that shows the negative impacts of rent controls. One example is described in this 2025 article by Eilidh Geddes (University of Georgia) and Nicole Holz (Northwestern University), published in the Journal of Housing Economics (ungated earlier version here). They looked at the impact of a large-scale rent control expansion in San Francisco in 1994, which removed an exemption from rent control for small (less than five units) owner-occupied buildings built before 1980, on evictions.

Their data are the number of eviction notices, as well as wrongful eviction claims and 'owner move-in' eviction notices at the zip code level, from 1990 to 2010. They apply a continuous treatment difference-in-differences, which essentially compares the change in evictions (or other measure) between zip codes that were more affected by the removal of the exemption and those that were less affected. Their measure of exposure to the treatment is the number of housing units in the zip code that became exposed to rent control policies after the passage of the voter referendum in late 1994. In zip codes where more housing units were affected by the change, we would expect to see greater impacts than in zip codes where fewer housing units were affected. One limitation of this is the data source that Geddes and Holz use, which is based on building data from 1999, five years after the change was implemented. However, they show that three main sources of problems (demolition of buildings between 1994 and 1999, splitting of land parcels, and construction that changed the number of units in each building), do not have much impact on the estimated number of units affected (and so, don't have a large impact on the treatment variable).

In their main analysis, Geddes and Holz find:

...an 83% increase in eviction notices filed with the Rent Board and a 125% increase in the number of wrongful eviction claims for ZIP codes with the average level of new exposure to rent control...

These effects are large and economically significant. We find an annual effect of an increase of 20.07 eviction notices per 1000 treated units in a zip code. Over the six years in our post period (1995–2000), this translates roughly into 12% of newly rent controlled units receiving an eviction notice.

So, the expansion of rent control leads to an increase in evictions. Geddes and Holz also find that the effects:

...are concentrated in low-income areas. These areas are not necessarily those that saw the largest increases in aggregate rents during the 1990s, suggesting that landlords may be more willing to engage in eviction activity in places where there are fewer resources to fight that behavior.

Geddes and Holz caution against taking a broad interpretation of their results though, as the removal of the exemption in 1994 primarily affected small landlords, who are often 'mom and pop' landlords and are able to take advantage of 'owner move-in' eviction provisions that are not available to large corporate landlords. However, the results are consistent with the broader literature, which suggests that tenants may be negatively affected by rent controls.

But not in all ways, it appears. In a more recent article published in the Journal of Health Economics (open access), Geddes and Holz look at the impact of the same 1994 expansion of rent control in San Francisco on intimate partner violence (IPV). They first note that that the effect of rent control on IPV is theoretically ambiguous, and there are two competing models with different predictions:

In the financial strain model, lower housing costs will decrease financial stress, leading to lower levels of violence. The effect of housing policies will thus depend on whether they lower costs for couples. However, in a bargaining model, there is a crucial distinction between policies that shift housing costs overall and those that shift the relative costs of housing inside and outside of the relationship. Policies that decrease housing costs overall will change the amount of resources in the relationship to be bargained over, but will not shift the bargaining power in the relationship. However, policies that decrease housing costs inside the relationship relative to those outside of the relationship will change the attractiveness of the outside option, shifting bargaining power away from the woman.

The empirical setup in this research is the same as for their earlier research on evictions. The difference is that the outcome variable of interest is IPV, measured as:

...the number of hospitalisations resulting from assaults that comes from California’s Department of Health Care Access and Information (HCAI, formerly OSHPD) from 1990–2000.

In their main analysis, Geddes and Holz find that:

...for every one percent increase in exposure to rent control in a ZIP code, hospitalized assaults on women decline by 0.08 percent. In levels, this translates to an almost 10 percent decrease in violence against women for the average ZIP code.

They find no corresponding decrease in assaults on men, which suggests that their results are not driven by an overall decline in assaults (including non-IPV assaults). They also find no effect on reported accidents, which suggests that their results are not driven by changes in the propensity to report IPV. Interestingly, they also find:

...no evidence of changes in household size or composition, suggesting that our results are driven by changes in violence within relationships rather than changes in cohabitation or relationship dissolution.

Overall, their results are most consistent with the financial strain model of IPV. Based on that model, we interpret these results as showing that rent controls, by reducing housing costs (and it is worth noting that housing costs in San Francisco are, and have been for some time, very high), decrease conflict within intimate relationships, and decrease IPV.

