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Well it is entirely obvious by now that life in the USA has changed due to the corona virus’s clutch on the world as a whole.  In these seemingly desperate times, as in similar crises, there is always a bit good mixed in with the bad and some other things worth commenting on as well.  Let’s start with some aspect of the good.

The scene is 5:30 am on a Tuesday morning.  I usually get up this early but ordinarily I stumble into my home office and look for research ideas or inspiration for a new blog.  This day I did nothing of the kind.  Shuffling off to the bathroom, I ran a comb through my hair, freshened my face, and changed from pajamas to street clothes.  Slipping out of the bathroom I went downstairs, fetched my fob, and at 5:45 am left my house.  My destination, the local supermarket, lay some ten minutes away.  When I arrived I queued up behind the dozen or so people there before me, each keeping a 6-foot  buffer between himself and his neighbors to the front and rear.  A little after 6 am, the store opened and we all somberly entered in single file.  Most, if not all, of us went straight down the paper products aisle looking for that one commodity that is to our modern situation what gasoline was to Mad Max – toilet paper.  It was eerie and surreal to walk through an area of the store that until 2 months ago held an abundance of products to find just under a hundred packs of rolls that were mostly scooped up by myself and my fellow early-morning shoppers.

There are many  good aspects of this sorry situation but I’ll only comment on three.  

The first is that, despite the stay-at-home orders and the general shuttering of the economy, the American can do spirit has not entirely withered.  There are still manufacturing activities going on in the country.  The supply chains may be clogged but are not stopped and we still enjoy such a high standard of living that was entirely inconceivable a century ago.   

The second is contextual and may not come home to everyone, even though it should.  What we are experiencing with these various shortages is a small foretaste of what socialism would be like if we embraced it.  Long lines, empty shelves, and desperation are always the earmarks of socialism and communism.  No country on Earth, even the so-called socialist scandanavian nations, can have a vibrant economy under socialism.  Denmark and Sweden (and probably the others in the fever dreams of politicians who believe in a Nordic utopia) have clearly rejected the label of socialism and pointed to their free-market practices.  And well they should, because free-market practices are what fill shelves with toilet paper, sugar, napkins, ground beef and so on.  And, touching on my first point above, we can see experientially just what happens when the market is not free and, hopefully, this will be the worst we’ll ever see.

The third is far more prosaic dealing with substitution as a by-product rule.  Economists like to point out that when supply is low and demand is high and prices rise, consumers will substitute similar alternatives for the good they usually purchased.  For example, people might switch to ground turkey if beef prices sharply increase.  I think economists should have a field day with papers galore based on what I have observed.  Everywhere I went in the supermarket, there were shelves totally missing contents next to shelves brimming with products very few wanted.  I know that I have tried new items that I ordinarily wouldn’t have purchased but it seemed that even in crisis, choosy mothers were finicky about what foods they were allowing in.  It would be fascinating to see a breakdown of what threatened people still wouldn’t touch and if the buyers of the various chains change how they purchase based on these observations.

On the bad front, I’ll focus only on one thing but a really bad one.  The nation’s governors, mayors, and elites seem to have let, in far too many instances, power go to their heads.  The textbook example is probably found in Michigan where the following table compares the do’s and dont’s, courtesy of governor Megan Whitmer,  

Louisville, KY Mayor Greg Fischer comes in a close second when he ordered churches to cease ‘drive-in’ services where each car was at least 6 feet from neighboring ones but wouldn’t ban drive-through food pickup, where the distances between strangers was much closer and number of direct-interactions much higher.  I challenge anyone to find the logical rhyme-and-reason of these allowances and prohibitions.  The table listings smack of lobbyist influence and crony-capitalism.  Milton Friedman certainly seems vindicated in his belief that big government exists to grant favors.  In addition, all sense of cost-benefit analysis and awareness of hidden costs seems to have gone out the window in shuttering the national economy.

Sure COVID-19 seemed like the super-flu ‘prophesied’ in Stephen King’s The Stand back at the beginning of March but now the emerging evidence seems to indicate that the communicability of the disease is much higher and the lethality a lot lower.  Still cries persist that even one life lost is too many.  What utter nonsense.  Below is a table adapted and supplemented from CDC data indicating how people died in 2017.

I get that social distance impeded the immediate spread (although the Chinese Communists could have nipped it in the bud if they hadn’t lied) but let’s get people back to work.  We don’t shutter the economy because over 600,000 people die of heart disease, no doubt aggravated by working in close proximity to other people.  The unseen cost of keeping the economy moribund will cause more addictions and more suicides for years to come.  

I’m not the only one advocating for a measured approach to the risk imposed by COVID-19.  Heather Mac Donald, in her article The Deadly Costs of Extended Shutdown Orders, argues quire convincingly that focusing on saving “just one life” effectively does more harm than good and that our governing elite are using anything but the science of risk analysis to make policy.

I’ll end on an ugly note, since the blog title suggests a more than passing similarity with a famous western.  The behavior of my fellow man can be very ugly, despite certain philosophers claiming that tragedy and crisis bring out the best in people as it shakes them from their complacency.  The scarcity of toilet paper could be understandable as a supply-side problem if I didn’t see a neighbor 3 streets away try to scurry into her home in the early hours last week.  With two 20-packs of toilet paper under each arm and another 20 pack in the trunk one has to wonder if she eats it or has she simply given into panic and fear and is hoarding.  Let’s just say that my answer to that question doesn’t favor toilet paper as any part of the food pyramid. 

This month, I came across a very interesting article about a proposed resolution to what the author regards as a long standing problem in economics.  The basic point of the paper, which is entitled The ergodicity problem in economics by Ole Peters (Nature Physics, Vol. 15, December 2019) is that classical economic analysis is fundamentally flawed.  According to Peters, the fatal mistake made for hundreds of years is the ergodic assumption that equates the time average of an economic process (say investing) by an individual to the average of the same process across an entire population, at a given time.  Determining whether this assumption holds is extremely important if economists want to be able to model what the average person will do.

Ergodicity is a concept originating in the branch of physics known as statistical mechanics.  Statistical mechanics seeks to characterize physical systems that possess vast numbers of moving parts in terms of a vastly smaller set of parameters.  Evolution of a complex system is generally described in terms of how the averages and standard deviations associated with all these parts change in time.  By assuming that the system is ergodic, the physicist can state how a system will evolve in time simply by looking at the average over multiple copies of the system at an instant in time.

