Cafe Hayek

In Defense of Usury

Especially in light of the renewed efforts to regulate the terms that credit-card issuers are allowed to offer to borrowers, Jeremy Bentham's short little classic Defence of Usury is well worth reading.  Below is a germane passage.  Writing of a potential borrower whose circumstances put him in desperate need of money, Bentham says

A man is in one of these situations, suppose, in which it would be for his advantage to borrow. But his circumstances are such, that it would not be worth any body's while to lend him, at the highest rate which it is proposed the law should allow; in short, he cannot get it at that rate. If he thought he could get it at that rate, most surely he would not give a higher: he may be trusted for that: for by the supposition he has nothing defective in his understanding. But the fact is, he cannot get it at that lower rate. At a higher rate, however, he could get it: and at that rate, though higher, it would be worth his while to get it: so he judges, who has nothing to hinder him from judging right; who has every motive and every means for forming a right judgment; who has every motive and every means for informing himself of the circumstances, upon which rectitude of judgment, in the case in question, depends. The legislator, who knows nothing, nor can know any thing, of any one of all these circumstances, who knows nothing at all about the matter, comes and says to him—"It signifies nothing; you shall not have the money: for it would be doing you a mischief to let you borrow it upon such terms."—And this out of prudence and loving-kindness!—There may be worse cruelty: but can there be greater folly?

The folly of those who persist, as is supposed, without reason, in not taking advice, has been much expatiated upon. But the folly of those who persist, without reason, in forcing their advice upon others, has been but little dwelt upon, though it is, perhaps, the more frequent, and the more flagrant of the two. It is not often that one man is a better judge for another, than that other is for himself, even in cases where the adviser will take the trouble to make himself master of as many of the materials for judging, as are within the reach of the person to be advised. But the legislator is not, can not be, in the possession of any one of these materials.—What private, can be equal to such public folly?

Price Controls and the Reign of Terror

In their 1975 book The Age of Napoleon, Will and Ariel Durant argue that the Reign of Terror during the French revolution was sparked, in part, by price controls.

The economy itself was a battlefield.  The price controls established on May 4 and September 29 [1793] were being defeated by the ingenuity of greed.  The urban poor approved the maxima; the peasants and the merchants opposed them, and increasingly refused to grow or distribute the price-limited foods; the city stores, receiving less and less produce from market or field, could satisfy only the foremost few in the queues that daily formed at their doors.  Fear of famine ran through Paris and the towns....

On August 30 a deputy pronounced the magic word: Let Terror be the order of the day.  On September 5 a crowd from the sections, calling for "war on tyrants, hoarders, and aristocrats," marched on the headquarters of the Commune in the Hotel de Ville.  The mayor, Jean-Guillaume Pache, and the city procurator, Pierre Chaumette, went with their delegation to the Convention and voiced their demand for a revolutionary army to tour France with a portable guillotine, arrest every Girondin, and compel every peasant to surrender his hoarded produce or be executed on the spot [pp. 62-63].

Joe Kennedy II Wants More Regulation of the Oil Industry

Joseph Kennedy II knows neither the relevant history nor economics.  Here's a letter that I sent today to the Wall Street Journal in response to Kennedy's essay that appeared yesterday in that paper.

Joseph Kennedy argues for more government regulation of the oil industry ("We Need a New Bargain With Big Oil," March 22).  His argument, however, is suffused with ineffective anecdotes (such as the untearful tale of the "young mother, who had to move in with her mother to keep her children warm and healthy") - with mistaken history (Teddy Roosevelt's attack on Standard Oil was for "the good of the nation" only if the nation was served by breaking up a firm that steadily pushed the price of kerosene down) - with naivete about government (Mr. Kennedy assumes that all those additional powers that he demands for government will be exercised by apolitical geniuses) - and with bad economics (his assertion that private firms have no right to charge "whatever they want" reveals his failure to understand that prices convey vital information and incentives to producers as well as to consumers).

So why, exactly, did you publish Mr. Kennedy's uninformed and ill-reasoned essay?

Sincerely,
Donald J. Boudreaux

Feedback, knowledge and the division of labor

Arnold Kling over at EconLog tells the poignant story of worrying about his father's health care. Anyone who has had a loved one in the hospital can relate. There are a lot of smart and caring people involved in the treatment, yet no one is overseeing the process and noting the interactions between this specialist and that one. No one is watching the heart rate zealously. The overworked nurse under pressure from another patient fails to note something crucial on the chart. Lots of cooks but no one's in charge. Usually a family member has to play that role, a family member who more often than not doesn't have the time for the full-time assignment and more than often not doesn't have the expertise other than to ask a lot of questions.

Economists talk about the power of specialization and the division of labor. Economists talk about how well things can work when no one's in charge. In the hospital though, it appears not to work as well as it might. Lauren in the comments to Arnold's post asks the right questions:

For which kinds of economic entities does division of labor break down? Why is it that sometimes having no one individual in charge is the economic ideal that is coordinated by the invisible hand, and other times not?

One answer is that maybe it works better in the hospital than it looks. Would we really want our parents in the hospital to be treated by a generalist? There are enormous amounts of knowledge and technology being brought to bear in curing people in a modern hospital.

But it clearly could be so much better than it is. We want the benefits of specialization without the costs, the same way we get them in other areas of our lives. What we want is someone to coordinate the process, someone other than ourselves to look out for the hammer-nail problem. All the specialists I've known are people with a hammer. Everything looks like a nail. The surgeon wants to cut. The oncologist want to give chemo. Beside the interaction problem, you want to make sure you don't have a specialist blinded by too much specific knowledge who fails to see the bigger picture

So why do we need someone in charge in the hospital but not in the graphite industry? In the graphite industry, there are plenty of pencils, tennis rackets and fishing rods and the dozens (thousands?) of products that use graphite. We don't need a graphite czar to make sure there's enough graphite to go around. All the specialists that contribute to those products don't get out of control. Their interactions don't get ignored. As Hayek pointed out, the knowledge gets coordinated without a coordinator. Why does it work there but not in the hospital?

