Economics With Alex

Is There a Difference Between Kickstarter and Panhandling?

2013-04-06T18:39:00.002-07:00

Why is it if you ask people to give you money on Kickstarter, it's (relatively) respected, but if you ask people to give you money on the street, that's called "panhandling"? I know what you'll say: "those bums are just going to spend that money on booze and drugs!" I'm sure some of them will. But hey, who's to say Kickstarter recipients aren't just snorting away the money people are giving them as well? Since donors are not really stakeholders in a Kickstarter transaction, is there really much accountability for the managers of crowd-funded projects to do what they say they are going to do with the money?
I'm not telling you, I'm asking you: Other than the little gifts and perks of donation that exchange hands, what's the difference between financing with Kickstarter and begging? Maybe there is a big difference, and I'm just not seeing it yet. Until then I won't understand why it's considered OK for a group of movie producers to beg for donations to finance a film adaptation of a cult TV show, for example, but not OK for a homeless man to seek the crowdfunding of passers by, to finance his own survival.
Really, both activities are OK by me. Desperate, worthy people often need to beg. And desperate, worthy indie projects may need to beg as well. But I still see no difference between the two methods of financing. Those aforementioned movie producers, in bypassing traditional methods of finance, are begging. And homeless people asking for donations on the street are just crowdfunding.
But, there is one major difference between the two situations. When you donate to a homeless person, that person gets 100% of the donation. Donate to a Kickstarter campaign and between 3% and 5% of it will go to Kickstarter itself, to pay for things like web servers to keep the site going, or maybe just mansions and yachts for the owners. Yes, Kickstarter is a for profit company. So while you may find yourself donating to a worthy project on the site, just out of the kindness of your heart, remember that up to 5% of that donation is going straight into Kickstarter's coffers.

Source: http://www.kickstarter.com/start

Jobs Reports

2012-09-08T12:50:00.002-07:00

If you were hoping for a bad jobs report this month just so that it would hurt Obama's re-election chances, you are sick in the head. And if you were hoping for a good jobs report just so that it would help Obama's re-election chances, you are equally sick in the head. Break the obsession with politics as a spectator sport!

Who's Winning the Battle of the Social Networks?

2012-06-14T02:50:00.000-07:00

Who's winning the battle of the online social networks? This screenshot, taken from a Cracked.com page I was just reading, speaks volumes:

The network externalities in the market for social media are perhaps too powerful for anyone to really compete with Facebook in the near future. Whether or not Facebook can fully monetize this dominance is another matter. Facebook's tumbling share price since its IPO indicates that investors are having some of the same doubts I have long expressed about the free-service/advertising-revenue model on which companies like Facebook are based.

As an investor, it's important not to confuse dominance over culture with profitability. Yes, Facebook has changed the culture of the entire world. But how much revenue does it have to show for it? Some, but not enough to maintain that IPO price. Perhaps Facebook has only grown to dominate because, to quote the Facebook log-in page: "It's free and always will be." Maybe the success stories of Facebook and Google, and other similarly monetized web-based companies are not the tales of the triumph of innovation they have been hyped to be, but are stories that prove something completely unremarkable: that people like to pay less for things. Yes, people like free stuff, people love free stuff. People will spend their time and energy to get "free" stuff. But there's one thing they won't do, and that's pay for it.

Hijacking The Collective Intelligence of the Web

2012-04-04T12:24:00.002-07:00

I've been talking a lot lately about how the collective intelligence of the web will help value-creating enterprises rise to success, while letting unworthy enterprises fail. Well, here's one way that these unworthy businesses are trying to combat this: fake Yelp reviews for pay.

Screenshot from Craigslist Los Angeles

Notice how for it to be convincing, the paid writers need to have active and established Yelp accounts. Very clever.

