Why are airlines in the US offering $13 cross-country airfares?

We have moved all teaching online, and my (now fully online) ECONS101 class is marching ahead. The last couple of weeks we have been covering the behaviour of firms with market power (that is, firms that have the power to set their own price). Firms with market power maximise their profits in the short run by setting the price at whatever level allows them to sell the profit-maximising quantity. As we discuss in class, this is the quantity where marginal revenue (MR) is exactly equal to marginal cost (MC). However, next week in my ECONS101 class we'll be looking in more detail at pricing strategy, and in particular we'll be talking about circumstances where it may be better for firms not to operate at the quantity where MR is equal to MC. Often, firms do this for strategic reasons (for example, as I discussed in this post a few weeks ago, about discounted toilet paper).

One strategy that firms may employ is to sell at a much lower price than the short-run profit-maximising price. So, it was interesting to read this article on View from the Wing recently:

One Mile at a Time noted $16 one way fares on American Airlines between Miami and Los Angeles. These are ‘basic economy’ fares that usually aren’t changeable (although they are right now to encourage bookings) and don’t allow advance seat assignments (but with planes empty you can more or less have any seat you wish).

These aren’t even the lowest cross country flights that are out there. For the next 30 days you can buy Fort Lauderdale – Los Angeles for just $12.89. (After that the lowest fare jumps to almost $27.)

As the article notes, those prices are below marginal cost (which is estimated at $20-$25). Why would the airlines offer airfares at below marginal cost? This is clearly not short-run profit-maximising behaviour (and is clearly not the price where MR=MC, since by definition that price must be equal to, or greater than, MC). Even if you take the view that having some consumers is better than none if the flight is going to fly anyway, selling tickets at below marginal cost would still make the airlines worse off than keeping the seats empty (because the cost of providing that seat, MC, is less than the price).

So, the airlines must be making a strategic play here. The article offers six possibilities, but I find these two the most persuasive:

1. Avoid shutdown. They want to show they still have some passengers, that people still need to get around, so that the federal government doesn’t order total shutdown of airlines. A shutdown is itself costly because it means parking planes and prepping them for storage, and pilots lose their ‘current’ status without enough takeoffs and landings.

2. Persuasive for a bailout. Consumer demand will be part of their application for bailout funding. The legislation has been passed but airlines still have to apply and their applications need to be approved.

If airlines are looking to profit-maximise and taking a long run perspective, then both of these options make sense. After all, for most airlines right now, they are concerned about their very survival. Even though they may be making losses on every passenger in the short run, avoiding being shut down completely and strengthening their case for a government bailout may result in higher profits (or, let's face it, lower losses) overall. At the least, it might help them survive into the future.

Firms' pricing strategy in the real world often isn't as simple as the MR=MC condition makes it seem. A broader perspective is often necessary for us to understand the complexity of pricing strategy, especially when firms like these airlines appear to be deviating significantly from short-run profit-maximising behaviour.

[HT: Marginal Revolution]

Subtitles help in learning a second language

If you've ever watched a movie or television show in a foreign language you're not confident in, you'll appreciate the value of subtitles. And if you've ever watched a dubbed movie or television show (with a voiceover in your language rather than the original language), then chances are you prefer subtitles (at least, I do!). But, have you ever thought about whether reading subtitles while listening to the foreign language helps your language skills?

That's the topic of this 2019 article by Augusto Rupérez Micola (Luxembourg School of Finance), Ainoa Aparicio Fenoll (Collegio Carlo Alberto, Italy), Albert Banal-Estañol (Universitat Pompeu Fabra, Spain), and Arturo Bris (IMD, Switzerland), published in the Journal of Economic Behavior and Organization (ungated earlier version here). Noting that, after World War II, most countries decided whether to dub or subtitle English-language films and television shows and have not changed their practice since, they compare the average English language proficiency of people from 'dubbing' countries with the average English language proficiency of people from 'subtitling' countries. English language proficiency is measured by the average score of people from each country who attempted the online TOEFL (Test of English as a Foreign Language) exams. Controlling for education spending, 'proximity' of the language to English (linguistically), and a number of other variables, they find that:

...a change from dubbing to subtitling translation mode in a country improves test scores by 16.9%.

The TOEFL test breaks down English language ability into reading, writing, speaking, and listening. Looking at those four domains, they find that:

All coefficients are positive and significant. The highest effect is found for listening (25.2%), followed by reading (18.3%), writing (12.6%), and speaking (11.9%). The coefficient for listening is significantly higher than the one of the average effect (16.9%).

Their instrumental variables estimates make these results plausibly causal, rather than simply correlations. So, subtitles appear to help with language learning, especially in terms of listening skills, which is what you would expect theoretically. So, I guess that when I used to find my daughter watching anime instead of studying, and she argued that it was helping her practice her Japanese, I was right to let it go.