So, at least there is some evidence for positive effects of rent control. These results also sit alongside earlier evidence from the same rent control expansion, which showed short-run gains for incumbent tenants, but long-run reductions in the supply of rental housing units, as well as an increase in inequality. However, few people are advocating for rent control policies in order to reduce intimate partner violence. And benefits in terms of reduced violence have to be weighed against all of the other negative consequences of rent control policies, many of which are outlined in the posts linked below.

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
• Rent controls make many tenants worse off in the Netherlands

The supply-side story behind falling meth prices in New Zealand

Chris Wilkins, Marta Rychert, and Robin van der Sanden (all Massey University) wrote an article in The Conversation last month about the price of methamphetamine:

Methamphetamine has become dramatically cheaper over the past seven years, even as authorities report record seizures, according to the latest New Zealand Drug Trends Survey.

The annual online survey of over 8,800 people who use drugs shows wholesale prices of the illegal and harmful substance (per gram sold to dealers) have fallen by 41%, while street-level “point” prices (0.1 gram retail deals) have dropped by 27%.

The decreasing price of meth is not a new phenomenon. In fact, I wrote about it last year. Wilkins et al. try to tease out the reason underlying the decreasing price. Based on a simple supply and demand model of the market for meth, there are two main possibilities: an increase in supply, or a decrease in demand. Wilkins et al. go through a number of plausible factors on both sides of the market, dismissing each in turn, including:

• sellers feeling that there is less risk of arrest (which would increase supply), but Police report record seizures, which Wilkins et al. argue seems to rule that out;
• less strict enforcement by Police against people found with small quantities of drugs (which would increase supply, but probably demand as well), but that wouldn't affect large sellers;
• decreasing production costs (which would increase supply), but production costs only make up a fraction of the street price; and
• a decrease in buyers (which would decrease demand), but wastewater data suggests that meth consumption has increased.

The last point, that meth consumption has increased alongside the decrease in price, points strongly to an increase in supply as the main change. That doesn't rule out a change in demand, but the increasing consumption tells us that the increase in supply must be greater than any possible decrease in demand. But if it isn't lower risks of arrest, weaker enforcement, or decreasing production costs, that is causing supply to increase in the New Zealand meth market, then what is? Wilkins et al. point to:

...new global sources of methamphetamine supply.

New Zealand and Australia have traditionally sourced methamphetamine from lawless regions of Asia known as the Golden Triangle. More recently, however, growing seizures have been linked to Mexican drug cartels, often transiting through Canada.

Australian authorities say these cartels can supply methamphetamine at less than one-third the price of Asian producers and that about 70% of seized meth now originates from North America.

It may also explain the rising supply of cocaine in New Zealand, with Mexican cartels deeply involved in global cocaine trafficking.

So, new sources of meth have increased the supply, decreasing the equilibrium price, and increasing the quantity of meth traded in the New Zealand market. Wilkins et al. also point to competition:

On top of this, digital drug markets – including darknets and social media sales – may be lowering the cost of finding alternative sellers and better deals, increasing competition and pushing prices down.

Economists often think of competition as a good thing. However, in the market for illegal drugs, that might not necessarily be the case. How can government best respond? Fighting the supply side of the market alone is unlikely to be successful, as I have noted before. The increased supply from new sources make this even more challenging. A renewed focus on reducing demand is necessary as well, and would likely be much more effective in the long run.

Read more:

• Police are not winning the P war - they need to focus on demand
• Evidence that the supply of methamphetamine is increasing
• The coronavirus lockdown and the New Zealand market for illegal drugs
• The increase in methamphetamine use in New Zealand has been driven more by supply than demand

The Strait of Hormuz blockade, trade passes in the Panama Canal, and the cost of imported goods

The New Zealand Herald reported last month:

The war in the Middle East has boosted demand to move vital cargo through the Panama Canal to such an extent that one vessel carrying liquefied natural gas (LNG) paid US$4 million ($6.7m) to skip the line and avoid a wait that can take up to five days, according to an official report.

A surge in such payments has been recorded since the US-Israeli attacks on Iran began February 28, which led to the blockade of the Strait of Hormuz, a critical waterway for one-fifth of the world’s oil and natural gas exports from Gulf countries.

