Thomas Schelling on equilibrium

I've been reading Thomas Schelling's book "Micromotives and Macrobehaviour". Usually I would wait and write a review (which I will later), but in this case I wanted to share a quote from the book now rather than wait. Schelling was an excellent writer (as many others noted at the time of his death - see here for some links), and this bit on equilibrium is important, particularly given that economics is often criticised for the focus on equilibrium outcomes (that may never arrive):

The point to make here is that there is nothing particularly attractive about an equilibrium. An equilibrium is simply a result. It is what is there after something has settled down, if something ever does settle down. The idea of equilibrium is an acknowledgement that there are adjustment processes; and unless one is particularly interested in how dust settles, one can simplify analysis by concentrating on what happens after the dust has settled...

There may be many things wrong with "equilibrium analysis", including the possibility that it oversimplifies by neglecting processes of adjustment, or exaggerates the prevalence of equilibrium by neglecting shifts in the parameters that determine the equilibrium. But nobody should resist "equilibrium analysis" for fear that, if he acknowledges that something is in equilibrium, he will have acknowledged that something is all right. The body of a hanged man is in equilibrium when it finally stops swinging, but nobody is going to insist that the man is all right. An unnecessary source of distrust of economic analysis is the assumption that when an economist discusses equilibrium he is expressing approval. I believe that assumption is usually - not always, but usually - a mistake.

Well said. More on Schelling's book to come in a future book review post.

The minimum wage increase and the 'right' measure of inflation

The minimum wage increases to $15.75 per hour on 1 April. The New Zealand Herald had an interesting article yesterday on this:

It will deliver $65m a year in higher wages for the 119,500 people now earning below $15.75 an hour - implying that private employers will have to pay about $35.6m extra on top of the extra cost to taxpayers.

The 3.3 per cent increase from the current minimum of $15.25 a year is at the high end of expectations, considering that consumer prices rose by only 0.4 per cent in the year to last September.

Business NZ urged the Government to keep increases to "no greater than inflation as measured by the consumers price index" until a full review of the minimum wage policy.

Should we be comparing the 3.3 per cent increase in the minimum wage to the 0.4 per cent increase in consumer prices? I argue not, for three reasons.

First, and most obviously, new inflation data out today shows that the annual rate of inflation in the December year was actually 1.3 per cent. But this is far from the most important reason.

Second, the CPI measure of inflation does not take into account the (rapidly rising) cost of home ownership, so certainly understates the increase in the cost of living. And as noted by the New Zealand Initiative, reported here:

New Zealand is not really suffering from an "inequality crisis" but instead a crisis of rising housing costs hurting the poor more than the rich...

That's still not the most important reason though, since I imagine that most people earning the minimum wage are not homeowners (at least, not in Auckland given the out-of-control house prices there!). Rents are included in the CPI, so it probably does reflect changes in the cost of living for renters on the minimum wage.

Third, and most important, the CPI measures the level of consumer prices for all consumers on average. And no one is an average consumer. Fortunately, Statistics New Zealand now publishes a series of household living-cost price indexes. The latest data is from the September 2016 quarter (when overall the CPI increased by 0.3 per cent), so we can expect the latest numbers when they are released to be somewhat higher. The great thing about these indexes is that they show the change in prices experienced by different households, including by income level. This is based on the prices most relevant to households within that group (so you can look at a price index for beneficiaries, superannuitants, etc. as well as by income quintile).

Someone on the minimum wage full-time is likely to be in the lowest income quintile (the bottom 20% of income earners). For the September quarter, their price index increased by 0.5 per cent, which was greater than the 0.1 per cent for all households (and the 0.3 per cent for the second quintile). In fact, in almost all quarters going back to the start of that data in 2009, lower income households have experienced a higher rate of price inflation than all households on average.

So, quite apart from arguing that we should be narrowing the gap between the minimum wage and a living wage (however measured), it is appropriate that the minimum wage rises faster than the overall increase in consumer prices, simply because the prices relevant to lower income households generally have been rising faster than the rate of inflation overall.

