A sample plain package

The Plain Tobacco Packaging (Removing Branding from Cigarette Packs) Bill 2009 has been supported by the Labor government, and now has the support of the Liberal-National Opposition. It will become law on 1 January 2012. The economic reasons to reduce smoking are summarised in the Australia’s Future Tax System review, conducted in 2009 (popularly known as the Henry Review).

Public income from smoking

Tobacco levies on Australian society both tangible and intangible costs that far outweigh income brought in by smokers. Government income in 2009-2010 from tobacco excise was $5.65b according to the budget outcome for that year. Excise does not include the GST take, so if sales in 2009 were about $10b, there is also another $0.9b in GST, giving total taxation income for Australians from tobacco of $6.6b (being generous, and round up).

Costs of smoking

The most recent readily-available data I could find was from 2004-2005. This suggested costs in that year of $31b (Victorian Cancer Council, National Drug Strategy).

Tangible costs – those that can be measured – were $12b. This includes expenditure on health care and drug subsidies, and also staffing costs to replace workers sick from smoking-related illness and the costs for those who leave the workforce as they can no longer work. Note that these are the net costs (less any savings made by, for example, smokers who die earlier than they otherwise would and so don’t require increased health expenditure). The important consideration with intangible costs is that when they’re reduced, the saving is freed up for other uses.

Intangible costs are harder to measure, but in many ways are the more important ones. Intangible costs include the loss of enjoyment of life, loss of life itself, and the pain and suffering of both smokers and their families. They were $19b in 2004-2005. Saved intangible costs can’t be reused. This $19b estimate is very low, as it only includes two components:

1. The value of a year of life lost to each person not alive in 2004–05 due to past drug abuse;
2. Estimates of pain and suffering due to accidents.

It does not include:

1. Purchase of over-the-counter and off-the-shelf medicines
2. Domiciliary care and allied health professional services
3. Reduced on-the-job productivity
4. Litter
5. Pain and suffering experienced by smokers and others.

Adjusting the costs

Change in price - tobacco, health and labour, 2005-2010

Remember, this cost is in 2004-2005, but the revenue is from 2009-2010. A more realistic comparison would be to do a simple cost adjustment for CPI from the 2004-2005 costs for inflation. Where possible, I’ve used the rise in costs associated with the specific cost (so, wages increases for labour costs, and health costs increases rather than CPI). A comparison shows that generally the cost of tobacco, health and labour are similar except for the spike in tobacco costs in 2009 (likely due to an excise increase). CPI lags these other indexes, and so adjusting for cost increases using CPI is generous.

Using the data provided by the National Drug Strategy’s report on the costs of tobacco¹ and adjusting for these changes in prices, we see that the total cost rose from $31,485.80M in 2004-2005 to $35,814.14M in 2009-2010.

I’ve included the growth in costs from June 2005 to June 2009, and so have probably underestimated the growth in cost. Data comes from the ABS (Consumer Price Index, Labour Price Index). Where there was no specific price index, I used the general index. I could have been more detailed, and adjusted health costs by the increase in the individual components, but that seemed unnecessary – the point I’m making is that the evidence clearly shows tobacco use costs far more than its taxation revenue².

On market failures

It would appear that tobacco use is a good example of market failure.The smoker has imperfect information, as smokers can’t assess the effects of smoking on them as individuals. In addition, externalities exist as smokers affect others.

Firstly, tobacco is addictive. It’s not like any ordinary product where consumption is nothing more than a simple choice made by a rational actor. The consumer has imperfect information about the costs he or she incurs. Most obviously, no-one knows how much their life will be cut short by smoking, or how much income they will lose due to ill-health, or almost any other effect of smoking.

Secondly, costs are incurred by households and business and these costs are not compensated for by excise revenue (presumably compensation could occur if excise income was being spent on things that alleviate these externalities) ³. These negative externalities⁴ need to be taken into account when considering the effect of tobacco consumption.

