Bastiat’s Bastions

Recently in class, we discussed the irrelevance of sunk costs.  When expenditures have already been made and cannot be reversed, there is no longer an opportunity for choice.  Economists say that there is no opportunity cost in this case, that “what is done is done.”  This principle is illustrated in that same Sydney Morning Herald story about $50 beer that served as the basis for the previous post  “Killing John Barleycorn in Sydney.”

“Scores were seen leaving within the first two hours of the nine-hour festival, fed up with the lack of basic services, cutting their losses on a $99 ticket.”

So once the $99 ticket was purchased and used, so that the ticket could not be resold, the ticket cost represents a “sunk cost” and since they face the $99 expenditure whether they go home or not, that $99 does not alter which decision is better.

Contrast this with the story that Duke Political Science Department Head, Mike Munger, tells of opportunity costs with tickets for another greenie concert, tickets for the fictional band, Green Way, in his ”A Fable of the OC.”  

People make decisions based on opportunity costs, not dollar costs.  Once the decision cannot be undone, the costs become “sunk” and no longer have an effect on choices, as the same expenditures are faced no matter which way one faces.

–MC

Usually, in classes I tell the story of prices rising in the face of shortages being a result of sellers seeing and seizing the opportunity to raise them in shortages.  That is not always the case.  Prices can also rise during shortages when buyers want to guarranty availability for themselves or wish to reduce their time waiting in line, because of the high cost of waiting.  That is what happened this weekend in Sydney.

Live Earth came and went this weekend.  In Sydney, the organizers way underestimated the Aussies’ penchant for beer (underestimating Aussies’ love for the brew is always a losing proposition–remember, the Aussies are the folks whose beer comes in cans the size of our motor oil cans) and, according to this news item from the Sydney Morning Herald, had too few beer vendors on hand, creating very long lines. 

“It was ‘unAustralian,’ one spectator protested. ‘This is what happens when you let hippies organise a big event,’ another said. One woman, asked by Missy Higgins ‘how you all are back there,’ earned a wry round of applause from the stands when she shouted: ‘Sober.’”

Tiring of waiting in line, missing performances that they really wish to see, the Sydney concert goers began to offer those who had already gotten their beer as much as $50 a beer.  The increase in price due to a shortage can cause buyers to offer more, just as it can cause sellers to raise their asking price.

So, once again, the greenies try to kill off John Barleycorn, this time by restricting sales, and John Barleycorn exacts his revenge, again with high prices.

–MC

Here is my offering along the lines of my class’s recent essay assignment.  The main assignment was to write an essay, much like my blog posts here, commenting on some news item using analysis we have developed in class.   

As you know, Congress has offered subsidies for ethanol production, in an attempt to become less reliant on foreign sources of energy.  Those subsidies, along with high gasoline prices, have caused the price of corn (the main crop used for ethanol)  to shoot up.  This article from USA Today (that appeared in the Arizona Republic) conveys one of the most unfortunate, and I would add, disastrous, side effects of high corn prices.   

With higher corn prices, the opportunity costs of growing other grain crops have gone up.  One of the crops that farmers have found easy to switch away from in order to grow corn has been barley.  This may not sound too bad if you are only thinking about putting barley in a soup.  However, think about what the biggest use of barley happens to be—making barley malt, the main ingredient in beer.  As a result, beer prices are expected to rise about 9% or so. 

In early English (and Scottish) folksongs and the poetry of Robert Burns, John Barleycorn is the personification of this great grain, a grain, after malting, that is used to make both beer and Scotch.  In fact the rock band, Traffic, title one of their albums and songs, “John Barleycorn must die” (you can see and hear Traffic perform the song on Youtube). See this article about John Barleycorn in Wikipedia.

In the songs, various people, especially those with addictions to drink, do their best to kill John Barleycorn.  In many versions of the song, people do indeed kill John Barleycorn.  However, Barelycorn comes back from the grave to get his revenge for those who mistreated him.

And Ahmadinejad thinks he is having trouble with riots over gasoline rationing!

–MC

In my class, I tell students that there are two causes of shortages, price controls in a market and bureaucratic or state control of the marketing of a good, where those who control the price have no incentive to raise prices.  Since scarcity is a constant problem of humanity, there is less available of everything than we would like, scarce resources (things used to make goods and services that we want to use) and scarce goods and services must somehow be rationed.  

