Recently in Economics--Micro and Markets Category

For more on the continuing story of Amtrak's growing popularity in the wake of higher gas prices, we turn to today's Wall St. Journal, which says...

WASHINGTON -- The number of people riding Amtrak surged 13.9% in July from a year earlier, as high gas prices caused more commuters to rely on intercity rail.

...

In July, Amtrak said, only one of its services saw fewer riders compared with the previous year. Elsewhere, there were major gains, such as a 33% jump on the Capitol Corridor between San Francisco and Sacramento, Calif.

Even on Amtrak's already heavily traveled Northeast Corridor line from Washington to Boston, passenger counts are up by nearly 8% over last year. Overall, Amtrak is on pace to serve a record 28 million passengers in its current fiscal year, up from the previous high of 25.8 million last year.

Amtrak's newfound popularity has made an impression in Congress, where lawmakers view the rail service as an environmentally friendly, energy-efficient approach to reducing gridlock and expanding transportation options.

The trains serving Macomb (the Illinois Zephyr and the Carl Sandburg) continue to sell out. The advice around here is to get your tickets well in advance.

Of course I have tried to accomplish some things on my summer break as well. In addition to doing a little research, I sat down and knocked out another Mathematica demonstration. You can download it from the Wolfram demonstrations website.

This one was actually pretty easy to do. It's a neat way of looking at how the coefficients of the cubic total cost function affect the average and marginal cost curves. If you use it in class, let me know!

Gas prices are up. So is Amtrak ridership. (Macomb Journal)

If there is any good news about $4 per gallon gasoline, it is that ridership on Amtrak is booming.

...

Ridership on the Illinois Zephyr and Carl Sandburg routes was up 41.4 percent in fiscal 2007, compared to fiscal 2006. Ridership on Illinois state-subsidized routes increased another 180,823 passengers during the first two-thirds of fiscal year 2008, to a total of 670,605.

When I ride the Illinois Zephyr or the Carl Sandburg, it is typically packed. Last time I rode, there were just a handful of empty seats.

I enjoy riding the rails. It's faster than driving, and without the hassle of driving. We don't drive to Chicago anymore if we can avoid it. Take the train!

UPDATE: Stephen Karlson has much more.

And now for something completely different...

One type of post that gets people talking is when I discuss the teaching of economics. So a few posts back, I pointed out that the NY Times confused "demand" and "quantity demanded". The Times wrote:

An open letter signed recently by more than 100 economists said the proposed tax holiday would do little to reduce gas prices. In part, that is because a fall in prices would lead to more demand, which would cause prices to return to their earlier level. The result would be that overseas oil-producing governments would get money now flowing to the United States government in gas taxes.

And I said:

The whole sentence about demand is the sort of circular statement that we caution our students not to make but that newspapers print all the time. Not only is it a terrible misstatement of demand vs quantity demanded, it's not even consistent with the claim (advanced by Krugman among many) that supply is fixed.

John Whitehead pointed out something similar in another story. After taking a little heat in the comments, he links back to me approvingly.

Why the heat? Well, I have to admit that when an economics professor starts to pontificate on demand vs quantity demanded, it tends to border on the pedantic. I know it does. I can't stand it, but I do it anyway. Why? Because the misunderstanding often leads to circular reasoning as it did here. You argue that prices fall, which causes demand to rise, which causes prices to rise and you're back to where you started.

Every principles of economics textbook seems to have a homework question devoted to identifying and critiquing that sort of circular reasoning--often from a real-life example like this.

So we've got a a real problem with the terminology here. It's made worse by the fact that the principles textbook terminology has absolutely zero chance of catching on in the wider world. Face it, journalists are not going to use demand and quantity demanded correctly in an Econ 101 sense. Not going to happen. But we need to figure out how to educate them to avoid making hideous errors even if they don't use Econ 101 terms.

I have addressed this before.... Digging into the archives for Polley's greatest hits of November 2005:

Stephen Karlson (Cold Spring Shops) links to Phil Miller's (Market Power) post and mine on a common media mistake. Karlson adds this,

...the source of the confusion in many observers' minds might be in the terminology of introductory economics (and nowhere else in economics) itself.

Much of the discipline refers to the act of drawing a new demand or supply curve as a "change in demand (or supply)," sometimes calling that an "increase" or "decrease" in demand or supply. A new choice along the same demand or supply curve goes by the cumbersome locution "change in quantity demanded (or supplied.)" Bleah. I recommend the use of the term "shift" to describe the drawing of a new curve, and I'm continually reinforcing "left shift" and "right shift" as "increase" and "decrease" have the potential for mischief on the supply curve. A new choice along the same curve is a "movement along."

I agree. Bleah. He is absolutely right that this terminology is only an issue at the introductory level. Why, you ask? Long story. At more advanced levels, the mathematics forces you to keep track of what is going on without resorting to these labels. That's part of it. We (those of us who teach this) also just tend to obsess over making sure students shift the right curve. These labels, properly used, do force you to be clear about what you're doing. But I agree with Karlson that there has got to be a better way.

Unfortunately, "shift" is not likely to catch on with journalists either. That only makes sense if you're thinking of the curve, and most of their readers aren't thinking that way. So I'm still puzzling over this one. Your suggestions, and any discussion on the topic, are very welcome.

Anyway, back to the article at hand, it is true that the writer confuses demand and quantity demanded. But the greater sin is that the passage was not even consistent with the main critique of the tax holiday. And I don't think that these errors are unrelated. Sloppiness begets sloppiness. Once you introduce that circular logic, the next step is more likely to go off-track. If anything, that's why professors need to continue to instill some professional discipline in the use of language to describe supply and demand.

We just need to come up with something that resonates better with journalists.

A summary of all of my recent comments on the proposed gas tax holiday is as follows:

1. The benefit to the consumer would probably not be literally zero. (This is the part everyone has been seizing on as the most charitable thing being said about the proposal. Ok, so be it. If you call that charitable, you go ahead and run with it. See where it gets you.)

My reason for saying it would not be literally zero is that there is evidence that inventories are higher than usual and that capacity utilization is lower than a couple years ago. The system is probably capable of squeezing out a few more barrels, but not terribly many.