Reducing the cost to society

Taxes paid by tobacco producers and/or smokers do not meet the costs to society caused by smoking. Even if only the tangible costs are considered, tobacco excise would need to be doubled to begin to approximate the measured costs. As tobacco demand is relatively inelastic (see here and here), smokers aren’t all that sensitive to price (as price rises, demand falls but not a great deal). Price alone can’t be used to reduce smoking⁵. Other mechanisms must be used. While detractors, including tobacco lobby groups such as the Institute for Public Affairs, either run ridiculous arguments about trademark appropriation or claim (without evidence) that it won’t work, given the massive drain on public finances and the social and individual costs concerned, plain packaging is a sensible approach.

The most obvious alternative to plain packaging for tobacco would be to impose significant cost increases; tripling the excise might be a start. If the tobacco industry finds plain packaging sufficiently onerous so as to take action in a futile attempt to protect branding cigarettes, perhaps the most suitable alternative would be an excise increase to ensure that the costs smokers levy on the rest of us are properly met by tobacco consumers.

Why plain packaging?

A common assessment of targeted solutions is that they fall into the trap of:

1. Something needs to be done.
2. This is something we can do.
3. So let’s do it then.

Plain packaging does not fall into this category. It’s likely to lead to fewer people taking up smoking ((From the link, “Plain packaging, along with astronomical price increases for packets of cigarettes, is likely to have a strong deterring influence for those who are new to smoking or considering taking up the habit.”)). Laughably, a report prepared by Phillip Morris claims that “plain packaging is expected to reduce prices and increase sales.” One would be left to wonder why they’re not introducing plain packaging themselves. When the assessment of why plain packaging won’t work is as trite as this, I think I’ll go with the Cancer Council’s assessment: “Plain packaging for tobacco products has the potential to be one of the most important policy measures in Australian history for reducing cancer deaths from smoking.” As its introduction is effectively free, there appears to be no valid reason to delay its introduction. I’ll leave the final word to the University of Sydney’s Simon Chapman and Becky Freeman with ANU’s Matthew Rimmer, referring to Morgan Stanley Research. “Plain and generic packaging of tobacco products (all other things being equal), through its impact on image formation and retention, recall and recognition, knowledge, and consumer attitudes and perceived utilities, would likely depress the incidence of smoking uptake by non-smoking teens, and increase the incidence of smoking cessation by teens and adult smokers [37].”

1. Collins, D.J. and Lapsley, H.M. (2007), The costs of tobacco, alcohol and illicit drug abuse to Australian society in 2004/05, National Drug Strategy Monograph Series No. 64.
2. Actually, even just the tangible costs of tobacco use outweigh the entire value of the tobacco market, which in 2009 was $9.98B
3. See table 37 for an assessment of who bears which costs.
4. From Chapter 2.6, “negative externalities occur when individuals or firms undertake actions which impose costs upon other individuals or firms, while providing no, or insufficient, compensation to those who bear these extra costs.”
5. More accurately, it can be, but would require a very large price increase to be effective.

Adam Schwab is probably wrong when he suggests that removing payroll tax would create jobs.  It’s not all that likely to be able to be linked to a singe job.

In Victoria, payroll tax is 4.9%, levied on companies with a payroll of over $550,000 each year.  This means a company with a payroll at the threshold pays $26,950.  The minimum wage is currently $569.90/week, or $29,634.80 per year.  On-costs (superannuation, WorkCover and other costs) add about 20% to this total (say $35,000).  The complete elimination of payroll tax could not create a single full-time job until it was removed on a company with a payroll of over $700,000.  But that’s only a possible job.  Once you consider the impact on a unit cost of goods produced (or services rendered), it gets to the point that payroll tax is a tiny component of the total cost of a good or service anyway.  Using an example, if Ford have 1,560 people employed in production of cars in Australia on an average $100,000 salary, and produce 80,000 cars, the payroll tax cost per car is less than $100 on a purchase price of $15,000 and up.  Ford buyers’ individual savings of $100/car are unlikely to do much to create a job.  Adam Schwab might counter by saying that the money saved will go somewhere – even if Ford pocket the entire corporate tax cut, sooner or later some of it will reach people and start creating jobs.  But currently the majority of payroll tax creates jobs too – teachers, nurses, police, and other public servant positions.  It creates infrastructure too, which creates private sector jobs.  Pretty much all of them are necessary for the state to function.  The hit to Victorian revenue of $4.7 billion (10% of the state’s income) would need to be made up from somewhere, as reduction in government funds leads to a reduction in the workforce.

