Restaurant Table Turnover
I’m on a blog break this week and all posts are reruns. The next new post will appear in the new year. This post originally appeared on 4 June 2009 on The Finance Buff. Visit the original post for comments.
Recently, my wife, friends, and I went into The Big City on a beautiful spring evening to see Leonard Cohen in concert. It was a superb show and a splendid night. The concert began at 8PM, as did many other theatrical and musical events in the area. Like many others, we were in the market for pre-theater dinner.
We arrived downtown around 6:30PM and found the restaurants packed with lines out the doors. We put our name on the list at a Malaysian establishment and were told it’d be a twenty minute wait. We killed the time with a stroll and then returned to wait for our table. By 7PM we were still waiting and I began to get concerned. I don’t like to rush through dinner but it seemed like we’d have little choice.
To take my mind off my concern, I began to observe the parties that were seated but seemed to be finishing, or had finished, their meals. They all seemed needlessly slow and casual. Some checked their watches. A few double checked that they had their theater or concert tickets. I saw an economics problem.
Those who were nearly done eating had an hour to kill before their shows. Their objective was to kill the time, which they could do by stretching out their dining experience. Those of us who were waiting to eat had the opposite problem: we would have to use that hour efficiently to eat and get to the theater on time.
The economist in me thought, “If only I could walk up to one of these slow-pokes and offer them some money to give up their table we could all be made better off.” Perhaps someone done with his meal would gladly accept $10 to move on. I probably would have been happy to spend that much to get the table more quickly. But there is no such market, not because it is illegal, but because nearly everyone would consider it gauche. We just don’t do that sort of thing, at least not in America, or not in The Big City anyway.
With more time to kill I contemplated the implications of such a market. A table auction might break out. The proprietors might participate to increase turnover. The incentive for early diners would be to linger longer in order to take advantage of the premium on tables that would occur about one hour before show time. How unpleasant and stressful I would find such a market!
Thus, I convinced myself that a market for tables based on financial transaction would not be helpful. The current market, driven by social norms and etiquette works quite well and, perhaps, could not be improved upon. As I completed my thought experiment about pre-theater diner table auctions the host led us to our seats. It was a good, albeit quick, meal and the price for the seat was just right.
Wealth Destruction
I’m on a blog break this week and all posts are reruns. The next new post will appear in the new year. This post originally appeared on 26 March 2009 on The Finance Buff. Visit the original post for comments.
In 2008 U.S. households lost just over $11 trillion in wealth, or 20 percent off the 2007 peak. Most of that loss was in the value of housing and equity holdings. Some have asked, “Where did the money go?” (Google this phrase and you’ll see it is a hot topic.) This question is actually pretty easy to answer, and I will do so. But I also find it interesting to explore why it is asked.
First of all, when asset values are growing very few ask, “Where did the money come from?” Perhaps we take for granted that asset prices rise over time and rarely stop to think about the source of the value. Nevertheless, when things go bad many people want to know where their money went.
But assets like houses and stock shares are not money in the same sense that cash, checking account balances, or money market funds are money. Such financial assets are valued in money (dollars in the U.S.) and are bought and sold for money, but they’re not money: houses are shelter (clearly not money), an equity share is a unit of corporate ownership (not money either). In fact, for the purposes of considering abstractly their market value you can think of stocks and houses as consumer goods, like toasters or iPods.
The value of an asset is determined by the market: supply and demand. The price today is different than the price yesterday or tomorrow. Maybe yesterday everyone wanted an iPod so it had a high price. Tomorrow everyone decides to buy the new brain implant and the iPod’s price plummets. The value of all those iPods on shelves or in circulation drops.
The same thing happens to houses and stocks. When the market for them weakens, wealth is destroyed, but only insofar as wealth is measured by the value of those assets. No actual money is destroyed, and nobody gets an offsetting gain. No money went anywhere.
