Economists Do It With Models

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On The Increasingly Unfortunate Economics Of Peanut Allergies…

August 24th, 2016 · 5 Comments
Buyer Beware · Econ 101 · Markets · Policy

So here’s a decent and concise overview of the latest issue to be taking over the internet:

Have a peanut allergy? Chance are you’re about to spend a lot more on EpiPens
by Emma Hinchliffe

Over the past few weeks, EpiPens have slowly overtaken the news. So what is going on with them exactly?

Source: Mashable

I feel like we’ve talked about this before as it relates to this guy, who apparently has some feelings about economists:

I don’t think he understands that economists are one of the groups likely most sympathetic to his ideals of profit maximization. Anyway, the general narrative is “company buys product, decides to make money from product, raises price of product,” and I would like to proceed by addressing one of Senator Sanders’ specific points:

This is where I point out that just because someone doesn’t like the reason doesn’t mean that the reason doesn’t exist. (As you’ll see in a bit, however, I pretty much agree with the spirit of what Sanders is saying.) In this case, the reason is some combination of inelastic demand and monopoly power– if consumers aren’t price sensitive (in this case because the product is a necessity) and they don’t perceive substitutes as being available (in this case one technically exists but often isn’t viewed as an acceptable substitute, so forgive me for not opining on the evils of patent protection at the moment), a producer can increase profit by increasing price. Sure, it will usually lose some customers, but the additional profit from customers that remain will more than make up for it. (In fact, the Lerner Index shows that markup over cost is inversely related to price elasticity of demand.)

Now, Bernie’s a smart guy, so I’m pretty sure that he knows this. He probably also knows that, even when producers are always maximizing profit, not all price increases are a result of cost increases. They could be the result of cost increases, but they also could be the result of an increase in demand for the product, at least in the short run. (That said, individuals do tend to view the former as fair and the latter as unfair.) In this case, there does seem to be an increase in demand for EpiPens over time, but what has more likely transpired is that the producer has shifted its values over time to focus more on pure profit maximization and less on keeping prices “fair.”

The somewhat uncomfortable reality is that, unless I’m interpreting price-gouging laws wayyyyyy too narrowly, the producer is within its rights to increase the price of its output, regardless of whether or not its costs have changed. (I feel like this point gets lost since companies often pay lip service to government to try to justify price changes in order to try to avoid future increases in regulation.) In fact, there’s even somewhat of an expectation coming from investors and capital markets that companies act so as to maximize profit. (While investors do seem to be increasing their emphasis on fairness and good corporate citizenship, the notion of a fiduciary responsibility to shareholders does still exist.)

I’m not saying that this outcome is right, either from an ethical or an efficiency standpoint, just that it shouldn’t be surprising. Again, the uncomfortable reality is that we rely on companies being “nice” as far as necessities are concerned in many cases, and recently we’ve gotten smacked with examples that show how fragile that trust can be. I’m also not saying that regulation is easy- how do you decide whether a product is truly a necessity? How do you decide whether a market is sufficiently competitive so as to solve its own problems? How do you regulate price or remove barriers to entry without destroying the incentives to innovate or keep costs down? (Economists have some models for regulating natural monopolies such as this, but they’re not perfect solutions.) I do think, however, that it’s a little unfair for policymakers to resort to shaming companies that are operating within the legal framework that they created because they kicked the regulatory can down the road (but, ironically yet likely justifiably, regulated enough to create the problem in the first place) rather than addressing what is an easily foreseeable issue from an economic standpoint.

→ 5 CommentsTags: Buyer Beware · Econ 101 · Markets · Policy

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More On The Disposition Effect, Now With Econometric Issues…

August 24th, 2016 · No Comments
Behavioral Econ · Videos

Last time, we discussed the main result that shows evidence for the disposition effect- i.e. the bias toward selling winning stocks and against selling losing stocks. What I didn’t tell you at the time was that the calculation suffers from somewhat of an econometric problem, so I make up for my oversimplification and discuss that here.