Adam Schwab does himself no favours by making silly arguments.  The notion of employing people to break windows so that others can be employed to fix them is obviously daft.  Schwab writes off the value of the BER projects, but I don’t think everyone else would be so quick to do so.  The projects have lasting value, and the available information suggests Bernard Keane’s point is well made – the projects were needed, delivered efficiently, in a timely manner, and supported the sectors that needed support (and where the multiplier effect is highest – although I suspect Schwab believes the multiplier is 1, if not less than 1).  And the jobs maintained were sustainable both in the medium and long term.

Finally, the notion that the costs of the various economic stimulus programmes are borne by those yet to be born is only true if you are also prepared to accept that the costs of doing nothing are also borne by those future taxpayers.  A proportion of those who would be unemployed after a severe downturn will never find a comparable job again, and some will never find a job again and join the ranks of the long-term unemployed.  And for those who do not find work, unemployment rates decline slowly.  The economic costs both in outlays by governments and in permanently lost national income should also be considered.

Recently, Andrew Leigh (ALP Member for Fraser) wrote a book called Disconnected, arguing among other things that the social fabric of society is fraying.  Christopher Joye critiqued the concern for income inequality:

The first observation is that a lot of people get awfully worked up about ‘income inequality’. I am not entirely sure what they are on about. That is, I don’t think there is anything wrong at all with a rise in income inequality if one assumes that: (a) we have equality of opportunity; (b) we are committed to combating extreme poverty; and (c) we are vigilant in protecting those members of the community who are fundamentally and irreversibly disadvantaged through, say, mental or physical disabilities. In fact, I think we should be focussed on dealing with (a), (b) and (c) rather than drumming up hysterics about inequality.

Matt Cowgill replied:

I view (equality of outcomes vs equality of opportunity) as a false dichotomy. I will assume for the purposes of this post that Christopher understands equality of opportunity to mean equal treatment before the law and by public institutions, in other words ‘procedural fairness’, plus perhaps support for public school education. If society ensures equality of opportunity, defined in those terms, should we be comfortable with the dimensions of the inevitable inequality of outcomes that results? I suggest not.

It wasn’t over yet, with Christopher Joye responding again:

Put plainly, Matt has misrepresented what I communicated in my essay, and twisted my remarks in order to construct a faux target with which to assault.

Debate on Twitter followed, insofar as bursts of 140 characters allows for debate.

christopher joye:

@MattCowgill has launched a left-right war on me. i will take no prisoners. in a world of lonely wolves, tis safer to be feared than loved

I think Matt’s response missed the key issue, and I think Christopher’s argument fails before it begins.  In the spirit of (what I take to be) the jestful jousting between the two above Tweeters, I offer this as the tl;dr version of my argument:

Hint: In this comic, I'm Dilbert.

In the absence of Dilbert comics settling debate, I’m going to address Christopher’s initial assumptions, and point out that a logical argument built on unsound assumptions is an unsound argument[1].  In this, I’m taking my lead from Paul Krugman, specifically, a pair of posts he’s written recently (Economics and Morality, and More Thoughts on Equality of Opportunity).  Do yourself a favour and subscribe to Professor Krugman’s blog.

Now, remember Christopher’s initial assumptions:

(a) we have equality of opportunity;
(b) we are committed to combating extreme poverty; and
(c) we are vigilant in protecting those members of the community who are fundamentally and irreversibly disadvantaged through, say, mental or physical disabilities

None of these are true.  Over the next few days, I shall aim to make the case that these assumptions – particularly the first – do not hold.  If they don’t, the argument that rising income inequality is not a problem seems to be damaged.

Equality of opportunity

I’m taking equality of opportunity literally here.  Christopher claims that Matt set up a straw man.  It’s not my intention to do that, so I’m going to take equality of opportunity to mean that everyone gets the same chances, irrespective of characteristics outside of their control.  “Outside of their control”, in this context, includes family income, parents’ education and job status, gender, sexual orientation, physical ability, and so on.

Digging out data on this shouldn’t be too hard.  I’m going to cover the admissions to University by socio-economic status (SES).  I am confident enough to say at this point that while students with equivalent ENTER scores enter universities at more or less the same rate irrespective of SES, ENTER scores correlate to SES.  In short, equality of opportunity may exist once you’re able to get in to a university, but the pathway to get an offer depends on how wealthy your family is.  I suspect – and have found evidence in favour – that high SES students perform better than low SES students, although we’ll see what more digging turns up.