An example will help make some of these ideas more concrete.  A typical ‘simple’ physical system with a vast number of moving parts is a bottle of water.  Describing this bottle of water at the supermarket is absurdly simple, one merely specifies the amount of fluid (250 ml, 500 ml, etc.) and the temperature.  If one wanted to be fancy, one could even specify the percentages of trace elements bringing the number of parameters, say, up to 100.  Despite the fact that 100 is a relatively large number of things to track, it’s still vastly smaller than the number of parameters needed to describe the bottle at a molecular level.  In a 500 ml bottle, there are approximately 1.86 x 10²⁵ water molecules or about 9.3 trillion trillion molecules for each dollar of federal debt and each requires, at a minimum, 7 numbers to describe its motion.

Once the bottle is bought and brought home, it will have its own local history.  It may be placed in the refrigerator or left in a hot car; it may be opened and partially or totally drained or kept shut for a later consumption; and so on.  Ergodicity assumes that each of the bottle’s observed states, as it evolves in time, can be matched with a single bottle in a large population of differently prepared bottles at a given time.  An unopened 500 ml bottle that warms from 5 to 20 C can be thought of as first visiting the state of an identically-sized bottle that is held at 5 C, then a different 500 ml bottle held at 5.5 C, then yet another bottle of the same size held at 6 C, and so on.   In this way the time average of the single bottle’s temperature can be derived from an average over a population or ensemble of bottles each kept constant at its own particular temperature. Alternatively, the large population’s statistics may be derived by taking a time average of a single member.  Which direction (time-to-ensemble or ensemble-to-time) depends on the physical system and the experiments being performed.

The ergodicity assumption has been quite successful in thermodynamics but Peters contention is that the types of dynamical systems found in an economy do not share this feature with the dynamical systems found in nature.  To support this claim, he offers a simple gambling model that will be explored in the rest of this column.

In Peters’s model, a person can participate in a repeated wager where 50% of the time he may increase his wealth by half and the other 50% of the time he will lose 40% of all that he has.  According to Peters, classic economics would predict that the potential gambler would jump at this chance.  The gambler’s enthusiasm derives from his analysis, using classical concepts from economics, the fact that the expectation value for this gamble (average gain or loss, denoted by E(gamble)) would result in a 5% gain since

where the notation Prob(win/loss) = probability of winning or losing (0.5 for both), Payoff(win/loss) = the outcome of a win or a loss (0.5 or -0.4 for a win or loss, respectively).

Peters points out that no rational person would actually agree to this gamble and thus the disconnect, he argues, between classical economic predictions and observed participation in the economy.  This is where ergodicity comes in.  Basically, the average person understands intuitively that this gamble, despite its constant positive expectation value as a function of time it is not ergodic.  That is to say that the time average of a gambler’s wealth, assuming he repeatedly plays, doesn’t result in a roughly constant 5% increase but rather it leads to ruin.

The article presents a rather disturbing graph in which the wager is simulated as a random process for 50 members of the economy who participate in repeated goes at the same gamble.   My own reproduction of this process using 150 members is shown below.

Each of the grey lines represents the time evolution of the relative wealth of a single gambler who repeatedly engages in the Peters wager.  The black line is the average over all the gambles – the time evolution of the ensemble average.  If ergodicity held, then this black line would equal the red line.

The bulk of Peters’ article is a sophisticated analysis why ergodicity fails to hold and under what conditions.  It is a difficult read but likely very important in revising economic theory.  But, regardless of how important the technical details that emerge may be, an even more important point will be understanding how the human participant, lacking all of this specialized expertise, understands to stay away from this type of gamble.  Insights into this last point are likely to be more profound than the underlying mathematics.

Ordinarily this column stays away from politics with a capital ‘P’. While economics necessarily borders on politics, defined as the basic interaction between people, this column tries hard not to call individual Politicians nor to take a partisan position. That said, the recent interaction between Elizabeth Warren and an unnamed Iowa father is worth discussing in that it brings into sharp focus the old point of Frederick Bastiat about what is seen and unseen in the economy.

The interaction is shown in the following YouTube clip (first minute is sufficient).

The dialog is short and worth repeating in print here.

The interaction got hotter after that but the main point of the Iowa Father made is correct. This observation certainly flies in the face of those who look only at the seen cost of student debt.

There are clear problems with young people holding student debt. In many cases students have been sold a bill of goods that a college education is simply the only way to get ahead and make good money. Plumbers, mechanics, and HVAC technicians all over the country would no doubt laugh at the idea that you need a college education to make money. In addition, graduates across the land are probably lamenting the fact that $50,000 of student debt and a degree have not led to the promised land.

This problem pairing of a bad degree with burdensome student debt is only exacerbated by the fact that students can even get out from under by declaring bankruptcy, which would be a fine remedy since the students would simply bear a different cost.

But the sympathy that we all may have for the plight of the bad-degree/burdened-by-debt individuals (a seen cost) should not blind us to the unseen cost that that Iowa Father pointed out.

The Iowa Father acted like the proverbial ant in Aesop’s parable of the ant and the grasshopper. In the original parable, the ant saved food during the summer against the lean days of winter. In contrast, the grasshopper frolicked and danced, putting nothing aside for any dark days. When winter descends, one finds the grasshopper begging the ant for food and the ant refusing the grasshopper to share in the fruit of his labor.

The Iowa Father did the right thing. He scrimped and saved. He forewent fun, new cars, and vacations. He delayed his gratification in order to secure his daughter a college education unencumbered by student debt. His buddy was like the grasshopper. He spent and he idled and his kids now have to live with student debt.

But just like some people want to rework the original parable to point out the lack of compassion of the ant (as if the ant were a villain and not a sober individual who recognized the need for thrift), some people only want to focus on how bad it is to have student debt. Suppose we, as a society, chose to forgive that debt. Any compassion one might be showing to the student and his family is far outweighed by the callousness and lack of compassion we are showing to the Iowa Father.

He is bearing two unseen costs and we are effectively telling him that his work, efforts, and his virtues are all reasons he should be enslaved by the state.