As usual, you can see the whole behavioral economics playlist here in case you want to catch up or need a review.

→ No CommentsTags: Behavioral Econ · Videos

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Please Don’t Let This Become The Norm, Ramen Edition…

August 23rd, 2016 · 1 Comment
Econ 101 · Macroeconomics

So the internet seems pretty much obsessed with this story right about now…

Ramen is displacing tobacco as most popular US prison currency, study finds
by Mazin Sidahmed

Cost-cutting measures by private facilities have led to subpar food quality and fewer meals, making noodles a commodity that trades well above its value

Source: The Guardian

The headline, taken at face value, isn’t particularly surprising to economists- we are quick to point out that a pretty wide variety of items can count as “money”, provided that they perform a few functions:

  • A medium of exchange
  • A unit of account
  • A store of value

By this characterization, sure, ramen could serve as money- I guess ramen packs aren’t so large as to be too cumbersome to be traded, you could quote “prices” of other items in terms of packs of ramen (and measure your wealth in packs of ramen, I suppose, though that sounds a little sad), and ramen isn’t particularly perishable so it could make a decent store of value. If you think about it, basically any non-perishable commodity could be used as money in this way, it’s just a matter of changing your “base currency” to the good in question. For example, let’s say that the “price” of a pack of cigarettes is 3 packs of ramen- this means that 3 packs of ramen can be traded for one pack of cigarettes. (Note that prices are really just terms of trade.) I could have just as easily quoted the price of a pack of ramen as 1/3 of a pack of cigarettes- nothing has changed except I’m in an universe where the cigarettes are the base currency, i.e. money. (This framing shift happens all the time in foreign exchange, since a nominal exchange rate is just the price of one currency in terms of another currency.) I used this example because, historically speaking, cigarettes are commonly used as currency in prison situations, as the article points out.

When economists talk about money, we are careful to distinguish between commodity money- i.e. money with intrinsic value- and fiat money, which isn’t useful in and of itself. Clearly, ramen falls under the heading of commodity money, since, if you are anything like me, you get utility from eating ramen. (Technically I am referring to the restaurant version, but just go with me here.) Interestingly, it’s precisely this feature that causes me to question a. whether ramen is actually being used as money is typically used, and b. whether, if true, such use would even be a good idea.

The article above states that “the decline in quality and quantity of food available in prisons due to cost-cutting has made ramen noodles a valuable commodity.” I completely buy this statement, but “valuable commodity” and “money” are not synonymous. The article does go on to mention that ramen does often get traded for other goods and services, and the “prices” imply that there is some sort of arbitrage opportunity for those who can acquire ramen at the commissary price of 59 cents and then trade for other goods rather than acquire the other goods directly. The “money” argument kind of breaks down, however, when the article clarifies that people do in fact want to eat the ramen- I suppose you can technically eat a dollar bill if you wanted to, and you see situations where people use pennies decoratively rather than as a medium of exchange, but it seems like the opportunity cost of forgone consumption is pretty low when it comes to traditional currency, and you don’t see a lot of traditional currency being diverted for consumption purposes. Ramen, on the other hand, has a high opportunity cost of forgone consumption, literally speaking…and a prisoner decreases the the money supply every time he or she gets hungry! I’m not convinced that that is how money is supposed to work- just imagine the hunger-related swings in interest rates that could result. (At least when money is used to buy food, the food gets consumed whereas the money just gets transferred.) Even if the prison economy isn’t sophisticated enough to support a market for loans, eating the ramen currency is going to result in deflation, since there’s going to be less ramen currency to go around to conduct other economic transactions. (In other words, ramen purchasing power will increase because there is less of it available for purposes of exchange.) This isn’t great, since stable prices are thought to be a desirable feature in an economy.