I would also add that the open letter signed by over 100 economists says, "...research shows that waiving the gas tax would generate major profits for oil companies rather than significantly lowering prices for consumers." I have already said that I agree with that letter, and I think they were correct (but subtle) in saying that it would not significantly lower prices, leaving open the very sensible possibility that there might be a very small benefit. I fully agree with their wording.

2. While not literally zero, the consumer benefit is likely to be very small. I'd say a third or less of the total (half of what these authors found concerning the Illinois tax holiday in 2000). And I would probably bet the "under" if it came to that.

3. Good public policy should be well outside of the neighborhood of "pointless". (That is, the effects should be economically as well as statistically significant.) This proposal fails, even under my most charitable assumptions.

4. A tax holiday at the federal level will have less impact than the state tax holiday Illinois had in 2000. Then, gasoline could be diverted to Illinois from other states. That's harder to do at the national scale.

5. The average consumer will absolutely NOT notice the difference. Differences in price between locations and over time in the last couple weeks have far exceeded my most charitable estimate of the gain. Econometric studies would be done after the fact. There would be t-statistics, p-values, arguments over assumptions, and in the end some very small, but probably positive, estimates.

In short, I stand by my statement that consumers would likely see a couple (maybe even a few) pennies worth of benefit. But most importantly, the point I was trying to make was that this: This proposal does not have to be literally pointless for it to be a really bad idea. I think that is a worthwhile point to make.

But again, the relevant question is how much the price would have to fall to get consumers to buy up whatever increase in production would optimally be obtained if the tax were temporarily gone. That is, I think, the clearest statement of the question--and the answer is not much.

UPDATE: I have sent a message adding my name to the open letter.

I posted this as a comment at Angry Bear.

The real question is this: How much would gas prices need to fall in order to induce consumers to buy up whatever additional production would be optimally squeezed out of the refineries if the gas tax temporarily went away?

When you think about it that way for a little bit, it becomes easier to see that the answer is probably greater than zero, but not much.

The most recent data point on refinery capacity from the EIA was 85% in February. Unless things have ramped up immensely in a way that hasn't been seen for years (which due to the higher than average inventories, I doubt is the case), then I am a little bit skeptical of claims that the supplies, even in the short run, are "fixed". (Get this data and more from the EIA.)

From the summer of 2006 to the summer of 2007, inputs of crude oil into the refineries went down, operable capacity went up, and idle capacity went up.

If capacity utilization were on the level it was in 2000, I'd be more inclined to see the supplies as fixed. Any extra capacity would suggest that the consumers would get some benefit from the tax holiday. But again, let me be very clear... the amount that the consumer would benefit would be a small fraction of the tax reduction--5 or 6 cents out of the 18.4 would be as high as I would be comfortable in guessing. Maybe more like 3 or 4 cents. That's just not enough to justify temporarily tinkering with the tax code to win political points. It's bad public policy. If you want to provide relief to working families, fine. There are a dozen better ways.

While looking for something else, I came across this from the Congressional Budget Office...

Various media reports are incorrectly attributing to CBO a figure (that the average driver would save about $30 this summer) associated with a gas tax holiday. CBO has not published such a figure and the citations to CBO are inaccurate.

This misattribution raises a larger point. CBO is a nonpartisan organization, and we are not in the business of scoring or evaluating campaign proposals. In some cases, CBO may have previously estimated or evaluated a proposal similar to one subsequently proposed in a campaign and those estimates generally are available on our website.

The bottom line: If you read something suggesting that we have issued numbers or an analysis about a campaign proposal, you should be skeptical — and also let us know.

Jabberwonk posts the open letter signed by a number of economists opposing the gas tax holiday. Here's the key paragraph.

There are several reasons for this opposition. First, research shows that waiving the gas tax would generate major profits for oil companies rather than significantly lowering prices for consumers. Second, it would encourage people to keep buying costly imported oil and do nothing to encourage conservation. Third, a tax holiday would provide very little relief to families feeling squeezed. Fourth, the gas tax suspension would threaten to increase the already record deficit in the coming year and reduce the amount of money going into the highway trust fund that maintains our infrastructure.

Read closely all of the reasons behind why so many economists oppose the gas tax holiday.

Now look at how the NY Times summarizes it.

An open letter signed recently by more than 100 economists said the proposed tax holiday would do little to reduce gas prices. In part, that is because a fall in prices would lead to more demand, which would cause prices to return to their earlier level. The result would be that overseas oil-producing governments would get money now flowing to the United States government in gas taxes.

The whole sentence about demand is the sort of circular statement that we caution our students not to make but that newspapers print all the time. Not only is it a terrible misstatement of demand vs quantity demanded, it's not even consistent with the claim (advanced by Krugman among many) that supply is fixed.

The Times' statement that oil producing countries would get some of the gain is only true insofar as gasoline production (and therefore oil consumption) would actually increase. As I have pointed out, that effect is likely to be small though positive. I wouldn't call it my main objection to the tax holiday. The open letter is careful to say that "it would encourage people to keep buying costly imported oil and do nothing to encourage conservation," in effect implying that it spending on oil could stay the same as the "fixed supply" adherents would suggest.

Students writing term papers often rephrase the words in an article that they cite, and occasionally the rephrasing ends up changing the economic meaning of the passage (sometimes with comic results). I see this all the time. If I had a nickel for every time I said to myself while grading, "That's not what that article really meant, was it?" I'd have a pretty big collection of nickels. Likewise when I read the Times article, I immediately said, "That can't be what was written in that open letter, can it? No economist would say it that way." Indeed, they did not.

I suppose the Times could say that the paragraph in question was not a summary of the letter but their own analysis. But that would be just as bad, wouldn't it?

Bottom line: Members of the media sometimes have trouble quoting economists correctly because we don't always fill in all the blanks. The media (and students writing term papers) want to fill in those blanks, and sometimes they get it quite wrong. Understanding that people want to fill in those blanks (and understanding the ways that they are tempted to do so) goes a long way toward making you a better communicator of economic ideas.

We've been tough on the "McCain-Clinton gas tax holiday". We economists, that is. Seems there's not one of us who thinks it's a good idea. It's just plain bad public policy. The actual effect will be small. A family that goes through two tanks of gas a week might see a difference of maybe a couple dollars a week under the best case scenario (full explanation here). If you want to give working families some relief there are certainly better ways to do so. A check for $50 for every family with less than $50,000 income would be better targeted, subject to less uncertainty, and would have a larger effect. Just about any economist would tell you this.

