Matt Nolan

Prisoner’s dilemma game justification for state housing

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I’ve been thinking about potential justifications for building a stock of state housing when we have no issues of credit constraints.

Say we have a bunch of people walking around wanting to buy two goods – housing services and non-housing goods and services.  People will, on average, allocate their spending such that the marginal benefit of an extra unit of housing services is equal to the marginal benefit of non-housing services.  This will lead to the appropriate level of housing services being provided, and it is all gravy.

But then say that the benefit of a housing service is actually a function of the quality of the housing service other people are receiving.  So if your neighbour/co-worker builds a big sexy house, you feel you need a bigger house to keep up.  The “marginal benefit” from housing services is higher, so you swap some non-housing goods and services for housing services (building a bigger house) – however, the marginal benefit is only higher because the other persons bigger house imposed a cost on you (making you feel inferior, or reduced the quality of the signal your house was providing regarding how well off you are).  As a result, house sizes are an arms race.

This view of consumption stems from back with people like Veblen, has been written about widely (and are used in modern macro-models), and in recent times has been reiterated by Rogoff and Shiller when discussing issues such as the “housing bubble” in the US.  A common term for this is of course “keeping up with the Joneses”.  An economics term for these sorts of goods is positional goods.

In so far as we see growing house size, and increasing borrowing to fund it, as a type of arms race based on this “positional good” logic we could well end up in a situation where we have “too few” houses that are “too big”.  We cannot rule out that this is in fact a contributor to high house prices and the limited stock of housing in Auckland, in addition to the zoning laws and high cost of subdividing.

Now when looking at this in terms of policy we can say this is really a standard prisoner’s dilemma.  Private value is only being created due to the larger housing being “relative better than” the current  – not because the house itself is bigger.  In that case, each individual sees building a bigger house as a dominant strategy – as if the other people don’t, they feel superior, if the other people involved do they don’t feel inferior.  As a result, everyone builds big houses, even though everyone would be better off with smaller houses and higher non-housing consumption (note this additional point).

Here, state houses may be a mechanism for trying to deal with that – by building a series of similar, smaller, houses at a lower cost.

This is the kicker though – to some people this argument sounds compelling.  To others it sounds horrible, as they genuinely get direct value from a larger house, and the fact that different houses on the street look different.  To buy the PD argument we have to make the case that:

  1. Much of the increase in house size and the variation between houses is due solely to “trying to out do other people”, and not due to actually valuing the additional housing services.
  2. That there are significant enough transaction costs within a community that prevent household near each other “negotiating” about this externality.
  3. That the “externality” itself is large enough to warrant attention.

And even with all that it is not necessarily policy relevant – as if people simply decide to overconsume housing, and lower their own welfare significantly, then we should really be asking why there isn’t more inter-community co-operation rather than arbitrarily throwing money at them.

A more compelling version of this argument would rely on the ideas Robert Frank – where the bidding up of house prices and size is occuring among those who are well off, and is having a negative impact on those with low incomes by also increasing the cost of their housing services!  This is the very issue that everyone is concerned about.  And yet, the data suggests that spending on housing service among the lowest declines relative to income has been declining and relative to incomes those in the lowest declines are spending about the same proportion of their consumer spending on housing …

There are no doubt some things going on in the housing market – but I’m not sure we can use the idea of positional goods to justify building a series of homogenous state houses in of itself.

Matt Nolan

Price discrimination based on gender: Sexist or fair?

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I see via Stuff that women have to pay more for haircuts.  This is true – in fact there are a number of service related areas where the woman’s version of that service costs more than the man’s version.  Undeniably, we are seeing price discrimination at work.

Now I’m not terribly against price discrimination – if the price discrimination is taking place based on a freely obsevable factor such as sex, then the outcome is efficient … and to be honest, price discrimination is going to become a larger part of our lives over time.  Now this doesn’t mean its fair, or unfair … in order to understand that we have to apply a series of “value judgments” about fairness.