I do think that there’s an important metaphor here- the above discussion suggests that sure, ramen can technically function as money, but the fact that it’s useful in itself causes it to function suboptimally as money in a number of ways. More generally, using an item as money either takes that item out of consideration as a useful resource or causes undesirable money supply/price stability effects (or some combination of the two). In this way, fiat money is pretty efficient in that it minimizes the productive stuff diverted to count as money (mainly some fancy paper, zinc, etc. Hey, it’s not a perfect system.). By similar logic, it’s not surprising that gold was a popular form of commodity money, since the uses for gold (electronics, jewelry, tooth caps. etc.) are actually pretty limited compared to the amount of gold available in the world. (If this were not the case, we wouldn’t see so much of it in bar form.)

I guess what I’m saying is that I hope this ramen as currency thing doesn’t catch on as a larger trend, since I don’t want to have to feel as bad about eating ramen as I do about leaving dollar bills in jeans pockets when I do my laundry. (I was going to say that I didn’t want to have to decide between eating the ramen and buying stuff with it, but I suppose the tradeoff between consuming one good and consuming another exists even when money itself is not consumable.) Also, it’s thought that contractionary monetary policy can cause recessions, and I certainly don’t want my ramen consumption habits to be responsible for that.


Update: The internet is a fantastic place, so now we’re discussing how the commissary could act as a ramen central bank and I am pondering the amount of seigniorage potential present in ramen minting. For now, I’m going to go in the kitchen and whip up some counterfeit ramen.

→ 1 CommentTags: Econ 101 · Macroeconomics

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Fine, We Can Talk About Exports Too, Coffee Edition…

August 19th, 2016 · No Comments
Policy · Trade

So a little while ago I wrote about the efficiency of free trade where I went through a situation in which a country would want to start importing a good from abroad. At the end, I noted that an export situation is basically the same but with a role reversal for producers and consumers. Nonetheless, there is an objection of “yeah, but you didn’t consider exports” in the comments section…I was mainly trying to not be repetitive, but in retrospect I think I inadvertently did what so many economists (especially economics instructors, sorry about that) do- we focus on the effects of imports and then gloss over the effects of exports. This isn’t great for students etc., and it’s particularly problematic because people more generally focus on the impact of foreign competition for production much more than the impact of foreign competition for consumption. So I apologize, and I’m here to make up for my earlier oversight.

I think this bias occurs at least partly because it’s easier to find motivating examples/case studies/etc. that have to do with imported goods. (This doesn’t mean that imports are a bigger deal, just that, like I said, we tend to focus on them more, so…chicken and egg, you know?) But here’s one on a topic near and dear to my heart…and stomach, and brain probably:

Meet the Man Bringing Coffee Back to Colombia
by Ethan Fixell

Despite the country’s reputation for fantastic coffee, it’s nearly impossible to get a good cup of joe in Colombia. The second largest coffee exporter on earth sent $2.6 billion worth of beans to other countries around the world last year, forcing locals in most Colombian cities to brew imported beans from far-off places like Vietnam.


Like before, I’m going to try to explain what’s going on here without using any graphs (even though I like them so much!). Say you’re a coffee grower in Colombia, and you live in a world where there is no trade among countries. Your only option, therefore, is to sell your coffee to people in Colombia, who might not have a lot of disposable income or might not like coffee that much or whatever. In this world, you sell your coffee (unroasted wholesale, to make the numbers make a little more realistic) for 25 cents per pound. (No, I don’t know why our Colombian transactions are denominated in USD, but let’s try to focus here.) The point is that Colombian roasters can buy your coffee pretty cheap, which is good since they can’t set too high a price for the finished product, what with Colombians not having a lot of cash and not liking coffee and whatnot.

Now let’s open up Colombia to some trade- you know, that thing that people have taken a sharp turn against for some reason:

If we’re honest with ourselves for a second, I think we can all agree that Americans have a (relatively) decent amount of disposable income and are pretty much welded (I was going to say wedded but I think the typo works better) to our coffee intake. This combination of factors leads to a higher willingness to pay for coffee, especially Colombian coffee, since we all bought into the coffee marketing of the 1980’s:

(No really, that ad is from 1983, and I have no idea why this marketing was so salient to my young self.)