Prices do a better job of rationing scarce goods and resources than anything else, because not only do they provide a good incentive for people to use things for their more important uses and refrain from putting things toward lower valued uses, they also provide an incentive for people to cut back in face of increasing scarcity.  More importantly, prices also give suppliers an incentive to provide more of a good that people want more of.  It gives both buyers an incentive to look for alternatives, for substitutes, and sellers an incentive to produce substitutes.  It is important to see that prices ration scarce goods and services (remember, if it is not free, it is scarce). If prices are not allowed to adjust to what economists call “the equilibrium price,” where the amount people want to buy at that price comes into equality with the amount that the producers want to produce at that price, shortages ensue, and something other than price must ration the scarce good. 

Often, we use first-come-first-served, or waiting lines to ration things.  This is what I think of as a “default” rationing device.  If something is in short supply, and we do nothing else, usually sellers will sell to whoever gets there first.  Sometimes sellers might use some other rule, though, for deciding who gets things.  The main point here is that price controls are one reason for shortages and, if they do anything at all, will result in a shortage. 

In socialist regimes, such as Venezuela, Iran, and Zimbabwe, prices are not controlled by people who stand to profit from increasing prices in the face of shortages.  Instead, the price signaling device in the economy, the mechanism that gets consumers to cut back in the face of increasing scarcity, or sellers to produce more if buyers want more, is “disconnected.”  Prices are set to please the rulers.  If the rulers depend on some popularity to maintain power, as is the case with many dictators, prices are often set low.   If you take a look at this photo gallery, and read the captions, you will see just how cheap gasoline, or “petrol,” is in Iran these days.  As you can see, the price of gasoline is set well below what it is in the rest of the world.  If sellers in Iran were motivated by the profit from the sale of gasoline, they would either raise price in Iran or export it where they could get a better price.

Since Iran has little capacity to refine crude oil into gasoline, they import most of their gasoline.  With the threat of economic sanctions from the UN because of Iran’s defiance of the international body’s orders to stop their nuclear program, Iran expects their may soon be a sharp reduction in gasoline for Iran to buy, so they are trying to stockpile gasoline to reduce the punch from any sanctions in the form of a gasoline embargo. Now, Iran’s President Ahmadinejad is facing some problems, because he has over-extended his promises to the people of Iran with his demagoguery (you should note H.L. Menkin’s famous definition of a demagogue: “one who preaches doctrines he knows to be untrue to men he knows to be idiots.”).  Ahmadinejad, unlike Zimbabwe’s Mugabe and Venezuela’s Chavez, has no one in his country to lay blame on, but can still blame the Americans.  

In a market economy, prices rise in the face of a shortage.  In a socialist regime such as Iran, where individual owners control the prices of their goods, prices are set by the government.  If the rulers see low prices as a way of placating citizens and staying in power, prices will be set to satisfy political goals instead of profit goals.  However, if rationing is suddenly instituted, people become upset over the rationing, the way they would over a sudden rise in prices. As a result, citizens in Teheran rioted a few weeks ago, setting fires to gas stations.  See the story, “Iran curses Ahmadinejad over petrol rationing,” by Colin Freeman in  ndon’s Telegraph and the story by Nazila Fathi and Jad Mouawad  in the International Herald Tribune.So, as I noted earlier, there are two basic ways to create a sustainedor persistent shortage, institute a price control or do the same thing with socialism, or bureaucratically administerd prices. 

–MC

Perhaps, by now, you should have heard of the proposal by economist Roland Fryer that poor children  in New York City and their parents be given financial rewards, money, for good grades in school, for good attendance, making it to parent/teacher conferences and so forth.  I am worried that payment for certain behaviors will create expectations for payment for others.  Behavior not rewarded may be the same as behavior that is punished, and less of these other behaviors would be expected to occur.  While I am not a fan of Fryer’s proposal, middle-class families, parents, or more usually grandparents, often give kids a few bucks for good grades.  Parents and grandparents giving money to kids for good grades certainly seems to encourage school performance, not diminish it. Poor children, however, seldom have such generous grandparents, so Fryer’s proposal, if enacted, does seem as if it would encourage good school performance. Barry Schwartz, a Swarthmore psychologist, penned this editorial for the New York Times, suggesting that Fryer’s proposal will backfire.  Schwartz’s argument is “filled with holes.” (That is a great phrase, isn’t it? Filling something up with holes–the Louisiana Department of Transportation’s method of road repair.)   For instance, his Swiss Canton example is about hypothetical choices.  What peoples say they will do or accept, and how they act are often at odds. 

