Tag Archives: economics

Equilibrium response to reduced material use for plastic bags

Probably to save material on the manufacture of the free plastic shopping bags in the US, these bags are small and thin compared to the ones in Estonia (which used to be free, but are now priced at significantly above production cost due to EU regulations on disposable plastic products). The equilibrium response of cashiers and customers to thin flimsy bags is to double-bag groceries, a practice unheard of in Estonia. After all, if one bag is sturdy enough, almost nobody will use two inside each other. I have successfully carried 10 kg in an Estonian plastic bag.

The equilibrium response to small bags is to distribute the groceries among many bags, especially the heavy or bulky items, for example to put each milk canister or large salad sack into a separate bag. Both double-bagging and the one-item-per-bag distribution lead to more bags being used in response to manufacturing each bag out of less material. It is an empirical question whether thinner, smaller bags result in less or more plastic waste overall. To incentivise reducing the one-time use of plastic bags and to encourage reuse, customers should have to pay for these, like in the EU.

One form of plastic bag reuse is as garbage bags (although it is only a one-time reuse, it is better than nothing). However, the flimsy free bags in the US come in bulk packs with the bottoms of the bags stuck together, so separating one from the stack often results in holes in its bottom an inch wide or more. The holes discourage many forms of reuse, including as trash bags, because small items (dust, crumbs, scraps) fall out. Partly the holes are due to the flimsiness of the material, partly to the way the bags are glued together to make a bulk pack.

Delivered food and restaurants are unhealthy due to moral hazard

Consumers observe the taste and cost of food directly, but checking the ingredients for healthiness takes extra effort and time. Rational inattention then implies that eaters are unlikely to verify the health claims. Thus food suppliers are subject to moral hazard: consumers buy based on the healthiness they expect, not the actual ingredients the seller chooses, so the seller has an incentive to improve taste, reduce the production cost and cut price even when this makes the food less healthy.

The standard solutions to moral hazard from economic theory are verification, repeated interaction and vertical integration (selling the firm). In the context of food, safety standards and truth-in-advertising laws restrict the substances manufacturers may add and claims they can make. Regulators verify claims made and punish for illegal additives or false advertising. Also, if a food supplier is found to use unhealthy ingredients (or amounts of sugar, salt and fat), then some consumers may switch to alternate providers, which is a repeated game punishment for the original seller.

The weakness of both verification and repeated interaction is imperfect monitoring: small increases in unhealthy substances are difficult to detect, because tests are noisy and food composition varies naturally. The variation sometimes makes the amount of an ingredient exceed the healthy limit, so honest suppliers would also be punished with positive probability. Incentives are created by the difference in payoffs, so reducing the payoff of the honest decreases their motive to stay honest. The imperfect monitoring allows unscrupulous sellers to outcompete the providers of healthy food on taste and price, for example by using various tricks to circumvent the legal requirements on labelling (https://sanderheinsalu.com/ajaveeb/?p=728).

The remaining solution to the moral hazard problem is vertical integration of the buyer and the supplier, i.e. home cooking. Of course, the ingredients bought to be cooked at home are subject to similar moral hazard – unhealthy substances can be added at any stage of the production process. The risk could in principle be even larger than for processed foods and restaurant meals, but in practice, it seems that simple and unprocessed ingredients are more difficult to manipulate than prepared meals, which are a mixture of many components. Adding sugar, salt, fat or monosodium glutamate to flour, rice or dry beans without mentioning it on the nutrition label is easier to detect than the same (amounts of) additives in shrimp fried rice, bread or a burrito. Raw meats and fish do have extra salt and food colouring added, but usually less than for ready-to-eat meals.

Relative prices are another reason why there may be less manipulation of ingredients than processed foods. There is a per-unit cost of adding unhealthy substances, as well as a fixed cost due to the risk of lawsuits and fines, especially if the additives are not declared on the label. Unprocessed ingredients are less differentiated, so the price competition is more intense. The increase in the price that customers are willing to pay if an ingredient tastes better than the competitors’ may be small if price is the main dimension of competition. The slightly higher price may not justify the per-unit cost of the additives. In contrast, for processed foods the margin may respond greatly to taste, motivating manipulation of the ingredients.

The taste of the final dish is likely to respond less to manipulating one ingredient than to altering the composition of the entire food, both because the ingredient may be only a small part of the final dish and because the taste of a dish is largely determined by the seasoning and the cooking method. In this case, additives to ingredients do not improve taste that much, reducing the profitability of manipulating these.

Intense price competition motivates cost-cutting, including by substituting cheaper ingredients or using additives (e.g. preservatives) that reduce the manufacturing cost. However, if the additives cost more than they save on production cost (such as preservatives for dry goods that already keep indefinitely), then they are unprofitable to include.