The simple answer is that the price system and profit motive interact in the graphite industry causing the whole thing to work smoothly without it being anyone's intention. The prices and the profit motive lead to feedback and accountability. There are a whole bunch of people with the incentive and the information to make the system work well.

The simple answer is right. But it cannot explain why other organizations work well without prices and profits. Within a firm and within a family, resources and decisions get made without prices and often without profits. The answer (as Coase understood and as Lauren notes in her comment) is that in these organizations, the savings in transaction costs overcomes the loss of feedback and information benefits from using prices. But there are still incentives. There still is a residual claimant who bears the costs of failure and the benefits of success—the boss or the parent. Love motivates the parent. Bonuses and keeping your job motivate the boss.

So why doesn't a hospital work better? The answer I think, is that the level of specialization in medicine has emerged from a process that has very few incentives to make sure that the level of specialization is as productive as it should be. There are very few informational feedback loops. Very little accountability. Sure, if a surgeon leaves a scalpel in your chest cavity and sews you back up, the surgeon bears a cost. And as a result, it doesn't happen very often. But the kind of errors that Arnold worries about, the kind of errors that I've worried about with my Dad in the hospital (and the kind I've seen made) are the ones that have little or no consequence to anyone other than the patient.

These errors are built into the system. When a drug leads to unexpected side effects because the right questions weren't asked, when an opportunity for a safer treatment is missed, when an aggressive treatment for one illness weakens the immune system and leads to other problems, who can you blame? Who bears a cost other than the patient?

You can blame the hospital of course, whatever that means, but the costs to the human beings who work in the hospital are small. There are no feedback loops within the hospital to reward generalists who look for the costs of specializations. And the reason there are not is because the patient is not the customer. The patient is not paying the bill. The financial incentives that do exist are coming from Medicare and Medicaid and the insurance companies. The normal feedback loops that protect the customer from error and greed and simple stupidity are missing. In a way, it's amazing it works as well as it does. It works as well as it does presumably because most doctors and nurses do care about the lives in their hands. But it's imperfect and could be much better.

And because there isn't a residual claimant within the hospital, it is left to the wife or the husband or the parent or the child of the patient to represent the patient's interests in the face of the decentralized incentives presented by the hospital and its specialists. Ironically, the monitoring and feedback comes from the family, another organization that is usually not using monetary incentives to improve performance. But the love works pretty well.

But the patient who is unrepresented for whatever reason, who must rely on the system itself to keep an eye on the treatment regimen is at a greater risk than the patient whose wife is a doctor or better yet, a loving doctor or better yet, a loving doctor who is at her husband's side 24/7 until he comes home safely.

It's a flawed system that will stay that way until the incentives change. In the meanwhile, my heart and prayers go out to Arnold and his Dad and to anyone with a loved one at a distance going through a medical challenge.

The Wages of Misunderstanding

Paul Krugman circa 1996 understood the point of this letter (below) that I sent yesterday to the New York Times.  Paul Krugman circa 2007 apparently doesn't:

Opposed to free trade, David Raines asks "How can it be good for workers to be subjected to competition from low-wage countries?" (Letters, December 27).  This question reveals a common misunderstanding.

Worker compensation in America is high because American workers are made highly productive by the great amounts of capital they work with.  (And by the way, America is rich in capital, in part, because she consistently runs capital-account surpluses - i.e., "trade deficits.")  Where wages are low, it is because workers in those places have little capital to work with and, therefore, are not very productive.

G.M. and Toyota continue to sell cars even though bicycles - a competing means of transportation, but one far less productive than cars - fetch much lower prices.  For the same reason, with free trade American workers will continue to sell their labor for high wages even though many workers abroad fetch much lower wages.

Sincerely,
Donald J. Boudreaux

Incentives vs. preaching

This Communist propaganda poster is worth many more than a thousand words (HT: Chris Fisher):

Miracles Performed Beneath Marble Domes

Rep. Bill Sali (R-Idaho) understands economic processes.  Here's his smack-down of minimum-wage legislation.  (HT to Amit Varma at India Uncut.)

"Your Call Is Very Important to Us"

I ruminate today, in the Christian Science Monitor, on spending time waiting on hold.

If This Is Monopoly In Action, Bring It On

Today I sent this letter to the Gray Lady:

You allege that Intel is guilty of "abuse of market power to protect [its] monopoly" ("F.T.C. Goes AWOL," October 29).  Sounds terrible - until we read that Intel's offense is to offer "big discounts and rebates to computer makers who minimize the use of processors made by rival Advanced Micro Devices." In other words, to keep customers, Intel keeps its prices low.

Monopolists raise prices; firms facing competition do not.  Intel keeps its prices low, meaning that it behaves competitively.  Yes, Intel's pricing practices make life more difficult for AMD and other rivals, but that's what competition is supposed to do.

Sincerely,
Donald J. Boudreaux

Rating Postal Rates

One of my students at George Mason University recently asked about my thoughts on the U.S. Postal Service's government-granted monopoly on the delivery of first-class mail.  I told him that I see no justification for that monopoly privilege -- that, if I could, I would eliminate it immediately.

"But postal rates aren't outrageous," he challenged (in good and appropriately skeptical spirit, I add).  "Wouldn't a true monopoly charge much higher rates?"

