Thursday, March 29, 2007

Should Resale Price Maintenance Be Legal?

If economists generally agree about anything, it is that competitively set prices maximize efficiency and welfare. On the other hand, another central tenet of economics is that efficiency may be achieved by allowing individuals and firms to enter into contracts with one another: for example, Ronald Coase famously showed that problems involving externalities could be solved if all affected parties could negotiate with one another.

However, not all contracts are legal. Most prominently, laws like the Sherman Antitrust Act place strict prohibitions on the kinds of contracts firms can write with one another. For example, airlines cannot agree with one another to keep prices high; that would be illegal collusion. Furthermore, manufacturers cannot require retailers to sell their products at a minimum pricea practice called "resale price maintenance."

The logic behind the banning of resale price maintenance is that the practice raises prices, and therefore decreases consumer welfare. This week, the ban came under attack as a leather-goods manufacturer argued before the Supreme Court that it should be allowed to dictate prices to retail outlets. Justice Antonin Scalia agreed, saying:

...the mere fact that [resale price maintenance] would increase prices doesn't prove anything. If in fact it's giving the consumer a choice of more service at a somewhat higher price, that would enhance consumer welfare, so long as there are competitive products at a lower price.

Recall that consumer surplus is defined by economists as the difference between what a consumer is willing to pay and the price they actually pay. One way of summarizing Justice Scalia's argument is that there are two variables in determining consumer surplus: the price, and the value of the service. If resale price maintenance encourages retail outlets to compete on service, the value to consumers may increase, and may increase more than the increase in price.

The key to this argument is the phrase "so long as there are competitive products at a lower price." In the case of the leather-goods market, it's true that there are lots of producers of leather goods. Therefore, high prices can only be sustained if there is an accompanying increase in quality of service.

Discussion Questions

1. Resale price maintenance agreements would seem to be good for retailers, as they allow them to sell at a price above marginal cost. Yet the plaintiff in this lawsuit was in fact the retailer, Kay's Kloset, who wanted to sell the leather goods made by Leegin Creative Leather Products at a discount. Who do you think benefits more from resale price maintenance agreements, manufacturers or retailers? Why?

2. On his blog, Greg Mankiw reprints the excellent summary from his textbook of the arguments for and against resale price maintenance. One argument for resale price maintenance is that it solves a free-rider problem that would otherwise prevent stores from offering good service:

[A manufacturer] may want its retailers to provide customers a pleasant showroom and a knowledgeable sales force. Yet, without resale price maintenance, some customers would take advantage of one store's service to learn about [a product's] features and then buy the item at a discount retailer that does not provide this service.
Do you think that resale price maintenance solves an important free-rider problem, as Mankiw suggests? Why or why not?

3. Resale price maintenance contracts are just one example of a kind of economic contract that is illegal. Philosophically, one might argue that it is illegal precisely because it limits the kind of contracts that one of the parties entering the contract can sign. For example, a resale price maintenance agreement that fixes the price of a leather jacket at $200 essentially stipulates that the retailer cannot enter into a contract with a buyer at which the jacket is sold for less than $200. Can you think of other contracts that people enter into that inhibit their ability to act freely in the future? Are they useful? Are they illegal? Should they be?

4. Some things are "per se" illegal under the Sherman Act, while for others, the "rule of reason" appliesthat is, courts judge how anticompetitive they are on a case-by-case basis. If the leather-goods manufacturer is successful in this petition, resale price maintenance contracts would shift from the former category to the latter. Is that appropriate? How would you apply the "rule of reason" to a resale price maintenance case?

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Friday, March 16, 2007

(How) Are Men and Women Different?

The subject of differences between men and women has always been a touchy one. Economist Lawrence Summers stepped down last year as president of Harvard, for example, after he touched off a firestorm by speculating that the differences between the achievements of men and women in academia might be due in part to differences in ability.

Suppose we posit that men and women are completely identical in their ability: or more specifically, that the distribution of ability is not dependent on gender. Even under such circumstances, there are two reasons that we might expect different outcomes among men and women: (1) institutional factors, such as discrimination, cause a woman to obtain a lesser outcome than a man of similar ability; or (2) women, for whatever reason, make systematically different choices than men, perhaps because their preferences are systematically different.

