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    Pricing Airline Tickets

    Aug 27 • Businesses, Demand, Supply, and Markets, Economic History • 224 Views

    During the 1970s, a ticket to fly between New York and Washington, D.C. cost $50 whereas one between Los Angeles and San Francisco-almost twice the distance-cost only $40. 


    Before deregulation in 1978, the interstate airline industry was subject to extensive regulatory control from the Civil Aeronautics Board (CAB).  For interstate travel, the CAB had to approve an airline’s decision to add or delete a route or to change a fare. Preserving profitability and service to large and small cities were government priorities. However, for intrastate travel, the market determined the price. As a result, intrastate flying tended to be cheaper.

    Fast forward to 2010. With government primarily regulating safety, the market shapes most other airline decisions.  According to the Wall Street Journal, four variables affect airline ticket pricing: 1) Competition from low-cost carriers for a specific route (When Southwest selects your route, fares drop.) 2) The number of carriers in the market for a specific route (More carriers…lower fares) 3) Whether passengers are discretionary or business travelers 4) Operating costs that would include landing fees and other airport expenses.

    The Economic Lesson

    A competitive market structure shapes a firm’s behavior. When government ran the industry, firms tended to behave like monopolies They had guaranteed profits, behaved inefficiently, and charged high prices.

    Now, with the market in charge, different routes have different market structures. When several airlines compete, and especially if one of those airlines is a discount carrier, fares tend to decrease. By contrast when the market is an oligopoly or one firm dominates, fares rise because the firm has more power. 

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    FDR and Obama: Similar or Different?

    Aug 26 • Economic History, Government, Macroeconomic Measurement, Money and Monetary Policy • 240 Views

    If this were 1930 or 1931, you would think you were experiencing a cyclical downturn–not a Great Depression. In an econtalk interview, Stanford’s David Kennedy begins this way, placing the listener in a contemporary context. Instead of looking backward at the Great Depression, we look forward to the 1930s.

    I recommend this podcast because Dr. Kennedy and George Mason economist Russ Roberts discuss facts from the 1930s that relate to today. Then we, as listeners can decide how contemporary economic policy and politics compare to that era. Kennedy alludes to “Black Swans“. If the Great Depression was perhaps the greatest Black Swan, how will this Great Recession compare? 

    Looking at presidential policy, he says we make President Hoover worse than he was and FDR better. While Hoover wound up not doing enough, he did initiate policies to fight the downturn and the Smoot-Hawley Tariff. By contrast, Dr. Kennedy reminds us that when FDR was president, unemployment remained high and production sluggish. Dr. Kennedy hypothesizes that perhaps FDR cared much more about creating a safety net for the bottom third of the economic population fighting the depression. After all, during the Roosevelt presidency the Social Security Act, Fannie Mae and the SEC were created.

    Do we have parallels? A cyclical downturn or a longer recession/depression? A minor black swan or a significant one? A president who cares more about the recession or a social agenda?

    The Economic Lesson

    As economic historians, our perspective changes when we look forward rather than backward. We see that when the stock market crashed and production declined in 1929, Herbert Hoover believed we were undergoing the beginning of a business cycle contraction, similar to many others. When FDR entered office during 1933, many worried about a balanced budget and federal spending. Meanwhile, the Federal Reserve was at best ineffectual.

    In December, 2007 our GDP started to decline and by the summer of 2008 financial markets were experiencing turmoil. After a 2009 stimulus package, we are debating whether more spending or austerity is the best policy.

    Looking at the past, we have implemented fiscal and monetary policies that do indeed reflect a grasp of the inadequacies of the past. But, I have to wonder what economic historians will say when they look back at us.


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    Overhead Problems

    Aug 25 • Businesses, Labor, Thinking Economically • 323 Views

    You’ve probably heard the story. Fed up, a flight attendant tells passengers what he really thinks of them, grabs a beer, presses the button for the emergency chute, and leaves the plane. The overhead storage bin might have been the reason.

    Overhead bins create frustration for everyone. They increase boarding delays. A cascading overflow can be dangerous when doors pop open. Attendants have to restrain impatient fliers from grabbing a bag before the plane has stopped. A cost saving fast turnaround for aircraft is delayed by passengers having to retrieve their paraphernalia. Deplaning is agonizingly slow.