I’m also going to cover the three-generations-unemployed.  It does strike me as a little odd that you could consider that equality of opportunity exists here.

Combating extreme poverty

I’m taking “extreme poverty” as the inability to meaningfully participate in society in Australia.  I’m going to cover Aboriginal and Torres Strait Islander poverty, and I’m going to argue that there’s no real commitment to combating this.  I’m also going to consider Australia’s homeless population, and the unemployed.  These three groups contain people who are living in extreme poverty, and I’m going to argue that we’re not really committed to fixing this.

Protecting the disadvantaged

I’m going to consider the groups of people Christopher includes as disadvantaged, and I’m going to talk about outcomes for those who face mental health problems, and those who are injured.  I feel reasonably confident that I’ll be able to show that selected key disadvantaged groups are more likely to be living in relative poverty than Australians outside of these groups.

What this means

If none of the above holds, then – according to Christopher Joye’s argument – income inequality matters.  I’d submit it matters anyway[2],but leaving this argument aside, income equality has to be strengthened in the absence of equality of opportunity.  And income equality is a part of both combating extreme poverty and protecting the disadvantaged.

FOOTNOTES
1. I’m happy to be shown that I’m wrong.  One of my favourite JM Keynes quotes is, “When the facts change, I change my mind. What do you do, sir?”  There are worse ways to live.↑
2. I am aware that critiques have been made.  The authors have responded to them, but the analysis I found the most compelling was that done within states of the US – a point the authors make as well.↑

The real reason

Briefly, retailers like Harvey Norman are slowly dying.  They’re mediators – they exist in between producers of goods and the consumers that want them.  In many cases, they add no value for the consumer except the dubious advantage of physically seeing the good(s) to be purchased.  To do this, one must travel to a retail outlet, suffer through trying to locate a sales assistant, and then – if the good is purchased – either pay more for delivery, or arrange it.  For some goods, there is value in this.  For a washing machine or a refrigerator, there probably isn’t (or, of there is, it’s not worth the few hundred dollars of markup a retailer charges).

The business model of getting people to come to you to give you extra money for no actual reason is coming to a close.  This should be something to be happy about.  No amount of interest-free scams periods is going to help keep it afloat.  Retailers will actually have to do something to justify their markup, and if they can’t, they’re going to fail.  Special protection for retailers who can’t adjust to the coming reality is unjustifiable.

An analogy

Analogies are always shaky, but there is one that serves.  When I first travelled overseas, a travel agent was almost a necessity.  They arranged your travel, confirmed visa conditions, booked your ticket, and (one hopes) got you the cheapest flight.  At some stage earlier than this, they were even used for interstate travel  They acted as a mediator between you and the airline.  This is no longer required – travellers can check visa requirements themselves, and find the cheapest flight through a range of online services.  The idea that you’d need a travel agent to find a cheap fare to London seems quaint now.  Travel agents have had to adjust to this new reality[1].  Travel agents used to make money from selling traveller’s cheques (remember those?).  These days, a small amount of currency from the local bank and a debit card gets you access to local currency.

Why it’s not the GST

The GST effect is unlikely to be a significant assistance to small (sub $1,000) purchases of goods for import.  This is because the price difference for comparable goods is often much larger than 10%.  As an example, I purchased a USB Blu-Ray DVD drive last year.  I checked three local computer parts suppliers (I also tried Harvey Norman, but that was a waste of everyone’s time).  One had no idea such a thing existed, and two could order one in for about $250-$300.  Or, I could buy a superior product from from a supplier in Hong Kong, shipped to my door for under $100.  I could pay $10 GST and still be significantly ahead.  What we’re seeing here is inept retailers, who have not needed to manage a supply chain for efficiency.  They’re adding no value (by which I mean, they’re not saving me money).  I’m under no obligation to subsidise Gerry Harvey’s inefficient supply chain management.

Why it’s not parity

The argument that parity of the Australian dollar with the US dollar is making online shopping cheaper for consumers seems, on the face of it, to be remarkably odd.  There are two main reasons for this – checking through the goods in a Harvey Norman, few of them would be made in the US.  And if we’re getting good exchange rates, why can’t they?

