Becker and Murphy confusion

In this Financial Times article, Nobel Prize winner Gary Becker and Clark Medal winner Kevin Murphy (both Chicago-school economists, and very good ones) argue that government just fails every time it tries to fix the economy so it should stay out.

The standard Chicago School argument is that markets work. Regulation is bad and only hinders economic growth. But there is one quite obvious thing they miss. Markets work when the incentives are correct. Alchian and Demsetz argued this probably 40 to 50 years ago. The incentives must be aligned so that everyone benefits.

Ben Klein further argued that firms (and people) can engage in opportunistic behavior and take advantage of these misaligned incentives to their own benefit. Williamson took that opportunistic behavior a step further by arguing that people (and firms) are self-interest seeking with guile.

Take that to the deregulated financial markets and you can see how the wrong incentives were created. As long as asset prices were thought to keep going up, there's no incentive to be careful in lending and investing. Then take those debts and reimagine them into some new financial instruments and sell them to unsuspecting firms. You get short-term gains for a few at the expense of long-term stability. In other words, there was no downside risk to these non-bank banks (see moral hazard).

The kicker to their argument against government intervention is that the government was bad in rescuing people from Katrina and poorly executed the war in Iraq. See Krugman's response here. They further argue that the Great Depression saw the world turn away from capitalism and towards government management of the economy and site slow growth in the undeveloped world. But what about those in the first world that mixed capitalism and government? What about the growth in the 1950s in the US? Great Britain? Germany (West)? Japan?

What is most surprising is that they say that derugulation (or insufficient regulation) was not the cause of this current crisis. The argument is that commercial banks didn't do so hot either and they're regulated heavily. But they fail to see the non-bank banks failures and complete collapse of those newly created financial instruments. I suggest they look back towards alignment of incentives and opportunistic behavior.

Movie and popcorn prices

An interesting comparison on popcorn and movie prices on Gizmodo. It compares prices from 1929 to today. Amazingly, they actually do the comparison in real terms, but don't cite what price index they used to adjust the 1929 prices to today's dollars. I checked the work using FRED's CPI database. Pretty close.

So what could explain why the huge difference in concession prices? My first thought is the vertical relationships prior to a, I think, Supreme Court decision that broke up the movie studio-movie theater relationship. Prior to that decision, movie studios actually owned movie theaters. It could be the case that the concessions were priced at marginal cost, while the fixed cost of the movie (the movie ticket) was set somewhat high. This is the idea behind a two-part tariff in microeconomics.

So why the big difference now despite the break up the vertical relationship? That's a tougher question. And here's an economics paper that looks at it. It's what economists call metering demand. And it's about tied goods. The basic premise is that the concession prices serve as a meter for demand for the entry good (the movie ticket). If these two are highly correlated, then the movie theater can charge more for both goods from higher type people. By higher type, I mean people who want both goods and are willing to pay for them. Hartmann and Gil show that when marginal customers are lured into the theater (more attendance), the average concession revenue decreases. This means these marginal consumers consume fewer concessions and fits with economic theory that justifies charging a premium on concessions to price discriminate.

Taxing video games will lower knife crime?

Well, according to some government adviser in the UK, yes. Is this a classic case of correlation and causation?

The "logic" goes like this: games are too cheap, so let's make them expensive, so kids won't become violent sociopaths. Yes, that makes sense. Perhaps the kids that commit the crimes are sociopaths in the first place?

Therefore, let's propose a government study where we randomly assign pools of kids that play violent video games and those that do something else like knit sweaters. Give them both access to knives and then set them free in a controlled playground and see if they start stabbing people.

Making decisions based on sunk costs

I really like this blog, but too often he falls into the trap of focusing on sunk costs.

In this post, he blasts the Times for recommending cutting the F-22 program. While he states that more analysis should be done, focusing on what is given up and what is gained...the focus on sunk R&D costs is particularly awful.

In the defense world, many are worried about what they've spent in the past getting the system ready for production. But it doesn't matter, or it shouldn't matter in the analysis. Those costs are gone, whether you continue buying the F-22 or not. The analysis MUST focus on the marginal costs and compare them to the marginal benefits.

The hard choices facing defense really do lie in procurement. Part of this is the cost of these unproven systems (EMALS in CVN-78, DDG-1000, LCS, CG(X)) but also in a strategy of what defense needs. It always seems that the analysis is done on some perceived threats and meeting them, damn the costs of doing so. But what this ignores is that you can't guard against everything. Not only would it be extremely costly, but it is impossible. What defense really needs is for someone to come in with a figure for procurement and then say, "here's the money we can spend, what can we defend against?" and then let DoD figure out what they can get to meet some threats.

Rock Band and Guitar Hero

I wonder if many artists and/or record labels are missing a huge opportunity with video games and music? I'm not talking just about the price of these downloads (usually 160 MS points, or about $2). I'm talking about bundling the rights.

So instead of only being able to play the music in Rock Band, but also take it to your iPod or your Zune or your computer. In other words, pay $x and get portability.

I'm also curious as to why bands/labels aren't lining up to get their music on the game. Maybe they are, but there's a lot of room for improvement. I'm really surprised that the Rolling Stones aren't on Rock Band (save for one song). Here's the chance to hook new listeners into your music and make money doing it.

I also wonder why new music releases aren't multimedia releases. Okay, maybe that has to do with the games needing the master tracks, so what about a delay of a week. But why not simultaneous? What's the fear? That it will leak out onto the internet? How would they get it into the game?

I think it's all a missed opportunity.

Studios fretting over fixed costs for blu-ray movies?

This article from high-def digest makes me wonder. Seems the studios are wary of spending money to restore classics for release on high-definition. But are they making people wary of spending money on the new format by focusing on new releases that are ready at near zero marginal cost for blu-ray? Perhaps.

It really depends on whether investing in the classics will make more people want what you are selling. But what's the marginal cost of cleaning up a film? The article hints at some of the large fixed costs. $1M for North by Northwest and some fixed costs (largely sunk) plus $200k for Gone with the Wind. But once you've restored the films (one-time cost), what's the marginal cost of producing a disc? Near zero. The studios should be thinking about that marginal revenue if they can convince more people to buy into the new format. That also means worrying about the price point of the movies.

The players are expected to be pretty pricey, but I think the studios have shot themselves in the foot regarding the prices of the movies. They seem more worried about differentiating blu-ray from DVD and they've chosen price (a luxury good, if you will). But what they haven't worried about is downloadable media. The quality is at least on par with DVD right now and iTunes HD is 720P and looks pretty good. More and more people are headed towards renting and streaming and the studios are still focused on price point (keep it high) instead of worrying about maximizing their profit. Look at bringing more people into blu-ray.