In a forthcoming paper in the Quarterly Journal of Economics, economists Muriel Niederle and Lise Vesterlund use an experiment to test the second hypothesis. Specifically, they split participants (usually college students) into groups of two women and two men. They then offered each of them a simple task: adding up series of five two-digit numbers. After a few rounds of practice, the participants were given a choice. If they selected the "piece rate" option, they would earn $0.50 for each correct calculation they made, no matter how the others in their group performed. If they selected the "tournament" option, they would earn $2.00 for each correct calculation—but only if they had the most correct calculations in the group.

What happened? About three-quarters of the men in the experiment chose the tournament option, compared to about one-quarter of the women. Indeed, most of the men who in fact had performed worst in the group chose the tournament option, and most of the women who in fact had performed best in the group chose the piece-rate option. In other words, mistakes were made by members of both genders: the men were too competitive, and the women chose the competitive option too seldom.

Niederle and Vesterlund conclude by saying:

It is generally agreed that ability alone cannot explain the absence of women in male dominated fields. In natural settings, issues such as discrimination, the amount of time devoted to the profession, and the desire for women to raise children may provide some explanation for the choices of women. However, in this paper we have examined an environment where women and men perform equally well, and where issues of discrimination, or time spent on the job do not have any explanatory power. Nonetheless we find large gender differences in the propensity to choose competitive environments… Much may be gained if we can create environments in which high-ability women are willing to compete.

Discussion Questions

1. If Niederle and Vesterlund's conclusion is correct, does this mean that "winner-take-all" competitions are inherently discriminatory against women? Why or why not? If they are, what, if anything, should be done to correct the situation?

2. Academia is one area in which there exists intense interpersonal competition for top jobs—for example, tenured positions at top universities. Steve Levitt of the University of Chicago recently called for the elimination of the tenure system. (Greg Mankiw responded that he's not surprised that Levitt, as a winner of the prestigious John Bates Clark Medal and co-author of the bestseller Freakonomics, places a relatively low monetary value on job security.) If we accept Niederle and Versterlund's conclusion, would eliminating the tenure system result in more women in academia, or fewer?

3. Many economists, when faced with a problem that some call a "market failure," like to recast the problem as one of "missing markets." For example, Ronald Coase famously showed that the problem of externalities could be resolved by allowing the affected parties to bargain with one another. Is there any way to recast the inefficiency shown in Niederle and Versterlund's experiment—i.e., the fact that women shy away from competition while men compete too much—as a problem of missing markets? If so, what market is missing?

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Friday, March 09, 2007

Leisure? What Leisure?

Between 1890 and today, inflation-adjusted average income in the United States has increased by a factor of 8, while the average hours of weekly work have declined by approximately 20. That's good news: we earn more (a lot more) than we used to, and we do it with a shorter work week. People also start work later in life (less child labor, more college educations) and retire earlier. So, what are we doing with all of that extra time away from paid work? In his latest New York Times column, Hal Varian considers recent research that attempts to answer the question.

According to economists Valerie Ramey and Neville Francis, the decline in hours of paid work has not corresponded to an increase in leisure time—primarily because leisure is not the same thing as time away from paid work. So, what exactly is leisure time? The American Heritage Dictionary defines leisure as freedom from time-consuming duties, responsibilities, or activities. But even this definition is vague: aren't all activities—including pleasurable ones like reading, sex, sailing, hiking, or watching TV—time-consuming?

The economists offer their own definition: leisure activities are those that provide direct enjoyment. Under this definition, undesirable and unpaid work we do on our free time (like taking out the trash) does not count as leisure. So what does? Read Varian's latest column to see how Ramey and Francis categorize leisure activities and why their research suggests that leisure time today is about as plentiful as it was in 1890.

Discussion Questions

1. In 1910, how many male children 10 to 15 years old were employed full-time? How many 14- to 17-year-olds were enrolled in high school? What's happened to teenage enrollment rates over time? What about the leisure time of children and teenagers?

2. How do Ramey and Francis determine what activities provide direct enjoyment? What about non-paid activities, like child care, that involve both pleasant and unpleasant aspects?