Which currencies are being converted?

I’m not a retailer.  There might be some eminently sensible reason why retailers are converting Australian dollars into US dollars and then into renminbi to buy Chinese goods.  It would seem more likely to me that there could be a direct AUD-CNY conversion, especially as China needs to buy our exports, and we only take AUD for them.  So I don’t see any particular reason why parity with the USD should have an effect here.  A comparison of the last twelve months of monthly average exchange rates for the CNY and the USD shows that they’ve varied against the AUD by reasonably similar amounts – at the December peak, the AUD bought 13.57% more CNY than at the June trough, and 16.51% more USD over the same period.  This is worth noting, and contributes, but not to the factors that consumers are experiencing.  So the AUD is a little stronger against the more relevant currency, but the improvements over the last 12 months have varied (comparing January to December, the difference is 6% more CNY per AUD and 9% more USD per AUD).

We’re getting good exchange rates – why aren’t the retailers?

Retailers should be able to make more efficient currency transactions than Visa or Mastercard (or Paypal) will charge individual consumers. Retailers will hedge their exchange rates so as to allow for some certainty, but it would be an odd thing to do to be paying much for a currency hedge for the next 12 months or so – there is a recovery of sorts happening in the US, but it’s very sluggish[2].  Individual consumers aren’t somehow getting a special deal from currency changes that’s unavailable to the retailers.  If anything, scale should tip the playing field in their favour.

Why none of this is (yet) a problem (unless you’re a retailer)

Unsurprisingly, the backlash has begun[3]. Today, the only meaningful downside is faced by those inept retailers who’ve been able to apply ridiculously inflated markups to generic goods.  They’re shortly going to die, and unless they innovate, they probably should.  Few mourn the loss of travel agents getting in the way of the cheapest air fare, and taking their cut of foreign exchange conversions by selling traveller’s cheques.  Some adapted, and some didn’t. But it’s probably not worth being too concerned just yet about a 10% GST on at most 1.5% of retail sales when much of the price difference can’t be explained by the tax-free status of low-cost imports.  Retailers deserve the shake-up.  If retailers could present data supporting their arguments, I’d be more sympathetic

What about the workers?

Firstly, any time you here a billionaire claiming something’s in the interest of his or her workers, it’s a safe assumption that that person is lying.  It’s not worth assuming that any owner or manager of a large retail chain has a genuine concern for their workers – reducing the CEO’s inflated pay packet and giving their workers a pay rise would be a signifier of real concern.

Retail is a very important employer of Australians – it gave many workers their first job, and any sector that’s that large is worth paying attention to.  But no favours are done by – for example – a tariff on imports.  You keep a few more people in jobs (possibly), but all consumers necessarily spend more on goods than they’d need to, which costs other jobs.

But there are two ways forward for workers in retail.  Retailers are going to need to justify their value, rather than act as oligopolists.  They can do this in two ways, and both require additional skills.  Firstly, improve service.  If retail staff are knowledgeable about their area, consumers are more likely to reward that.  After-sales service can assist here.  Services can’t easily be imported – Apple’s workshops in their stores are a great example of how to generate customer loyalty.  Secondly, price properly. Retailers are going to have to justify their existence to their customers, and the sooner they start the more likely they’ll survive.

Australian retailers are going to need to have to engage with online retailing.  People are going to need a reason to come and give you their money, and Harvey Norman certainly doesn’t give you one now.  If I know what I want to buy, why should I not be able to discuss my purchase with an informed staff member, and complete the transaction online?  Gerry Harvey has, it seems, forgotten a key lesson of sales – don’t make it difficult for people to give you their money.

But it will be a problem soon

Someday.  And there are some reasonably straightforward ways to address this without dropping the GST exemption to $100.  If I were Bill Shorten, immediately after washing my brain in bleach I’d be asking Treasury to start planning.  The points of entry into the country are clear.  What’s harder is how to implement an import taxation regime without affecting gifts, for example.

Tariffs and taxes on the importer are out.  There’s often no importing corporation to apply the tariff to – China Post sends something to Australia Post, who send it on. Applying the GST is possible, but the primary reason not to do this today is that the cost of applying a GST would be likely to be greater than the amount of money it would raise.