This question recalled to mind the very first letter that I published in the New York Times, back in 1994.  (It is co-authored with my good friend, the University of Georgia's George Selgin.)

It has been suggested that, because the nominal price of first-class postage is about where it was in the late 18th century, Americans who complain about the proposal to increase postal rates are merely whining wimps who are lacking in historical perspective.

However, the real price of transportation (a key input in postal service) has plummeted over the last 200 years. In 1799 it took 53 days for an Army courier to travel from Detroit to Pittsburgh.

Today the same trip can conveniently be made in minutes. Likewise, the productive efficiency of the United States is vastly greater now than it was even a few decades ago.

Given the plunge in transportation costs, joined with other technological improvements and a large increase in the scale of postal activity, the price of postage should have fallen dramatically.

Americans do not oppose postal-rate increases because of their ignorance of history. 

Rather, opposition to these increases grows from the correct perception that a legally protected monopolist such as the United States Postal Service can keep prices higher, and service inferior, to what these would be under competition.

Regardless of how today's postal rates compare with rates in the past, opening the delivery of first-class mail to competition would lower rates still further while improving service.

DONALD J. BOUDREAUX
G. A. SELGIN
Clemson, S.C., March 24, 1994

The writers are, respectively, an associate professor of legal studies at Clemson University and an assistant professor of economics at the University of Georgia, Athens.

Good luck, BLS

The iPod will be six years old next month. The newly released iPod Classic with 160 GB of memory is $50 cheaper than the original iPod, holds 40 TIMES more songs and also plays color videos and displays photos. It is smaller, lighter and has a better battery. I wonder how the BLS takes account of the quality differences when measuring the price index and inflation.

Cape Cod Traffic

In a comment on a recent post of Don's about Cape Cod, Spencer asks about my prediction about Cape Cod traffic. He is referring to this article I wrote in the Boston Globe last November where I predicted that the $62 million project to eliminate congestion at the entrance to the Cape was likely to fail. Here is what I wrote:

Getting rid of the rotary can't solve the traffic problem because it doesn't change the underlying cause of the congestion: the relative scarcity of sand and surf next to magnificent dunes.

A lot of wonderful scarce things are expensive. Think box seats at Fenway on a perfect night in June, Van Gogh's paintings, or a condo overlooking Central Park.

But sitting on the beach at Cape Cod is wonderful and scarce and relatively cheap -- cheap measured by the out-of-pocket costs of a day trip. So more people want to enjoy the Cape than there is room for them on the Cape's roads and beaches. Removing a rotary makes that problem worse, not better. It removes one of the costs of enjoying those beaches. So other costs emerge in response, though no one wants it that way.

Next July or August, there will be a new bottleneck. I'm not sure where it will be, but I'm confident it will be there. The only question is how bad it will be.

The first test of the so-called Sagamore flyover came on Memorial Day. The Globe reported:

For thousands of visitors, going to  Cape Cod   over Memorial Day weekend was much easier and more pleasant than heading home.

The new $60 million flyover, which erased the hated rotary at the base of the Sagamore Bridge, smoothed Cape-bound travel on Friday and Saturday. But drivers returning from the Cape Monday found themselves in a worse-than-usual traffic nightmare, with backups that stretched as far  as 17 miles to Yarmouth at midafternoon.

To avoid a repeat this summer, state transportation officials said yesterday they plan to install electronic signs urging vacationers to stagger their departure from the Cape as well as their arrival. Officials said they will also look at possible changes to the roadways around Exit 1, where Route 6A merges into Route 6 at the base of the bridge.

Evidently, there are still problems as this article a week and a half ago from South Coast Today illustrates:

For Gov. Dukakis, a recent trip to the Cape reiterated the need for the rail line when he and his wife sat in heavy traffic before and after crossing the Sagamore Bridge.

Money that went into the $62 million flyover project would have been better spent on rail lines, he said.

When something valuable (experiencing Cape Cod) is underpriced, it will inevitably be overused and congestion will ration access. Something that appears to be an engineering problem (an inefficient traffic rotary) is really an economics problem.

Two reports don't prove a prediction. I'd love to see some real data on whether delays are more common or less. Anybody out there have any info? Diligent observers can go here on Fridays and Sundays and make their own estimates of whether traffic is free-flowing. Meanwhile, here's a story from December 2003 that called it a $35 million project. I guess it's hard to keep costs down in Massachusetts.

Two worlds

Here is a very nice essay by GMU student Geoffrey Lea on Hayek's argument that we need to behave differently when we interact with friends and family compared to the strangers we meet in the extended order of market transactions.

The virtues of scalping

Here is Jeff Jacoby on the decline of anti-scalping legislation and why it's a good thing. Here's my slightly off the beaten track podcast on scalping.

Scalping

The latest EconTalk is a bit off the beaten track. I'm out in California and thought it might be interesting to go the All-Star Game (or at least stand outside the stadium) and interview people about ticket prices and scalping.

The podcast opens with a story about my wife and I getting scalped to say Les Miz, a few months after it opened in 1987. Reminiscing with her about it, we got to talking about why the atmosphere outside a stadium or concert gets so intense as people buy and sell tickets on the street. Part of it is that there are often few substitutes for the pleasure that is being anticipated. Most baseball fans for example rarely get to go to an All-Star Game. There isn't going to be one every week. And the tickets are fixed. If a lot of people want to go, they don't expand the stadium. So there's a lot of potential value there for the serious fan. Even so, there's a wide distribution of value as well. So even though the ticket on the street is $400, someone might be willing to pay much much more. Of course the scalper is often aware of that. So there's a dance of negotiation playing against the backdrop of competition from other buyers and sellers.