Ah, but what do they know.

“Well I’ll tell you what, I’m not going to put my lot in with economists,” -- Hillary Clinton

And...

“When the federal government, through the Fed and the Treasury gave $30 billion in a bailout to Bear Stearns I didn’t hear anybody jump up and say, ‘That’s not going according to the market, that’s rewarding irresponsible behavior.’ We’ve got to get out of this mindset, where somehow, elite opinion is always on the side of doing things that really disadvantage the vast majority of Americans.”

The market reference is strange. You see, I think many economists did have reservations about what happened with Bear Stearns, although many of us ultimately feel that it was necessary to prevent even further catastrophe--one which might have had a pretty sizable impact on "the vast majority of Americans." Rather than take that chance, the Fed decided to put its own credibility up as collateral--no small decision, that.

So suddenly Senator Clinton has all this concern for markets? Is she implying that her gas tax holiday should be supported by economists because it removes the tax that is somehow distorting the free market?

No, more likely it was just a convenient sound bite. But I do see one very troubling problem in this exchange and it's going to have me thinking for a while. These quotes by Senator Clinton show that economists have not done a very good job of explaining what we really know objectively and scientifically to be true. Though my previous post (as well as posts on other blogs) pointed out some caveats, the basic thrust of tax incidence theory is not in question. The questions deal with specific issues such as whether summer production quantities have been set and how costly it would be to change them. That's an objective scientific question. Once we know the answer to it, we know whether the market price of gas would go down by roughly half of the tax cut (as econometric research suggests) or not at all (if quantities are already set).

The level of economic literacy in this country is so low that few people know that this is a point of near 100% agreement among economists. But correct though it may be, it is a counterintuitive result. People expect that the tax cut would drop the price one-for-one. People will believe a politician who tells them that this tax cut will help them. In fact, other policies would help them more, but because this one is believable and strikes an emotional chord, they'll remember it at the ballot box.

To add insult to injury, the same politician can discredit the economists on this point of near 100% agreement and mountains of objective evidence by pointing to a more controversial and unsettled issue where our pronouncements seem to favor the "elites" for reasons that are hard to explain in a hundred words or less, hard to draw on a blackboard, and are based on more recent scholarship.

It's sort of like saying that the meteorologist who sees clouds, hears thunder, and predicts rain should not be believed because he's on the wrong side of the global warming issue for your tastes. That would be ridiculous and should be called out as such. The level of economic understanding necessary for good citizenship is a level that would enable a person to see that connection.

True economic literacy does require some understanding of the concept of elasticity.

Let us begin with this short little post from Brad DeLong which sums it up nicely.

In my inbox right now, from a highly-respected public finance economist:

In the long and sad annals of truly bad ideas, it is unusual for one to receive bipartisan support at such high levels right in the middle of a campaign as this one has...

He is referring, of course, to what has come to be known as the McCain-Clinton gas tax holiday. Reuters has the summary.

"Score one for Obama," wrote Greg Mankiw, a former chairman of President George W. Bush's Council of Economic Advisers. "In light of the side effects associated with driving ... gasoline taxes should be higher than they are, not lower."

Republican McCain and Democrat Clinton, who is battling Obama for their party's nomination, both want to suspend the 18.4-cents-per-gallon federal gas tax during the peak summer driving months to ease the pain of soaring gas prices. The tax is used to fund the Highway Trust Fund that builds and maintains roads and bridges.

Economists said that since refineries cannot increase their supply of gasoline in the space of a few summer months, lower prices will just boost demand and the benefits will flow to oil companies, not consumers.

"You are just going to push up the price of gas by almost the size of the tax cut," said Eric Toder, a senior fellow at the Urban-Brookings Tax Policy Center in Washington.

Paul Krugman adds,

Why doesn’t cutting the gas tax this summer make sense? It’s Econ 101 tax incidence theory: if the supply of a good is more or less unresponsive to the price, the price to consumers will always rise until the quantity demanded falls to match the quantity supplied. Cut taxes, and all that happens is that the pretax price rises by the same amount. The McCain gas tax plan is a giveaway to oil companies, disguised as a gift to consumers.

Is the supply of gasoline really fixed? For this coming summer, it is. Refineries normally run flat out in the summer, the season of peak driving. Any elasticity in the supply comes earlier in the year, when refiners decide how much to put in inventories. The McCain/Clinton gas tax proposal comes too late for that. So it’s Econ 101: the tax cut really goes to the oil companies.

The Clinton twist is that she proposes paying for the revenue loss with an excess profits tax on oil companies. In one pocket, out the other. So it’s pointless, not evil. But it is pointless, and disappointing.

Is it?

Maybe not totally pointless, but definitely in the neighborhood. This is Econ 101--tax incidence theory. This is bread and butter for economists. But our pronouncements are only as good as what we really know about the relevant supply and demand elasticities. To make things even more interesting, the question of incidence (i.e. whose price will rise or fall) is not just a matter of absolute elasticities, but of the relative elasticities of demand and supply. Supply may be relatively fixed in the summer, but if short run demand is also inelastic, it is not a foregone conclusion that the suppliers will get all the benefit.

We take as one of our stylized facts that gasoline demand is fairly inelastic in the very short run. A 10% change in gas prices this month will probably not cause me to change my driving habits much. A permanent 10% increase will cause me to change my habits more over time. The federal excise tax of 18.4 cents is roughly 5% of the going price. In fact, I think we can expect that the fluctuations in price over the summer due to refinery maintenance, hurricanes, pipeline problems, etc. could be as large or larger in magnitude. I wouldn't expect it to change driving habits much at all. In other words, the demand is inelastic. Not perfectly inelastic, but quite inelastic.

Krugman suggests that the supply is practically fixed. If he's right in the extreme case (i.e. perfectly inelastic supply) then the game's over. The oil companies get all the benefit. But that's probably not the case either. A commenter at Angry Bear posts a link to the ever useful Energy Information Administration, or EIA. They point out in a recent newsletter that gasoline inventories are currently at the high end of the normal range. Given that production of the summer formulations has probably not fully ramped up yet, they probably have a little more wiggle room than Krugman is assuming. I'm not saying that they have a lot. But if demand is also quite inelastic, they wouldn't need an awful lot of wiggle room for the tax incidence to be split more equally.

