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    Incentive Matters

    Sep 30 • Regulation, Thinking Economically • 478 Views

    Economics always seems to relate to incentives. Whether looking at demand and supply, or health care policy, or international trade, always we can return to how incentives shape our behavior. This takes me to several good incentive stories.

    An op-ed in the Boston Globe recently described why used car prices are soaring. As a part of the cash for clunkers program, old gas guzzling, fume emitting vehicles had to be destroyed by car dealers when their owners had the incentive to trade them for newer vehicles. The upward sloping supply curve for used cars responded by shifting leftward. In addition, with joblessness soaring, when more people sought “pre-owned” transportation, the demand curve shifted to the right. The result? Equilibrium price is higher.

    In 1989, Mexico initiated a pollution reduction policy for autos. One day weekly, depending on the last number of your license plate, you could not use your car. Incentive? Acquire a second car. Minimally used, that car could be older and less fuel efficient. The second response? Find a second license plate for your car. Third response? Use a taxi. As you might conclude, overall air quality did not improve.

    Here is an 18th century story from Planet Money where government ultimately figures out the correct incentive. Hearing that close to one third of all felons died when they were shipped by sea to Australia from Great Britain, people were horrified. They demanded more onboard doctors, added lemons to cure scurvy, and  delivered sermons encouraging moral behavior. Nothing worked until the payment system changed. “Instead of paying for each prisoner…on the ship…” the government paid for whoever “…walked off the ship in Australia.” Adopted in 1793, the new incentive solved the problem.  

    The Economic Lesson

    If anyone suggests that economics is primarily about money and math, you could suggest looking further. At the core of economics is scarcity. Because there are limited quantities of all land, labor, and capital, we have to make choices. Incentives shape our choices. 


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    More Than Chicken Feet

    Sep 29 • Businesses, Demand, Supply, and Markets, Developing Economies, Economic Thinkers, International Trade and Finance • 385 Views

    Chicken feet are back in the news. But the story is about much more.

    A delicacy in China, chicken feet are a perfect U.S. export. Except for animal feed, there is little demand for them in the U.S. By contrast, the Chinese want our chicken feet. They are fat and juicy because we grow big chickens. In addition, their “natural scarcity” (only 2 per chicken) bestows some prestige on diners who order them.

    As you know, though, our trade relations with China are much more complicated. A year ago, because of a U.S. tariff on Chinese tires, they said they would retaliate by taxing our chicken feet. The result, as reported this week, is a tariff  on U.S. chicken feet which could exceed 100%. The World Trade Organization  (WTO) has been involved because of complaints about the tariffs from both countries.

    Beyond tariffs, the U.S. has expressed concern about China’s undervalued currency and their massive trade surplus with the U.S. However, with so many Chinese savers and a positive balance of trade, China has been a major purchaser of the U.S. debt.

    There is a lot to evaluate when determining our Chinese trade policy.

    The Economic lesson

    David Ricardo’s principle of comparative advantage says that worldwide productivity increases when nations specialize and export the good or service for which they sacrifice the least to make.

    But what if the other country does something unfair–like subsidizing a good or keeping a currency undervalued?

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    Popcorn Margins

    Sep 28 • Businesses, Demand, Supply, and Markets • 373 Views

    Higher quality film? Better projectors? Online ticketing? No. The “most important technological innovation since sound” was the armrest cup holder (according to a movie theater owner).

    Please think about a cup holder. The cup holder makes huge popcorn buckets manageable. With other revenue sources less lucrative, popcorn and other snacks have become the key to profits. Also, through extra salt, popcorn enables theater owners to generate extra soda sales.

    That takes us to one other extra. Calories. At 1600 calories, a medium bucket of popcorn has the same number of calories as 3 quarter pounders and a stick of butter. Recent health care regulation will require posting calories in movie theaters. Do you think their popcorn sales will suffer?

    A note. Theater owners prefer less gripping movie stories so that people are willing to leave for more popcorn and soda.

    The Economic Lesson

    Economists like to say that we make decisions at the margin whenever we do more or less of an activity. For movie goers, thinking at the marginal can involve more or less popcorn, soda, and calories.

    For movie theater owners, consumers’ snacking purchases become marginal revenue. The profit margin for popcorn has been 90 cents for every dollar sold.



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    V.O.D. Wars

    Sep 27 • Businesses, Demand, Supply, and Markets, Regulation • 296 Views

    Usually, for an average of 120 days, theaters have an exclusive right to show a movie. Then, for about $4.99 we can use video-on-demand to see it on television. It sounds simple but so much more is happening.

    It all relates to competition. The first step was preventing us from copying V.O.D. rentals. Also, timing is crucial. With DVD sales plummeting, the studios would like theaters to have a shorter exclusive showing period. Then, Hollywood could generate revenue from a $24.99 premium V.O.D. for new movies available at home after 45 days. Of course theater owners object.

    You can see who is competing here and how. The movie theaters and the movie studios are competing with each other through non-price competition. Also though, competition continues within the movie theater industry and within the movie studio industry.

    The Economic Lesson

    While we theoretically can place business firms in four basic market structures, actually, we have a market continuum along which firm behavior becomes increasingly less competitive.  At the left end of the scale is perfect competition where many small firms with little power have their prices controlled by demand and supply in their entire market. At the other end is monopoly where the firm has considerable price making authority. In between are monopolistic competition and oligopoly.

    Defined as many small to medium sized firms that are similar and yet have a unique characteristic, monopolistic competition is next to perfect competition on the continuum. Next, with markets composed of 8 to 12 dominant firms who have some price making capability, we have oligopoly.

    Where on the competition continuum would you place movie theaters? Movie studios?




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  • What Does Quantitative Easing Do?

    Sep 26 • Money and Monetary Policy • 348 Views

    A quantitative easing limerick:

    “I’m afraid,” said Bernanke to Geithner,

    “The debt crisis still has lots of bite in ‘er.

    Though it may cause some ranklin’

    I’ll print lots more Franklins;

    We’ll loosen our money, not tighten ‘er!”


    When the Fed said “The Committee…is prepared to provide additional accommodation if needed to support the economic recovery and return to inflation…,” Slate’s Plain English Tool said they really meant to say, “We’ll keep an eye on things, and if we need to create trillions more dollars out of thin air to bring down unemployment and pump up inflation, that’s what we’ll do…”

    The Economic Lesson

    The standard story in econ textbooks says that when the Federal Reserve buys treasury securities or other financial instruments (quantitative easing), its goal is to expand the money supply through the money multiplier. Specifically, the Fed buys securities, the money is deposited in banks, reserves increase, more money is available for loans, interest rates fall, and borrowing accelerates.

    But maybe, the standard textbook story is wrong. According to a recent Federal Reserve paper and a speech from a Fed vice chairman, “Bank loans are primarily driven by demand factors. If there is an increase in demand for loans, banks increase their supply of loans…and obtain the funding by issuing uninsured deposits.”(p. 39 from the Fed paper)

    In other words, the key to activating the money multipier could be the demand for money rather than the supply of money. There might sometimes be a correlation between the Fed’s security purchases (quantitative easing) and the money multiplier but not necessarily causation.

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