It just isn't like most of the other economic transactions we make. It's nothing like buying a cup of coffee or even going to a regular season baseball game. Unless you go to one a year. Then it's similar. It's like buying a cup of coffee if you could only buy one cup a year and you weren't sure you'd be able to get a cup. You'd really look forward to it and savor it if you got one at a price you liked.

Where do prices come from?

Whenever I teach microeconomics I spend about 40% of the class on supply and demand. For me, supply and demand is by far the most useful tool for conveying the economic way of thinking. I find it strange that it gets dismissed by some as unrealistic because the conditions for perfect competition rarely apply in the real world.

Supply and demand is supposed to be unrealistic. It has to be. It is trying to capture the main thing about prices. When people want more of something than is available, the price tends to rise. When people want to sell more of something than people want to buy, the price tends to fall.

There's no such thing as supply and demand. It's a way of thinking. It's a way of organizing the chaos of all the different transactions that take place in a market yet that are linked because of competition and arbitrage.

In this essay for the Library of Economics and Liberty, I try and explain the ideas behind supply and demand without using graphs. It's part of a series of essay I'm writing for the site on economic fundamentals.

Here's my graphical treatment of supply and demand for those who want to work a lot harder.

The Reality Reflected by Prices

Here's a letter that I sent last week to the Washington Post:

To the Editor:

Kings of yore occasionally killed messengers bringing bad news.  By voting to outlaw so-called "price gouging," the House of Representatives proves that its members are just as irrational as these ancient monarchs ("Tipping-Point Shock," May 24).

Higher prices report an underlying reality such as constrained refining capacity, rising demand, higher taxes, and more regulations.  Statutes that prevent prices from rising do nothing to improve the underlying reality. Indeed, by silencing information about reality, restraints on price hikes keep consumers and producers acting in ignorance - thus making matters worse.

Sincerely,
Donald J. Boudreaux

More(iss) on Gasoline Prices

My friend and co-blogger (at Market Correction) Andy Morriss has a new paper here that compellingly explains why the gasoline prices Americans now pay at the pump are unnecessarily high.  Here's the abstract:

Rising gasoline prices have brought energy issues back to the forefront of public policy debates. Gasoline markets today are the result of almost a hundred years of conflicting regulatory policies, which have left them dangerously fragmented. In this article, I analyze that regulatory history, highlighting the unintended consequences of regulation that have pushed the United States into a series of loosely connected regional markets rather than a broad, deep national market. This fragmentation leaves the American economy is vulnerable to natural disasters, terrorist attacks, and foreign dictators in ways that it need not be. It also produces higher prices for consumers and reduced innovation by refiners.

The Answer Is In the Margin

Muirgeo asks, in response to this post on Congress's latest effort to keep the price of gasoline below its market-clearing level:

Can anyone tell me why the oil companies would want to build a refinery when profits are so high just the way they are?

Also in the Comments section, The Albatros and Methinks offered very nice answers.  I offer here my own response -- or, actually, a response to a Washington, DC, radio news anchor who asked on air the very same question that Muirgeo poses:

News Editor, WTOP Radio
Washington, DC

Dear Editor:

Morning anchor Mike Moss proposes that the U.S. government enter the business of gasoline refining.  He argues that the private sector has no incentive to build more refining capacity as long as oil-company profits are high.

Moss's economics is backwards.  It implies that private firms would consistently refuse to expand outputs of MP3 players, gourmet coffee, cell phones, and other high-demand products. Firms instead would invest only where profits are low or negative - treating consumers to endless supplies of the likes of chocolate-coated olives and cardboard condoms.

In fact, of course, the profit motive drives firms to invest precisely where returns are highest -- assuming that they're not thwarted by government regulations.

Letters to the editor must be short, inevitably resulting in some simplification.  If the oil-refining industry were monopolized or if its firms could effectively cartelize, then any high profits currently earned would be less likely to spawn new investment in refining capacity.  I have no sense that the oil-refining industry enjoys monopoly power (except, perhaps, insofar as government regulations that artificially raise the costs of building new refining capacity do help to shield existing firms from the full force of market competition).

More directly, although I can't read minds, the impression I got from listening to the radio announcer, and from reading Muirgeo's comment, is that these persons commit the same fundamental economic mistake that many freshman students commit: the failure to think at the margin.

Thinking 'at the margin' reveals that, yes indeed, if profits are higher for sellers of product A than for sellers of product B, devoting resources to the production and sale of more units of product A will yield higher returns on those resources than would be yielded on those same resources were they instead used to produce and sell more units of product B.

In this way, high profits direct resources owners to use their resources where the return available on those resources is highest -- which is generally also where those resources most ably satisfy consumer desires.

Will the So-Called "Reality-Based" Community Condemn this Affront to Reality?

The poseurs, preeners, pontificators, and interest-group pimps in the U.S. House of Representatives yesterday passed a bill to outlaw so-called "price-gouging" by oil companies.  And the vote in favor of this foolish piece of legislation was 284-141 -- meaning that lots of Republicans joined Democrats in this opportunity to prove, yet again, that both parties boast members who are either economically illiterate or morally stunted (or both).

A couple of years ago I published this short essay "On Price Gouging" (using the example of bottled water rather than gasoline -- but the same economic principles apply in both cases); here's an excerpt:

Of course, merchants can voluntarily keep their prices below market levels. But to do so would be not only harmful but also unfair! If a grocer refuses to raise the price he charges for bottled water up to the market level, he will find his store besieged by consumers.  Only consumers near the front of the line will be lucky enough to get the water; those closer to the rear will go home empty-handed. Is queuing a fair means of deciding who gets the water?