The impact on the price of transits through the Panama Canal is shown in the diagram below. Before the Strait of Hormuz was blockaded, the market for Panama Canal transits was in equilibrium, where demand DA meets supply SA. The equilibrium price was PA, and the quantity of transits was QA. The blockade increased the demand for Panama Canal transits from DA to DB, increasing the equilibrium price of transits from PA to PB, and increasing the quantity of transits from QA to QB.

This increase in the price of Panama Canal transits doesn't just affect the cost of transporting oil or natural gas. Other ships must also pay the higher price. That increases the cost of shipping, which will flow through to the prices of imported goods, as shown in the diagram below. The market was initially in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of imported goods traded of Q0. The higher cost of Panama Canal transits increases the 'costs of production' of imported goods, which decreases supply to S1. This increases the equilibrium price of imported goods to P1, and reduces the quantity of imported goods traded to Q1.

So, it's not just oil and natural gas prices that will be pushed up by the blockade of the Strait of Hormuz. The resulting higher shipping costs will flow through to all sorts of other goods that are traded internationally and require shipping, including and especially those passing through the Panama Canal.

How home loan customers can use switching costs against the banks

Economists often consider switching costs to be a problem for consumers. High switching costs can lock a consumer into buying a particular product, or lock them into buying from a particular seller. Often, the seller extracts additional profits from their locked-in customers by charging them a higher price, or selling them complementary products. However, sometimes locking in can benefit consumers, especially when they can play off one seller against another, where both sellers want to lock the customer in. Consider the example of banks, on which the New Zealand Herald reported last month:

Home loan borrowers are taking cashback incentives to stay with their current banks, as competition continues in the mortgage market.

The focus on cashback incentives intensified through the end of last year, when ANZ offered cash payments equal to 1.5% of loan amounts to new home loan borrowers.

In a competitive environment, banks really want home loan customers, and are willing to pay to attract new customers. Retaining their existing customers is important too, and banks may be willing to pay to keep their customers. However, not all customers will be able to extract the same 'retention payments' from their bank. The bank needs to weigh up how likely it is that they will lose a customer:

Helen Stuart, a mortgage adviser at Compass Mortgages, said she had seen “retention payments” offered by several banks lately, especially when someone had all their lending come off a fixed term...

It is harder to change to lenders when some of the loan is still fixed, because it usually means a break fee has to be paid.

That makes sense. When a bank customer has a fixed rate mortgage, they have to pay a 'break fee' in order to change banks. Their current bank can feel quite secure that the customer is going to stay with them, and so the bank is unlikely to offer a retention payment (or, if they do, any retention payment is likely to be quite small). On the other hand, when the fixed rate on the mortgage expires, the bank customer can change banks without paying a 'break fee', and so the bank would be more likely to offer a retention payment (or would offer a more generous retention payment). Of course, the retention payment itself is likely part of the bank’s lock-in strategy, since cashbacks often come with conditions that make future switching more costly to the customer.

Thinking further:

Jeremy Andrews, of Key Mortgages, said what people could get would depend on how long a customer had had their loan, whether they had taken a cashback previously and whether they had more than 20% equity.

“Some banks will refuse retention cash if the clients are already fixed in and they see it as of no benefit to the client to refinance to another bank. Some examples include if it’d be detrimental either in break fees – they’re already on higher than market rates, or if they would need to move to higher rates in the market, or the legal costs associated exceed any cashback benefit of moving.

So, in general, the bank is weighing up how likely it is that the customer will change banks. If changing bank would lead the customer to end up paying a higher interest rate on their mortgage, the bank infers that the customer is less likely to leave, and the bank will therefore be less likely to offer a retention payment. It is a similar story if legal costs are high - the customer is less likely to move, and the bank will be less likely to offer a retention payment.

Bank customers should be savvy about this though. Any time that they have the 'upper hand', through low switching costs, they could use their position to extract a large retention payment from their bank. This happens when their home loan comes off a fixed rate, and especially when other banks are offering enticements for the customer to switch. Of course, they need to consider not just the retention payment, but the interest rate, break fees, legal costs, the hassle of switching, as well as whether accepting the retention payment locks them in and for how long. If it makes sense overall, then playing off the banks against each other may allow the home loan customer to reverse the logic of switching costs to their advantage.