This is a matter that will have to be addressed.  But it should be addressed as part of a considered response, rather than because a selection of inept retailers can’t work out how to compete in a market economy.

FOOTNOTES
1. The ABS has an outline of travel agents and their income sources from 2003-2004.  22,609 people were employed in the sector in June 2004.↑
2. There’s something to be said for hedging against the renminbi.  There are solid arguments that China is keeping the value of the CNY artificially low.  The Chinese government has given every indication that it will continue to fix its exchange rate according to targets that support its export industries, but if this were to suddenly change, one could expect the CNY to rise quote quickly.  This is extremely unlikely to occur.↑
3. In spite of the stupidity of the article claiming that retail employs 15% of the population – try 15% of the workforce.↑

While I hesitate to enter into a debate with people like Richard Denniss and Tim Jackson – who know much more about this than I do – I feel there are basic things that are missing from critiques of economic growth.  In itself, I don’t see economic growth as a problem, and so I thought I’d note why.  This is going to be complicated, so I’ll do it in parts.

The first thing to do is define your terms, and then to defend the definitions.  I’ll go with a conventional definition of economic growth, which is growth in Gross Domestic Product (GDP) over time.

In defence of Gross Domestic Product

This leads to an obvious problem.  GDP is often criticised as a bad measure.  I’m going to argue not that it’s perfect, but that it’ll do.  Near enough can occasionally be good enough.

First, an overview.  GDP (Y) is simply consumption (C) plus investment (I) plus net government expenditure (spending minus taxes – G) plus exports (X) minus imports (M).  So, Y = C + I + G + X – M.  GDP approximates total economic activity.  It’s a measure of income as well (because income can only be consumed or saved, and C + I captures spending and saving).  The conventional critiques are not without merit, but are misguided when considering economic growth.  Here’s why:

So, for arguments about growth, GDP serves well enough as a measure.  Generally, given the correlation of GDP with many measures of interest, it’s a handy proxy measure for comparisons between countries.  It fails as a measure within countries, but then again, that’s not what it was designed for.

Next up, I’ll talk about the nature of economic growth – what causes it, the reason why zero growth is improbable, and the reason why it’s undesirable.

Garrett revisited

CATH Bowtell – Labor’s new candidate for the federal seat of Melbourne – may well believe in same-sex marriage, workers’ rights, a fair go for refugees and everything else (The Age, 6/7). But her party does not. Any organisation that can turn Peter Garrett from staunch advocate for the environment and social justice into a faint echo of his former life should have no problems eliminating Ms Bowtell’s beliefs in less than a single term. Progressive Melbourne voters know that our Labor MPs do not stand up for us. This will not change with a new face.

Apple iPad

A typical example of price discrimination is student pricing to see a movie.  Cinemas aren’t giving a discount to students because of any sense of charity – they do so because it’s a crude way to identify people with lower incomes and sell them tickets they otherwise wouldn’t buy.

The iPad makes a great example for price discrimination because the models are so similar.  The hardware is identical, except for two options – storage capacity, and 3G data network capacity.  The pricing – in Australian dollars at the time of writing – is below.

This price model can be expressed another way – as the base price plus the price of the only two things that can change:

The price jumps are pretty much consistent.  You pay $130 to move from 16 GB to 32GB, and another $120 to move to 64GB.  And you always pay an extra $170 for 3G data network capability.  But these components cost nothing at all like these amounts for Apple (even once currency conversions are taken into account).  The 3G capacity costs Apple about US$25, and the three storage options cost about US$30, US$60 and US$118 respectively.   Price discrimination is a key reason why Apple’s pricing is so out of line with its costs[1]}.If a potential buyer doesn’t have a high disposable income, but wants[2] an iPad, she can settle for the cheapest model, and manage storage needs by swapping in and out the data she needs.  Books take up little space, after all, so with a little planning, 16GB is adequate for most uses to which an iPad would be put.  If this user wants to be able to access a 3G network, she’s going to have to pay for the privilege.  It’s assumed that she’s a little better off, as she will have data network charges to pay.  The reasoning would be that if she can pay for the network traffic, well, she can also afford to pay a little more for the iPad as well.  A similar argument holds for storage.  If you are the sort of person who wants 64 GB of storage on a portable device, you’re probably using it to store films which (in theory, at least) you paid for.  Given that a digital copy of a feature film weighs in at 1.5 to 2 GB, that’s a fair few films.  If you can pay for the films, then you can pay for the 64 GB iPad.

