Matt Nolan

The Halo Effect

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I was reading the New Zealand Commerce Commission’s public release on the potential Warehouse merger with one of the two massive supermarket chains. On page 15, paragraph 81 of this document, Ian Morrice of the Warehouse mentions ‘the halo effect’. He states that this is a term that the Warehouse invented to describe what happens when a firm introduces a new product, with the aim of increasing consumer throughput, which will lead to an increase in demand for the original set of goods sold.

This concept makes sense as there is a transaction cost of going somewhere to buy something. So once you introduce groceries into a Warehouse store, people can now get groceries and general merchandise in the same place, lowering the transaction cost of buying a bundle of both types of goods. This allows the Warehouse to increase the price of general merchandise goods, and to increase the quantity of merchandise goods they sell.

Now I thought that the halo effect was a pretty cool term, so I decided to look it up on wikipedia. Much to my surprise the term existed well before the Warehouse used it. Not only did it exist, but it meant something a little different. In industrial organisation terms the halo effect is what happens to the consumers’ perception of a firm’s set of products when a new product is introduced. For example, Sony makes electronic stuff, like DVD players, that I think are pretty high quality. Now say that they make a battery that really sucks. If I use this battery and don’t like it, then I may also downgrade my perception of the quality of other Sony products. Implicitly, people use brands to proxy the value of a product. If a firm makes a shoddy product, consumers will use this as information about the quality of other products under the brand.

These two definitions are both important, but I think it is important to distinguish between them:

  1. Goods as complements: By putting more products under one roof, a firm can reduce the consumers’ transaction costs, allowing the firm to increase sales and prices for the initial set of goods.
  2. Goods as signal of brand quality: The quality and desirability of a new good sold by a firm can change consumer perceptions (and ex-ante expected values) about other products sold by the firm.

Now if you ever hear the term being used, you should ask the person to define exactly what they mean.

jamesz

Product diversity and development

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Tim Harford’s latest Undercover Economist column covers some interesting research on industrial development. The paper examines the type of products that countries produce, and the way that a country’s ‘manufacturing portfolio’ changes over time. The key finding is that countries tend to develop by producing similar products to those that they already produce.

This makes intuitive sense: if a country already has infrastructure suited to the manufacture of a particular product then it will be less costly to develop similar products than to develop radically different ones. The problem arises when a poor country with limited production diversity approaches the limits of its current manufacturing processes. It is very difficult and costly to make the transition to producing a new, unrelated product type. The paper’s data confirms that this rarely happens. Notably, the authors find that:

Rich countries have larger, more diversified economies, and so produce lots of products […]. East Asian economies look very different, with a big cluster around textiles and another around electronics manufacturing […]. African countries tend to produce a few products with no great similarity to any others.

If poor countries are to make the step to producing new products then some intervention in the development process may be required. This points to a role for some government industrial policy at a national level, or structural intervention at an international level. It could mean a new justification for infant industry protection in developing countries. It also, perhaps, points to a different way of making effective use of the limited aid money available to organisations such as the IMF and World Bank.

Matt Nolan

The regulation of beer

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I realise that a lot of important economic figures were released today, however, I have found an issue more important than any amount of labour market data, the regulation of beer.  Now, according to this article, most binge drinkers drink beer.  So they think we can reduce binge drinking by taxing beer, and reducing availability late at night.

I think that they have ignored that fact that their are substitutes to beer, and that if someone wants to binge drink they will drink them instead.  The reason I drink beer when I go on a bender is to minimise the damage the next day.  If they banned beer from me I would drink Vodka, and that would cause significantly greater negative social externalities, and leave me with a worse hangover.

Having a tax on alcohol is a different story.  If alcohol causes a negative social externality, tax it so that the social cost=the social benefit.   However, taxing beer alone simply gives people the incentive to find other drinks, as those other drinks are more potent regulation is likely to worsen the social externality.   Do you think the same argument holds for taxing cigarettes?  When we tax cigarettes are we really giving people the incentive to move onto harder drugs instead?

Matt Nolan

Import substitution, good or bad?

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Free exchange and Dani Rodrik have both made intelligent posts on the issue of import substitution. Free exchange sticks to the common line that import substitution is bad, Dani says that there is evidence that it is good.

I know very little about any of this, but I’m going to say something anyway. As far as I can tell, trade policy should work off the idea of comparative advantage, implying that each country should make what the good they are ‘relatively’ better at making (specializing in goods with the lowest opportunity cost). As a result, government policy should react in ways that take advantage of this concept.

This might imply to some people that government should not intervene in trade, and just let the free market choose the most efficient industries, which will in turn trade with the rest of the world. However, I’m not sure I fully agree.

It is possible that an industry that would have a comparative advantage in trade terms may not have been founded given high fixed costs and the requirement of skilled and experienced labour which will only be created when the industry exists (infant industry type argument). If the government can recognise these industries, it can subsidise their creation until they become fully efficient, by which times they will be net exporters.

Now this form of intervention isn’t the same as import substitution (although it is often placed as a subset of it). Import substitution involves creating the goods you import at home, now if this is a good where another country has a comparative advantage then all you are doing is hurting yourself and the other country. Import substitution is a bad idea (unless there are security of supply or political issues), but government policy to develop domestic industries does have some potential.

Matt Nolan

Image does make a difference

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So food with a McDonalds wrapper does taste better. Now I’m sure many people will take this as a sign that advertising is evil, as it can lead to children being overweight, however I think it is an awesome service provided by McDonalds. You see McDonalds advertising makes food taste better, they increase the value of the product to an individual by advertising it, and getting all your senses excited. Although two otherwise identical products might seem homogeneous to you, the fact that the McDonalds wrapper is on one and not the other implies that one has the value associated with advertising while one doesn’t. As all McDonalds is doing is increasing the value of their product, thereby increasing demand I don’t have a problem with it.

However, there may be a role for government intervention yet. If McDonalds is an addictive good, and the consumer had no a priori knowledge that it was addictive, then the increase in future consumption (and the associated negative effects) of McDonalds is not taken into account when the person purchases a product. By advertising, they can increase demand and make more people fast food addicts. Now to do not know the degree with which fast food is addictive. However, government regulation, such as education or limits on advertising could be useful.

Update: Hehehe a cartoon.

Matt Nolan

Creative destruction

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I’ve always had a soft spot for the idea of creative destruction, even though my understanding of the it is well below par.

I found the following article interesting, in the way it used the idea of job creation and destruction to describe the process of changing unemployment.  It gives us a good idea about the massive flows associated with input changes in the labour market.

Using this concept, it describes how the composition of employment in NZ is changing, with more highly paid, high value jobs being created, at the expensive of low value, low skill jobs.  In my opinion, and the opinion of the article, this is a good thing.  What do you think?