Also, by not raising the price, the grocer will mute the price signal sent to the global market that bottled water is especially needed in this locale. Muting this signal will reduce how much or the speed with which additional, much-needed supplies of bottled water are shipped from where they are valued less to the disaster area where they are desired more.

Will on gouging

George Will does a superb job explaining how prices work (HT: Sandy Baillie). Read the whole thing but the ending is particularly good:

Pelosi announced herself "particularly concerned" that the highest price of gasoline recently was in her San Francisco district -- $3.49. So she endorses HR 1252 to protect consumers from "price gouging," defined, not altogether helpfully, by a blizzard of adjectives and adverbs. Gouging occurs when gasoline prices are "unconscionably" excessive, or sellers raise prices "unreasonably" by taking "unfair" advantage of "unusual" market conditions, or when the price charged represents a "gross" disparity from the price of crude oil, or when the amount charged "grossly" exceeds the price at which gasoline is obtainable in the same area. The bill does not explain how a gouger can gouge when his product is obtainable more cheaply nearby. Actually, Pelosi's constituents are being gouged by people like Pelosi -- by government. While oil companies make about 13 cents on a gallon of gasoline, the federal government makes 18.4 cents (the federal tax) and California's various governments make 40.2 cents (the nation's third-highest gasoline tax). Pelosi's San Francisco collects a local sales tax of 8.5 percent -- higher than the state's average for local sales taxes.

Pelosi and others who just know, evidently intuitively, the "fair" price of gasoline must relish what has happened in Merrill, Wis., where Raj Bhandari owns a BP gas station. He became an outlaw when he had what seemed, to everyone but the state's government, a good idea. He gave a discount of 2 cents per gallon to senior citizens and 3 cents for people who support local youth sports programs.

But Wisconsin's Unfair Sales Act requires retailers to sell gasoline for 9.18 percent above the wholesale price. The state's marvelously misnamed Department of Agriculture, Trade and Consumer Protection has protected consumers from Bhandari's discounts by forcing him to raise his prices. Some customers now think he is price gouging.

Some Wisconsin legislators are considering changing the Unfair Sales Act to allow retailers to discount gasoline to benefit things those legislators think should be benefited. In Madison, Wis., as in Washington, D.C., it is considered eccentric to think that government should butt out, let people buy and sell as they please, and let markets equilibrate.

Reaping Rewards from Human Capital

Here's a letter that I sent yesterday to CBS newsman Charles Osgood (Fordham, '54; Economics) after I listened to this broadcast of The Osgood File:

Dear Mr. Osgood:

Today you insinuated that oil retailers who sell a particular inventory of gasoline at a price higher than they expected to receive when they first purchased that inventory are misbehaving.  You're mistaken.

You attended Fordham University in the 1950s, investing in yourself in the hopes of earning a good living.  Surely your real income today is much higher than you, when you were in college, expected it to be.  Are you misbehaving by accepting from CBS a salary that is higher than you once anticipated?  Of course not.  But just as it is legitimate for you to reap benefits from increases in the market value of the asset that you invested in (namely, yourself), it is legitimate for oil companies to reap benefits from increases in the market value of whatever assets they invest in.

Sincerely,
Donald J. Boudreaux

The imperfect market for passports

Plenty of fodder here (HT: Doug Ransom) for an Econ 101 class discussion or exam. Because of a new requirement that Canadians visiting the US need a passport, there's been an increase in demand to get a passport and the Canadian bureaucracy hasn't responded as briskly as they might. The result is excess demand for a passport on short notice and that means price gets paid in other

Pat has a layer of cardboard beneath him, a wool blanket on top of him, two paperbacks found in a dumpster in his hand and the promise of $80 when he wakes up.

     “I’m a lucky guy,” the 40-year-old homeless man said, from one of the most coveted spots in town these days.

Pat was first in line at the Fort Street passport office lineup yesterday. He claimed his spot at 1 p.m. the afternoon before, and slept out on the sidewalk with about 15 other homeless people who have put themselves to work holding space in line for those a little more fortunate.

“I’m taking advantage of an opening in the marketplace,” Pat said. “Capitalism is what our whole society is based on. It’s the foundation of what we are and what we’ve become.”

If people don’t want to wait the hours in line that it’s taking to get passports processed, Pat and others are willing to sleep on the street — as many of them would be anyway — and get paid for it.

One of the nice lessons here is that even though the homeless are willing to sleep on the street for nothing, the market is rewarding them. I'll leave as a homework question (use the comments if you'd like) why the market works this way. Another lesson comes from Pat's analysis:

"I’m taking advantage of an opening in the marketplace,” Pat said. “Capitalism is what our whole society is based on..."

The first sentence is true. The second? Let's just say the decision of how many clerks to put int he passport office isn't exactly capitalism in action.

Adaptation, Prices, and Climate Change

Both the Atlantic (not yet online) and Sports Illustrated (HT: Michael Rizzo) feature cover stories on global warming. The Sports Illustrated piece is a bit of a stretch. They have a long tradition of trying to be about something more consequential than sports. Does global warming have anything to do with sports? Sure:

The next time a ball game gets rained out during the September stretch run, you can curse the momentary worthlessness of those tickets in your pocket. Or you can wonder why it got rained out -- and ask yourself why practice had to be called off last summer on a day when there wasn't a cloud in the sky; and why that Gulf Coast wharf where you used to reel in mackerel and flounder no longer exists; and why it's been more than one winter since you pulled those titanium skis out of the garage.