[HT: Marginal Revolution]

The U.S.-Mexico border fence and homicides in Mexico

On Tuesday, I posted about the effect of coronavirus on the price of illegal goods, particularly in Mexico:

When goods (or people) become more difficult (more costly) to transport, the equilibrium price of those goods and services will rise. That is the case even when those goods and services are illegal.

Stricter policing of border controls make goods more difficult to smuggle. Even something as simple as building a fence will increase the costs of smuggling, even if only fractionally. Building a fence in some parts of a border, but not others, changes the incentives for smugglers, in terms of where the best places to cross the border are located. And if smugglers want to change their location, they may come into conflict with their rivals. That is the context for this recent working paper by Benjamin Laughlin (University of Pennsylvania).

Considering the construction of 649 miles of border fencing over the period from 2007 to 2011 resulting from the Secure Fence Act, Laughlin looks at how the number of homicides changed in Mexican localities within 10km of the border, before and after the construction of the fence. He finds that:

With both dependent variables [logged homicides, and homicides per capita], the localities with access to alternate smuggling routes suffered a significant increase in lethal violence that persisted for over two years. At the same time, localities near the new border fence saw a decline is violence.

Laughlin doesn't make clear in the working paper the size of the effect. Eyeballing his figures, it looks like around 2 additional homicides per 10,000 people per half year. My back-of-the-envelope calculation suggests that the additional border fence increased homicides by nearly 2000, [*] which is an appreciable amount. Laughlin argues that this arises because:

 ...the border fence restricts drug smuggling routes, which increases the value of alternate routes that circumvent the border fence. As a result of this change in the value of territory, competing drug cartels fight for control over territory that provides access to alternate smuggling routes, which leads to a spike in fatal violence. Over time, a new equilibrium is reached as cartels settle on an arrangement over territory sharing, and fatal homicides will subside.

That last sentence is important, because it explains why the increase in violence in areas without a border fence lasted for just two years before returning to the baseline level. His results are robust to the use of different control groups (of localities), and robust to controlling for the intensity of law enforcement in Mexican localities, and the capture of cartel leaders.

When Donald Trump declared in 2016 that the U.S. would build a wall and make the Mexicans pay for it, many people scoffed. However, based on these results it appears that even if the Mexicans don't have to spend a dime on wall construction, they will probably end up paying a high price.

*****

[*] In Laughlin's dataset, the average locality with no new border fence has a population of 2142, and there are 1144 such localities, which means a population-at-risk of 2,450,488. At my estimated two additional homicides per 10,000 population, that is 490 additional homicides. The model is based on half-years, so for two years that is 1960 additional homicides.

$13 cauliflower is just the beginning

Cauliflower was in the news today, for being sold at the incredibly high price of $13. That's pretty extreme of course, and may be an example of the supermarkets taking advantage of their market power. On the other hand, higher prices are an inevitable consequence of the situation we find ourselves in (and weirdly, high cauliflower prices in March seems to be a thing, as I've posted on this same topic twice before, here and here). On Tuesday I posted about the costs of illegal goods rising because of coronavirus. But legal goods are going to be hit by higher prices too. This article in The Conversation, by Michael Rose (Australian National University) outlines a number of reasons why, but this one is most relevant:

The major variable in whether the coronavirus crisis will hurt fruit, vegetable and nut supplies (and prices) depends on how they are picked while the nation’s border remains closed to the foreign seasonal workers on which Australian farmers depend...

Rural Australia’s dependence on the muscles of tens of thousands of backpackers and workers on temporary working visas is sometime minimised by official statistics...

The indefinite closure of Australia’s borders to non-resident foreign nationals jeopardises this supply of farm workers.

Pretty much the exact same dynamics will play out in New Zealand. Much of our horticulture industry relies on migrant labour, and the border closures mean that the labour is either not available, or is going to be more expensive if it is. Even if you believe that local workers laid off as a result of coronavirus could pick up the slack, local workers have proven unwilling to take up these jobs in the past (which is why we have migrant labourers doing this work in the first place). Rose quotes migration researcher Henry Sherrell in reference to Australia:

 “In theory, Australians laid off in the many sectors now facing recession could head for the countryside and start picking fruit,” he argues in an article co-authored with Stephen Howes, an economics professor at the ANU Crawford School of Public Policy.

"In practice, it is just not going to happen. The work is difficult, and farms often geographically isolated. It would take years not months to change the reality that farm work is just not in the choice set of most Australians – who, after all, live in one of the most urbanised and richest countries in the world."

A lack of horticulture workers, or more expensive horticulture workers, raises the costs of production of fruit and vegetables. This looks the same as in the demand and supply model I posted on Tuesday,

A decrease in supply of fruit and vegetables (from S0 to S1), leading to an increase in price (from P0 to P1). You may be worried about $13 cauliflower, but it is just the beginning.