So the variable pricing is a neat way for Apple to identify its customers who are willing to give it more money, which is one of the key conditions that allows a firm to price discriminate[3].  It really serves little other purpose.  Apple could easily have released all iPads with 64 GB, and only varied between 3G and no 3G (or, given that the 3G capacity costs it US$25, just released all of them with 3G).  If they had, even at the price of the Wi-Fi + 3G 32 GB model ($928), they’d be losing sales from people who might have had $630, but not $930 (so generating zero revenue) and also not generating the extra revenue from people who were willing to pay at least $1,049.

A final note.  Apple probably could have charged more for the 3G versions, at least on release.  They’ve sold out very quickly, at least in Melbourne.  There’s significant unmet demand and a shortfall in supply, which is a pretty good indicator that the in short term at least, the equilibrium price is higher than Apple has charged.

.

FOOTNOTES
1. Another key reason is to allow for rationing of components, which may be the subject of a later post one day.↑
2. No-one, anywhere, needs an iPad.↑
3. The others are that the firm needs some form of market power, which Apple has (if you want an iPad, you buy it from Apple), and either the capacity to vary the goods (like the different capabilities on the iPads) or the ability to prevent resales (like selling your student movie ticket to a person who would otherwise have to pay full price).↑

Alister Air writes: Re. “Tobacco debate: plain packaging anything but plain sailing” (yesterday, item 12). It’s delightful to see serial lightweight Tim Wilson gracing the inboxes of Crikey subscribers again.

In between juvenile name-calling and the non-disclosure of the IPA’s relationship with tobacco companies, Wilson tries to make an actual point; that article 20 of the Agreement on Trade-Related Aspects of Intellectual Property Rights may be breached. Wilson’s interpretation of the relevant section seems unnecessarily heroic, as he cherry-picks the elements he believes supports his argument, and disregards the rest.

The biggest problem, however, is that Wilson presents no reason why we should believe what he writes. Mark Davison does IP law for a living, and has published and teaches in the field. Tim Wilson works for a lobby group. If I were Simon Chapman, I know who’s advice I’d be taking.

It’s possible I was a little harsh.

Fixed price purchasing

Firstly, consider a Metcard.  Let’s think about a zone 1, ten trip, two hour ticket.  In 2008, such a Metcard would cost $28.00.  In 2009, the price increased to $29.40.  This represented a 1.05% price increase – lower than CPI.  But Metcard tickets, once bought, entitle the buyer to their trip – in this case, ten zone 1 trips.  The value of your purchase is not diminished over time.  A Metcard does not store value – it stores journeys paid for in advance, with a set charge at the time of payment.

Diminishing value to the traveller

A Metcard holds its value fixed.  Myki does not.  Going by current prices, let’s consider a balance of $100 on a Myki in December 2008, as opposed to $100 worth of ten trip Metcards.  Myki is bright enough to give the same discount for buying ten trips at a time.  This gets you 35.7 trips on a Metcard or on a Myki.  In January 2009, the price increases.  Your Metcard still gets you or 35.7 trips.  Your Myki now only gives you 34 trips.  This represents a 1.05% decline in value for the traveller in the space of a month.  This will be endemic, even if smaller price increases are introduced more frequently, the number of trips a given value of money allows diminishes over time with Myki in a way that it does not with a Metcard.

Buy in bulk and save

What’s been done correctly is that the price for a two hour zone 1 trip with a Myki is $2.94 – the same cost as a ten trip Metcard.  On the assumption that prices standardise on the bulk purchase rate, this leaves a consumer who buys in bulk no worse off with Metcard or Myki.  While Myki has a fixed cost of $10 to buy, this cost can be split over the cost of every trip made throughout the life of that card.  If you lose cards frequently, you’ll pay for it, but if you don’t, the cost per trip of the purchase of your card rapidly approaches zero.  And travellers who frequently buy their tickets on the tram or bus, or who don’t usually buy in bulk will benefit from Myki’s charging regime[1].