If You are Advertising, There Must Be Something Wrong With You, Part 2

2012-03-08T18:11:00.003-08:00

I apologize that perhaps too many of my latest articles have covered the topic of advertising. I can justify that to myself because I feel, in today's world of almost unlimited "free" content online (either offered for free, or free through piracy), the issue of monetizing the web in a way that efficiently rewards producers of content (films, software, books, ideas, artworks) is and will continue to be one of the our great economic dilemmas. The current model is heavily based on advertising, and I feel that the monetization model of pay per click, "put everything out for free, because it's just going to be pirated anyway, then pray that someone clicks on the ads" will soon fail.
Why? As I covered in my earlier article on this topic, because if they haven't already, people will soon realize advertising has become a mark of bad quality for the advertiser. In the wired, social media fueled economy, word of mouth and the collective intelligence of the web are king. Not the word of advertising. Ask yourself, of the two following choices, who would you be more willing to trust?: a paid celebrity spokesman telling you that a product is great, or hundreds of user reviews online telling you a product is bad? If you answered the former, you must really like that celebrity.
But there's another more basic reason why advertising is a mark of bad quality. Advertising costs money. And money spent on advertising is money not spent in other areas, the areas of spending that, unlike advertising, help to actually create a good product or service.
Ask yourself the following question: When was the last time you saw a national advertisement for Harvard University? You know, just to spread the word: "Hey everybody, Harvard's a great school!" Probably not very recently.
Now ask yourself when was the last time you saw an advertisement for ITT Tech or other for-profit trade school offering community-college level education at 10 times community-college prices? I see them all the time, on TV and all over the web. These are the kinds of products and services that need to advertise: Scams, predatory lending and herbal "male-enhancement" supplements.
In other words, products and services that suck.
And speaking of sucking, advertising sucks. That is, advertising costs suck money, like leeches from an organization's funds. These funds could be used to help provide a better product or service. And in a world where social media has created 'roided up engines for the transmission of instant, global word of mouth, perhaps the better companies will find that money is more wisely spent on improving their products, rather than simply trying to convince people that their products are good. So if you see a company advertising heavily, ask yourself "why do they need to advertise so much?" and "where is the money coming from to pay for all these advertisements?" It could very well be that the heavy advertising company never counted on offering a quality product or service in the first place, and was just planning on pulling a fast one. And if you want to find out if a product is good or bad, often a quick Googling will suffice. Just watch out for those Google ads.

(Post script: Yes I am a total hypocrite for attacking the web advertising model from a blog covered in ads supplied by Google.)

The Economics of the Worst Meal I Ever Ate

2011-11-20T20:36:00.000-08:00

(I'll be the first to tell you that this article is based on my very limited, subjective experience eating once at a single restaurant, and my theories on the economic and political implications of this one meal are total generalizations based on extremely limited evidence; evidence based on a sample size of 1. Nonetheless, there might be something to my theory. Read on.)

When I ordered the very worst meal I ever ate, I was on a lunch break from jury service. I had left the downtown LA courthouse and walked a couple of blocks in a random direction looking for a restaurant. I walked into what turned out to be a grubby, nasty place and ordered a hot dog and what they called "homemade mac and cheese", basically a pile of inedible, greasy, flavorless, stringy slop. I try not to waste food, but I couldn't make it through this. It was definitely the most disgusting, seemingly half-assed meal I have ever seen prepared.

Disregarding the possibility that I came into the restaurant on a very very bad day, how would such a substandard restaurant stay in business? I'll theorize with two words: Jury Duty. Think about it, every weekday, thousands of people coerced by the legal duty to perform jury service converge upon the courthouse, and they all need to eat. Like me, many of them will just walk down a block in a random direction, stop at the first restaurant they see, eat there, and possibly prop up the fortunes of a restaurant that would otherwise fail. But this is not simply a matter of an increased volume of foot traffic outside. If that were the case, restaurants next to all highly visited areas would have lesser quality food, but that is clearly not true. A restaurant next to, for example a large office building that the same workers go to every day, needs to maintain high standards to keep those same people coming back. But this restaurant next to the courthouse would get a different set of suckers almost every single day. So where is their incentive to improve? Nowhere. Each day the restaurant could survive by pumping out disgusting slop for a new set of unsuspecting people called in for jury duty; people who will probably not set foot on that same block unless one day they get called back for jury service at the same courthouse. Also, word-of-mouth is inhibited. What's the use of telling your friends and neighbors about a bad dining experience in a completely different neighborhood than they live in? And while bad restaurants near the courthouse would gain benefits from this lack of word-of-mouth, the good restaurants would be harmed by this.