The first unseen cost is opportunity cost he bore while saving for his daughter’s college education. Think of all the merry times he not only missed but will never be able to experience again. There must have been a trip, perhaps to Disney World, with his teenage daughter that he passed over in order to put money aside. Probably, he can afford the trip it now but his daughter is much older and the moment is lost. He also was denied the fond memories of many family outings or the enjoyment of a new car, all of which he sacrificed so that she graduated without debt.

The second unseen cost is now the increase in taxes and cost of living that this fellow must endure so that the creditors can have their loan returns met while the profligate takers of those loans skate free. This step adds insult to injury making him not only pay for his own sacrifices but also making him sacrifice for the gains the other family enjoyed.

By ignoring the costs born by the Iowa Father, what we are effectively saying is that there is a certain class of people in society who deserves to be oppressed and exploited and that this class is exactly the group that should be rewarded and held up as an example. We’ve turned the world upside down because forgiving student debt not only victimizes the “ants” amongst us it incentivizes the “grasshoppers” to be even more prodigal.

In short, the Iowa Father was correct – he is getting screwed.

Well another Black Friday is upon us.  Once upon a time, when I was younger, I actually viewed Black Friday as a special day to go out and enjoy the hustle and bustle of shopping, to see the Christmas decorations festooning every store, and to buy gifts for the loved ones in my family.  As I got older and became a bit more cranky, the lust and obsession exhibited by certain people began to weigh me down and cause me to think that Black Friday was to be avoided at any cost.  As I’ve gotten even older and more educated about economics, I’ve come back around to liking it but for different reasons.

When viewed objectively, Black Friday is quite an economic miracle.  Starting, some time after Thanksgiving (the exact time seems to change every year), millions of Americans make hundreds of millions if not billions of economic choices in just one day.  Stores have to plan and prepare for this bacchanalia of bargain hunting by answering a host of questions.  These include:

• which items should be stocked,
• how many of them should be ordered,
• at what price should they be sold,
• how much should be sent on advertising,
• and so on.

What is truly remarkable is that no central planner set this organized insanity up.  No elite intelligence manages all of the variables for each and every institution.  Rather the invisible hand of capitalism operates on a massive scale.  Every step from discovering and processing raw materials, to designing a product that people want, to the manufacture, shipping, distribution, and retailing of the good, is done by an intricate, complex web of self-interested decision making.

It is in this way that Black Friday really is a descendent of those first lessons from Thanksgiving: the abandonment of the ultimately destructive rot of forcing shared work and outcomes and the embrace of achieving the satisfaction of earning your position by hard work.  Stated simply, the creation and participation in a free (emphasis on free) market.

So, it was with great disappointment that I read the Thanksgiving section (Section 3) of James W. Loewen’s book Lies My Teacher Told Me: Everything Your American History Textbook Got Wrong.

Loewen starts his section with a variety of quotes, obviously intended to set the overall tone about the myth that citizens of the United States entertain about the significance of the Thanksgiving.  The three most provocative quotes are:

and

Sigh…, where to begin with the material fallacies that abound in each of these arguments.  To start with a general observation that each of these quotations address points that have nothing to do with Thanksgiving’s root but rather what each commentator perceives as a modern corruption.  It is okay to criticize the modern corruption but it in the spirit of charitable argumentation, each of them should have discussed, at least in passing, the original reason for celebrating Thanksgiving.

Now on to the individual quotes.

Michael Dorris’s quote is distinctly sloppy in failing to define ‘standard fare’.  What exactly does he mean?  Perhaps the Macy’s day parade or the Black Friday advertisements or even something he saw on TV.  How hard would it have been to say something like ‘… none of the standard fare, which maintains…’?  And in what way is celebrating the core fact that the Pilgrims eschewed socialism have anything to do with ‘exploiting and debasing America’s victims’?

Francis Jennings’s quote misses the point of the proper roots of Thanksgiving.  Yes, on the surface, everything Jennings says is true; Europe could not maintain an outpost colony in the new world.  William Bradford said as much in his writings.  He bemoans the fact the colony has to stand on its own two feet while trying to live under the ‘socialist requirement’ levied by the Company of Merchant Adventures of London, who backed the enterprise.  He recognizes the weakness of the arrangement when commenting on the colony’s lack of success in 1622 and early 1623.  Finally, Bradford directed the colony to abandon the communal property arrangement in favor of individual rights and obligation.  Bradford goes on to say the new arrangement ‘had very good success, for it made all hand very industrious’.  His analysis of what went wrong under the communal arrangement was that it was ‘found to breed much confusion and discontent’.  It was the abolishment of this terrible communal arrangement and the success adopting individual rights that is the real story of Thanksgiving, a story that Jennings’s quote (and all the others) ignore.

Simpson’s quote is the most egregious of the lot.  The Pilgrims were neither militaristic nor were they particularly religiously motivated to conquer a new land (they came to the America’s because they had to escape the religious persecution they faced in Europe).  And, as Bradford’s narrative attests, they originally had no ambition and no greed under the communal arrangement.  All of these points may apply to other colonies at other times, but they are mismatched with Thanksgiving as the subject.  Still, I may have been able to overlook these flaws but for the last sentence.  It defies common sense to believe his last assertion; none of the European settler’s would have been happy to bring disease to the New World; it would counter-productive since they would have to worry that the disease would turn around and attack them.  This claim is particularly baseless considering the devastation that Europe bore after the Black Plague ravaged the land.  Judging the Pilgrims through a lens of modern biology is simply ridiculous given that the germ theory of disease was a discovery of the late 1850s, centuries after the colonization began and at least 80 years after the ratification of the US constitution.

There isn’t much to recommend the rest of the section as well.  Loewen engages in a variety of material fallacies of his own, including a equivocal use of the term ‘settler’, an ad hominem attack on WASPs, and an over-emphasis on the diseases that tragically ravaged the Native American population. But, perhaps, the most tragic thing about Loewen’s presentation is his failure to recognize and celebrate the triumph of individual rights over collectivism.