A similar argument was made in 1970 by a British social scientist, Richard Titmuss, wrote a book, The Gift Relationship: From Human Blood to Social Policy (see this book review of a 1999 reprint of Titmuss’ book).   In his book, he argued that the British system, where blood given out of altruistic motivation (love) was superior to the

U.S. blood supply system, where we paid for whole blood in many areas.  Red Cross, of course, loved Titmuss.  Economists, such as Kenneth Arrow, took issue. 

There are, admittedly, safety reasons to be concerned with paid blood.  Many blood banks located near skid row and paid homeless men (we called them bums back then) for their blood, who sometimes gave blood tainted with hepatitis.  The problem, though, with the safety of the U.S. blood system, however, was that the medical associations in every state of the union had lobbied their state legislatures to make blood supply a “service instead of a good.”  This enabled them to skate product liability laws that would have made the doctors liable for giving tainted blood.  Doctors, however, are the ones administering the blood and are in the best position to pick blood banks.  If doctors had be liable, they would not have used blood banks that used the homeless.  In fact, in those days, the safest blood in the country was “paid’ blood in Minnesota used by the Mayo Clinic.

Titmuss was exactly wrong about blood and so is Schwartz about the rewards of learning.    Different people see different things as rewarding.  Some see learning as its own reward, but many of the students that Fryer is dealing with, from poor, disadvantaged families in New York City, do not.  The thing about money is that it is a generalizable reward, and can increase selected behaviors with just about anyone–if the monetary reward is salient.  The larger the monetary reward, the more people who will engage in the monetarily rewarded behavior. So, while one person out of a thousand may have their warm fuzzy rewards of learning “crowded out” by financial rewards, so many more will perform according to Fryer’s expectation. 

The idea that one reward crowds out others, seems mostly mistaken.  Suppose in my earlier years, I had been a roady for my favorite rock band.  I might have done it for free, to get to go to all their concerts, hang out with them.  Oh, but they want to pay me, too?  Can life get any sweeter?

Not everyone gets warm fuzzies from giving blood.  Not everyone gets warm fuzzies from learning Shakespeare, or high school chemistry.  The ones that do say “wow, I get to do what I like and someone pays me for it, too.” 

Do scholarships reduce the learning by students?  If we gave everyone A’s (or C’s) would they start learning more because now there is no kick to learning?  Does the performance of TOPS scholars fall because of the financial aid?  I doubt it.

While there may be one or two twisted souls who respond as Schwartz suggests, far more people respond to monetary incentives, especially people who are on the financial edge.  Monetary rewards are likely to be more important for the very poor than for the well-to-do for the same behavior.

There are very few things that people do that they take offense to getting paid for.  There are, admittedly a few.  Dating and sex seem to lose a bit of excitement when they involve financial exchanges.  On the other hand, very few people who love to play sports would say “gee, now that someone wants to pay me for doing something I love, it loses all its spark–find someone else to return kickoffs–I’m outta here.”

While there may be cases where students who see learning as its own reward, with the financial worries of poor families, and the extent that educational success is often looked down upon by peers in poor communities, it is doubtful that the net result of Fryer’s suggestion of paying for grades will be reduced performance.  The Church relies on higher callings to fill the ranks of the Priesthood, and few, at least few Americans, get called.  We rely on Titmuss and Schwartz reasoning and forbid payment for blood and for organs–and we see bad shortages of each with thousands dying each year waiting for organs to be donated, while viable organs get buried.  What if we relied on altruism to fill the ranks of the military, the police force and the medical profession.  We would be very sick victims of crime, living in a country over-run by some foreign demagogue, such as Venezuela’s Chavez.

–MC