So, because of the (perhaps absolutely necessary and unavoidable) government coercion of people to come to courthouses, I am putting forth the theory, (arrogantly generalizing based on my own reasoning and the evidence of one bad experience) that many bad restaurants near courthouses in large urban areas probably get the benefit of a distortion of the market. The jurors are a captive audience, and have little power to move that "invisible hand" away from such nasty, disgusting restaurants.

Or do they? Perhaps the internet will come to the rescue. On websites such as Yelp, that an increasing number of jurors will have access to on their smartphones, website users can blow the lid off of the nastiness of bad restaurants such as this one, and promote the good ones. This however, depends on how widespread smartphone based restaurant reviewing becomes. It all depends on whether or not more Americans become mobile-device-addicted, whining foodies (like me). And on a completely different topic: would that be such a good thing?

Anyone else out there had any interesting juty duty lunchtime experiences, good or bad? I've got to get more evidence.

Gotomeeting's TV Ad: Slacktivism In Action

2011-09-22T00:39:00.000-07:00

I've been Googling and Googling and can't find any reference to the "Kenyan Water Project" showcased on a recent commercial for the web-conferencing company Gotomeeting. I guess it was all made up for the commercial. (Gotomeeting, if you are reading this, and the commercial was actually based on something real, not just a hypothetical use of your services, please let me know). I can't quite put my finger on why it's so offensive to me that this commercial for Gotomeeting would use a fictional charity to sell itself. Here's the ad:

If it had been a fictional clothing company, or fictional donut shop, that would be par for the course. The fictional depiction of a use of one's goods or services has been a staple of advertising from time immemorial. But this is different. Perhaps it offends me so because it is a prime example of "slacktivism". Wikipedia defines slacktivism as
"a portmanteau formed out of the words slacker and activism. The word is usually considered a pejorative term that describes 'feel-good' measures, in support of an issue or social cause, that have little or no practical effect other than to make the person doing it feel satisfaction. The acts tend to require minimal personal effort from the slacktivist."
But this isn't just slacktivism. It is worse. This is slacktivism used to make money. This commercial is used to associate the company, Gotomeeting with fictional well-intentioned folks bringing fictional clean water to fictional Kenyan villagers, which in turn elevates the public's view of Gotomeeting, bringing the company not-fictional money.
So does the fact that this commercial showcases the non-existent "Kenyan Water Project" promote the clean water cause? Not at all. If anything, this feel-good commercial harms the real cause it hijacks, because the worst part of slacktivism is that it breeds complacency. Because who needs to start a real charity when there's a fictional one out there in TV land doing fictional good?

Pictorial Evidence of the Benefits of Relaxed Drug Policy

2011-09-18T18:13:00.000-07:00

The other day I was walking down an L.A. street and saw a man holding this sign (above), outside of one of the city's many (perfectly legal) medical marijuana dispensaries. He was working for a group protesting the dispensary's allegedly shady business dealings. The economist in me had to take a picture, as this was something one could only see in a region with relaxed policies towards marijuana: a public business dispute. When a product is illegal, as marijuana is for non-medical use in some states like California, and banned outright in all others, negotiations and disputes must be held in private, away from the watchful eye of the law. This illegality brings about an entirely different way of doing business. In an illegal industry there can be no legal backing behind business contracts, and suppliers certainly could not publicly call for a boycott, as it would alert the cops. To me, this openness is a step forward. If you stop and think about the methods of negotiation and conflict resolution available to people in the illegal drug trade, you might think so too. Here's a short list of methods that can be used to enforce contracts in illegal industries:

Stabbings
Shootings
Bombings
Good old-fashioned ass-whoopings
Leg breaking
Blackmail
Vandalism
Kidnapping
Etc. etc. etc.