The last two columns examined the impacts of having monopolies within the economy.  They established that, despite popular opinions and accepted common knowledge that a monopoly can control everything within its sphere of activity, the reality is that a monopoly (or an oligopoly) is under immense pressures that narrowly limit its behavior.  The structure and extent of these limits are best understood by analyzing marginal cost and revenue curves within the context of the supply-and-demand curves (see the previous two posts).  These very forces limit the production of a monopoly to levels below the societally optimal value, which is the real complaint that society at large should have against the monopoly.  A textbook case that demonstrates that market forces rule regardless of a company’s size is the tragic and disastrous MCAS system that downed two Boeing 737 MAX 8 and that has left the company’s reputation in tatters and its future uncertain.

The resulting economic conclusion, based on sound logic and observed outcomes within real business sector, is that monopolies do damage to consumers by keeping the supply lower than desired, not because of malice on its part, but because it has no choice (or rather it has no profit-optimal choice, which amounts to the same thing).

The natural follow-on inference is that it is in society’s best interest to eliminate monopolies; and, for many cases, this is true.  However, there are times when a monopoly is societally beneficial if not outright necessary.

The prototype example of this ‘exception’ are those industries that deliver services that require wide-spread standardization.  The most obvious examples are utilities that deliver gas, electricity, water, and telecommunications to a community.

Imagine the chaos that would ensue if there were more than one electric company in your town.  Each company, say Exciting Electric and Pinnacle Power, would have to construct its own delivery system (its own wires) to send electric power to the consumer.  What a waste of resources: duplicate sets of power lines, consuming more land, and so on.

An additional concern is that each company would try to have a unique standard (say Exciting Electricity would use 60 Hz and Pinnacle Power would use 50 Hz) as a way of locking the consumer into their service.  Based on these conclusions, local communities established utilities as essentially publicly owned trusts with a suite of regulations covering every aspect of the enterprise.

At least that’s how the conventional wisdom goes.  And there is some truth in it, certainly in the past where the electric company owned both the power plant and the delivery system.  But I think there are definite places for improvement.

To understand the possibility for improvement, turn to a utility that was deregulated after decades as a monopoly – telecommunications.  The telephone infrastructure was essentially a regulated utility for decades.  During this time, there was little innovation particularly where the consumer phone was involved.  Since the phone company owned the phones in the consumer home, choices were limited to the standard model or the princess phone, available in a dazzling array of something like three colors: white, black, and beige.  There might have been a red version but who cares, the point is that there wasn’t much choice nor was there any incentive to listen to customers.  As a utility, the phone company could charge the consumer with a certain amount of impunity and provide services below what a competitive market would.

Many changes happened after ‘Ma Bell’ was broken up in the 1980’s.  Suddenly, there was a freer market and an incentive to innovate.  However, the real change came with the invention of the cell phone.  Here was about as free of a market as could be imagined.  Different cell service providers sprang up, each providing access on the common, shared delivery system that is the electromagnetic spectrum; each offering competitive pricing, better service, and an increasing pace of innovation.  The market started with ‘brick’ phones, evolved to more compact and slim designs, which then evolved to flip phones, and finally to the smart phones most of us enjoy today.

None of this innovation would have happened under the old system and the competition has lead to a much better experience for the consumer.  Of course, none of the providers are perfect and there are times when the consumer has had enough with his particular provider and moves elsewhere, but that is just what a free market promises, a mechanism for improvement not a perfect finished system.

With these observations in hand, let’s return to the question of electric power generation and delivery.  In The Complete Idiots Guide to Economics, Tom Gorman mentions in passing that deregulation has had mixed results.  To quote:

While Gorman’s analysis of telecommunications is spot on and his warnings about air travel seem to be reflected in the recent Boeing disaster one can’t help but wonder why he is so pessimistic about electric power generation.  The probable answer is the manipulation of the energy market by Enron (the ‘burn baby burn’ scandal) but this situation was hardly the free market gone bad.  There is ample evidence that government and industry were in cahoots resulting in “secret deals with power producers, traders deliberately drove up prices by ordering power plants shut down” and that it was deregulation-in-name-only replete with many flaws.

In the case of power generation, many markets have moved or can move to having a common delivery infrastructure structure with power generation being separately owned by different companies that compete for their market share.

And at least some reports show that power generation deregulation works and can save the consumer up to 30%.  So, the lesson is that seems that deregulation will work if some imagination and ingenuity is used to harness market forces, while preventing government and/or business placing thumbs on the scale, and that society should be actively working to eliminate or minimize the presence of even ‘blessed’ monopolies in the economy.

Last month’s post dealt with the disastrous rollout of the Boeing 737 MAX 8 aircraft.  At the heart of the problem were a redesign of the basic jet propulsion system, flaws in the MCAS automation system, and a cutting of corners where safety was concerned, all of which resulted in numerous close calls and two crashes on takeoff that ended the lives of hundreds of people.  It was argued in that post that the reason Boeing rushed the MAX 8 to market was the pressure they were experiencing from Airbus, the other member of the current commercial aircraft duopoly.

The conclusion of the preceding narrative, that Boeing’s presence in a duopoly made it vulnerable to market forces, may seem foreign and counterintuitive to anyone raised on the usual stream of fantasy stories about powerful businesses.  Contrary to the laws of economics, monopolies/oligopolies are usually portrayed in movies as being nigh-omnipotent villains that require extraordinary heroism to overcome. Films, such as Rollerball, The Running Man, The Hunger Games, and Repo! The Genetic Opera reinforce the idea that a monopoly or oligopoly sit above the usual laws of scarcity that govern the rest of our lives.

In reality, monopolistic and oligopolistic firms are subject by the same economic forces as the rest of us.  The outcomes and particulars are, of course, different because of the firm’s position within the economy, but the idea that a monopolistic firm runs unchecked and roughshod over society, insinuating its tendrils into every nook and cranny of life are fantasies that serve as fodder on for the storyteller or the polemicist.

Surprisingly, the real societal ill that monopolies (for simplicity this post will only look, hereafter, at monopolies) represent is not their unmatched influence on society as much as their disengagement from society.  The simple way to understand this seemingly up-ended position is to recognize that without competition to spur a firm forward, complacency takes hold and the resulting output is below what society demands.