An interest free loan

Using Myki, you don’t buy trips, but rather you store value.  You could think of it like a savings account that pays no interest, and the money in it can only be used for one thing.  It’s a store credit, if you will.  The key difference here is that when public transport costs increase, the value in your Myki in no way will reflect this, whereas the value of a Metcard does.  A 3% rise in fares coupled with a 3% increase in the cost of living is cancelled out with a Metcard (roughly – see the forthcoming page on indifference curves and CPI).  A 3% rise in fares with Myki represents decrease in the value of stored money (as seen above).  But that stored money also represents an opportunity cost for the Myki account holder and a bonus for the State Government[2].  Let’s consider 500,000 Myki holders (roughly an eighth of Melbourne’s population in 2010), each with a balance of $20.  This gives $1,000,0000 in credit.  Invested at 5%/annum, this returns $50,000 in profit.  So at the same time as the value stored in your Myki (as measured in trips) is declining, your money able to be used to get investment returns for someone else.  You’re caught coming and going[3].

Returning the value

The two flaws above are by design.  They’re part of the point of the system.  They tilt the field slightly against public transport travellers and in favour of the State Government.  Over the lifetime of Myki, this tilt may represent a reasonably significant amount of money.  Designing the system to accommodate this would be simple.

One way – which would not work – would be to not increase fares again.  This gets around the first problem, but not the second.  And it creates a new one.  Fare income is (I hope) put back into the system.  The real cost of no fee increases in an inflationary environment would, over time, approach zero.  A zero fare public transport system will still cost the state money, and would represent a transfer of wealth from areas without public transport to areas with it.  I’ve a feeling that areas without public transport are already generally less well off than areas with it, so a close to zero fare approach is probably regressive.

A way to ameliorate both problems above can be implemented with two steps.  Keep fare increases (only at a reasonable level), but increase the value stored on a Myki at the same time, to the same proportion as an increase.  If fares increase by a flat 2% across the board, increase my $20 balance by 2% (to $20.40).  Any money I put in after that increase in balance would not be subject to that increase[4].  This allows me to still make the same number of trips before and after a fare increase, but also helps fare income has the same real value from year to year[5].  In addition, balances should also be increased  by the rate of return the State Government gets on the money invested[6].  If the Myki Fund is returning 5% on the amount invested, balances could be increased by this amount annually (as with footnote 4, probably 5% of the average balance in a year).

Wrapping it up

I’m aiming to write short pieces on things that are happening to consider how basic economic concepts can be applied to real life in a way that helps to understand those concepts.  I’m not proposing public policy here – I’d be amazed if any government would do anything other than offset the profits from the two problems identified above against the losses from single trip tickets, not to mention the $1.35 billion (at least) that Myki has cost.  But hopefully this has you considering money and value, how they can change over time, and the effects of leaving money stored in a card that doesn’t increase with value over time, rather than leaving money in your bank account (or better, paying off any debts you may have).

FOOTNOTES
1. It’s likely that this will have a significant impact on ticket income, but there was never going to be any other way to implement it.  Given a single two hour zone 1 ticket is $3.70, imagine the outcry if each Myki trip cost you $0.76 more than the equivalent bulk Metcard rate?↑
2. I can’t find who owns the money stored in travellers’ Myki accounts.  I’m assuming the State Government does, but the argument holds irrespective of who keeps your money.  If it’s shared between the private consortia who are managing the public transport system, it represents a bonus for them.↑
3. Clearly, $50,000 is not a lot of money.  My point is not to suggest that there’s some grand plan to rake in loads of cash at the expense of travellers.  My point is to help you think about money and value over time.↑
4. And we introduce a new problem – if I then put in $100 on December 31, I get an increase in value of $2.  A better version would be to increase the value by the mean value stored on the card throughout the year, but my simpler example above serves as a theoretical explanation.  Software makes such tasks trivial.↑
5. In a period of sustained deflation, it would be impractical to reduce balances if fares were reduced.  But no government would actually reduce fares, so there’s no substantial problem here.↑
6. Again, a theoretical example – it would cost much more than $50,000 to return $50,000 to 500,000 Myki users.  I am not actually suggesting that this should be implemented (whereas the balance increase at the same time as a fare increase one probably should be).↑