Is it worth it to keep a drug illegal, when its illegality leads to a wider-spread use of the above-mentioned "negotiation methods"? Watching some episodes of Boardwalk Empire might help one mull it over.
I'm not denying that this is a complex issue. Drugs cause harm to society; one must only look to the devastating effects of alcohol and tobacco to see this. However, I think there's one thing everyone can agree on: boycotts are better than bombings.

If You Are Advertising, There Must Be Something Wrong With You

2011-08-15T21:56:00.000-07:00

Have you ever watched a "featured" or "promoted" video on Youtube? I haven't watched them very often, because from my experience, they usually suck. Why else would someone need to pay to get his or her video high up in the listings? Really good videos gain popularity organically. Ironically, at least for me, seeing that a video on Youtube is "featured" is the kiss of death, and guarantees that I will not watch it. "Featured Video" is the mark of a bad video that is probably trying to sell something. A video's mark of quality can only come from a large number of "thumbs up" ratings. This is a democratization of the whole marketing environment. You can see it everywhere on the web, not just on Youtube. Star and thumbs up systems provide a collective intelligence that can communicate to everyone which products and services are truly worthwhile. These collective rating systems are one reason that advertising is becoming less relevant in today's wired world. Though today there are more and better opportunities to reach your customers through advertising than ever before, advertising itself is taking a backseat to organically-spread word of mouth. Word of mouth rules, and now that there are automated ways to instantly and globally spread word of mouth, advertising has taken a new, secondary place. For example, if advertising misleads, word of mouth, or rather, word of type or click, can correct things eventually. If a company promises amazing results from a product, a consumer must only check user reviews on one of many websites to get the real scoop from people who have actually used it (though maybe also a scattering of fake reviews marketing people at the company have thrown in there). So this leads me to what I think is a new law of marketing in our viral world: if you are advertising there must be something wrong with you. I am being slightly facetious. This is an exaggeration. No matter how easily word of mouth can spread, companies will need to advertise. Some industries need advertising more than others. And even the best companies will need to advertise, at the very least to get the viral marketing snowball going in the first place. But if you take a look at who is doing the most advertising nowadays, you're going to see a lot of predatory lenders, shady herbal supplement companies and expensive trade schools, not so much reputable and well regarded companies. Many of the best companies may have found that they can thrive from the free advertising of web-based word of mouth. Perhaps our collective intelligence on the web will lead to a world where companies, (gasp!) must actually make a decent product to survive.

Web Advertising Bubble?