A simple example of this is the typical department of motor vehicles (DMV).  The DMV has an effective monopoly on the goods and services it provides but, as all of us who have had to endure a trip to renew a driver’s license can attest, the service is painfully slow, the processes Byzantine, and the outcomes uncertain.  Its monopoly arises because it produces a unique good (official driver’s licenses) and there are high barriers to entry into the marketplace (here the barrier is law).

To see how a monopoly can underproduce compared to the socially optimal value, one must make a trip through a few graphs about supply, demand, revenue, and cost to construct a monopoly graph.  The arguments here are inspired by a suite of educational YouTube videos, especially the Monopoly Graph Review and Practice-Micro 4.7 lecture by Jacob Clifford, who has a manic style that seems to have been honed by years of teaching high school students, with additional insights and examples taken from Principles of Economics: Economics and the Economy, Version 2.0 by Timothy Taylor.

The first ingredient is the typical graph of supply and demand curves showing the producer’s and consumer’s points-of-view in determining how much of a particular quantity to produce or consume as a function of price within a given market (say, for example, for televisions).  Where they cross determines the equilibrium number of items produced, Qeq, and the equilibrium price the market is willing to pay, P_eq.

The shaded regions are perhaps less well known.  The blue one represents the total consumer surplus defined as the total amount those consumers, who would have paid more, saved by having the market drive the price down to its equilibrium value.  The green one represents the total producer surplus defined as the total profit those producers, who would have sold the item for less, earned by having the market drive the price up to its equilibrium value.  In combination, these additional savings or earnings represent additional resources that can be put to use in other areas of the economy.

The next step involves understanding how an individual firm producing items within a given market fits into the market as a whole.  Here the economist defines a spectrum of possibilities with perfect competition being on one extreme and monopoly on the other.

Within perfect competition, there are so many firms producing identical products (say oranges) that any individual firm is unable to cause the market as a whole to deviate far from Peq.  Such a firm is said to be a ‘price taker’ and it perceives its demand curve as being perfectly flat.  This means that no matter how many products it places on the market each one will sell at the equilibrium price.  In contrast, a monopolist perceives its demand curve to be identical to the demand within the market as a whole since it is the only provider.  A monopoly is often called a ‘price maker’ since it can set its price but this should not imply that the monopoly is all powerful. It is bound by two constraints.  First, it is unable to negotiate different prices for different customers (this is called price discrimination) since if it did, the customer receiving the lower price would then resale to the customer subjected to the higher price at an intermediate cost, thereby taking some of the profit away from the monopoly.  Second, the monopoly can’t force people to buy their goods and so they must face the downward sloping demand curve of the market as a whole.

This fundamental difference in the shape of the perceived demand curve is the key to understanding why monopolies produce below the societal demand of the good.  The only other ingredients are marginal cost and marginal revenue.

Both marginal cost and marginal return quantify the idiom ‘too much of a good thing’.  Marginal cost/revenue measures the change in the cost/revenue for an increase in production by one unit.  Functions as derivatives, the values of marginal cost and marginal revenue signal actions that a firm should take to optimize a variety of outcomes.

Based on the concepts of economies and diseconomies of scale, marginal cost will generally fall as production is scaled up from an initial size.  At some point, though, the improvements that come with size taper off and additional structure becomes self-defeating.  As a result, the expected shape for a marginal cost curve (MC) will be downward sloped for smaller quantities until it hit a minimum at which point it rises.  Related to the marginal cost is the average total cost curve (ATC), which, as the name suggests, is the total cost divided by the quantity produced.

The marginal revenue curve (MR) is generally downward sloping with no minimum, reflecting the fact that it does no good to cut costs to attract new customers if the price changed is at or below the cost to produce the good.  The zero of the MR reflects the breakeven point where the cost to produce a good equals the price it fetches.

The monopoly graph sports the perceived demand curve already discussed along with the MR, MC, and ATC curves.

There is a lot to mine from this graph but we will content ourselves with seeing how a monopoly introduces inefficiency.  The point where the MC and MR curves intersect determines the quantity (Q₁) that the monopoly should produce to maximize profit, since this means that the rate at which the revenue is decreasing exactly balance the rate at which the cost is increasing.  The corresponding price (P₁) is determined where a vertical line from Q₁ intersects the demand curve (point B).  Taken together, the shaded green and tan areas represent the total revenue (Q₁xP₁).  The tan area has a height determined by where the vertical line from Q₁ intersects the ATC curve and it represents the total cost incurred to produce this quantity.  The green area is then the profit.

Analogous to what was discussed above, the blue triangle is the consumer surplus that represents the money those willing to pay more than P₁ saved.  The gray triangle is a new feature of the monopoly’s presence in the market. It is called deadweight loss and it represents the lost efficiency that obtains because the monopoly produces away from the equilibrium value (Q₃).  Paraphrasing Taylor, this loss of social surplus occurs because the monopolistic profit-maximizing pricing is blocking some demanders from making transactions they would be willing to make.

So there, in a nutshell, is the real reason why monopolies are to examined carefully and possibly regulated.  Not because they are evil or world dominating or corrupt but because they are inefficient producers.

Next column will close out this discussion of monopolies by looking at the how monopolies form and some of the reasons why their production inefficiency might be tolerated.

By now the world is painfully aware of the shortcomings of the Boeing 737 MAX 8 aircraft.  The Maneuvering Characteristics Augmentation System (MCAS) system, designed to prevent stalls on takeoff have caused numerous close calls and two catastrophic crashes with the loss of all passengers and crew onboard.  The entire fleet sits idle on the ground while Boeing attempts to correct the flaws in the automation and provide a patch that will restore confidence in the plane. Several airlines have cancelled their orders and it will be years or even decades before Boeing has rebuilt and restored public trust in their products.

Gregory Travis covers the technical points in his highly understandable (albeit somewhat long) article entitled How the Boeing 737 Max Disaster Looks to a Software Developer (IEEE Spectrum).  It is natural to want to understand how the design and manufacturing details contributed to these disasters and, indeed, stories digging into how the MCAS went wrong have riveted many people around the globe.

But as important as the technical details are to ferreting out the tangible safety aspects of the problem, they do not explain but merely point towards the managerial and business failings that caused Boeing to go so far astray.  And there are more black clouds on the horizon for the corporate infrastructure of one of the US’s largest companies.