The Australian government has 'subscription traps' in its sights

As I noted in a post last week, firms are increasingly selling subscriptions rather than products because consumer inertia can make them substantially more profitable. Once a customer starts a subscription, they tend not to cancel the subscription as soon as they should, simply because it requires some thought and attention (as well as a little bit of time) to execute a cancellation of the subscription. This 'customer inertia' is a form of switching cost, which locks customers into buying the subscription. However, sellers can easily amp up the switching cost by making it more difficult (and therefore more costly) to cancel. This makes customer lock-in more effective, and can 'trap' customers into their subscription.

In this article in The Conversation last year, Jeannie Marie Paterson (University of Melbourne) provides a couple of examples of 'subscription traps', each of which represents an instance of the firm increasing the switching costs for the consumer:

One example is when consumers sign up for a service quickly and easily online, but can only cancel on the phone (sometimes needing to ring another country)...

Another example, known as “confirm shaming”, involves requiring consumers to click through multiple screens before they can cancel.

Typically, each of those screens has a message asking consumers to reconsider, often reiterating the service’s purported benefits and even offering new discounts on the price not previously available.

When the switching costs are higher for the consumer, the customer lock-in is more effective (it is harder for the consumer to cancel, or switch). The firm can then profit through selling at a higher price, or by selling complementary goods and services to the locked-in consumer.

It is deceptively easy for a consumer to get locked in as well. I'm sure that you will have been offered the first month free on a subscription. That is how the firms get you. Firms often offer subscriptions at a low price initially (or free), then once the consumer is locked in, the firm can raise the price (this is referred to as multi-period pricing).

However, governments are wising up to the 'subscription traps' that Paterson highlights. She notes that:

Making it hard to cancel – commonly called a “subscription trap” – isn’t currently illegal. But now the federal government has announced a plan to ban subscription traps and other hidden fees.

Since then, the policy process in Australia has advanced, with draft legislation released in early 2026 that would impose disclosure, notification, and easy-cancellation requirements on subscription contracts from 1 July 2027, if the legislation is passed.

It is worth noting that banning subscription traps is not the only policy solution here. Anything that reduces the switching costs will likely be effective at reducing customer lock-in. One example that Paterson notes is:

California’s “click to cancel” rules also mean consumers must be able to cancel using the same method of communication they used to subscribe. And businesses must offer consumers information on how to cancel.

So, if signing up for a subscription requires a single click, then cancelling a subscription must also require a single click. That minimises the switching costs, and minimises customer lock-in. Making subscriptions easy to cancel would allow consumers to retain the genuine benefits of subscriptions (including lower transaction costs and fewer service interruptions) while reducing the unnecessary costs from subscriptions they no longer use. Firms may still be able to offer discounts or reminders to retain customers, but the cancellation process should inform consumers rather than obstruct them. Reducing these artificial switching costs is therefore likely to improve consumer welfare overall.

Read more:

• The subscription economy as price discrimination
• The switching costs of online subscriptions
• More on the switching costs of online subscriptions
• Cancelling subscriptions and customer lock-in
• Why do firms increasingly prefer to sell subscriptions, rather than products?

Why do firms increasingly prefer to sell subscriptions, rather than products?

An increasing number of goods and services that were once sold as one-off purchases are now offered as subscriptions. Newspaper subscriptions and gym memberships have existed for a long time, and 'software as a service' is now commonplace. But the model has spread much more widely: consumers can now subscribe to meal kits (such as HelloFresh), razors (such as Dollar Shave Club), and a growing range of other products. Why are firms that once sold products outright increasingly choosing to sell subscriptions instead?

That is the question addressed in this 2025 article by Liran Einav (Stanford University), Ben Klopack (Texas A&M University), and Neale Mahoney (Stanford University), published in the prestigious American Economic Review (ungated earlier version here). They start by noting that the rapid growth in subscriptions is often attributed to the rise of digital products, and the convenience of a subscription for consumers. However, Einav et al. focus their attention on a third factor:

Because subscriptions are automatically renewed, consumers who are inertial may continue to pay for subscriptions they no longer value... If consumers do not fully anticipate their inertia at sign-up, this may create supply-side incentives to offer subscriptions to exploit inertial consumers, amplifying the growth of subscription offerings.

My ECONS101 students will be familiar with this explanation for subscriptions, because we literally covered this in the lecture today. Einav et al. test for the extent to which inertia matters using transaction data from "a large payment card network in the United States between August 2017 and December 2021". Their final dataset includes over 800,000 accounts, and about 870,000 account-service pairs (each account-service pair is a set of observations of a payment card account that subscribes from one of the ten largest subscription services).