Global warming is not coming; it is here. Greenhouse gases -- most notably carbon dioxide produced by burning coal, oil and gas -- are trapping solar heat that once escaped from the Earth's atmosphere. As temperatures around the globe increase, oceans are warming, fields are drying up, snow is melting, more rain is falling, and sea levels are rising.

All of which is changing the way we play and the sports we watch.

  It's a bit of a stretch. A huge stretch. And of course it's a stretch in one direction only. It could have been written this way:

The next time you get to enjoy throwing a baseball in February or enjoying a December game at Chicago's Soldier Field instead of viewing it mostly as a rite of passage or a test of your toughness, thank global warming.

Oops. Not scary. The cover of the magazine is the way to go—a Florida Marlin (the baseball kind) in thigh-deep water in the outfield of the Marlins' stadium. I'm going to save the cover. It will be either the crow I eat in 25 years as a repentant ex-skeptic or the poster to share with friends who thought the experts were right all along.

Over at the Atlantic, recent EconTalk guest Gregg Easterbrook has the courage to stretch in both directions, looking at who might lose, yes, but also who might benefit from global warming. There's some good stuff in it. Lots of interesting speculation for example, on land values and how Buffalo might again become the place to be, while Arizona real estate plummets in value.

Toward the end, he offers this insight into coping with global warming:

The market has caused the greenhouse-gas problem, and the market is the best hope for solving it. Offering market-incentives for the development of greenhouse-gas controls—indeed encouraging profit making in greenhouse-gas controls—is the most promising path to avoiding the harm that could befall the dispossessed of developing nations as the global climate changes.

He then goes on to say that because global warming is already here, adaptation is also important.

Crops that grow in high temperatures, homes and buildings designed to stay cool during heat waves, vehicles that run on far less fuel, waterfront structures that can resist stronger storms‚the list of needed adaptations will be long, and all involve producing, buying, and selling. Environmentalists don't like talk of adaptation, as it implies making our peace with a warmer worlds. That peace though, must be made—and the sooner businesses, investors, and entrepreneurs get to work, the better.

Well said, but there is one more key point to make. Prevention, if it is indeed prudent, is likely to require collective action, government action, internationally imposed action. Action that is going to have all the rent-seeking and other mistakes that come from centralizing power. Adaptation comes from the market, as he calls it—from individual action. It is self-organizing. We don't need to exhort entrepreneurs to come up with cooler homes or better crops. Their own self-interest will push them to discover those innovations and at the right pace. And sooner isn't necessarily better with adaptation. Sooner comes at a cost of foregone other innovations and uses of time and energy and the sweat of the brow. Entrepreneurs have an incentive to take those costs into effect. Politicians don't. So don't worry. All the adaptations that you can make money from will come into being without any exhortation. Money talks. Loudly, but not too loudly.

One more thought on adaptation and the role of prices. If the worriers are right, if global warming really does threaten to make Miami uninhabitable, we'll see real estate prices in Miami start to fall as Easterbrook points out. The fact that they are not falling means that people do not believe the worriers. So someone is wrong. Either Al Gore or the guy who is paying the going rate for a lot in South Beach. My impulse is to choose Al Gore as mistaken simply because there is no consequence for him being wrong and the purchaser of the real estate has a much greater incentive to act on an inconvenient truth.

But maybe people are myopic. Maybe they inadequately perceive the risk of one-time events. Maybe it will take a while for all those Sports Illustrated covers to sink in. Even so, if sea levels really rise, eventually buyers and sellers of land will catch on. The demand for Florida real estate will go down and the prices will start to fall. The prices elsewhere will rise. Not uniformly. Some places will go up more than others. These changing prices will encourage some people to go to Buffalo and others to Omaha. Some people will leave Florida quickly while others will stay for a while as the waters rise.

The changes in the price of real estate will not happen overnight. They will happen gradually over time, giving people the signals about which places are relatively attractive and which places are less so. This adaptation will take place without any centralized direction.

When the price of land in Miami starts to fall relative to the rest of the country, then you'll know people are taking global warming seriously. That is one more piece of evidence you can use to figure out whether any political action will take place. Until that happens, bet on the status quo politically.

Getting the most out of life

Here is the opening of an essay of mine at the Library of Economics and Liberty on getting the most out of life and the concept of opportunity cost:

One of the challenges of being an economist is explaining what you do for a living. People understand that one of the things a professor of economics does is teach economics. But what is that, exactly? Most presume it has something to do with investing and financial management. When I once told my seatmate on an airline flight that I was an economist, she said, what a shame, my husband loves the stock market. Hmm. I didn't tell her that other than the advantages of investing in indexed mutual funds, I know next to nothing about the stock market.

My seatmate might have profited from reading Alfred Marshall who called economics "the study of mankind in the ordinary business of life." This was the enterprise of Marshall and Adam Smith and Friedrich Hayek and Milton Friedman: they tried to understand what people do and the implications of their behavior for the society at large.

But my favorite definition of economics is a variant of Marshall's. It comes from a student who heard it from another teacher of hers: economics is the study of how to get the most out of life. I like this because it strikes at the true heart of economics—the choices we make, given that we can't have everything we want. Economics is the study of infinite wants and finite means, the study of constrained choices. This is true for individuals and governments, families and nations. Thomas Sowell said it best: no solutions, only tradeoffs. To get the most out of life, to think like an economist, you have to be know what you're giving up in order to get something else.

The entire essay is here.

The Law of One Price

Kevin Kelly gives us five prices for the same book. But of course it's not the same. (HT: Josh Hill)

Credit Competition

Yesterday's New York Times had a letter-to-the-editor from Mr. Morton Mintz who suspects that credit-card interest rates are too high -- he even used the word usury.  Mr. Mintz calls upon Congress to investigate whether or not these interest rates really are usurious.