The Air Force has halted deliveries of Boeing’s KC-46 Pegasus tanker due to the presence of “foreign object debris” (FOD to those in the know) being found in close compartments throughout the aircraft.  For those of us who don’t speak military jargon, FOD includes anything you should never see in a new plane ranging from an abandoned wrench left behind by a careless worker, to aluminum shavings that weren’t swept up after manufacturing, to wrappers from spent food items.  As Air Force Secretary Heather Wilson characterized to the House Armed Services Committee the cause is due to “a manufacturing discipline issue, on the line … and we saw a breakdown there.”

Boeing has misstepped in other areas (the 787 Dreamliner has had its share of problems) as well and the overall for outlook for the company was being openly questioned as it was getting ready to report its first quarter revenue.  And indeed the questioning was quickly replaced by pessimism when Boeing announced its revenue had been adversely affected by the Max 8 issues, although it just as quickly rebounded.  It also interesting to note that Boeing’s stock took a sharp climb during the year or two before the 737 Max 8 received FAA approval on March 8, 2017.

In any event, either through poor management or bad luck or some combination of both, the Boeing corporation is on shaky ground and numerous technical and safety questions abound for which the US government has a clear role to play (including some hard soul-searching as to whether the FAA was too chummy with Boeing).  But this is not a technical blog and so the operative question here is what, if anything, should the US government do to economically support the company?

For most people, the knee-jerk reaction is that Boeing made its bed and it should lie in it.  This type of question also conjures up resentment over the ‘too big to fail era’ that marked the Great Recession and the government’s intervention in the financial, housing, and automotive sectors.  Ordinarily, I would agree. Living in a capitalist society, we should hope that any company (especially a company as large as Boeing) should be able to stand on its own two feet and live with the consequences of its actions.  The market can vote to put its money behind another supplier and stock owners can make the appropriate response by voting directly at shareholder meetings or indirectly by selling stock.

Furthermore, for all intents and purposes, the commercial market for passenger airliners is a oligopoly consisting of only two players; a duopoly spanned by Boeing and Airbus.  The two companies are protected behind one of the most formidable barriers to entry ever enjoyed by current or past industries. Modern aircraft are extremely complex mechanical, electrical, computational machines sporting a mix of modern materials.  Building an airliner requires a huge knowledge base, large collections of capital, and intricate supply chains. In addition, there is an enormous compliance burden imposed by countries all around the world and only companies with deep pockets can afford to pay the host of lawyers, lobbyists, and compliance officers needed to keep various governments happy and out of the way.

To many, the fact that Boeing is essentially engaging in monopolistic practices is all the more reason to argue against government intervention on its behalf.  Heartened by the observation that no monopolistic company is invulnerable to competition in the long run and that Boeing’s once seemingly unbreakable membership in the commercial aviation market is now showing substantial cracks, the same group may even think that now is the time to do some old fashioned trust busting wherein the government hastens Boeing’s fade.

But, those engaging in such an argument might do well to look past Boeing’s sins and consider what happens as it loses market share or even exits from commercial aircraft manufacturing completely.  Articles such as Clive Irving’s piece in the the Daily Beast (Boeing’s Disaster Could Turn China Into Aviation Superpower) and ‘Your Loss my Gain!’ Airbus now reaping on Boeing crisis at Daily Active Kenya, gives us some clues by showing us how fast Airbus has moved to fill the order vacuum created when China cancelled its order for MAX 8s.  And as Airbus’s dominance grows, the duopoly moves closer to a monopoly that, paradoxically, may mean even fewer planes in the sky than when both companies were swilling at the trough together.

Next month’s column will take a look at how monopolies work and how economists think about them and then will try to sort out whether or not it’s in everybody’s interest to help Boeing out.

Football (the American, not metric, variety — for my international readers) is deeply ingrained in the United States.  Each weekend during the fall, millions of viewers tune in to watch the televised matches between college rivals on Saturdays.  And the National Football League (NFL), which organizes the most popular men’s professional sport in the US, rules most Sundays from late August to early February, and inspires conversation and controversy (and commands a lighter viewership) during the intervening week.

The NFL has been so dominant for so long, that it may be hard to believe (or recall if you are old enough) that once professional baseball was the preeminent spectator sport in this country, with football coming in a distant second.

Steeped in its own brand of mythology, Major League Baseball’s (MLB) storied past formed the stuff of legend.  Within its history, one could find heroic and inspiring tales of triumph by figures like Babe Ruth, Lou Gehrig, Jackie Robinson, and Roberto Clemente.  One could also find tragic tales of failure as in the 1919 Black Sox scandal and Pete Rose’s fall from grace.

Baseball was so pervasively woven into the fabric of American life that its players and their personal lives often spilled out of the field and into every other facet of American life.  Joe DiMaggio, one of the famous New York Yankees from the WWII era, became even more famous for his much-discussed but brief marriage to Marilyn Monroe and was immortalized in the song lyrics of Mrs. Robinson.  Numerous war movies showed soldiers who were behind enemy lines proving their bona fides by answering some obscure baseball question that only a genuine ‘yank’ would know.  An excellent example of just how deeply ingrained baseball is, is the following clip from the TV show M.A.S.H., which aired in 1980.

Despite its unrivaled dominance for over 100 years, by 1985 (the first year viewer preferences were polled) ESPN reports that the NFL had beaten MLB 24 to 23 percent.  The same article cites that 30 years later, the gap had widened to 21 points with 35 percent of all fans citing the NFL as their favorite compared to only 14 percent who had the MLB at the top of their list.

The economics behind how “America’s Pastime” became past its prime and what MLB is trying to do to improve its standings is fascinating.  It provides glimpses into how labor disputes can disrupt product delivery to the detriment of both management and labor, how complacent businesses can squander the good will of their customer base, and the role of marketing and advertising.

The place to start our analysis is with the emergence of the modern era of collective bargaining between the players (labor) and the owners (management).  According to Sean Lahman’s A Brief History of Baseball, this era of baseball labor relations began in 1965 when the Major League Baseball Players Association (MLBPA) hired Marvin Miller.  Miller, who had been a member of the United Steelworkers union for years prior, began his tenure by collecting statistics on player salaries.  By the time he stepped down the modern era of free agency in sports labor had emerged.