Demand for cooking ingredients may also respond less to price and taste than for restaurant meals or delivered food (raw ingredients may even be an inferior good, but eating out is more like a luxury good). In this case, there is a range of fixed costs of unhealthy substances for which adding these to ingredients is unprofitable, but to processed foods profitable.

Pill testing, placebos and illegal market efficiency

Testing illegal drugs for the active ingredient differs from testing for poisonous adulterants. Both tests have opposite effects on drug use before and after buying. After the pill has been purchased, testing reduces use, because sometimes the drug fails the test, whether correctly or not, and is discarded. Before purchase, the option to test for and avoid adulterated or inactive drugs reduces the buyer’s risk, thus increases use.

In the longer term, testing benefits the dealers of purer, more predictable and less toxic drugs, putting some suppliers of fakes out of business. Pill predictability reduces overdoses – a health effect similar to lower toxicity. If old drugs can be tested, but new ones not, then buyers experiment less and the incentive to invent new narcotics decreases.

The avoidance of poisonous adulterants is good for public health, but purer pills not necessarily so. Inactive drugs undermine consumer confidence in the illegal market, reducing use, prices and casual purchases. Trust then requires a long-running relationship with the seller, which has multiple benefits. It motivates dealers to care about the health of their loyal customers, simplifies policing and gives researchers and social workers better long-term access to the at-risk population.

One claimed benefit of party drugs is that they reduce anxiety, increase the user’s confidence and social interaction, thus improving mental health. Evidence from psychiatric medicines suggests that many such benefits are due to the placebo effect. Users are quite inaccurate in estimating the purity of ingested drugs, and factors like price and place of purchase strongly influence their perception of purity. The price per pure gram is negatively related to purity in some markets, further supporting the placebo interpretation. If inactive pills boost confidence similarly to illegal drugs, then there is a clear case for flooding the market with harmless placebos. The availability of pill tests for the active ingredient reduces this opportunity to make the illegal market inefficient. Tests for toxic adulterants, however, actually favour harmless placebos.

Easier combining of entertainment and work may explain increased income inequality

Many low-skill jobs (guard, driver, janitor, manual labourer) permit on-the-job consumption of forms of entertainment (listening to music or news, phoning friends) that became much cheaper and more available with the introduction of new electronic devices (first small radios, then TVs, then cellphones, smartphones). Such entertainment does not reduce productivity at the abovementioned jobs much, which is why it is allowed. On the other hand, many high-skill jobs (planning, communicating, performing surgery) are difficult to combine with any entertainment, because the distraction would decrease productivity significantly. The utility of low-skill work thus increased relatively more than that of skilled jobs when electronics spread and cheapened. The higher utility made low-skill jobs relatively more attractive, so the supply of labour at these increased relatively more. This supply rise reduced the pay relative to high-skill jobs, which increased income inequality. Another way to describe this mechanism is that as the disutility of low-skill jobs fell, so did the real wage required to compensate people for this disutility.

An empirically testable implication of this theory is that jobs of any skill level that do not allow on-the-job entertainment should have seen salaries increase more than comparable jobs which can be combined with listening to music or with personal phone calls. For example, a janitor cleaning an empty building can make personal calls, but a cleaner of a mall (or other public venue) during business hours may be more restricted. Both can listen to music on their headphones, so the salaries should not have diverged when small cassette players went mainstream, but should have diverged when cellphones with headsets became cheap. Similarly, a trucker or nightwatchman has more entertainment options than a taxi driver or mall security guard, because the latter do not want to annoy customers with personal calls or loud music. A call centre operator is more restricted from audiovisual entertainment than a receptionist.

According to the above theory, the introduction of radios and cellphones should have increased the wage inequality between areas with good and bad reception, for example between remote rural and urban regions, or between underground and aboveground mining. On the other hand, the introduction of recorded music should not have increased these inequalities as much, because the availability of records is more similar across regions than radio or phone coverage.

Would a protest influence you?

Help, a politician I don’t like is in power! I should do something about it. But what? I know! I will join a protest – this is something. Now I can feel good about myself for having done something. And post on social media how I opposed evil so effectively. I am a socially conscious, altrustic person.

On a more serious note, one way to evaluate whether a given protest could change the situation is to put yourself in the position of the target audience. If your favourite politician was in power, would this protest change your support for said politician? If you were the politician in power, would you change your policy when many opponents use this protest against it?

Even if the answer is no, a protest may still have some effect, because it may change the preferences of the swing voters. The „no” may come from deeply ideological people, whereas more open-minded folks may conform to the herd. If they see many people opposed to something, they may start to oppose it too.

On the other hand, a protest may have the opposite effect to the one intended. It may harden ideological positions and increase polarisation. If the majority is weakly in favour of a policy, then protests against it may strengthen the support of the majority for it, leading to greater turnout and more yes-votes.