    An economist would disagree with a NY Times solution: “Carry-Ons and Courtesy Need to Co-Exist“. Instead, incentives have to change. Because checked baggage generates huge revenue, airlines have the incentive to charge. Responding, passengers have the incentive to take more onboard. One solution? Spirit is charging for carry-ons. Your opinion?

    The Economic Lesson

    Two economic concepts explain the problem:

    1) The fallacy of composition states that what is good for one is bad when everyone does it. An example is fleeing from a fire in a crowded movie theater. One person, alone, can quickly leave but everyone together cannot. Similarly, one person can enjoy the plane’s overhead bin but everyone together cannot. When airlines decided to charge for checked luggage, they worsened the fallacy of composition.

    2) A negative externality is a cost to a third party because of the unrelated agreement between 2 other individuals. Here, the airline agrees with you or me that it is okay to bring baggage onboard. The result, though, is a cost to other passengers and the flight staff. On an aircraft, the negative externalities multiply geometrically because everyone is creating them.


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    The Locavore Challenge

    Aug 24 • Environment, Households, Thinking Economically • 205 Views

    Being a locavore is not always easy but it can feel very good. Those of us who are locavores believe that we are helping the planet by saving on transport costs and emissions, patronizing small businesses rather than distant impersonal corporate giants, and eating healthy fresh food. In many ways, locavores can have their cake and eat it too (although it usually is broccoli and local produce). While buying good, healthy food, locavores are helping the planet…

    But are they?

    In a recent post, I suggested cost/benefit analysis of environmentally friendly preferences such as wind farms, ethanol production, and buying local. Instead, though, we can let price do it for us. As economist Steve Landsurg points out, for local food purchases, cost/benefit analysis involves an undoable amount of research about “land, fertilizers, equipment, workers, transportation and energy costs” and still we would not have considered everything.

    Using a tomato as an example, Landsburg explains that the price conveys all we need to know. Assume, for example, that the local tomato laborers would have been more efficient growing grapes. As a result, the tomato supply curve would shift up and to the left because of lower production, and the price of the tomato would increase. You don’t have to ask specifically about cost and benefit because a high or low price provides the answer.

    The Economic Lesson

    Cost is more than money. Economically defined, it is sacrifice. The cost of a decision is the next best alternative that you sacrificed.

    Because the vast assortment of “costs” that relate to producing a good or a service affect the price, consumers who care about the environment can optimize decision making by considering the dollars they are spending. Indeed, all of us can look at a price as a source of information about the good or service we are purchasing. We can use price to become a better locavore.

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    The Two Sides of ZIRP

    Aug 23 • Economic Debates, Money and Monetary Policy • 211 Views

    Hearing economists discuss the Fed’s zero-interest-rate policy, Harry Truman would again search for a one-handed economist.

    On the one hand…if you can borrow money cheaply, you are more likely to expand your business and buy a house or a car. Especially during a recession, low interest rates can encourage business expansion and consumer loans. As a source of economic stimulus, many believe that zirp is desirable.

    On the other hand…households and businesses that have income based on interest rates are suffering. Historically, savers have been able to earn an average of 3 percent. Now, they receive close to 0% when they invest in such financial instruments as short term treasury securities, The problem? If we look at what they could have earned, savers have lost a total of $350 billion annually–350 billion that would have been saved or spent.

    For countries also, there are two sides. According to the Bank for International Settlements (BIS), countries with zirp, such as the U.S., can borrow money very cheaply. Also though, other nations such as Australia that pay higher interest rates, can lure investors away from lower yielding securities elsewhere.

    The Economic Lesson

    The interest rate is the price of money. When an economy experiences rapidly rising prices, central banks usually increase the price of money to constrain spending. Recession, by contrast, requires a lower price of money (interest rate) in order to stimulate business and consumerr spending. 

    The Federal Reserve has three traditional tools to affect interest rates in the U.S. 1) It can change the amount of money that banks have to keep in reserve. 2) It can change the interest rate that it charges banks when they borrow the Fed’s money. 3) It can enable banks to have less to lend by selling them securities or more money to lend by buying securities from banks.

    During the recent recession, the Federal Reserve expanded the contents of its monetary policy “toolbox”.

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