Along the way Miller secured the first collective bargaining agreement (CBA) between the players and management in 1968, helped in 1974 to undermine the reserve clause that limited the ability of players to negotiate contracts with other teams, and broke up the the network of “gentleman’s agreements” that owners employed to keep a lid on player’s costs.  Miller also organized a variety of labor walkouts including a 13-day one in 1972 and a 50-day strike in 1981.

While undoubtedly beneficial for players salaries and freedom, the general public was sometimes hostile to what was seen as attempts by players to ruin the game for the fans.  As the animosity grew between labor and management, so too did the level of action each took against the other.  The escalation culminated in the 1994-95 baseball strike that cancelled the 1994 World Series and did major damage to baseball’s popularity.

Baseball managed to recover some in the latter half of the 1990s and the early 2000s with the home run drama surrounding the players such as Mark McGwire, Sammy Sosa, and Barry Bonds.  But revelations that much of the hitting success during this time was allegedly fueled by steroid use further damaged baseball’s reputation.  The owners, hungry for a quick fix to the hangover caused by the labor-management squabbles of a generation prior, looked the other way, only to have it blow up in their faces.

And so, we arrive at the current day.  The modern game is filled with contract negotiations, mandatory drug tests, and long games, typically lasting over 4.5 hours.  Matthew Corwin, in his article for Odyssey, believes this last problem to be the most serious.  Baseball’s leisurely pace of 1930 does not mesh well with the hectic pace of the 21^st century.

Baseball execs seem to agree.  The new rule changes seem to center on speeding up the game by: 1) keeping pitchers in the game to face a minimum of three batters, 2) limiting who is allowed to pitch, and 3) shortening commercial breaks during innings.

This latter change is particularly interesting in that it may be showing tell-tale signs of lasting wisdom on the part of the owner and players alike.  In the short run, limiting advertising time will limit ad revenue and profits on both sides.  But, if shorter games led to an increase in the fan base, then both sides may actually come out ahead, and that would be a real triumph of economic cooperation.

It is an encouraging sign of trust between two sides that have been all but mortal foes for decades.  As to whether this new detente will last, we are still in the early innings.

Representative Kamala Harris recently tossed her hat into the ring as a contender for the Democratic Party’s nomination for president in the 2020 election.  The one plank in her platform that has stirred the most discussion is Harris’s bid to institute a single-payer health care system for every American, called Medicare For All.

Her reasons for this, in her own words are:

In her conception of health care access, Medicare for All would eliminate all existing private insurance companies.  As the end of the clip shows, when asked about their fate, Representative Harris simply said “Let’s eliminate all of that.”

Now there are obvious political ramifications for such a single-payer proposal.  Doctors and the health systems they work with and for have powerful lobbyists.  Insurance companies also have a great deal of influence in politics given their financial holdings and their presence in every state.  And whether such a plan would be popular with a majority of voters has yet to be tested.  But let’s leave that all behind and simply ask what economic factors exist that support Harris’s assertions and what factors refute it.

One of the cornerstone ideas in economics is the law of supply and demand that dictates that the price goes down when the supply is higher than demand.  The primary way to encourage an ample supply is to allow the suppliers to reap a profit when they persuade a consumer to buy their offering.  Ideally, we would want more health care professionals to enter into the market than is strictly necessary by statistics alone.  These individuals would compete fiercely with each other, driving the price down and forcing less-competent professionals out of the marketplace, in the process making way for more-competent ones to enter.  Less expensive health care would go a long way to addressing her complaint that “[H]aving a system that makes a difference in terms of who receives what based on your income is unconscionable.”

Currently, competition in the health care arena is blunted primarily by two factors.

First, by government regulation, insurance companies only compete amongst themselves within specific states.  No buying of insurance across state lines is permitted.  For example, the ugly battle between UPMC and Highmark only takes place within western Pennsylvania with neighboring states being completely ignorant.  UPMC mostly furnishes health care through its networks of hospitals.  Highmark is the largest insurer in Pennsylvania.  While their battle is fierce, it is between payor and payee with neither having strong competition in their own sphere.  As a result, the western PA consumer gets to watch two behemoths smack each other around, wasting resources that could be better put to use.  How much better behaved would these institutions be if there were credible health care providers and insurers who could swoop in while UPMC and Highmark were distracted with their little war?

Second, since the primary mechanism by which most of us get our health care coverage is through our employment, competition is further limited to the number of choices provided by people (i.e. employers) who aren’t directly consuming the product.

Under Harris’s plan for a single-payer system, competition would be erased rather than enhanced.  With the elimination of private insurance would also go any incentive for the provider, in this case the Federal Government, to lower costs.  Without competition, the average bureaucrat would have little reason to push for a higher efficiency and almost no motivation to put patient/customer first.  For the health care practitioner, the situation could go one of two ways.  Either the government would attempt to fix prices in order to address costs, or it would subsidize the activity, thus the pervasive government regulations would likely discourage the really good people from becoming doctors and nurses while encouraging substandard ones to become part of what, for them, would be a lucrative payday.

Having the majority of Americans secure their health coverage through their workplace, a vestigial practice left over from the wage-controlled years during World War II, also blunts our ability to engage in the marketplace, and this lack of market knowledge leads to higher prices and lower quality.  By having our employer provide health care coverage as a ‘benefit, we lose sight of the cost we incur (lowered wages) and, therefore, we have less motivation to push back on the market.  As a previous blog discussed, each of us is a far savvier consumer of car repair than human repair.  Our knowledge of the mechanic market not only allows us to usually figure out when we are being scammed but also places a strong pressure on repair shops to be reputable.  Most of us develop and groom this knowledge because we directly bear the cost.  But, because we often don’t perceive the cost of employer-supplied coverage, we know far less about the business side of medicine.  As a result, we have no sense of quality or proper cost and so doctors and insurers have no pressure to provide higher quality.

Under Harris’s plan, we would become even further removed from the marketplace.  At least when we receive health care coverage through our employers we can always quit and go somewhere else with better benefits.  Once the government is the only game in town, how do we go somewhere else for benefits?

There are plenty of stories of how single payer systems drop the ball on quality.  Well-documented problems in the Veterans Administration, Britain’s National Health System, and a particularly gut-wrenching piece on Canadian care (video excerpt follows – click here for Steven Crowder’s full video) abound.