Fundamentally, numbers are abstract. When you subtract two from four nothing tangible is destroyed. Nevertheless, the answer is two. Where did the other two go? I guess the same place it came from. There is not a fixed supply of twos. The price of a house is just a number. It goes up and down. When it goes up we say that there is more house-wealth. When it goes down, some wealth has been lost. Still, no money has been destroyed since houses are not money. Nobody gets an offsetting loss when your house appreciates, and nobody gets an offsetting gain when it depreciates. The money value of houses (or assets in general) doesn’t go anywhere.
Why do we ask, “Where did the money go?” during an economic downturn? Why is there a notion of conservation of the money value of assets, that everything is zero-sum? I think the confusion stems from two other ideas in finance and economics. One is the zero-sum nature of a transaction. When I buy a toaster from you for $20, my $20 becomes yours and your toaster becomes mine. There is no overall change in money or toasters between us. Both obey the law of zero-sum (my gain is your loss, and vice versa).
Another concept related to the conservation of money is the size of the money supply. The total amount of cash in circulation is fixed, until the Treasury Department prints more. We do not normally think of cash being destroyed, of piles of currency going up in smoke. (Currency can devalue so there is a sense in which it isn’t that different from an asset. Let’s not go there.)
So, if we have the notions of zero-sum transactions and a fixed money supply we are easily tricked into thinking wealth cannot be destroyed in aggregate. My loss must be somebody’s gain. The money must have gone somewhere. But, as I said, assets are not cash. And, while a transaction may be zero-sum, what happens later to the value of the assets that were transferred is not zero-sum. When the toaster I bought from you depreciates to $10 you still have the $20 I gave you. That I may now only be able to trade my toaster for $10 on the secondary toaster market has nothing to do with the $20 I paid you for it. You do not achieve any further gain for my loss of toaster-wealth. My declining wealth in toasters is my own, offset by nothing.
So, where does the money go when wealth is destroyed? Answer: the same place the two goes when you subtract it from four. It was a number. It wasn’t money. Wealth, yes, with value denominated in money, yes. But money itself, no.
Profiles in Plausibility: The Politics of Health Reform Rollback
I still agree with Matt Yglesias and Aaron Carroll, both of whom find the my scenario of a Republican rollback of health reform provisions unlikely, even if it is more likely than repeal. The key to its implausibility is the 60 votes it would take in the Senate. That’s the nature of filibuster politics. As long as that’s still the game, I think health reform is safe. (Of course one can contemplate budget reconciliation and changes to the filibuster rules…Let’s not go there now.)
But that doesn’t mean the threat of rollback isn’t important. It is. As I wrote before, perhaps the biggest political risk of health reform’s passage is not to the statue but to the party that backed it. Republicans may not be able to repeal or rollback anything, but they can gain seats campaigning as if they can and will. Their plausible pitch, which I outlined in my prior post, is to the middle class. Wouldn’t it be better for the middle class, Republicans might argue, if they had access to cheaper insurance (never mind it would cover less) along with some tax cuts paid for by allowing the low-income subsidies to gradually erode in real terms?
In fact, as a campaign tactic, one doesn’t even need to explain how to pay for the tax cuts. A simple message of the type, “This reform doesn’t do much for the middle class. Obama and the Democrats are taking your money to pay for a new wasteful entitlement. Wouldn’t you like it back?”
On the campaign trail it may not even matter if this makes any sense. Although, the fact that it doesn’t is exactly how liberals and progressives should attack it. If health reform is debated at all, this is how I expect the debate might go.
A Plausible Threat to Health Reform
I’m in agreement with Matt Yglesias and Aaron Carroll that chances of health reform being repealed are exceedingly slim. But that doesn’t mean it can’t be watered down to a far less ambitious scale. As I wrote before, money attracts a crowd, and there’s a lot of money in health reform that some would like to use for other purposes.
What I think is more likely than repeal, though by no means certain or even highly probable, is an erosion of the low-income subsidies in real terms, perhaps tied to a change in the minimum level of coverage required. A Republican congress and president might pass such changes along with a tax cut. It is very likely that Republican candidates will campaign on it.