3. How have advances in technology affected the amount of non-paid housework we choose to do? There's a tradeoff between non-paid housework and leisure. What do the choices we've made about housework over the past century suggest about the value of additional leisure time compared to the value of additional nutrition, health, and cleanliness?

4. Have job characteristics changed over the past century? Have jobs become more pleasant (or less unpleasant)? What about non-paid housework? Ramey and Francis contend that the amount of time we devote to purely enjoyable activities hasn't changed much over the past century. In what ways has the time we spend on paid and non-paid work become more (or less) enjoyable?

5. Steven Landsburg discusses leisure in his latest Slate column.What's been happening to the distribution of leisure time since the 1960s?

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Thursday, March 01, 2007

Inflation Gone Wild

With an annual inflation rate of 1,600%, Zimbabwe currently holds the world title for fastest-increasing prices. As the late Milton Friedman put it, “Inflation is always and everywhere a monetary phenomenon. To control inflation, you need to control the money supply.” The inflation cure seems simple to understand from a textbook perspective: drastically cut back the money supply in order to lower the expected inflation rate.

Unfortunately, the cure might be worse than the disease. With the current unemployment rate at 80%, drastic cuts in the money supply could increase unemployment and cause a coup d'état before the expected inflation rate falls. The monetary contraction is inevitable if Zimbabwe wishes to tame the inflation monster, and the International Monetary Fund has urged the government to liberalize its exchange rate regime as a means to cushion the unemployment effects.

In order to understand the IMF’s position on Zimbabwe’s exchange rate, we must examine how maintaining an overvalued currency might contribute to soaring inflation, and how floating the currency might provide relief to both inflation and unemployment.

The graph on the left shows the market for Zimbabwean dollars. Assume that the government fixes the exchange rate at E1. A fixed exchange rate is the official value of the currency despite fluctuations in supply and demand. Initially, the official value equals the market value where D1 intersects S1 (point A). Then, due to unsustainable fiscal deficits and government land reforms that usurp private property, foreign investors flee Zimbabwe. Consequently, the demand for Zimbabwean dollars decreases from D1 to D2.

If Zimbabwe were under a floating exchange rate regime, the fall in demand for Zimbabwean dollars would result in the depreciation of the currency from E1 to E2 (point B). But because Zimbabwe’s government insists on a fixed exchange rate regime, the fall in demand for Zimbabwean dollars will cause a surplus of Zimbabwean dollars (Q1 - Q2). At point C, the currency is considered overvalued because the official value is greater than the market value. In order to eliminate downward pressures on the currency, Zimbabwe will instruct its central bank to buy the surplus of Zimbabwean dollars (and sell U.S. dollars), which will return the market to point A. Zimbabwe's central bank will eventually deplete its U.S. dollar reserves as the economy deteriorates from questionable domestic policies, and will borrow U.S. dollars in order to maintain the fixed exchange rate.

Since the loans are denominated in U.S. dollars, Zimbabwe must make periodic payments in U.S. dollars or face getting cut off from all sources of international capital. Due to disastrous domestic policies, the government has little tax revenue to make those periodic payments, and the only way to service their international debts is to print more money, just as Germany did after World War I. As the central bank expands the money supply to pay international debts, inflation increases, which places additional downward pressure on the Zimbabwean dollar: as foreigners demand less and less of the failing currency, Zimbabwe has to print more and more money, and sooner or later, everything will spin out of control.

One solution is to eliminate the fixed exchange rate regime altogether and allow the Zimbabwean dollar to float freely. If the currency were allowed to float today, its value would fall tremendously, which would stimulate exports and reduce imports. The graph on the right shows that as the exchange rate falls from E1 to E2, net exports increase from NX1 to NX2. A floating exchange rate would boost job creation as the central bank institutes the tough medicine of curing inflation by drastically reducing the money supply.

Discussion Questions

1. If the fixed exchange rate regime were eliminated, what would happen to the size of Zimbabwe's international debts in terms of Zimbabwean dollars? Would it increase or decrease?

2. The central bank has recently declared inflation illegal. How do price controls affect domestic markets like those for corn, wheat, electricity, and labor?

3. This analysis assumes that Zimbabwe's reduction in real GDP is due to domestic policies such as unsustainable fiscal deficits and poor private property rights. How might hyperinflation directly contribute to higher unemployment?

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