Einav et al. exploit the fact that when a card expires and is replaced, consumers typically have to update the billing information for their subscriptions, prompting them to either update or cancel each subscription. To the extent that card replacement decreases the retention rate of subscriptions, this provides evidence of customer inertia. If consumers cancelled subscriptions whenever they stopped making use of them, then there would be no difference in subscription retention between months with card replacements and months without.

Unsurprisingly, Einav et al. find evidence of customer inertia, and the effects are large and consequential for firms selling subscriptions:

We use the estimated model to perform counterfactual exercises that assess how much more quickly consumers would cancel their subscriptions if there was no inertia, which corresponds to fully attentive consumers (inattention model) or default cancellation every month (switching cost model). We find that seller revenues (or equivalently average subscription durations) are significantly higher due to subscriber inertia with important heterogeneity across services. Specifically, in the inattention model, we find that inertia increases seller revenues by 87 percent on average, with increases that range from 14 percent to more than 200 percent depending on the service. In the switching cost model, inertia raises revenue by 120 percent on average, with a range of 17 percent to 259 percent.

So, there are strong incentives for firms to engage in the selling of subscriptions, and to take advantage of customer inertia in subscriptions. However, many consumers are clearly spending more on subscriptions than they need or necessarily want to. Think about yourself as an example - how many subscriptions do you have right now that you rarely use and probably should cancel? I don't have any, but that's only because writing this post made me think about this and cancel one that I was no longer really using!

Subscriptions can provide important benefits for consumer though, including reducing transaction costs (it is simpler to pay a monthly subscription than to buy goods or services individually over and over), and reducing service interruptions (because a subscription makes it more likely that the consumer won't run out of the good they are buying a subscription for). However, we might still be concerned that customer inertia makes some customers with subscriptions worse off overall. So, Einav et al. then turn to evaluating what the most appropriate policy response is. They focus attention on a rule requiring firms to provide consumers with an active renewal decision at regular intervals. Using their two models, Einav et al. find that:

In the inattention model, we find that requiring active choices at a six-month frequency would reduce the excess revenue from inattention by 45 percent. The switching cost model makes a similar quantitative prediction; moving from default renewal to default cancellation once every six months would reduce excess revenue by 48 percent.

Those are quite substantial effects, which again illustrates just how much consumers are giving away to subscription firms for subscriptions that they no longer make the best use of and should be cancelling. What becomes clear from this paper is that one important reason why firms that previously would have sold products instead prefer to sell subscriptions is that consumer inertia can make them substantially more profitable.

Read more:

• The subscription economy as price discrimination
• The switching costs of online subscriptions
• More on the switching costs of online subscriptions
• Cancelling subscriptions and customer lock-in

A surprising example of block pricing with heterogeneous demand

My wife and I just got back from holiday in Europe, and stopped in the duty-free store at Auckland Airport to pick up some bottles of gin for my mother-in-law. The price was $45 for one bottle, $69 for two bottles, or $95 for three bottles.

Standard block pricing (as described in this post) calls for the seller to sell at a declining marginal price per unit. In this case, the first bottle is $45, and the second bottle is $24 (for a total of $69 for two bottles). However, the third bottle is $26 (for a total of $95 for three bottles). Did the duty-free store get its block pricing wrong?

Certainly, their pricing is inconsistent with the standard block pricing story, because the third bottle should be less expensive (or, at least, not more expensive) than the second bottle. However, as Nobel Prize winner George Stigler noted, the pricing strategies that we see in the real world are likely to be those that work fairly well (otherwise, the strategy wouldn't persist and we wouldn't see them). So, there must be something about this pricing strategy that makes it work.

I think that the duty-free store is doing a bit of a mix of block pricing and menu pricing. Menu pricing is a form of price discrimination, where consumers sort themselves into those who are high-demand consumers and low-demand consumers. Low-demand consumers buy one bottle (or perhaps two), and pay a relatively high price per unit, while high-demand consumers buy three bottles and pay a lower price per unit.