Overlook the ambiguity of such words as "usurious."  (Note: Mr. Mintz apparently believes that a clear dictionary definition of "usury" means that in reality usurious rates of interest are objectively distinguishable from non-usurious rates.  Such a belief is mistaken -- as mistaken as would be, say, the belief that because the word "profound" has a clear dictionary definition that Congress (or anyone else, for that matter) could determine which books in a library are "profound" and which ones aren't "profound.")

Overlook also the utter lack of expertise of politicians to assess the merits and terms of contracts between merchants and their customers.  And overlook Congress' s unavoidable political nature: members of Congress are politicians who will behave as politicians rather than as objective finders of fact.

The germane fact is that many investigations into the appropriateness of credit-card interest rates and charges are continually underway.  They take place ruthlessly and constantly.  They are  done by competitive card issuers and by potential other suppliers of consumer credit seeking out, searching for, ways to expand their market shares.  They are also done by consumers themselves who can switch card issuers or refuse altogether to use credit cards.  If rates are too high, these investigations will discover this fact and correct it.

Am I naive?  Certainly no more naive that is Mr. Mintz and others who suppose that an investigation by Congress into credit-card rates will uncover trustworthy information and use this information as the basis for sound corrective actions.

Of course, I think that I am not naive (although I concede that, were I in fact naive, my naivete would itself hide its reality from my notice).  If there are government-imposed restrictions on the ability of banks and other firms to compete to offer consumer credit, then credit-card rates would then likely be too high.  But absent such restrictions -- and I know of none -- then our best guess is that rates are appropriate.  If rates were too high, then the greedy quest for profit would prompt one or several firms to lower rates or offer better terms to consumers.

I close by acknowledging that credit-card issuers sometimes resort to sneaky tactics.   Indeed, every time I write against the notion that such issuers should be hauled before Congress and "investigated," I receive a fair number of e-mails from people informing me of the tricks and snares that card issuers sometimes use to increase their profits.

The fact that such tactics are widely known reduces their effectiveness.  More to the point, fraud -- if that's what some of these tactics are -- is an offense at common law and should be punished.  High interest-rate charges and late fees are themselves not fraudulent.

Taking advantage of people's need

Mexico is putting price controls on tortillas to protect the poor from increases in tortilla prices caused by rising prices of corn. The AP reports (HT: Noah Yetter):

President Felipe Calderon signed an accord with businesses on Thursday to curb soaring tortilla prices and protect Mexico's poor from speculative sellers and a surge in the cost of corn driven by the U.S. ethanol industry. The corn tortilla is the basic staple of the Mexican diet and is especially crucial for the poor. The accord limits tortilla prices to 8.50 pesos ($0.78) per kilogram and threatens to use existing laws to achieve prison sentences of up to 10 years for company officials found hoarding corn. Some stores have been selling tortillas for as much as 10 pesos ($0.91) per kilogram.

It also raises quotas for duty-free corn imports to 750,000 metric tons (826,733 U.S. tons), most of which will come from the United States.

The measure is to be reviewed for possible modifications on April 30.

"The unjustifiable price rise of this product threatens the economy of millions of families," Calderon said. "We won't tolerate speculators or monopolists. We will apply the law with firmness and punish those who take advantage of people's need.

Why is corn getting more expensive?

The rise is partly due to U.S. ethanol plants gobbling corn supplies and pushing prices as high as $3.40 a bushel, the highest in more than a decade.

So because of a bad law in the United States (the requirement to put ethanol in gasoline), the Mexicans have decided to pass a bad law that can only lead to a tortilla shortage.

But wait. There's another source of high corn prices in Mexico. Re-read that earlier line:

It also raises quotas for duty-free corn imports to 750,000 metric tons (826,733 U.S. tons), most of which will come from the United States.

Quotas? Mexico keeps out American corn? Wait a minute. Didn't the United States sign a free trade agreement with Mexico, the North America Free Trade Agreement? I guess there was a exception for corn. Or a very slow phase-in. Maybe we should call it NAMTA—the North America Managed Trade Agreement. Or maybe NAFTA stands for the North American Fair Trade Agreement because it protects Mexican corn farmers from  unfair competition by American corn farmers.

Getting rid of corn quotas would be a lot better way to help the poor than imposing price controls on tortillas. Maybe President Calderon should spend more time listening to Mike Munger. 

Picture the Minimum Wage

A picture sometimes is worth a thousand words.

(HT to Ray Gardner.)

Munger on gouging

We're back on a weekly schedule at EconTalk. This week is Mike Munger talking about price gouging—his personal experience of the aftermath of a North Carolina hurricane and how people reacted to market prices for ice when the electricity went out. We get into a variety of issues—including the market for vaccines and the motives behind those who charge market-clearing prices. The conversation may be of particular interest to students taking microeconomics or teachers teaching microeconomics. But normal people should find it interesting as well. The conversation is based on his essay for Econlib on the same experience.

Demand Slopes Downward

Even in Washington, D.C., demands slopes downward. The city has proposed raising fares on the city's subway, the Metro, as a way to eliminate a multi-million dollar deficit. From yesterday's Washington Post:

Rush-hour Metrorail riders face a $2.10 fare increase, and some off-peak passengers could get discounts under a proposal designed to raise money, change rider habits and ease crowding.

The possible changes are part of a far-reaching plan that Metro budget officials present to the agency's board today that could drastically alter how much riders pay and how they pay it. The plan is aimed at closing a $116 million budget shortfall, but it also attempts to improve service by encouraging the use of electronic SmarTrip cards and changing the times that people use the subway.

