Tag Archives: incentives

05.23.2013 | Price Ceilings: Venezuelan Toilet Paper Shortages

One shopper had to search for toilet paper in 6 stores. Another arrived in a supermarket just after a delivery but was limited to a 4-roll maximum. Attempting to deal with its toilet paper shortage, the Venezuelan government has said it would import 50 million rolls. Because the country’s monthly demand for toilet paper is 125 million rolls, I wonder if 50 million is enough.

In addition…

Venezuela’s Central Bank Scarcity Index indicates that shortages of other items like cooking oil, sugar and cornflour are worsening. Just above 21%, the scarcity index tells us that for every 100 goods, 21 are not available in markets. Correspondingly, with an annual inflation rate close to 30%, purchasing power is sinking.

Venezuela's Scarcity Index from the Atlantic

So where are they? Venezuela’s President Maduro continues to cope with the perverse incentives that are the legacy of his deceased predecessor, Hugo Chavez. Even the recent increase in capped prices by 20% for several basics like milk, cheese, butter and beef had little impact. The gap remains between quantity demanded and quantity supplied.

Even with a 20% increase in prices, if the ceiling is below equilibrium, shortages result.

Our bottom line? Price ceilings lead to immense dysfunction:

Too much quantity demanded.
Not enough quantity supplied.
Huge transaction costs spent when people waste time searching store after store.
Inadequate resources allocated to developing oil wealth.
Factories operating way below capacity.

Sources and Resources: There are so many articles about the toilet paper shortages in Venezuela. Reuters, the BBC, Bloomberg all had something to say while my Scarcity Index is from The Atlantic.

Posted by: adminEcon
Tags: demand and supply, incentives, price ceilings, price controls, shortages, Venezuela
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05.14.2013 | A Mixed Economy: Ownership Incentives

Thinking about our mixed economy in which government and the market intermingle, I have always gravitated to this quote from former Secretary of the Treasury, Lawrence Summers:

“In the history of the world, nobody has ever washed a rented car.”

And now, doing a bit of research on the colonial United States, I wanted to share the same ideas from 18th century economist Arthur Young:

“The magic of property turns sand into gold.”
“Give a man the secure possession of a bleak rock, and he will turn it into a garden; give him a nine years’ lease of a garden, and he will convert it into a desert.”

Finally though, maybe this comment from a blogger at The Economist can take us a step further. His example is a case study on military airplanes and how maintenance workers who had long term oversight of the same equipment felt “ownership” more strongly than specialists who were responsible for the engine or the wing of thousands of aircraft. His point is that it all depends on how the job is structured.

My bottom line? In our mixed economy, can we retain the incentives of “ownership?’

Sources and Resources: I recommend reading the entire blog from The Economist for a full discussion of the origins and limits of the Summers quote. And, for slightly more about Arthur Young, here is a brief bio.

Posted by: adminEcon
Tags: " Lawrence Summers, incentives, mixed economy, ownership, property rights
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05.12.2013 | Behavioral Economics: Menu Incentives

In economics, sometimes psychology comes in handy…

If you were creating a wine list for a restaurant, which order would you select:

Alphabetize everything.
By price, start with the cheapest bottles.
By price, start with the most expensive bottles.
Group by wine type, and then select, from above, one of the first 3 choices.

If psychologists are right, first you should diminish our choices by grouping items. But not too much. Too many items and we might select none of them. Too few and we are dissatisfied. Recent research indicates that at fast food establishments we like 6 items in each category (chicken dishes, pasta, starters…) while in finer restaurants, we prefer selecting among 10 entres.

Next, a reference point is important. Where you start determines how you assess the subsequent selection. One analysis of a menu (below) at Balthazar, a NYC restaurant, explained that they listed a $155 seafood platter at the top right hand side and a $100 platter next to it to create a reference point or an “anchor.” Seen next to the $155 item, people happily select the $100 platter because it appears more reasonably priced. So, for the wine list, place the most expensive bottle first.

Finally, another study indicated background classical music can make a difference. In upscale restaurants, the music seemed to influence more expensive wine purchases. French music even appeared to generate a preference for French wine. Add in slow music and a hint of lavender and people linger more.

Fundamentally, when designing a menu, restauranteurs hope to attract us to their most profitable items, their “stars” and steer us away from popular items that are unprofitable, their “plow horses.” On the Balthazar menu below, their “stars” like the seafood platters and shrimp cocktail initially attract us. By contrast, I suspect they do not want us to order items at the bottom in their “menu Siberia.”

In the menu pdf, here, prices are easier to read than below.

You can see why, in 2002, Princeton psychology professor emeritus Daniel Kahneman won the Nobel Prize in economics (actually called the Sveriges Riksbank–Sweden’s central bank– Prize in Economic Sciences in honor of Alfred Nobel). I recommend his most recent book, Thinking Fast and Slow, as the perfect example of how behavioral economics is the intersection of psychology and economics.

Sources and Resources: This fascinating Guardian UK article describes menu psychology in greater detail while this one provides further analysis of the Balthazar menu.