Now, as I noted in this post, block pricing doesn't typically work when there is heterogeneous demand, because low-demand consumers are unaffected by block pricing (they buy the same quantity as if there was no block pricing), while high-demand consumers may buy more of the good, but spend less overall (because of the lower price per unit). The duty-free store avoids this negative outcome because consumers can only buy three bottles of gin duty-free. If they buy any more than that, they have to pay duty on the additional bottles. So, that effectively caps the number of bottles that high-demand consumers can buy to three. So, the high-demand consumers are stopped from buying four, or five, or six, or twenty bottles at the lower price. That means that the high-demand consumers may buy more bottles than if there wasn't block pricing, but they don't end up spending less overall.

That also helps explain why the third bottle can be priced a little higher than the second. A plausible interpretation is that the two-bottle deal is designed to attract moderate-demand consumers, while the three-bottle deal is aimed at the highest-demand consumers who are constrained by the duty-free limit. If that is the case, then the store does not need the third bottle to be cheaper than the second. Instead, it needs the three-bottle bundle to be attractive to a different group of buyers than the two-bottle bundle or a single bottle. Again, this points to menu pricing as part of the explanation.

So, while the duty-free store isn't conducting block pricing exactly as I describe in my ECONS101 class, we can nevertheless puzzle out what they are doing. And it makes sense, even if it is surprising to see a seller that is able to use block pricing when there is heterogeneous demand.

Price discrimination in tourism... French tourist attractions edition

The latest development in pricing at French museums should be familiar to my ECONS101 students, or to regular readers of this blog. As reported by the New Zealand Herald back in January:

France is hiking prices for non-Europeans at the Louvre this week, provoking debate about so-called “dual pricing”.

From Wednesday local time, any adult visitor from outside the European Union, Iceland, Liechtenstein and Norway will have to pay €32 ($64) to enter the Louvre – a 45% increase – while the Palace of Versailles will up its prices by €3...

Other state-owned French tourist hotspots are also hiking their fees, including the Chambord Palace in the Loire region and the national opera house in Paris. 

This form of pricing is, of course, known as price discrimination - offering the same product (in this case, museum entry) to different consumers for different prices. Price discrimination works when the seller has consumers with heterogeneous demand for their product. That means that some consumers have more elastic demand for the product (and are more price sensitive), while other consumers have less elastic demand for the product (and are less price sensitive). The seller charges a higher price to the consumers who are less price sensitive.

Why do foreigners have less elastic demand for tourist attractions? As I noted in this post back in 2014, there are two reasons. First, consumers tend to have less elastic demand for goods with few close substitutes. There are few substitutes for visiting the Louvre (or other tourist attractions), making demand less elastic. Arguably, for foreign tourists there are fewer close substitutes to the Louvre. Locals can do all sorts of things with their time, but tourists tend to want to go to tourist attractions while on holiday. Second, the significance of price in the total cost of the good is lower for foreign tourists than for locals. Foreign tourists have usually also travelled a long way at great cost to get to France, so the cost of entry into the Louvre is pretty small in the overall cost of their holiday, making demand less elastic. For locals, the cost of the ticket to the Louvre is probably most of the total cost of attending, so a change in the ticket price would have a greater effect on whether they go (making demand more elastic).

The New Zealand Herald article focuses attention on the ethics of price discrimination, noting that:

Trade unions at the Louvre have denounced the policy as “shocking philosophically, socially and on a human level” and have called for strike action over the change, along with a raft of other complaints.

That criticism is not trivial, because museums are not just profit-maximising firms - they also have a public-access mission, so charging more can look inconsistent with their public access goal. However, it is important to recognise that price discrimination is not illegal or even necessarily immoral, and may provide greater support for the long-term goals of the museum.

Price discrimination is in fact relatively common at tourist attractions (see the links at the end of this post), especially in developing countries but also increasingly in developed countries like New Zealand. And:

Britain has long had a policy of offering universal free access to permanent collections at its national galleries and museums.

But the former director of the British Museum, Mark Jones, backed fee-paying in one of his last interviews in charge, telling the Sunday Times in 2024 that “it would make sense for us to charge overseas visitors for admission”.

Society should want museums to remain sustainable. However, funding purely by taxes doesn't ensure sustainability, which is one reason that museums charge entry fees in the first place. And since museums are charging an entry fee anyway, it is right to consider what is the 'best' entry fee. There is no reason why that entry fee needs to be the same for locals and foreigners. After all, locals likely already pay for the upkeep of the museum through their taxes, so having a lower price for locals (as many tourist attractions do) is in that sense a fairer option. Price discrimination therefore has fairness in its favour, in addition to being a way of increasing profits for the museum, increasing its financial sustainability.

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