From an economic viewpoint, marching on the street with signs, chanting slogans or commenting on social media has no direct impact on politicians or most voters. The exception is those who are stuck in a traffic jam when a protest closes a street. Rational agents should not pay attention to protests which do not affect them (such activism is „cheap talk” in economic jargon, or at best „money burning”).

Real people may be swayed by the opinion of a large crowd. However, a form of protest that has an objective impact on people’s lives is likely to influence people more, because it affects them via both the opinion of the crowd and the direct impact. Both the belief shift and the hardening of the opposition are probably greater.

There are many illegal means of directly affecting the population, but also some legal forms of protest with objective impact. Economic protest is boycotting certain countries, firms or goods, refusing to work for the regime, and moving elsewhere („voting with one’s feet”), and is usually legal. The objective impact is that if enough intelligent and hardworking people shift their spending and taxpaying elsewhere, then the regime will be in fiscal trouble. If this does not change the policy of the leadership, then at least the lack of money will make the program harder to carry out.

There is a larger personal cost for economic protest than for cheap talk. One has to give up certain goods, or pay more, or experience the hassle of moving residence. This is why most people who threaten to boycott a firm or leave a country do not end up doing so. The threats are just another form of cheap talk, which can be posted on social media to impress other cheap talkers.

On backpackers and low-spending tourists

Countries encourage tourism to make money. The same goes for local governments, tourism industry associations and tour firms. Some places provide options for low-spending tourists like backpackers, despite not making much money from them. These options may be cheap campsites, backpacker hostels, allowing hitchhiking and work-travel visas. At first sight, any positive revenue from poorer tourists would justify welcoming them. This simple revenue calculation, however, neglects the substitution effect and dynamic demand.

Substitution means that if cheaper travel options are available, then some tourists who would have spent more in the absence of these options now spend less. For example, a person who would stay in a hotel if there was no other accommodation, stays in a backpacker hostel instead. On the other hand, if all options are expensive, then the poorest tourists do not come at all. There is a tradeoff between the number of tourists and the average tourist’s spending. If introducing cheaper options leads to many tourists switching to these, but does not attract many additional low-spending people, then creating these cheaper options reduces total profit.

Dynamic demand means that a person who has toured a particular location once changes his or her likelihood of going there in the future. For example, having seen a tourist site, a person does not visit it again. Or someone going on vacation and liking the location starts going there year after year. If a region encourages young, low-income people to visit as backpackers, then it may increase or decrease future visits by these people when they are older and wealthier. In particular, if people do not tour the same location again (and spend more when older), then encouraging them to visit when young reduces the total profit from them over their lifetime.

The fact that some regions welcome backpackers has several possible explanations. There may not be much substitution, or a visit may increase future visits. The tourism industry may not have thought this through and may be reducing their own profit inadvertently. Or the government may have other objectives than taxes from the tourism industry. For example, allowing people from other countries to visit cheaply may make these people friendly to the host country, which may yield some nonmonetary benefit in international relations.

 

Measuring a person’s contribution to society

Sometimes it is debated whether one profession or person contributes more to society than another, for example whether a scientist is more valuable than a doctor. There are many dimensions to any job. One could compare the small and probabilistic contribution to many people’s lives that a scientist makes to the large and visible influence of a doctor to a few patients’ wellbeing. These debates can to some extent be avoided, because a simple measure of a person’s contribution to society is their income. It is an imperfect measure, as are all measures, but it is an easily obtained baseline from which to start. If the people compared are numerous, un-cartelized and employed by numerous competitive employers, then their pay equals their marginal productivity, as explained in introductory economics.

People are usually employed by one firm at a time, and full-time non-overtime work is the most common, so the employers can be thought of as buying one “full-time unit” of labour from each worker. The marginal productivity equals the total productivity in the case where only one or zero units can be supplied. So the salary equals the total productivity at work.

Income from savings in a competitive capital market equals the value provided to the borrower of those savings. If the savings are to some extent inherited or obtained from gifts, then the interest income is to that extent due to someone else’s past productivity. Then income is greater than the contribution to society.

Other reasons why income may be a biased measure are negative externalities (criminal income measures harm to others), positive externalities (scientists help future generations, but don’t get paid for it), market power (teachers, police, social workers employed by monopsonist government get paid less than their value), transaction costs (changing a job is a hassle for the employer and the employee alike) and incomplete information (hard to measure job performance, so good workers underpaid and bad overpaid on average). In short, all the market failures covered in introductory economics.

If the income difference is large and the quantitative effect of the market failures is similar (neither person is a criminal, both work for employers whose competitive situations are alike, little inheritance), then the productivity difference is likely to be in the same direction as the salary difference. If the salary difference is small and the jobs are otherwise similar, the contribution to society is likely similar, so ranking their productivity is not that important. Comparison of people whose labour markets have different failures to a different extent is difficult.