2011-08-10T12:18:00.000-07:00

The Ugly Side of Web 2.0 Marketing: A Facebook Toilet Paper Poll

Recently I've been listening to Jeff Jarvis's "What Would Google Do?" on audiobook. I haven't finished it yet, so I will suspend my final judgment, I am enjoying the book so far, though sometimes the effusive Google worship gets kind of tiresome (not a fan of the phrase "Google Juice", barf). Don't get me wrong, I love Google too. I am writing this blog article on a Google platform, use their search constantly, Google Earth is amazing, et cetera, et cetera, et cetera. However, in all my years of using Google, I could count on one hand the number of times I have clicked on a Google ad. And every time my clicks have arisen through simple curiosity, not a real desire to buy something. Though I don't have the figures, I know Google reels in an imponderable number of people to its ads, but I'm sure there are also countless others out there just like me, taking full advantage of Google's favors, but never repaying by clicking on an ad. But it's worse than that. For web advertising to fully pay off for Google, not only must there be a click, but an actual exchange of money, or else, in the long run, companies will not find it worthwhile to advertise with Google. If anyone out there is actually reading this article, I'm curious, and please let me know in the comments: how often do you click on Google advertisements? I really would like to know. With Google ads, for all they try to zero in on me with laser precision, with ads that I would find useful, often what is being sold just seems like crap, or a scam to me. Which leads me to what I shall call, pretentiously, "The Great Contradiction of Web Monetization". The great contradiction is as follows. Jeff Jarvis and people like him would be the first to tell you that the old model of marketing is dead. Thanks to the web, word of mouth can spread like wildfire or a virus. But, you cannot engineer virality. Viral word of mouth will only help sell a product that is truly valuable. So in our brave new world of viral phenomena, truly great products don't need advertising like they used to. Maybe they need a spark to get the wildfire going, but that is all. So, companies with truly great products will only end up handing Google a little bit of money, but after that, Yelp and Amazon reviews will take care of the rest. Because it is the real users of a product or service that truly spread word of mouth, not people who have only seen an advertisement, in a viral world, advertising becomes less relevant, not more. So what does that leave us with in the Google ad bar? Usually crap and scams, like I said. This does not bode well for a company whose revenue stream comes almost entirely from advertising. So what would happen if people everywhere just stopped clicking? I imagine Google would be in trouble. I am not forecasting Google's collapse, that's just ridiculous. They are too good at what they do, which is very many things. However, though Google's domination is widespread, their success is not inevitable. If in the distant future through some freaky combination of a collapse of values in the web advertising market and bad management, Google were to fail, I think a government bailout would be in order. This company has poured out its heart and soul to give consumers so many amazing free tools, that we have all felt the benefits of. They would deserve a bailout much more than the bankers.

Hydrolyze This

2011-08-09T02:00:00.000-07:00

For a free market system to function properly, government must at the very least step in to enforce laws against false advertising. This is why I have been so disappointed to repeatedly see a blatantly false TV commercial for "Hydrolyze", a wrinkle cream for the under eye region. I can't vouch for the usefulness of the product. For all I know the product does everything they say it does, but the tactics used to sell this product are definitely dishonest. This commercial airs each time with a voice-over saying that "the first 100 callers" get it free or something, and then proceeds to show a counter in the bottom left corner, supposedly counting how many people have called in already. As the commercial runs, the number increases by seemingly random increments, thus attempting to provoke a sense of urgency among viewers. This high pressure sales tactic is, to use the proper economics term, a bunch of crap. Obviously it would be damn near impossible, or at least prohibitively costly for the Hydrolyze call centers to relay a count of the number of calls occurring after every airing of the commercial to each television station so that, in real time, the counter shown on the commercial could be updated while airing. I hope nobody falls for this. How stupid do the think we are? To quote comedian Lewis Black, "It's as if they believe that we fell asleep on a nuclear reactor, and our brains had melted, and we are now nothing more than meat with eyes."

The Invisibility Cloak: Bad for Human Rights?

2011-06-18T15:16:00.000-07:00

There was some dramatic news last year. Scientists in Germany have apparently been getting very close to making an invisibility cloak. For the first time ever, through innovations in light-bending materials, a small object was made invisible from all angles. Though the technology is not yet usable in a Harry Potter-like fashion, the development of a cloak one could just throw on to become invisible may only be a few years away.
Now before all you sci-fi and fantasy fans go nuts, just ponder the question: what are the possible uses for an invisibility cloak? I think you'll come to the conclusion that an invisibility cloak would mostly be useful for two things: mischief and mayhem. If invisibility cloaks became widely available to the public, the crimes of peeping toms, shoplifters and murderers for example would all become easier to get away with. Which brings me to the subject of human rights. To understand the full ramifications of widespread invisibility, it's useful to become familiar with the idea in law and economics, of a mathematical equation for the "optimal punishment" for a crime. Donald Wittman's excellent textbook on law and economics explains this concept the best. Because not all criminals can be caught, in order to make them face the full costs their crimes bring upon society "...the expected punishment, probability of being punished (P) times the fine (F), is set equal to the harm of the crime. That is PF = H. Thus the lower the probability of being caught, the higher the level of punishment should be." In other words, for the legal system to adequately dissuade people from committing crimes, two things are possible: 1) increasing the probability of catching the criminal, or 2) increasing the punishment. So the necessary punishment F varies inversely with the probability of being caught. So if suddenly it were half as likely for someone to get caught for a particular crime, to maintain optimality, the punishment must become twice as harsh. This seems to explain at least in part why countries without advanced systems of crime detection and law enforcement (low P) may punish small crimes with huge punishments (high F, e.g. cutting off someone's hand for shoplifting, or hanging, drawing and quartering for various crimes in medieval England).