Let’s look at the example of haircuts.  It is true women are charged more than men.  This happens due to women, on average, valuing the service more than men and generally being “less responsive” to the price.  Furthermore, even for the same haircut for a man and a woman, the service offered is not the same – not just because the women values the haircut subjectively “more” but because the physical service that is offered is usually different.

The hairdressing industry is an interesting one as well, it is hardly a place where “competition” issues exist – there are hairdressers everywhere.  As a result, a hairdressers ability to charge a premium above cost is severally limited – although it is the case that women value a haircut more than men, the very competitive nature of the hairdressing industry and the existence of a price gap seems to indicate that the “haircuts” a woman gets costs more than the haircuts a man gets.

If this is the case, I struggle to see how we could view this as unfair.  If we were to “ban” such price discrimination based on sex male haircuts would have to cross-subsidise womens cuts – to me this sounds like much more sexist pricing.

There is also the issue of choice.  Say that, somehow, all the 100 million hairstylists in Wellington were able to inforce an OPEC type relationship – and thereby collude on the price of haircuts to women.  I don’t understand what is to prevent:

  1. Entry of another hairdresser – the fixed costs seem reasonably low.
  2. Women going to a mens barber – a lot of mens barbers in Wellington wouldn’t care … if you were getting the same cut as a guy

I think this specific example shows how careful we have to be about criticising “price discrimination”.  Such discrimination is often a good thing – even given its negative sounding name.

 

Matt Nolan

On “currency wars”

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We keep hearing concerns about “currency wars” around the wold, with the blame being put on Quantitative Easing.  In fact our Reserve Bank even came out to complain about QE.

But to be honest, this argument is nonsensical unless you are explicitly forecasting “monetary policy failure” overseas.

Lets go back to Essays on the Great Depression by Ben Bernanke – when talking about countries depreciating by rolling off the gold standard:

Depreciation, in this context, should not necessarily be thought of as a “beggar thy neighbor” policy; because depreciations reduced constraints on the growth of world money supplies, they may have conferred benefits abroad as well as at home.

With interest rates stuck at the zero lower bound, and a sharp contraction in lending across the world, the fact that QE lead to devaluation in the US currency should not be seen as a bad thing.

QE is, in essence, aiming to lower interest rates within the US economy in order to bring forward spending and investment – to stimulate “aggregate demand”.  Why did we not get similar arguments from people whenever the US cut interest rates prior to the crisis … as it is essentially the same thing.

Instead of getting annoyed at the high currency, lets ask what it is telling us about monetary and economic conditions here – instead of assuming that the value of the dollar is “wrong”, and asking for arbitrary organisations to “do something” lets use it like any other price, and try to understand what it is telling us.

Matt Nolan

Habit formation and the economic core

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I have repeatedly been informed that the “economic man” is a poor description of individuals, and given this economic models provide a poor description of the world we live in.  As I have said previously, I don’t agree with this conclusion – and we really need to ask what an economic model is, and why we are using it, to understand the scope of economics and the appropriateness of the assumptions.

In essence my view is that we use economic models to describe, and in some way explain, tendencies that exist (from induction) using assumptions about choice that satisfy two conditions:

  1. They are as weak and loosely binding as possible
  2. They are appealing in the sense that, when I ask myself about my actions I can deduce laws that guide them.  I could go a step further and say that we can set up “ideal experiments” in our minds, but I’ll leave that for now.

This is all well and good.  But then someone will say “what about habit formation“.  This is an important issue, people obviously develop habits and these habits bind and constrain behaviour.

In fact, I would go as far as to say that habits, and the formation of habits, provide the key to tying together a lot of different strands in experiments and behavioural economics – and that an understanding of habits and habit formation is an important part of improving economists way to describe the world and give advice.

So how do we “describe habits”?

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Matt Nolan

On supermarket petrol vouchers

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Yesterday I received a phone call asking why New Zealand supermarkets offer petrol vouchers with purchases, and whether consumers are really paying for it all anyway!