Local and organic food is wasteful

The easiest measure of any good’s environmental impact is its price. It is not a perfect measure. Subsidies for the inputs of a product can lower its price below more environmentally friendly alternatives that are not favoured by the government. Taxes, market power, externalities and incomplete information can similarly distort relative prices, as introductory economics courses explain. However, absent additional data, a more expensive good likely requires more resources and causes more environmental damage. Remembering this saves time on debating whether local non-organic is better than non-local organic fair trade, etc.

Local and organic are marketing terms, one suggesting helping local farmers and a lower environmental impact from transport, the other claiming health benefits and a lower environmental impact from fertilizers. Organic food may use less of some category of chemicals, but this must have a tradeoff in lower yield (more land used per unit produced) or greater use of some other input, because its higher price shows more resource use overall. From the (limited) research I have read, there is no difference in the health effects of organic and non-organic food. To measure this difference, a selection bias must be taken into account – the people using organic are more health-conscious, so may be healthier to start with. On the other hand, those buying organic and local may be more manipulable, which has unknown health effects. Local food may use less resources for transport, but its higher price shows it uses more resources in total. One resource is the more expensive labour of rich countries (the people providing this labour consume more, thus have a greater environmental impact).

If one wants to help “local farmers” (usually large agribusinesses, not the family farms their lobbying suggests), one can give them money directly. No need to buy their goods, just make them a bank transfer and then buy whichever product is the least wasteful.

There are economies of scale in farming, so the more efficient large agricultural companies tend to outcompete family farms. The greater efficiency is also more environmentally friendly: more production for the same resources, or the same production with less. Helping the small farms avoid takeover is bad for the environment.

Fair trade and sustainable sourcing may be good things, if the rules for obtaining this classification are reasonable and enforced. But who buying fair trade or sustainable has actually checked what the meaning behind the labels is (the “fine print”), or verified with independent auditors whether the nice-sounding principles are put into practice? When a term is used in marketing, I suspect business as usual behind it.

Economics to guide materials science

There are too many possible materials to test them all, or even simulate by computer. Materials scientists theorize what combinations of elements are likely to yield the desired properties, but still there are too many possibilities. One way to narrow the choice is to use economics.

If the goal of developing a material is to change the world or make money, the benefit of the invention must exceed the cost. The benefit comes from the improved characteristics of the material relative to existing alternatives. What the market is willing to pay for an improvement depends on its size. There may be a theoretical maximum for a property, or its historical rate of increase may be used to forecast the likely improvement. Once an approximate willingness to pay for a unit of the candidate invented material is known, this can be compared with its estimated cost.

Financial firms dealing in commodity futures forecast the prices of chemical elements over the likely commercialization time horizon. Only materials using a combination of elements that is cheap enough are commercially promising. Cheap enough means that the improved material must cost less per unit than the market is willing to pay for it. An expensive element can be used, but only in appropriately tiny quantity. The requirement that the bundle of elements cost less than some bound cuts down on the number of combinations that are worth testing. Similarly, the manufacturing method must be cheap enough, so some methods may be ignored.

The basic cost-benefit analysis is a simple idea, though the benefit estimation may be complicated in practice. Probably the companies producing various materials are already taking the potential cost and benefit of an innovation into account in their R&D, but academic materials scientists perhaps not. If the goal is to advance fundamental science and satisfy one’s curiosity, then the cost of the material may not be an issue. But for the world to use the material, it must be cheap enough.

A practical recommendation is for an application-oriented lab to put up a periodic table with the prices of the elements added. A spreadsheet with the prices of commodities can be used to calculate the cost of a candidate combination for a new material. Testing the candidates should proceed in the order of decreasing “profit” (benefit minus cost of the material). This profit is not necessarily the same as commercial profit, because the benefit may include its whole contribution to society, not just the revenue to the producer.

Empirical project ideas with econjobmarket and AEAweb JOE

The websites econjobmarket.org and AEAweb JOE are centralized job finding sites for economics PhDs. These have databases of application materials of thousands of job candidates, and the interviews many of them got. The subsequent jobs and publications of the job candidates are listed on the web. There are many empirical projects that can be done with this data, for example how certain keywords in recommendation letters predict the job that a candidate gets, or how the CV at the time of job application predicts future performance. One comparison that has been done in the sciences (http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2572075/) is how recommendations of male and female candidates differ, i.e. what words are frequently used for one gender that are not used for the other. It is likely that economics recommendation letters contain similar biases.
The professors of top universities who have access to the databases of the job market websites have an advantage in hiring. They can predict which candidates perform well in the future and offer jobs to those. The employers without access to the databases are left with less promising candidates.