The most recent piece of academic research on this that I could find is in Economics Letters (2004) by Hayley Chouinarda and Jeffrey M. Perloff (non-gated version here). They find that the incidence of the federal tax is split roughly equally between suppliers and consumers. The state taxes fall more on the consumers, and the burden on consumers is smaller in large states.

That last fact might have been useful for Obama to have known back in 2000 when he supported a statewide gas tax holiday in Illinois. As a resident of Illinois then as now, I can tell you that I didn't notice much of a difference. All I remember is seeing the signs on the pumps that told us that the legislature had suspended the sales tax on gas and that this should be reflected in the price.

I remember how I chuckled about it each time I filled up.

You did notice a few cents difference in the immediate run (i.e. shorter than the short run... first few days), but as time went on, elasticities and tax incidence theory did their thing. It was hard to see the difference with the naked eye. So was there any academic research on it?

Funny you should ask... in fact there was. (Hat tip to Daily Kos). Joseph J. Doyle, Jr. and Krislert Samphantharak of MIT and UCSD, respectively, found that the elimination of the 5% tax was associated with about a 3% drop in the retail price, or 6 cents on the (now) quaint sounding average price of $2 per gallon. But again, with the normal market fluctuations going on in the background, this was hard to see without your econometric glasses on.

But that's actually a reasonable conclusion. Given that Chouinarda and Perloff find that the consumer incidence of state taxes was quite high (close to 100%) but definitely smaller in the larger states (like Illinois), I would not be surprised to see that the breakdown was maybe somewhere between 50 and 75% for a state like ours. Doyle Jr. and Samphantharak put it at 60%. So like I said, it's reasonable.

But if Chouinarda and Perloff are correct in that the burden of the federal tax is more evenly split, then you'd notice it even less than we did in Illinois in 2000. If Krugman is even somewhat correct that it is too late in the game for quantity adjustments to be made, then the consumer's benefit shrinks further. Just guessing at a number, say maybe the consumer gets 5 or 6 cents out of the 18.4. With gas at $3.50 and perhaps more than 5 cents of variation across local markets and over time... you're going to need to have super-powered econometrics glasses to see the effect.

My conclusion: Maybe you would benefit 5 or 6 cents per gallon, give or take a couple pennies. Maybe a couple dollars a week. Better than nothing, I suppose, but only a tiny fraction of the "fiscal stimulus" check that I received this week. But then there's the issue of how to replace the lost revenue (revenue that is used to maintain the crumbling roads and to create jobs in a seasonal industry that is going to need to take up some of the slack from the slowdown in construction and manufacturing). Clinton proposes a tax on oil company profits. That's the part that Krugman calls not evil, but pointless. In one pocket and out the other. Maybe not totally pointless, but definitely in the neighborhood.

UPDATE: The Wall Street Journal's Real Time Economics blog says that my comments (specifically the last sentence above) are "probably the strongest show of support available". That may be. Though I meant it to be a bit of "damning through faint praise." My criteria for good public policy is that it be well out of the neighborhood of "pointless." Still, I'll bet others would agree that the consumer might benefit a few cents, but I think it is safe to say that we stand firm in agreement that this is a bad, bad idea.

From MSNBC:

NEW YORK - Drivers have long known that slowing down on the highway means getting more miles to the gallon. Now airlines are trying it, too — adding a few minutes to flights to save millions on fuel.

Southwest Airlines started flying slower about two months ago, and projects it will save $42 million in fuel this year by extending each flight by one to three minutes.

On one Northwest Airlines flight from Paris to Minneapolis earlier this week alone, flying slower saved 162 gallons of fuel, saving the airline $535. It added eight minutes to the flight, extending it to eight hours, 58 minutes.

Kind of reminds me of when American Airlines took an olive out of every salad and saved loads of money. Of course, that was not a response to the price of olives, it was just a general cost cutting measure. But the idea is similar. By decreasing their speed (i.e. decreasing the thrust from the engines) they save a few dollars on each flight. Multiply it by many flights a day over many days and before long it does potentially save a respectable amount of money.

As the price goes up, there does come a point where the airlines decide to try to reduce the quantity of fuel purchased. The demand for fuel by airlines is "derived demand" meaning that it also depends on the market (i.e. the price) of the output. But derived demand curves slope downward too, ceteris paribus.

I received a link to this article via a listserv on teaching economics. It's a sobering look at the effects of bread subsidies in Egypt. Here's a sample:

“The most corrupt sector in the country is the provisions sector,” said a government inspector who asked not to be identified for fear of punishment. His job is to go to bakeries to ensure they are actually using the cheap government flour to produce cheap bread that is sold at the proper price.

The inspector explained why the system was so open to abuse. The government sells bakeries 25-pound bags of flour for 8 Egyptian pounds, the equivalent of about $1.50. The bakeries are then supposed to sell the flatbread at the subsidized rate, which gives them a profit of about $10 from each sack. Or the baker can simply sell the flour on the black market for $15 a bag.

Read the whole thing.

Today's howler is from CNN/Money:

Gasoline is one of those items that some economists consider "inelastic," that is, people will buy it no matter what the cost. But the recent drop in demand puts that into question, and suggest people will cut out unnecessary trips if they are too expensive.

As I try to tell my students, a good or service is not elastic or inelastic--the demand for or the supply of it is. Second, inelastic demand doesn't mean that people will buy it no matter what the cost--budget constraints ensure that eventually the curve slopes back to the left as you go up higher in price. Third, if you want to get really pedantic, it's not a drop in demand, but a drop in the quantity demanded as this is a change induced by higher prices (caused by increased input costs which reduced the supply). Fourth, one should consider short-run vs. long run demand for gasoline since it takes a while for habits to change.

When I read that I had flashbacks to grading exams.

No wait, I did not grade any exams this term that packed this many errors into two sentences. My students are better than that.

I was in the St. Louis area this weekend as several inches of snow fell. A story on the local news (sorry, couldn't find a link) interviewed a young man who was going up and down the streets in a neighborhood shoveling sidewalks and driveways for cash. As I recall, the going rate he charged was $10. It looked like a middle class neighborhood. The people could certainly afford the $10. The young man probably made couple hundred dollars for his day's work. Not an insignificant sum. It really was a significant snowfall for St. Louis, maybe 6-8 inches in some places. (Contain your laughter, King!) So there were a lot of people who don't like to shovel that much snow and were willing to pay to have it done. While it's not a disaster on the scale of a flood or a hurricane, there still is a sense of disruption. A lot of man-hours need to be expended in a short time in order to restore a sense of normalcy.