Sir Tony Atkinson, 1944-2017

I was saddened to hear of the passing of the British economist Sir Tony Atkinson recently. Atkinson was one of the giants of the economic analysis of poverty and inequality and a sometime co-author of both Thomas Piketty and Joseph Stiglitz. His latest book, "Inequality: What Can Be Done?" is currently sitting in my to-be-read-soon pile (along with Branko Milanovic's latest book on global inequality). The Financial Times has a good obituary of Atkinson. Here's one bit:

For more than 50 years Atkinson battled for economics to take poverty and inequality seriously, crediting his interest in the subject to a stint of voluntary service working at a deprived hospital in Hamburg in the mid-1960s. From 1967 when he took up a fellowship at St John’s College, Cambridge, he dedicated himself to the theory and the practicalities of understanding differences in society.

Tutor2u.net has collected tributes to Atkinson here, and this piece by Beatrice Cherrier is a nice reminiscence that covers his many contributions. He will be missed.

Birkin handbags and the signalling value of Veblen goods

I was recently interesting by this Brooke Unger article published in 1843 magazine last year, about the economics of Birkin handbags. The usual story about very high-end luxury goods (like Birkin handbags) is that they are Veblen goods - goods where the extremely high price is a signal of the high status of the purchaser. This conspicuous consumption can come in many forms. However, when it comes to Birkin handbags it turns out there is more to the story than simple conspicuous consumption:

So-called Veblen goods reverse the normal logic of economics. With most goods, demand falls as price rises; with Veblen goods, the higher the price, the higher the demand, for the more expensive they are, the more effectively they proclaim the status of their owners. The gap between the cost of producing a Birkin and the price tag suggests that it falls into this category.

Yet in a couple of ways, Birkins do not look like classic Veblen goods. First, they’re not all that conspicuous. Almost everyone can identify the provenance of Gucci’s double-G spangled Dionysus shoulder bag; only initiates can spot a Birkin. So Veblen’s theory needs to be adapted to explain the power of inconspicuous but expensive goods. The authors of “Signalling status with luxury goods: the role of brand prominence”, which appeared in the Journal of Marketing in 2010, do so by dividing the rich into two groups: “parvenus”, who want to associate themselves with other rich people and distinguish themselves from have-nots, and “patricians”, who want to signal to each other but not to the masses. They theorise that more expensive luxury goods, aimed at patricians, will have less obvious branding than cheaper ones. Sure enough, they found that Gucci and Louis Vuitton charge more for quieter handbags and Mercedes slaps bigger emblems on its cheaper cars. People who cannot afford luxury but want to look as if they can (“poseurs”) go for big logos: counterfeiters usually copy louder goods.

The interesting bit is that the luxury goods that people buy depend on to whom they want to send signals. Remember that a signal is only effective if it has two characteristics: (1) it is costly; and (2) it is costly in a way that makes it unattractive for those with 'low-quality' attributes to attempt. With a Birkin handbag, the first characteristic is assured. What about the second? One of the ways the second characteristic can be achieved is if it is more costly (in some way) for those with 'low-quality' attributes. Which brings me to this bit from the article:

You cannot walk into an Hermès boutique and expect to walk out with a violet ostrich 30cm bag with palladium hardware, or indeed a Birkin of any description. You have to place an order, and wait. Hélène Le Blanc, then a lawyer working in Paris, was initially rebuffed when she approached the flagship shop in Faubourg Saint-Honoré several years ago. Once she persuaded the saleswoman that she was serious, and willing to wait, she was presented with binders filled with leather samples and hardware options, and allowed to place an order...

In an episode of “Sex and the City” from 2001 Samantha jumps a five-year queue by claiming she wants the bag for actress Lucy Liu.

Yes, the second bit of that quote is fictional, but let's say for argument's sake that celebrities and other sought-after clientele don't have to wait as long to get a bag. The time spent waiting is part of the cost, so if you are an average Jane wanting a Birkin bag, then the waiting time will be longer (and hence the cost for Jane will be higher than for a celebrity).

This bit also struck me:

But as Solca observes, there are good commercial reasons why rationing by queue rather than price can make sense. First, it gives Hermès a buffer: even if demand drops, sales will not. Second, it creates surplus demand for the bags, which overflows into demand for other Hermès products. Much of the firm’s business consists of selling consolation prizes: wallets, belts, beach towels and so on. As J.N. Kapferer of the Inseec Luxury Institute in Paris observes, the wait induces “impatient buyers to switch to other products of the brand, to calm their hunger until the much-awaited object of desire is achieved.”

In ECON100, we talk about selling complementary goods as a way of capturing value and increasing profits, and this is another example of that. Again, the unwillingness to wait for the handbag (and instead buying a belt or beach towel) further demonstrates the signalling value of the handbag itself.

[HT: Marginal Revolution]