I could see the whole thing being spun as middle class assistance: options for cheaper insurance and a lower tax bill, albeit with subsidies for the poor that don’t keep up. Since the poor aren’t a big constituency this strikes me as at least plausible.
Another wrinkle that could make this work is a weaker mandate that includes exemptions when the premium-to-income ratio is above a threshold. Put it all together and you’ve got a gradual erosion of health reform: worse insurance, less low-income assistance, fewer individuals covered, a weaker mandate. That’s not repeal, but it would make a mockery of the hard-won reforms. Watch for it.
Google Reader and Economic Welfare
I’m on a blog break this week so all posts are reruns until the new year. This post originally appeared on 19 May 2009 on The Finance Buff. If you wish to leave comments, please do so on the original post.
What follows is an illustrative sketch of a classical economic welfare analysis using Google Reader as an example. It is intended for an audience with no economics background. At the risk of disappointing readers, I confess that, due to lack of data, I make up all the numbers. However, anyone with better estimates of the components could improve the calculation by following the steps outlined. Those familiar with Google Reader may wish to skip the next paragraph.
One way to read blogs is to visit each one’s website. Wouldn’t it be better if each could send new posts to one consolidated place for you? Well, nearly all can; the way to take advantage of this efficiency is using an aggregator like Google Reader. Blog sites, like The Finance Buff, advertise this service with icons that say “subscribe,” “RSS,” or “Atom,” or with a symbol like this. By clicking on these icons, you can add blog “feeds” to Google Reader (or another aggregator). The result is akin to a receive-only e-mail experience in which blog posts are listed in your reader and updated automatically.
Google Reader has enhanced my life, changing how I work and spend leisure time. I would not easily keep up with blogs of interest without Google Reader or something like it. (The blogs to which I subscribe are listed in this spreadsheet.) Google Reader is free, but it provides more than zero dollars worth of value to me. If it were not free I would pay something for the service.
For the sake of argument, let’s say I’d be willing to pay $100 per year for Google Reader. This represents the gross value of Google Reader to me. Since I actually pay $0, then the net value I receive from Google Reader is $100 – $0 = $100 per year. This is just like $100 in my pocket because I’d have paid that amount more for Google Reader than I had to. That $100 represents my individual annual consumer surplus.
I don’t know how many Google Reader users there are, but let’s say there are 10 million. Suppose the average individual user is like me, with a consumer surplus of $100 per year. Then the annual total consumer surplus of Google Reader is $100 x 10 million = $1 billion per year. That’s a lot of value. Of course, I made the numbers up.
There is also value that Google receives beyond its costs of producing Google Reader. Google does not receive revenue directly from its Reader right now. Let’s assume it attributes revenue to its Reader because it draws users to other (ad-based) revenue-producing Google products. Ad revenue earned by Google subsidizes the price consumers would otherwise pay for its services in general and the Reader in particular. A market in which producers use revenue from one group (e.g., advertisers) to subsidize another (e.g., viewers, readers) is called a two-sided market. Broadcast TV is another example of a two-sided market.
Let’s pretend that ad-based revenue Google imputes to its Reader is, on average, $11 per user per year. Let’s also assume that the average marginal cost of providing Google Reader to each of the 10 million users is $1 per user per year. So, Google nets $11 – $1 = $10 per year for an average user and, therefore, $100 million per year for all users. This $100 million is the annual total producer surplus associated with Google Reader.
Total surplus is the sum of consumer and producer surplus, and is an economic measure of welfare. In our example total surplus is $1.1 billion, $1 billion for consumers and $100 million for the producer.
Typically an economic welfare analysis of a market includes comparisons of surplus values for different market configurations. Doing so leads to conclusions about which group, consumers or producers, is made better or worse off in one setting versus another. It is possible for both producers and consumers to be made better off (or both worse off) via a structural change in the market. Total surplus is maximized in the circumstance of perfect competition, an ideal situation which is actually quite rare.