It was just a man with a shovel--not a professional snow removal firm. I'm not even sure if it was his neighborhood. For all I know, he might have come from across town. (I don't recall if the news story went into that much detail.) Good capitalism? I think so. Self-interested? Absolutely. Is it ethical to engage in this sort of "profiteering" (if we wish to call it that)? Comments are open.

Now, right after the news crew interviewed that young man, they showed a group of citizens going around a neighborhood digging people out for nothing. They were doing it purely out of kindness. I believe that that particular neighborhood had more elderly residents who were the beneficiaries of the volunteers' labor.

So what are we to make of their selfless act? Could they have profited but chose not to? Probably. Are they bad capitalists? Good neighbors? Both?

Does the fact that this is a trade in services rather than goods have any bearing on how we perceive the actions of these individuals? Though the entrepreneur may be charging a little more than what the market for snow shovelers might bear in other times, is it ok since he is providing a labor service? (After all, it's not like he loaded up a pickup truck with shovels and sold them for $20 a piece, right?)

But then, hurricane regions often have guys in trucks swooping in offering their labor services for an exaggerated fee as well. Sometimes they get excoriated for price gouging. What's the difference?

Would it be wrong or unethical to go around charging $10 for shoveling in a neighborhood of poor elderly residents?

This is precisely what I meant in Saturday's post when I said that our attitudes (as well as the law) affect our supply response. So I can be perfectly comfortable saying that I applaud the entrepreneur as well as the volunteers. There are social customs, sometimes at a very local level, that may dictate when it is ok to raise prices in a case like this. Someone charging high fees to the poor and elderly might be met with disapproval from the neighbors (and maybe politely told to take a hike). Yet, people of means are perfectly willing to pay to avoid this unpleasant task that nature has thrust upon them. Few people would have a problem with that.

Honestly, I cannot imagine trying to think through this sort of economic problem without considering these kinds of issues. As Milton Friedman put it this when he wrote his oft-cited article, "The Social Responsibility of Business is to Increase its Profits"

That responsi­bility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while con­forming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. (emphasis mine)

and...

That is why, in my book Capitalism and Freedom, I have called it a "fundamentally subversive doctrine" in a free society, and have said that in such a society, "there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

We've had a rather spirited discussion of price gouging on this and other blogs. My position is, as it always has been, that the profit motive induces people to bring goods and services to the areas where they are needed most, and that prices should rise to compensate people for the opportunity cost they incur. How much the price will rise, the exact locations where it will rise, and the length of time it will remain elevated will necessarily depend on the particulars of the situation. Modern supply chains are likely to make the price increases smaller, more localized, and shorter. But it still will happen, often in ways that are hard to predict until that particular disaster occurs. But it will happen.

However, that does not give anyone license for deception or for violating the basic social norms. The question is how best to make sure that the goods and services go where they are most valued while discouraging people from violating those social norms. I do not think that vague and selectively enforced price gouging laws are the answer to that question. Information is the greatest weapon against price gougers. Information helps the process of price discovery happen more efficiently. There are private and public means of providing information that are not always used to their fullest extent. That would be a start.

If you look at anyone who looks to recover their opportunity cost as a criminal, then it will discourage the sort of people you want from coming into the affected area--unless they are large enough to be able to eat the cost. But then what of the people in areas out of Wal-Mart's reach? Will their only choice be the suppliers who are willing to risk the condemnation of society--those with less to lose and less of a conscience when it comes to those social norms?

Those are questions worth thinking about.

Apropos of recent discussions here, at Cafe Hayek, and at Angry Bear, I offer this example of how higher prices really do induce people to move goods from one area to another. Supply curves really do slope upward. Transportation costs are important. Read this from the Columbia Missourian from last February. Here's a sample:

A two-year drought and this year’s harsh winter weather are contributing to a national hay shortage that’s hurting many Missouri farmers. Back-to-back years of low hay production are forcing them to decide between selling their livestock or paying two to three times more than last year for hay.

...

The hay shortage has spread across the Midwest and southern Plains states such as Texas and Oklahoma. Tony Hancock, market news reporter for the Missouri Department of Agriculture, said farmers are hard-pressed to find any hay in Missouri. Most are looking to Northern states such as Iowa and Wisconsin that have seen more rainfall.

...

Going north for hay forces farmers to dig deeper into their wallets, especially those in the southern regions. Jeff O’Laughlin, owner of Missouri Hay and Straw in Ashland, said high fuel prices have forced the price of small square bales up $2 to $3. He’s charging $5 to $9 for a small square bale now.

...

The Missouri Department of Agriculture is trying to help the situation by running the “hay hot line,” which connects hay producers with those in need of the product.

If our recent discussions have intrigued you, then you definitely should read the whole article. There are so many things about this article that make is wonderful for an economics course. It is a good illustration of the application of the supply and demand model in the way that it is often applied in discussions of price gouging. And yet, the word "gouging" is not in the article at all, nor is there any sense of moral indignation. It's very matter of fact. There was a drought in Missouri. Hay became scarce. The price rose. Supplies came in from several states away. End of story.

And while I raise this point to defend the economist's usual way of approaching the issue (upward sloping supply curves and all), I am not at all trying to deny spencer's point about how Wal-Mart et al. operate in disaster regions. There are similarities in terms of the overall issue. But there are important differences that are too obvious to even warrant mentioning to the informed readers of this blog, but that I would probably take 5 minutes in a class to discuss (ideally through a Socratic dialogue).

But perhaps the most important difference does warrant a mention, and that is that the time over which this plays out is longer. There is perhaps less of a sense of urgency and catastrophe. Thus there is more time for a reasoned response by both parties in the transaction.

There is an important similarity as well. That is that there is always an additional cost to moving the goods, and that's going to show up on someone's bottom line. Wal-Mart may find that it's costs are small because of its distribution network--small enough that they can absorb it. Great. But that's not always going to be the case. Even for Wal-Mart, if their stores are damaged, the cost of the "last mile" increases substantially.