(Update:  I’ve been informed that they were actually discussing this on Close Up yesterday, and they were trying to say that for some reason people pay “more” – because people who don’t use the vouchers are cross-subsidising people who do use the vouchers.  This sort of issue fits into point 2 below – and I’m not convinced that we are seeing a welfare loss due to this, in fact I think even this view would lead to better outcomes for consumers … ignoring point 3 below which strongly shows why this is likely to be the case.)

I decided the best way to answer the question was to try and understand the reasons why supermarkets and petrol companies would set up an agreement where these vouchers are offered and there is some (unknown) transfer between supermarkets and petrol companies.

Now remember, for the supermarket and petrol companies to come to an arrangement, it must be in both of their interests.  They must decide that offering a voucher to consumers who shop at the supermarket increases the sum of total profit in both markets – if that occurs, then they can negotiate over any “surplus” gained when they set up the contract.

At first brush we might say that it must somehow make consumers worse off, because profits are higher then they were without the supermarket and petrol company coming to that arrangement.  But if we think a little deeper, we are going to find out this is not the case 😉

Off the top of my head I can pick out three reasons why this agreement exists:

  1. Assume a monopoly supermarket and petrol station to start with.  The first reason may be weird behaviour by consumers.  For some reason, the fact the voucher is offered gets them to spend more at supermarkets and petrol stations overall.  This is the least compelling explanation in my opinion – but it is the only one that could create the result of consumers genuinely being worse off.
  2. Price discrimination:  Stick with our monopolies.  Lets remember that some people drive, and some don’t.  People who don’t drive tend to live in big cities, and are often environmentally conscious – both factors correlated with higher incomes, and more inelastic demand for supermarket goods.  This tell us that, by offering petrol vouchers our monopoly supermarket can then increase prices – thereby imposing a form of implicit price discrimination.  And of course, price discrimination shouldn’t be seen as a bad thing!
  3. A prisoner’s dilemma:  Now our assumption of a monopoly has been ridiculous – we actually have a duopoly in the supermarket industry in New Zealand, and even greater competition in the fuel industry.  This gives us another way to justify the use of vouchers – competition.  Take our two supermarkets – if neither supermarket agreed set up a deal with a petrol station, they would both sit there making tidy profits.  However, if one of them offers vouchers, a lot of customers would go to that supermarket – making the supermarket offering the vouchers heaps better off, and the other one much worse off.  If both offer vouchers, then consumers once again don’t really care where they go – so the supermarket does better than in the case when their competitor offers vouchers and they don’t, but worse than in the case when no-one offers vouchers (due to the cost of the voucher).  In this case, it is in the supermarket’s interest to enter the scheme – as they make a higher profit by offering vouchers no matter what the choice of the other supermarket is.  But the existence of the scheme makes consumers undeniably better off!

Overall, this suggests to me that the existence of the petrol vouchers is adding to consumers welfare – and we should encourage any sort of scheme that increases competition in the marketplace 🙂

Matt Nolan

My suggestion for Facebook

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A long time ago my university friends and myself used to use this thing called Myspace as a social network site – before it effectively became a music site.  Facebook turned up, and it destroyed Myspace – leading us to crawl over and make Facebook accounts.

My guess is this happened because Myspace pages were so clunky, busy, and confusing – you would go to write something to a friend and you would get your eyes molested by a set of animated gifs and your ears ripped open by whatever terrible music they liked.  There was also another feature Myspace had that would wind people up – top friends.

In Myspace you would choose your “top friends” for everyone to see.  People would constantly change these, knocking people off the list to upset them, or switching people around following any sort of conversation.  It is all a bit childish – but I think Facebook could introduce something similar in order to increase revenue.

Myspace friends ....

Simply put, Facebook could introduce their own top friends feature – however, have it based on the amount of interaction between people on Facebook.  By doing this, people who care about being on top friends lists will use Facebook more, increasing hours and pushing up advertising revenue.

If there is anything Myspace showed me, its that there was a group of people who took the idea of being a “top friend” seriously – lets not try to understand why.  Given these people are now on Facebook, it is undeniable that they would make a concerted effort to get up their friends top friends list – thereby triggering more ad revenue for Facebook as an organisation.  Do you think this would work – and what do you think the downsides are?