As a result, let’s say that roasters in the US will pay $1 per pound for Colombian coffee. Also, let’s note that we drink a lot of coffee, so the US roasters are willing to buy as much as Colombia will sell us at that price. What are Colombian coffee growers going to do?

I feel like the article preview pretty much ruined the suspense here- if coffee growers can sell all they want to the US for $1, they aren’t going to sell to Colombia for less than $1, so the price to Colombian roasters goes from 25 cents to $1. Colombian roasters don’t buy as much Colombian coffee (demand curves do slope downward after all), and Colombian coffee drinkers get coffee imported from Vietnam rather than the stuff that it right around them. Weird, right? But is perfectly understandable from an economic standpoint.

In this scenario, Colombian coffee producers are better off because of trade and Colombian consumers are worse off. (Told you it was the reverse of the import situation.) Like with imports, trade is efficient since the producers win from trade more than consumers lose from trade. Why is this? Well, let’s think about this in a few consumer-group parts:

  • Those Colombian roasters who are still buying coffee at $1: They are 75 cents worse off, but the coffee producers are 75 cents better off, so there’s no net value change.
  • Those Colombian roasters who were willing to buy at 25 cents but not at $1: They are losing less than 75 cents in value (read, consumer surplus), since if this were not the case they would still be willing to buy at $1. (For example, if a roaster was willing to pay 60 cents, pricing him out of the market causes him to lose the 35 cents of value he had been getting at a price of 25 cents.) The coffee producers are better off by 75 cents since they are still able to sell the coffee at $1 to foreign consumers. This results in a net value increase.
  • Those foreign roasters who are willing to buy coffee at $1: Since the Colombian growers aren’t selling at a loss, this has to be a value increase.

This combination of no change, increase, increase has to result in an overall increase in value for Colombian society. (Like the basic import analysis, however, this doesn’t address distributional concerns regarding winners and losers.)

Not gonna lie- it’s pretty perplexing to me that this dynamic doesn’t seem to call for export restrictions nearly as much as the reverse situation results in calls for import restrictions. If I had to guess, I would hypothesize that people are more inclined to think about their welfare in terms of money coming in (i.e. the producer side) rather than in money going out (i.e. the consumer side). On the other hand, people complain way too much about inflation for this explanation to be entirely satisfying, so who knows. Maybe it has to do with the fact that producers tend to be more concentrated than consumers, and more protest happens when losers are more concentrated? In any case, it *is* sort of unfair to talk about the effects of imports without considering the effects of exports, or vice versa, if for no other reason it’s difficult to include a “we want to sell you stuff without restriction but we’re going to tax the stuff you try to send to us” clause in trade agreements nowadays.

→ No CommentsTags: Policy · Trade

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Empirical Evidence For The Disposition Effect, Results Edition…

August 17th, 2016 · No Comments
Behavioral Econ · Videos

In a previous video, my class went over the empirical setup in one of the main papers about the disposition effect in stock-market behavior. Now they got to talk about the results of that analysis:

If you need a refresher, you can see the whole behavioral economics playlist here.

→ No CommentsTags: Behavioral Econ · Videos

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When Matching Pennies Takes An R-Rated Turn…

August 16th, 2016 · 3 Comments
Game Theory · Just For Fun

You know you’re an econ/math nerd if you read this and think “haha, it’s like the matching pennies game”:

But hear me out…here’s the matching pennies game, and, like the joke, the crux of the game is that there is no Nash equilibrium without randomization. To further the analogy: The matching pennies game works as it does because player 1, let’s say, “gets off” when the pennies match whereas player 2 gets off when the pennies don’t match. (This wording hopefully shows the intuition of why there is no pure-strategy Nash equilibrium, since the goals of the players are clearly mutually exclusive.) The…uh, matching fetishes game works in a similar fashion, since the guy gets off when he and his partner are in agreement, but the woman gets off when there is discord.

With some minor labeling changes, you could even make a payoff matrix for the matching fetishes game, the conclusion of which is…hm, can one randomize being turned on or not?

→ 3 CommentsTags: Game Theory · Just For Fun