Finally, there's the government's part in the situation. Rather than punishing price gougers, in the Missouri hay shortage, the government established a hot line for the dissemination of information. Thereby improving the process of price discovery. In a disaster situation, the process of price discovery, so important for markets to work, is severely hampered. The presence of large retailers in competition with each other leads to lower prices because they are able to aggregate a lot of that information. If you have only a few of what spencer so beautifully refers to as "guys in pick-up trucks", the burden of aggregating that information falls on the consumer and that is costly. Having more guys in pick-up trucks (and box trucks, flat beds, and independent semi-truck drivers) would help. Perhaps Wal-Mart can do better, but Wal-Mart is not all powerful. There will be some places they will not reach. There will be some places too costly for them to go the last mile, at least temporarily. Why not encourage local independent sellers to move good into the area, and why doesn't the government assist with the process of price discovery like they do in Missouri. Then, while prices might rise, it would be a smaller and more temporary rise that would be more likely to do some good.

I say this with all due respect to Wal-Mart et al. and spencer's excellent defense of them because any newsreel of disaster footage will tell you that for all the big box retailers do for those areas, they do not completely solve the problem. If they did, you wouldn't have people trying to invent machines that can extract drinking water from the air. Why waste time on that if Wal-Mart can do it all at no additional cost? Because they can't. They can't do it all, and if they tried, their costs would at some point go up. Supply curves do slope up, at least when you're talking about transportation costs in the very short run in a disaster area.

Spencer always comes back to one point. Why should we celebrate the guys in pick-up trucks? Why should we hold them up as examples of how market capitalism works? Well, I'm not sure we should--at least not in the way that he is implying that free market economists do. I think what we should celebrate is the process of price discovery and whatever mechanism helps speed that process along--whether it comes in a pick-up truck, a flatbed, or a blue and white semi-truck from Bentonville. Because in different times and in different situations, each may have more or less role to play. And if government can do something to speed that process along during a time of crisis, then that is an appropriate role for government to play as well.

This post is already getting lengthy and there is, I'm sure, a lot more could be said. But rest assured, spencer, that in a 75 minute class period, there is a lot of time to discuss those other issues that don't always make it into the textbooks. It's not about celebrating the guys in trucks. It's thinking about how our attitudes and how the law affects supply responses and whether that does more harm than good. It's about how there may be good reasons for price gouging laws, but our present ones are too vague to work well. It's about whether there are things the government can do besides passing price gouging laws that might make things work better. That's what it's about--the guys in trucks are bit players in my story.

Spencer at Angry Bear points us to a Division of Labour post. This is from The Oregonian.

In cases of extreme weather and natural disasters, some of the nation's largest retailers now behave like municipalities -- sometimes better.

[R]etailers have created specialized divisions -- or hired outside firms -- to gird for emergencies. The goal: to speed recovery for customers, employees and ultimately sales.

No one is clear how many retailers operate internal emergency units, but the practice is now standard among the biggest players, including Target Corp. and Lowe's Cos. Inc.

This past week, Wal-Mart donated a 40-foot tanker of potable water to Vernonia, [Oregon,] while up north Home Depot opened its still-waterlogged Chehalis store for the town's Chamber of Commerce to pick up face masks and cleaning supplies free of charge.

Such coordination became clear during Hurricane Katrina in 2005, when local governments praised initial responses from retailers as more expedient than those of the Federal Emergency Management Agency.

Spencer adds a jab at libertarians.

Because they [libertarians] seem to be believe the only way to get supplies to natural disaster victims is some guy in the back of a pick-up truck gouging them with high prices.

Well, I don't know if I'm the right guy to defend libertarians. I sympathize with them often, but don't really fully consider myself one. But anyway, I'll bite. After all, spencer has raised the issue here before. I suppose we could dig into the archives and see what I wrote then...

So no, I don't have evidence that guys in pick-up trucks would do a better job. That's the wrong question. I do have a very strong reason to believe that large companies could do a much better job if they knew they wouldn't be excoriated by politicians and the media for making a modest amount of money from it. While I praise them for their generosity, I think you'd get more than five truckloads [of bottled water] from Culligan if they could charge a modest amount for their trouble. The fact that there are still guys in pick-up trucks means the established, reputable companies are not doing enough.

In the present story as well as back then, most of the supplies from the big box stores were donated. A cynical person might say that the big boxes are making that donation hoping that when things get back to normal people will remember their generosity and buy their rebuilding supplies from them. Think of it as a tax deductible advertising expense.

Even so, I don't have any problem with them doing this. I think it's great. Look, there are many reasons that a big box company might have for making these donations. But the bottom line is that they can get supplies into these areas at a low cost, so they aren't losing much. Furthermore, they can afford to take a bit of a hit in the short term in the name of goodwill, community relations, advertising, or what have you.

Let me put it even more bluntly. I hope that Wal-Mart puts all the small time mom-and-pop price gougers in pickup trucks out of business. The world would be a better place.

Maybe it is starting to happen. I think you see fewer stories these days about "guys in pickup trucks" these days. (Though they did at one time exist, and I think they still do. My above-mentioned post has some links in the comments where I point to media discussions of them, though they are getting a bit dated.) But even so, I think the big boxes are still going to fall short of the optimal outcome, meaning the "price gougers" will still exist in the hardest-to-get-to areas.

Here's where the rubber meets the road. There are two reasons that prices can go up. It's either a supply issue or a demand issue. (It can, of course, be both.) In the immediate aftermath of a disaster, the supply of certain items decreases and demand for those items increases. But if a number of large (competing) firms with nearly constant marginal costs and with vast distribution networks can move the supply from one area to another at a low cost, then prices will not rise very much... even if demand increases.

However, I'm not at all convinced that the big boxes are going to donate enough to satisfy all of the demand. Why would they? At some point they would be donating to people who would be willing and able to pay the retail price that prevailed before the storm. Are they able to donate close to the "right" amount that would get the goods to the people who need them most and then sell at the previous price to those willing to buy? Admittedly, I do not know the answer to that question. Though I suspect the answer is no. Do we suffer some loss of efficiency because the big boxes are careful not to give even the appearance of profiteering? Admittedly, I do not know the answer to that question. Though I suspect the answer is yes.