Posted by: adminEcon
Tags: behavioral economics, Daniel Kahneman, demand, incentives, menu psychology, reference prices and achors
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05.10.2013 | Supply and Demand: Who Responds to Fair Labor Practices?

The Bangladesh building collapse tragedy led me to 3 types of news articles. I wonder what the impact is when you combine them. Please let me know your opinion.

1. Suppliers: Low Cost

The cost attraction of Bangladesh has been tough to resist. At $40 a month, the average Bangladesh worker gets one-quarter of the Chinese entry level wage. Add to that an EU loophole that eliminated duties on imports from Bangladesh and the incentive to produce there multiplied.
You can see why Benetton, facing price competition from H&M and Zara, started using factories in Bangladesh. Even when they placed an order with an Indian contractor, he did some of the manufacturing in Bangladesh. In a 2012 report, McKinsey called Bangladesh the “next hot spot” for manufacturing.
Now, responding to the outcry, firms are saying they will not use their Bangladesh facilities. However, in an NPR interview, a worker advocate in Bangladesh emphasized that she did not want jobs to leave her country. Her people needed the work.

2. Consumers: Low Prices

Bangladesh is one reason shoppers believe there is a $5 t-shirt and a $6 bikini waiting for them. Commenting on the tragedy in Bangladesh, one Primark London shopper said, “They definitely need to improve, but I’ll still shop here. It’s so cheap.” Another shopper, also at Primark, said, “If prices went up I wouldn’t buy from here.”

3. Fair Trade Labels: New Incentives

Researchers from Harvard and MIT concluded that even at outlet stores where they expect affordability, certain consumers are willing to pay more for ethically made clothing. Using data from 111 Banana Republic stores, researchers chose 3 products: A $130 woman’s linen suit, a $12 men’s T-shirt, $18 yoga pants. Buyers of the linen suit were willing to pay $18 more for a fair labor standards label. However, people purchasing the cheaper items were not influenced by elevated labor standards.
I suspect here, we are looking at price elasticity of demand. With higher prices leading to considerably fewer purchases, the demand is elastic for lower priced items. On the other hand, people purchasing a more expensive item demonstrate more inelasticity. For them, a relatively substantial price hike does not affect buying behavior.

So…

We have cheap production costs, low retail prices and burgeoning ethical incentives. How will supply and demand respond?

The World’s Leading Clothing Exporters from WSJ.com

Sources and Resources: Each of my articles ideally conveyed the incentives to which producers and consumers are responding. Bloomberg (quotes source) and the WSJ (graph source, above), here and here, conveyed the cost incentives while the NY Times optimistically (and perhaps unrealistically) presented a burgeoning response to fair trade publicity. You might want to ground all the news articles with these two studies that display for Banana Republic and fair trade coffee what we really buy rather than what we say.

Posted by: adminEcon
Tags: Bangladesh, demand, demand elasticity, fair labor standards, fair trade, incentives, supply
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04.23.2013 | Entitlements: What is the Right Size for the Safety Net?

At the beginning of The Intouchables, we meet an unemployed French worker awaiting a job interview. Uninterested in being hired, he needs a third signature for his benefits form to prove he is looking. Inexplicably, he gets the job and the result is a great movie.

While The Intouchables is not really about entitlements, it took me to Denmark’s dilemma. Long thought to be the ideal welfare state, Denmark’s entitlements include free college, free health care and universal child-care payments. Private businesses can run public institutions and, unlike the French, fire workers freely (which means they will hire more willingly). Still, some Danes are increasingly concerned that public sector perks are diminishing the work ethic.

As a result, during June 2010, Denmark halved the time that you could receive unemployment benefits from 4 years to 2. Displaying why, the following graph shows that the number of people who get jobs spikes just when fired or 4 years later (or 5 years during the 1990s) when they figure they better take any job because their benefits will soon expire. However, because it is tough to go back to work after 4 years, many do not.

Debating the merits of the welfare state, most researchers look at haves and have-nots inside countries. Instead, in this paper, 3 economists look at the impact of the Scandinavian welfare state on other nations. Fascinatingly, they conclude that the world would be less affluent and less innovative (see below) if we all adopted Denmark’s “cuddly form of capitalism.” As they tell us in their last sentence, “we cannot all be like the Scandinavians, because Scandinavian capitalism depends in part on the knowledge spillovers created by the more cutthroat American capitalism.”

From “Can’t We All Be More Like Scandinavians?”

Sources and Resources: For more from those who totally agree with Denmark’s welfare state, I suggest reading this post from Dean Baker and The Economist’s series of articles on Scandinavia. Tilting toward the other side, are these articles (and my unemployment graph), here and here, from the NY Times. But, if you had to choose just one paper to read, I recommend the introduction and conclusion that frame the AceMoglu, Robinson, Verdier paper, “Can’t We All Be More Like the Scandinavians?”

Posted by: adminEcon
Tags: entitlements, incentives, Nordic Welfare State, safety net, The Intouchables, unemployment benefits
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