Closely associated with the quality facet is the timeliness of receiving health services.  With a profit motive driving delivery, markets are incentivized to deliver high quality in as speedy a fashion as possible.  After all, the higher the throughput, the greater the profit (and for those worried about the lowering of quality in order to increase speed refer to the discussion of market knowledge you just read).  Under a single-payer government system, no one is incentivized to do anything rapidly.  No additional profit flows for timely action.

Having just criticized a single-payer Medicare-for-all solution, the reader may be asking if I am defending our current system.  The answer, in a word, is no.  Our current system delivers excellent care but for too high a price.  To get costs in line with benefits, I would recommend four things:

1. Eliminate tax incentives for businesses to offer health care coverage as a ‘benefit’. Each person should purchase their own insurance as they do for home, car, or property.  By having ‘skin in the game, each of us would become more market-aware.
2. Eliminate barriers that prevent insurers from competing with each other nationwide as is done for home, car, and property.
3. Significantly curtail the AMA’s ability to shield a health care professional’s reputation. I don’t care if a doctor spent years in school, he needs to deliver in the here and now.  Education of the public on the shortcomings of licensing would also help here.
4. Significantly curtail tortious suits against health care professionals. Society doesn’t need to punish a doctor with punitive damages yet allow him to continue to practice.  Damage to his reputation will rid him from the market with far less human cost than the system we engage in now.

To close, I appreciate the human cost that Harris spoke passionately about and her desire to see that everybody, regardless of station, receives timely, quality health care.  I share those ideals with her – and that is why I am against Medicare For All.

I had the occasion recently to visit family and friends in Western Pennsylvania.  A brief pre-Christmas chance for reacquaintance and holiday cheer.  Since there are so many houses to visit, each spread relative far from the others, there is always some wrestling with logistics, especially where to stay.  After some deliberation, we decided to stay near the point – the narrow portion of Pittsburgh that lies at the place where the Allegheny River, coming from the north-east, joins the Monongahela River coming from the south-east, to form the Ohio River.

The location is beautiful and, because of a very late booking, also economical as the hotel needed to sell rooms, even at the rather absurdly low rate that I received.  But this post isn’t about the law of supply and demand as it applies to the hotel business.  No, it is about the moribund state of what was once one of the most vibrant locations in Pittsburgh and why.

Nearly three decades ago, while attending one of the fine institutions of higher education in Pittsburgh, I used to amuse myself by heading into the shopping districts.  A particular favorite was Kaufmann’s department store located on 5^th avenue consuming the entire block between William Penn Place and Smithfield Street.

Known for its iconic clock, its window displays, and its gourmet deli on the 9^th floor (note the plaque below the ornate support of the clock – it and others like it play an important role in what follows),

Kaufmann’s anchored one end of what was an exciting set of stores that dotted 5^th avenue and surrounding streets.  Towards the other end, closer to the point, were the two other large department stores of Gimbal’s and Horne’s.   The Warner Theater sat in roughly in the middle, next to an old Woolworth’s ‘five and dime’ that had one of the most eclectic selection of goods and a fish market to boot.  No matter the weather or, seemingly, the time of day there was always something exciting going on and a bustle of activity that one expects from a thriving metropolis.  Activity on the sides of the rivers, particularly the South Side of the Monongahela, was far more sedate.  The center of the city was the place to be.

As the decades wore on, the center lost it shine.  One by one, the great department stores went insolvent and disappeared.  The smaller shops became more run down with empty store fronts capturing greater and greater amounts of real estate.  The vibrancy was gone.

No doubt, the casual observer chalks all this up to the gradual dwindling away of the industries that once made Pittsburgh one of the great cities of the world.  And there is some truth to that.  But only some.  The bulk of the industrial upheaval actually occurred nearly forty years ago when US Steel closed down most of their activities.  Pittsburgh not only survived but managed to bounce back.  This resiliency was initially powered by its world class medical service and research and the numerous universities its sports.  These later institutions have contributed to a growth of late in data analytics and computer technology and the Steel Town has seen a resurgence in the last ten years.

Numerous new trendy locations have sprouted up designed with idea of separating the consumer from his money in various different ways.  From the thriving North Hills, to the Waterfront center that stands where the great mills once did, to the new and burgeoning hipster locales of the South Side and Lawrenceville, to the old faithful neighborhoods of Squirrel Hill and Shadyside, certain regions are active and growing.

So how to reconcile all this growth with a dead and empty downtown?  In one phrase – designated historic landmarks.  Almost everywhere one goes within the core of the downtown region, one finds a building bearing the historical landmark plaque (the total list of Designated City Landmarks and Historic Districts spans 14 pages).  And this plaque is the economic kiss of death.

To understand just why a designation as a historical landmark stifles the microeconomy associated with the object in question consider the restrictions that burden the property owner.  A brief consultation with Section 1101.05 of the Pittsburgh Municipal Code shows that a property bearing the historic landmark designation cannot have exterior alterations without approval of the Historic Review Commission, an extra layer of bureaucracy over and above the mandatory Bureau of Building Inspection.

The hidden cost of ownership of such a building is far larger than is simply totaled from property taxes and upkeep and utility costs.  There are opportunity costs that have to be figured as well.  For example, as a younger more fitness conscious workforce begins to call Pittsburgh home, the candy shops of yore should now be replaced by yoga studios and organic markets.  Simply exterior redesign, including modern signage and architectural sensibilities, should be one of the first orders of business.  But these changes may be extremely costly, if not impossible, if the building in question is a historic landmark.

Each piece of land is a scarce resource unto itself.  As market forces clamor for changes, historic landmark designations and the bureaucracy that goes along with them slap the invisible hand from reshaping the building to fit the demanded change.  As a result, business move to locations less encumbered and the landmark falls into disuse.

Pittsburgh is by no means alone in this predicament.  As the following video shows, the historic landmark designation may be spelling the end to one of New York’s most iconic bookstores.

It is hard to fathom that the entrepreneurs of decades-gone-by would actually approve of these policies.  After all, they were the innovators who turned their backs on older style construction and whose dynamism produced what were new structures at the time.  They were willing to bury the past in favor of economic growth.  Surely, they would expect no less from us today.