So in the end, what the big box stores are doing is definitely a good thing. The fact that they are doing something (and doing it well and at low cost) is beneficial. They seem to do better than government at times. In fact, maybe the government should pay Wal-Mart and Home Depot to step it up a notch! One way or another, price incentives still are important. Donations won't completely solve the problem.

Ask anyone reading these stories if they think that the big box stores could do more. You'll probably get a lot of "yes" answers. So then the next logical question is, "why don't they?"

UPDATE: More in the comments. And King has more at SCSU Scholars.

How could you forget? Well, it seems that at least one unhappy customer won't let it go. (Wired News)

Dongmei Li of Queens, N.Y., claimed the company violated price discrimination laws when it slashed the price of the 8-gigabyte iPhone by a third, from $599 to $399, within two months of the gadget's June debut.

...

According to Li's lawsuit, filed on Sept. 24 in the U.S. District Court, Eastern District of New York, the price reduction injured early purchasers like herself because they cannot resell the product for the same profit as those who bought the cell phone following the price cut.

Cannot resell the product for the same profit? She was an iPhone speculator?

I could have told you that speculating on iPhones would probably not be wise. Just sit back and enjoy your consumer surplus.

In the newest Journal of Economic Perspectives (Summer 2007) is an article titled "Repugnance as a Constraint on Markets" by Alvin Roth. It's part of a symposium of three articles on organ transplants. I've skimmed it now and will read it more carefully later. Roth makes the claim that as economists we should continue to educate the public about efficiency and tradeoffs, but also be aware of the sources of repugnance that has led legislatures to outlaw drugs, prostitution, ticket scalping, and the sale of human organs, among other things.

It would be a great reading for an undergraduate seminar.

Tyler Cowen has been pushed too far. Why? Listening to people complain about Apple cutting the price of the iPhone.

One customer, Kevin Tofel, was quoted in the NY Times as saying:

“I just felt so used as a consumer,” he said. “They hyped up the iPhone for six months and built up our expectations, and then they grabbed our extra $200 and ran.”

This was too much for Tyler.

It is you people, you who resent Coase (1972), you people who induce wage and price stickiness and widen the Okun gap. You people, who don't know what it means to sit back and enjoy your consumer surplus. You beasts! (emphasis in original)

Ok, so who among us did not expect that this would happen? In fact, when the iPhone came out, one blogger wrote:

There is one certainty however. In a few months, there will be a better model that will be released at about the same price and this one will be sold at a discount. For tech products like this, there is most certainly a dynamic form of price discrimination partly due to the nature of quality improvement and innovation over time and partly due to calculated profit maximizing behavior. The effect is to segment the market into the patient and the impatient.

Man, that sounds familiar.

The only thing I didn't get right about it was how fast it would happen. Two months is sooner than I would have expected, but not terribly so.

So let this be a lesson to you. Big hype around a high tech innovation just cries out for this sort of dynamic price discrimination. The market will be segmented into the patient and the impatient. If you are impatient, you will pay more than those who are patient. There is a price for being the first on the block with a new toy. You gave away some of your consumer surplus, but you've probably got some left. So enjoy being first as long as it lasts. The patient masses will soon join you in enjoying what Tyler calls those "icons of modernity". Should I feel sorry for someone who buys a $2000 computer and complains that a few months later a better one sells for $1800?

"You people...who widen the Okun gap." That's just beautiful.

UPDATE: Wired has a story that should soothe Tyler

"If they told me at the outset the iPhone would be $200 cheaper the next day, I would have thought about it for a second - and still bought it," said Andrew Brin, a 47-year-old addiction therapist in Los Angeles. "It was $600 and that was the price I was willing to pay for it."

Via IN-FORUM (Fargo, ND)

"It gets rid of the stigma that surrounds our business a little bit," [ticket broker Michael] Nowakowski said of the law change. "I just think for years people in Minnesota have been taught that buying or selling tickets at over face value is very similar to buying and selling drugs."

Prosecutions of ticket scalpers have been on the decline for the last few years.

Records kept by the state courts system show only a small number of cases resulted from the scalping law. In Hennepin and Ramsey counties, where the pro sports venues are located, there have been 104 cases carrying a scalping charge since 2002. The most was 35 in 2003; this year saw only two.

First it was copper pipe. Now this... (MSNBC-Associated Press)

With metal prices rising, beer makers say they expect to lose hundreds of thousands of kegs and millions of dollars this year as those stainless steel holders of brew are stolen and sold for scrap.

The beer industry is coupling with the scrap metal recycling industry to let metal buyers know they can’t accept kegs unless they’re sold by the breweries that own them. They’re also pushing for legislation that would require scrap metal recyclers to ask for identification and proof of ownership from would-be sellers.

Some distributors are raising the deposits that they require from customers. How high can they raise the deposits? Certainly a bar owner can put up a few extra dollars per keg, which might encourage them to keep the kegs locked up when not in use. It's the occasional customer buying a keg for a weekend get-together who may be more sensitive to the deposit amount.

What do you think?

Read the whole thing.

Max sounds his "barbaric yawp" over at the TPM Cafe.

Let's look at a few of his positions.

1. Supply and demand, 1. This celebrated and most basic economic model while in principle multidimensional in practice obscures anything interesting that affects market conditions. It bespeaks militant, ideologically-based reductionism. A good illustration is the minimum wage debate. In the usual S&D model, a MW can only reduce employment. Nothing else is logically possible.

We've been over this before. I am reminded of the old quote by Thomas Carlyle that I first heard when I was taking principles of economics, "Teach a parrot the terms 'supply and demand' and you've got an economist." Max's concern that the supply and demand model is taken to a reductionist extreme is nothing new. Unfortunately.

In principle it is multidimensional, but general equilibrium theory is hard to put into the format of a sound bite or an op-ed. The blog medium maybe does a little better at conveying the message because it allows for a more extended and thoughtful discussion.

My main caution about the supply and demand model in its simplest form is that it assumes homogeneous goods (or factors of production--to use the minimum wage example) and perfect competition. When the basic model is used in cases where those conditions are not satisfied, there is potential for mischief.

2. S&D, 2. The outcome in an S&D model in principle has no inherently attractive qualities, in and of itself, since it depends on the distribution of ability to pay. If Oliver Twist has no money to buy a crust of bread, his zero allotment is "efficient." The lack of any normative foundation is typically glossed over.