As an example, we could consider the RSS aggregator market with and without the participation of Google Reader. The analysis above is almost complete for the market with Google Reader. What it lacks is the consumer (producer) surplus associated with RSS aggregator users (producers) who do not use (supply) Google Reader that can be attributed to its presence in the market. It is plausible that its presence in the market causes other aggregators to be less expensive or of higher quality. Thus, users of other aggregators receive consumer surplus and their producers lose producer surplus due to lower prices and higher marginal cost of higher quality.
A separate analysis is required to compute the surplus of consumers and producers in the RSS aggregator market in the absence of Google Reader. To conduct this analysis, one would need a model that predicts what current Google Reader users would do in this case. If Google Reader left the market, how would aggregator market shares adjust? How many Reader users would forego aggregator use altogether? I’ll leave suggestions of ways of making such predictions to a future post.
One thing the above explicitly illustrates is that both producers and consumers are made economically better off through market transaction. It isn’t just that producers get revenue and consumers get products. Producers earn profit and consumers receive value beyond the sticker price. Since most of us are in the role of consumer frequently but seller hardly ever we tend to begrudge the firm its profit and pay little notice to the additional value beyond price we receive in return. Google Reader is not the only bargain. Given the enjoyment and convenience obtained by the multitude of products we use it’s a wonder how little of that full value we actually pay. The rest is consumer surplus.
How Many Umbrellas Do You Need?
I’m on a blog break this week so all posts are reruns until the new year. This post originally appeared on 15 July 2009. If you wish to leave comments, please do so on the original post.
Rain was expected by the afternoon. I was not carrying an umbrella on my morning commute, and I had none at my office. So I purchased one on my way into work. It came with a “lifetime limited guarantee.” Does this suggest an improvement to the two-umbrella system described in the “umbrella problem” that was posed to me over a dozen years ago?
In 1996 I took an oral exam to qualify for my school’s PhD program. The exam included one question from each member of a three-professor panel of inquisitors. Professor Dimitri Bertsekas was on my panel, and he challenged me with ”the umbrella problem.” In those days neither the umbrella problem nor its solution was not on the internet. Today you can read about it in a Mathworks.com post and in a talk by Jeff Buzen (Power Point). In Example 6.5 (Chapter 6, page 15) of the Introduction to Probability lecture notes (co-authored by John Tsitsiklis), Bertsekas poses the umbrella problem as follows.
An absent-minded professor has two umbrellas that she uses when commuting from home to office and back. If it rains and an umbrella is available in her location, she takes it. If it is not raining, she always forgets to take an umbrella. Suppose that it rains with probability p each time she commutes, independently of other times. What is the steady-state probability she gets wet on a given day?
Unless you are accustomed to such problems it may not be immediately clear how to solve it. In the context in which it is posed in Bertsekas’ (and Tsitsiklis’) lecture notes it is simple. It is a straight forward application of basic properties of Markov chain models, which are described in the chapter that includes the problem.
So much of success in life is being prepared. I knew which professors would be on my oral exam panel. In the month before the exam I asked older graduate students what those same professors had asked prior years’ candidates. There was no guarantee that a professor would ask the same question twice. But this was a way to study questions likely to be similar to ones asked of me. Sure enough, the umbrella problem was a Bertsekas favorite; he asked it in prior years. I was prepared for it. I must have done well enough on the other two questions too, neither of which I recall, because I was admitted to the PhD program.
I think about the umbrella problem almost every rainy work day. In fact, it is probably due to the umbrella problem that I’ve implemented a two-umbrella system so I don’t always need to bring an umbrella with me if rain is expected later. But today for the first time, I forgot that the state of the system was zero umbrellas at work and two at home. I had forgotten to carry an umbrella from home and there was a good chance it would rain during my afternoon commute. Perhaps two umbrellas were not enough.
