Economists Do It With Models

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December 17th, 2015 · No Comments
Macroeconomics · Policy · Tumblr

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Economists Can Explain That! Black Friday Edition…

December 8th, 2015 · 1 Comment
Buyer Beware · Game Theory

Well color me not surprised…

Did anyone really think that stores being open on Thanksgiving was actually going to substantially increase how much consumers buy rather than just change the timing of purchases? I like an intoxicated post-turkey Target fest as much as the next person, but this just seems largely implausible, if for no other reason than it’s difficult to increase sales without increasing consumers’ incomes. It may be tempting to conclude that the stores are making bad decisions here but, as usual, a little economics can shed a lot of light on the matter.

First…hey, remember the prisoners’ dilemma?

The basic principle of the prisoners’ dilemma is that the payoffs of the game make it such that not cooperating is superior to cooperating for a player regardless of what the other player does, and individual incentives result in an equilibrium outcome that is worse than what would happen if the parties could commit to cooperating. The prisoners’ dilemma setup has been used to explain a number of outcomes that we see in the world- including, but not limited to, arms races. And anyone who’s witnessed Black Friday shopping firsthand should not be surprised that I’m comparing it to an arms race.

Think about it…retailers would probably be better off if they all agreed to not be open on Thanksgiving, since they would likely be making pretty much the same sales without having to incur the costs of being open as many hours. BUT…if a retailer thinks that no one else will be open on Thanksgiving, it has an incentive to open on Thanksgiving in order to try to capture the sales of shoppers who are either impatient or hate their families. Similarly, if a retailer thinks that everyone else is going to be open on Thanksgiving, it’s optimal to open on Thanksgiving in order to not get left behind when shoppers get impatient. So what happens? Stores follow their individual incentives, open on Thanksgiving, and achieve the prisoners’ dilemma or arms-race outcome where they’re basically back where they started but incur an additional cost. In addition to not being great for the retailers’ bottom lines, staying open on Thanksgiving puts an unnecessary burden on those employees who are pressured or forced into working on Thanksgiving. (Those workers who are cool with working on turkey day, more power to you.)

So what can be done to mitigate the inefficiency of this situation? We know from the prisoners’ dilemma that non-binding agreements to cooperate don’t work because of the incentives to renege, and besides, cooperation (especially binding cooperation) runs afoul of that whole antitrust thing. Companies are left with what is essentially a coordination failure, leaving government as the store closer of last resort. This gets into uncomfortable territory on a number of levels, not the least of which being that it’s not obvious what companies are playing the arms race game and which have efficient reasons to stay open on Thanksgiving. (Also notice that, while some states do still have “blue laws” on the books, requiring businesses to close on a wider scale is largely uncharted territory.) So, for now, we’re stuck with the consumption arms race. That said, some companies have actively tried to buck the trend by trying to get customre cooperation rather than competitor cooperation. Case in point, from REI:

I worry that this is not entirely generalizable, but it’s at least an interesting start.

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November 25th, 2015 · No Comments
Econ 101 · Tumblr

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November 24th, 2015 · No Comments
Macroeconomics · Tumblr

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Economics Can Answer That! Adele And Spotify Edition…

November 20th, 2015 · 2 Comments
Music Biz

In case you haven’t heard, Adele has a new album titled 25 coming out. (If this refers to you, let me know and I will send help to get you out from that rock you are under.) Now we’re being told that we won’t be able to stream said album anytime soon:

Not gonna lie- from the numbers I’ve seen, it’s entirely possible that this withholding strategy is profit maximizing as far as recorded music is concerned. To get a handle on this tradeoff, consider some numbers:

So what is the “break even” point? At which point are Spotify listens more profitable than selling music? In other words, how many times would someone have to listen to your song on Spotify until it is the equivalent of them actually buying the song for the typical price of $1? (a typical full length now a days usually goes for $10, and a typical full length is usually around 10 songs, or $1 per song) We can calculate that quite easily. Taking the value of the song at $1 per person, we can simply divide the $1 by Spotify’s royalty payment of $.0072, and we get about 139. If you want to account for the cost of the CD to the artist, (about $1 per CD, or $.10 a song) we divide $.90 by $.0072 and get 125. If an artist can get every single fan interested in buying their music to listen to each song at least 125 times on Spotify, the artist will make out better on Spotify. If not, the artist will make out better on CD sales or downloads.

If you want to put some personal perspective on this, there are a number of applications that will look at your iTunes library and give you a play frequency distribution for your songs. To be fair, however, this analysis is a bit too simplistic in that it ignores revenue from streaming listeners who wouldn’t have actually paid for the CD or track (and, in Adele’s case, revenue from just dumped people listening to Someone Like You on repeat for days at a time). But this isn’t the main point, so let’s not get distracted…

The fact of the matter is that today’s musicians don’t only sell recorded music- they also sell concert tickets, merchandise, licensing rights, and many other things. If a musician’s team is smart, it will attempt to maximize profit over all revenue streams together and not just on recorded music by itself. Such a strategy would likely involve using streaming services (and recorded music more generally) as somewhat of a loss leader to gain exposure and drive demand for complementary goods such as the aforementioned concert tickets and merch. This approach likely explains why many artists have chosen to remain on Spotify…but then why is Adele different?

As it turns out, the incentive to cross-subsidize with a loss leader decreases when a producer doesn’t have a whole lot to drive demand to. In Adele’s case, well, she hates touring. Okay, that’s a bit of an exaggeration, but if you google “Adele hates touring” you will see what I’m talking about. For example:

During a recent interview with On Air with Ryan Seacrest, Adele said she’s not entirely sure if she’s ready to take that next step.

“I definitely will do as many shows as I’ve always done before,” she revealed. “I’d love to do a world tour and I’d love to be able to say I’ve done it in the end, but I don’t know if I’m strong enough for it.”

Before you judge, keep in mind that her view on touring is driven by not only by the fact that she doesn’t like it but that she also means “strong enough” quite literally, since a large number of shows puts a strain on her voice and has put her out of commission a few times already. Nonetheless, her strategy is exactly what the economics of the situation would predict- if you don’t have razor blades to sell, you’ve got to focus on actually making profit from the razors directly. And if you think that casual listeners are not going to make up for lost revenue from more die-hard fans (and don’t need the exposure since the world is doing that for you), then staying off of streaming maximizes profit from your recorded output.

Fun fact: it used to be the case that tours were used as loss leaders to sell recordings rather than the other way around…though when people describe Adele as retro, I don’t think that this is what they mean. 🙂 Personally, I’m hoping that her long-term strategy is to engage in temporal third-degree price discrimination*, since I’m not a huge Adele fan but would like to explore her new work on Spotify eventually.

* Technically, temporal third-degree price discrimination refers to lowering the price over time once customers with higher willingness to pay have actually purchased in order to capture revenue from more price elastic customers. It applies here, however, since adding one’s product to a free (at least in a marginal sense) service can be viewed as a form of price decrease.

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November 16th, 2015 · No Comments
Finance · Tumblr

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