Somehow, when there's a budget shortfall, people always assume that the solution is to raise prices. Increases in prices can lead to higher revenue. But revenue is the product of price and quantity and when you increase price, you inevitably get lower quantity—demand slopes downward. The question is, how much lower? If the decrease in quantity is large enough, it can offset the increase in price and actually lead to lower revenue. Sometimes, the way to raise more money is to lower price and attract enough customers to offset the drop in price.

Today, the Post reports that demand slopes downward and that demand may be sufficiently responsive to price to cause real problems for the Metro system's plan:

Scores of Metro riders, reacting angrily to proposed fare increases, say the hikes are so dramatic that taking the subway may no longer make sense, raising the possibility that large numbers will ditch mass transit altogether.

"It's ridiculous," Mike Green, 42, who takes the Red Line during rush hour between Shady Grove and Farragut North, said in an interview. "Surcharging people to ride during rush hour is like saying goodbye to the commuter," he wrote in an earlier e-mail. "I will drive."

Talk is cheap. We'll see many riders will actually start driving. But it is always good to remember that when you change a price, you can't hold everything else constant. I wonder if the Metro even considered the likelihood of a reduction in ridership in response to a fare increase.

Always Low Prices

I love this letter that appears in today's Wall Street Journal:

I was surprised to learn from your editorial that Hugo Chávez is allowed to sell oil to Joe Kennedy's Citizens Energy Corp. at a 40% discount. Surely a price this far below market runs afoul of the "antidumping" policies beloved by many in Mr. Kennedy's party. Shouldn't the American public be protected from lower prices on oil in the same way they've been protected from lower prices on bicycles, frozen concentrated orange juice, tissue paper, footwear, fishing tackle, hot-rolled carbon steel, televisions, replacement windshields, shrimp and several hundred other imported items. If Democrats allow lower prices here, they may even have to tolerate Wal-Mart.

Bruce E. Ikawa
Professor of Business and Economics Hillsdale College
Hillsdale, Mich.

(Hat tip to Mike LaFaive.)

HBiPod

The iPod is five years old today. When it first came out, it held 1000 songs and cost $399. Today, for $349, you get 20,000 songs. It can also display videos and photos. It's smaller, too. So it's $50 cheaper and more than 20 times better.

I wonder how the BLS handles this when it calculates the CPI.

The Society of Real Economists

Some have suggested to me that it would be a good idea to have a counter-petition to the one advocating an increase in the minimum wage. I'm not so keen on it for a variety of reasons. We could get more signatures. We could get more Nobel Laureates. But so what? We'd just encourage the world to think that economists don't agree on anything, even the minimum wage, which used to be the dividing line between economists and everyone else.

Here's a different idea. Let's start a new society of economists—not the American Economic Association but the Society of Real Economists (SORE). When people ask you what you do for a living, instead of saying "economist," you'd say you're a "real economist."

It's a big tent kind of group. Here's my first cut at a list of principles that makes you a real economist:

1. Demand slopes downward--people do less of something when it gets more expensive
2. Prices respond to market forces
3. Motives and intentions do not matter. Results and actions do.

Maybe that's it. The beauty of these principles is that there's room for people on the left and the right. You can be an interventionist or a free-marketer. You can be a member of SORE and be in favor of the minimum wage because you think the benefits of helping some people get a higher wage outweighs the costs of some people losing their job or having a hard time finding a job because there are fewer opportunities.

But if you support the minimum wage because it's important as a symbol of our desire to help people or because the minimum wage doesn't effect employment, you can't be a member of SORE.

I'm in. It's somewhat exclusive, though. Here are a list of 650 people who are out.

If you agree with the three principles I've listed, just send me an email with your affiliation and you're in.

On Rent Control

Today's New York Times ran this letter from me on rent-control:

To the Editor:

An Oct. 4 letter says New York City “must quickly develop a plan to retain the middle-class population.” The city can start by abolishing rent control.

By decreasing the profitability of supplying units occupied by renters, these controls spawn condo conversions and prompt builders to construct fewer rental units and more units for sale to owner-occupiers. People who can’t afford to buy housing are unnecessarily disadvantaged.

Rent control also encourages empty nesters, who enjoy below-market rents for their three- and four-bedroom apartments, to stay put rather than move into smaller units, thus discouraging younger families with children from moving to the city.

Donald J. Boudreaux
Fairfax, Va., Oct. 4, 2006
The writer is chairman of the economics department at George Mason University.

The Ethics of Rationing

Sharon Begley in today's WSJ raises the issue of rationing in a life or death situation:

You have 100 doses of a vaccine against a deadly strain of influenza that is sweeping the country, with no prospect of obtaining more. Standing in line are 100 schoolchildren and 100 elderly people.

The elderly are more likely to die if they catch the flu. But they also have fewer years left to live and don't get out enough to easily spread or catch the disease. The kids are more likely to act like little Typhoid Marys, sneezing virus over anyone they encounter, and have almost their whole life ahead of them. But they're also less likely to die if they get sick.

Whom do you vaccinate?

This dilemma is haunting experts concerned that avian influenza might start spreading from person to person instead of (as far as we know) mainly from birds to people. But it also applies to regular old flu, which always has the potential to reach pandemic proportions. In response, studies now are shedding light on the ethical issues and the most effective strategy for reducing illness and death if vaccine must be rationed. Sadly, they make a pretty good case that current U.S. policies leave a lot to be desired.

But how could we possibly find ourselves in this situation. We never ask, if there's not enough shoes to go around, should young or old people get the shoes. Or the oranges. Or the houses. Or cars. We don't even have to ask these questio