Hence my morning purchase of a Weather Zone brand “Oversize Automatic” black umbrella, style 1101, $5.24 at 7-11. This bumped me from a two-umbrella system to a three-umbrella one. That it included a “lifetime limited guarantee” gave me an idea. If it ever breaks, threatening to disrupt my now three-umbrella system I could make a claim under the guarantee and get a new umbrella. Perfect!
Not so fast. It is a lousy guarantee. It only covers manufacturing defects of the umbrella frame, not the fabric, case, or handle and not “any damage caused by accident, abuse, or failure to allow the umbrella to dry in an open position.” Worse, to make a claim one must ship the defective umbrella, an original receipt, and $5 (for shipping and handling) and wait four to six weeks for a repaired umbrella or replacement. Since paying to ship the umbrella would cost more than $0.24 it would be far easier and less expensive to buy a new umbrella if my new one breaks.
But is it worth it? If my new umbrella breaks and I switch back to a two-umbrella system, what are the chances it will rain and I’ll be without an umbrella? Following the techniques in Bertsekas’ and Tsitsiklis’ lecture notes, it is no more than p*(1-p)/(3-p) where p is the probability of rain on my commute. The chances of rain in a day is about 0.34 where I live. Thus, the probability I’ll get wet is no greater than 0.08. It is almost certainly lower than 0.08 because the chances it will rain during my commute are lower than the chances it will rain in a given day. Plus I am not (yet) totally absent-minded. The solution to the umbrella problem shows that a two-umbrella system is quite good. The useless “limited lifetime guarantee” of my new umbrella does not offer an improvement.
New Service: StumbleUpon
I’ve been messing around with StumbleUpon. If you’re curious about what I’ve found you can find me there as IncidentalEcon. If you don’t even know what StumbleUpon is, read this Wikipedia entry. I confess, however, it didn’t help me much. I didn’t get it until I tried it. In brief, it is a way to find and share interesting things on the web. I’ll be using it as a way to note/share interesting and fun stuff on the web that is not important enough to include in this blog’s News & Links feed.
Quick Update on Google Wave
The bold bits below are new information about Google Wave invitations.
As I wrote earlier I have invitations to Google Wave I don’t need. If you’d like one, send me a message with your e-mail address in the body of the message (that makes it much easier for me).
If you don’t get a Google Wave invitation it means I’ve run out or the Google Wave team has stopped sending them. Don’t expect it right away in any case. They’re sent out by the Google Wave team whenever they like. I’m just nominating you.
OK. Now I’m on a blog break.
Blog Break and Holiday Gifts
This blog has featured nearly 250 posts. That’s about 125,000 words, easily the length of a novel. Since every single one of those words was chosen with great care to inspire and inform it is worth revisiting them. So, next week (Dec. 28 – Jan. 1) I will take a blog break and post a few reruns from my archives, with updated titles for fun. (They’ll appear below this post on the site since I’ve made this one “sticky.”)
Unless there are dramatic developments I cannot ignore, the next original post will appear on January 5.
Meanwhile, would you like to give yourself a free holiday gift? Here’s my suggestion. If you’re not reading blogs by RSS feed with a reader, use some of your vacation time to begin doing so. Get a Google account and start using Google Reader. Fill it up with content I suggest, or whatever you like. Don’t forget to subscribe to this blog too. You will love this gift to yourself. I know that because here you are reading a blog. Clearly you like to do this. Do it better with RSS!
I’ve got another gift for you. I have invitations to Google Wave I don’t need. If you’d like one, send me a message with your e-mail address in the body of the message (that makes it much easier for me). If you don’t get a Google Wave invitation it means I’ve run out or the Google Wave team has stopped sending them. Don’t expect it right away in any case. They’re sent out by the Google Wave team whenever they like. I’m just nominating you.
Happy holidays.
Now I Can Retire
A decade out of graduate school and finally I’m recognized as a “health-care expert” (h/t, Ezra Klein). Now I can retire, except I’m expert enough in health care to know I can’t afford the non-group market, among other things.
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