Matt Nolan

The overestimation of Pigovian taxes

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Over at Anti-dismal Paul Walker points at a paper on Pigovian taxes by John VC Nye from George Mason university. In this paper Dr Nye makes the following point:

A claim about the optimal Pigou tax is a joint claim about the size of the externality and about the optimality of observed outcomes, not just the externality. Measuring the size of the observed Pigovian externality – even if done perfectly — is not a reliable guide to the proper level of the Pigovian tax because in a world of efficient transfers we will still observe some externalities

Now this is very true – if we sit in the world of partial equilibrium analysis (which a lot of Pigovian analysis is based on) for too long we can forgot the fact that markets do not act independently, and this is bound to colour our view on the correct level of the Pigovian tax.  At some level this is a critque of Dr Mankiw’s Pigou Club.

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Matt Nolan

The value of value

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One of the major questions I face when discussing economics is:

Why do we feel that prices are the appropriate measure for illustrating the value someone receives from a product?

Now I only have a limited understanding of welfare economics, but I am going to attempt to discuss the issue anyway 😉 . If anyone more knowledgeable would like to correct me I would be happy to hear from them.

In a micro sense this idea could be criticised insofar as one person may have a lower “willingness to pay” for a product which may stem from having a higher opportunity cost (as they have a lower wealth level then other people) rather than truly receiving less value from the consumption of the good/service. If this is the case we may feel that we should re-distribute the resource from the wealth to the poor in order to increase the level of aggregate welfare.

Now accepting this relative ranking of preferences and the given endowment in the market this could be a suboptimal situation in terms of welfare. After all, we know that the poor person values both of these goods more than the wealthy person (assuming no linkages between them) so “total satisfaction” in society will be maximized by this implicit “redistribution” resources. However, this does not make the price mechanism pointless, let me attempt to explain.

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Matt Nolan

Collusion, retail petrol prices, and market activism

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In New Zealand there has been an email going around suggesting that everyone should stop purchasing petrol from selected retailers (such as BP) in order to start a price war.

Now I accept that this doesn’t make much sense in the face of no collusion – which currently appears to be what is going on (h.t. No PC). However, if we did have collusion, how would this scheme work?

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Matt Nolan

Interesting critiques from LAANTA

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Over at the excellent LAANTA blog, Terence has written a couple of posts discussing issues I have raised here.

The first post covers our discussions on Utilitarianism. Fundamentally I think we have reached a point where our only disagreement stems from value judgments (specifically what we view as the fundamental measure of value, something I plan to write about separately another time) – which implies that his post is a good place for us to leave it.

The second post argues that goods and services taxes are infact regressive, contrary to my own musings. This is something I will discuss in this post.

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Matt Nolan

Collusion, multiple equilibrium, and petrol prices

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Conjecture is rife regarding why petrol prices have risen so strongly. There are a number of common explanations:

  1. Rising demand for oil,
  2. The weak US dollar, increasing the US$ price,
  3. Peak Oil (Infometrics article requires a subscription),
  4. Negative real interest rates in the US (as not mining the oil is the same as investing in inventories),
  5. and speculation.

All these factors are playing a part in the saga of ever rising oil prices. However, Calculated Risk has suggested another, highly interesting way that fuel prices could have risen – a backward bending supply curve and multiple equilibrium.

This idea is pretty cool – so I thought I would spend a little bit of time explaining how it could work.

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Matt Nolan

The currency market – small menu costs matter

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Immediately following the release of the overseas merchandise trade data today the dollar slumped by about 20 basis points, however it didn’t stay down for long, more than recovering from this low point:

Source NBNZ

You might wonder why this fall and rise is even interesting – but the reasons behind it imply that issues such as “menu costs” can be important.  Why?  Well the headline number of today’s result provided a bad headline (monthly trade deficit biggest in 26 years!), but for a small time investment (reading the Statistics New Zealand news release) it would become obvious that the headline number was deceiving and in fact today’s result was relatively positive (as a significant proportion of the additional import activity was the result of one-off capital imports for further oil production).

The menu cost mattered in this case as the opportunity cost associated with time it would require to read the release was high – if a bad headline comes out it is in the dealers interest to react before everyone else!  As a result, a situation like this truly does have a substantial menu cost (which results from the first-mover advantage implicit in the situation) even though, on the face of it, it would initially seem difficult to view spending a minute reading a free release as a significant cost!

Why does all this matter.  Well menu costs can be the basis of price rigidity (although I doubt this in the case of currency trading) and also can be the basis of what we may view as “irrational” behaviour in the marketplace.  If small information asymmetries can have such a large impact on the behaviour of agents, and the equilibrium price, it dilutes the power of the price as an efficient signal to allocate resources.  This does not mean we should give up on prices – it merely shows us the importance of the provision of information in the economy.