Or as I like to say, "No normative judgments, please; we're economists." Deirdre McCloskey as chided the profession with variations of that phrase as well, so that's where I picked that up. Max is right up to a point. The supply and demand model is value free in and of itself, but it can shed light on the effects of imposing alternative policies, and policies are generally based on some set of values or norms. It is true that economists often shy away from doing the latter. There are good reasons for being circumspect about recommending one policy over another, and indeed there is some value in specializing in the positive analysis. But we live in a political world, and our models can deal with that if we let them. There is no reason to suppress the normative discussion. The normative questions are the interesting ones--if we give up on those, our students will lose interest.

3. GDP. Add up all the Qs in the S&D models over the year ("final goods and services") and you get GDP. Solemn assurances that GDP is not synonymous with economic welfare fall easily by the wayside. More GDP (and less leisure time, less environmental quality, a less sustainable economic future) is always better. If terrorists knock down the Empire State Building, GDP could go up. More! Better! Comrade Stalin would approve.

See the broken windows fallacy.

7. Capital fundamentalism. As with reductionism of the S&D model, growth modeling zeroes in on private capital accumulation, even though a) other factors are demonstrably important and beg for attention; and b) private capital accumulation may be a consequence of other factors, rather than a cause and appropriate object for policy. Out of an obsession with this premise, the International Monetary Fund has screwed up a lot of countries too weak to ignore its advice.

Other factors are always important. If a model is simple enough to use, it necessarily leaves out many other factors. Those two fundamental facts are at the heart of more than just this criticism. In some research that a student of mine conducted we found that the relationships between growth, capital and other factors can be notoriously hard to identify. Yet, I think it is important to try. And yes, my confidence interval around theoretical growth models has increased once I started reading more of the empirical papers. Does that make me heterodox? Nah, probably not. But I know enough to know that some fundamental questions haven't been answered yet, and thus a little modesty is in order.

9. The unnatural rate of unemployment. Economists used to say it was 6.0, maybe 5.5. Lower would give rise to ruinous inflation. The huge social benefits of another couple of percentage points less unemployment were -- are -- implicitly discounted. Current rate is 4.5. 'Nuff said.

I think I know what he's getting at here. While I also am no fan of the natural rate concept of the old days, I come at it from a different angle. Max's statement here suggests that the social benefits to having a 4.5% unemployment rate were feasible back when economists thought the natural rate was 6%--and without the inflation we all feared back then. I'm not sure about that. The productivity gains of the 1990s did allow for lower unemployment and lower inflation.

When inflation and unemployment came down together in the 1990s, the Friedman-Phelps version of the natural rate gave way to the NAIRU (non-accelerating inflation rate of unemployment). It was not without its skeptics. Estimating the NAIRU is like finding your way around the room in the dark when someone keeps moving the furniture. It is easier to identify what it was in the past based on your experience, but there is no guarantee that it hasn't changed. Again, in what seems to be a common theme here, that would lead me to exercise caution in using the NAIRU to guide policy. Yet, the practical advantages in doing so carry a lot of weight, and so you use your past experience and hope that the furniture hasn't moved too much. And that means that occasionally you'll stub your toe.

But what mechanism would allow the policymaker to systematically do better?

10. "Power? You want the political science dept." Power looms over economic transactions, except in economic theory. Workers do not hire capitalists. Consumers do not choose merchants. Shareholders do not choose managers. Voters do not choose elected officials.

I have wrestled with this problem in my own models. It becomes difficult to produce clear predictions when you allow variations in power (e.g. bargaining power) to enter the model. It is similar to allowing preference shifts. Suddenly you can explain everything--and therefore you can explain nothing. Yet acknowledging the role of power (of various kinds) makes for a compelling narrative sometimes. It's something of a shame that it often needs to be excised from published research. It gives the impression that we don't care about it. That would, at least in my case, be a wrong impression. Yet at the same time, I believe it is appropriate to keep those power considerations separate from the rest of it, lest we end up with a model where anything goes.

I guess that makes me orthodox. Ultimately, I line up on the neoclassical free-market team more often than not, but I never stop asking many of the questions that Max does. And so I temper my free-market analysis with thoughts like: perfect competition is hard to find, rent-seeking in politics influences outcomes, real time estimates of the NAIRU should have a decent confidence interval, not all $1 transactions have the same social value, and power does matter even if it is hard to measure or even describe.

In some circumstances, those considerations are more important than others. But much of the time, they don't radically alter the main story that incentives matter--a story that the orthodoxy mostly gets right.

UPDATE: Max links back. Robert Waldmann also responds. Other blogs covering the topic include Greg Mankiw, Angry Bear and Cafe Hayek.

Everyone knows by now that when a thunderstorm passes through Chicago, it can cause airport delays across the country. Air traffic is all about the flow. Disrupt the flow at one major hub and everyone feels it.

From IN-FORUM (Fargo, ND):

KANSAS CITY, Mo. - Consumers are beginning to pay more at the pump because flooding at a southeast Kansas refinery has reduced fuel supplies and sent wholesale prices soaring, industry experts said.

...

Jon Callen, president of the Kansas Independent Oil and Gas Association, predicted the states most affected by the Coffeyville flooding would be Kansas, Missouri, Arkansas, Oklahoma, Nebraska, Iowa, Minnesota, north Texas and parts of the Dakotas.

"Effectively, the market was balanced before Coffeyville had to shut down. There's now a big hole in the entire market centered in Coffeyville, so the gasoline that Coffeyville was providing the region now is going to want to be made up from other refineries that already have been balanced and had people wanting to buy their gasoline," Callen said.

If paying for something is as easy as swiping a card or passing under an electronic sensor, will you become desensitized and less likely to notice price or tax increases?

Maybe.

PGL at Angry Bear points us to this TPMCafe piece by Jared Bernstein. They both reference the Barry Schwartz piece I discussed here in my last post.

Bernstein uses the Schwartz article as a springboard for detailing the shortcomings of the economics profession, including forecasting (thus the title of this post). Two of his critiques stand out:

2. Economists are reductionists.... the world doesn’t work like the textbooks say it should.

...

3. And one reason for that is, as the NYT oped argues, we misunderstand incentives. To be specific, we exaggerate them.

I have frequently