So what does this have to do with invisibility cloaks? Clearly, (no pun intended), if invisibility cloaks became cheap and widely available to criminals, the probability of getting caught (the P in the optimal punishment equation), for many crimes would decrease. Most crimes would become easier to get away with by use of an invisibility cloak. But not only would it help in the perpetration of crimes, an invisibility cloak would help people resist arrest for any crime, even those not utilizing invisibility, such as cybercrime and fraud perhaps. If the cops came to your door, you could just slip on your invisibility cloak and make a break for it.
So in a world of widespread invisibility crimes, to once again make criminals fully face the costs they bring to society, the legal system could greatly increase F, the punishment, or alternatively attempt to bring P back up to its original levels, perhaps by becoming ever more invasive into peoples lives. Either way an invisibility cloak sounds like bad news, both for the possible victims of invisibility related crimes and for human rights in general. I personally wouldn't want shoplifting a pack of gum to be punishable by years in prison just because pesky invisible people have ruined the legal system for everybody.
Haven't these scientists seen "Hollow Man" or "Predator"?

Sources:
http://articles.nydailynews.com/2010-03-20/news/27059544_1_invisibility-cloak-dimensions
Donald Wittman, Economic Foundations of Law and Organization, Cambridge University Press, 2006

Party-nomics, Facebook and Positive Network Externalities

2011-06-14T01:45:00.000-07:00

Have you ever been party-hopping with friends, found a party or a bar that wasn't highly occupied, and then (maybe due to a unanimous decision, or maybe due to the whining of a few) immediately left to seek a more popular venue? If so, you have helped fulfill a self fulfilling prophesy. In this kind of situation, if more people are willing to stick around at the unpopular venue, it can have had a chance to become popular. But with everyone leaving 5 minutes after getting there, the place will remain, in the parlance of our times, "dead" (as in "dude, this party is dead, let's split"). This phenomenon is very well described by what economists call "positive network externalities". Unlike a good without positive-network externalities such as a banana, where one person's benefit from eating a banana does not depend at all on how many other people eat bananas, a person's benefit from going to a party greatly depends on how many other people go to that particular party. This is because as another person joins the party, benefits (positive externalities) go to all the other partygoers. The more people there are at the party, the more chances there are for exciting social encounters. Therefore there is more benefit both for people already at the party as well as for prospective partygoers. This self-fulfilling prophesy will attract people to the party up to the point when things get overcrowded. After this point, each person's benefit will actually decrease as each additional partygoer arrives. With the number of partygoers on the x axis, and the individual enjoyment of the party on the y axis, a graph of the "total fun" of a party (if we could quantify it) would look something like this:

Note the steep drop-off at a certain point, when the number of partygoers reaches the maximum capacity of the party's physical location. Clearly people like a good party, but no one wants to get squished. As you can see, the appeal of a party is a function of the number of people already there, and this determines how many people will want to join that party in the future. The self fulfilling prophesy is in full effect. Because of this, the success or failure of a party depends largely on the number of people attracted in the initial stages, and this can depend largely on chance. When a party has reached a "tipping point" of popularity through word of mouth, it can fill up to the point of reaching the maximum capacity of the party's physical location. Then there will be spillover to the less popular parties, and a new equilibrium will be reached.
But what about a party with no physical location, other than tiny ones and zeroes occupying a server? Yes I am talking about the internet, and specifically the huge social gatherings that occur 24/7 on social networking sites like Facebook and Twitter. Just like a parties, these sites bring positive network externalities to their users. Meaning, the more people there are on Facebook, the more beneficial it is for a new person to join Facebook. But unlike parties, huge websites do not face the constraints of physical space. So, roughly graphing the benefit of being on a social networking website in response to number of users would look something like this:
Rather than a drop in total fun occurring at the point of some number of users as we saw with the physical party, there is simply a levelling off. There are diminishing marginal returns to fun here, because, for example with Facebook, you can only have so many Facebook friends (5000 as of today I believe, and even fewer you really interact with on a regular basis). But there is no drop-off in benefit, because there is no restriction on capacity. Unlike a real physical party, this party on the internet shows no sign of slowing down. Facebook has become a fixture, and it would be very difficult for another company to come in and compete with it on its own turf. A new site would need to provide amazing new benefits to compete with the massive positive network externalities Facebook has built up through its user base. And why did Facebook build up such a large base of users? Partially because it's a very well designed site, but also because of the initial luck of the draw. Mark Zuckerberg's party got the initial rush of partygoers it needed to sustain itself and grow. Without any capacity restrictions, it seems to be here to stay. Even if there were a better party next door, people would probably ignore it.

Value of a Bird in the Hand in Terms of Birds in Bushes

2011-05-28T09:26:00.000-07:00

Is a bird in the hand really worth two in the bush? A GEICO commercial, where an antiques appraiser values a sculpture of a bird in the hand as worth "two in the bush" got me thinking about that expression. Maybe a bird in the hand is really worth 3 or 5 birds in the bush. I'm no bird hunter, but I am an amateur economist, and I know to find the value of a bird in the hand in terms of birds in bushes, we can break it down mathematically. The expression "a bird in the hand is worth two in the bush" can be mathematically expressed by the following equation: valueOfBirdInHand = 2*valueOfBirdInBush

But this is inadequate. To fully flesh out the economic wisdom contained in this colloquialism, we need several variables other than the number of birds dwelling in the bush. These variables are as follows: 1) The probability of catching a bird, given that it is in the bush.
2) The fixed costs involved with going bird-catching in the first place. By fixed costs, meaning the same amount of these costs must be incurred regardless of the bird-yield.

3) The variable costs that must be incurred per bird that is caught. Variable meaning that these costs increase per caught bird.

So adding in these variables, by my reckoning, the equation for the value of an attempt to hunt birds in the bush is:
totalValue= P(catching bird)*numBirds*unitValue - (numBirds*unitVariableCost) - fixedCost
with P(catching bird) denoting the probability of catching a bird given that it is in the bush. Unit value gives a measurement of value to a caught bird, for example the prevailing market rate for that particular bird.
To explain this perhaps perplexing equation, P(catching bird)*numBirds*unitValue gives the total expected value, meaning you might catch 50% of 10 birds valued at $20 each for $100 total yield, or 25% of 12 birds valued at $5 each for a $15 yield. NumBirds*unitVariableCost gets you your total variable cost. Subtract that out along with your fixed cost and you have the expected net value of your hunting trip. It's like an expected profit.

So to find the value of a bird in the hand, set totalValue to the value of a single bird, and solve for numBirds in the following equation:
P(catching bird)*numBirds*unitValue - (numBirds*unitVariableCost) - fixedCost = unitValue

Solving,

factor out numBirds and move fixedCost to other side,
numBirds*(P(catching bird)*unitValue - unitVariableCost)=unitValue+fixedCost
divide both sides by (P(catching bird)*unitValue-unitVariableCost)) and we have our answer:
numBirds=(unitValue + fixedCost)/(P(catching bird)*unitValue-unitVariableCost)
This equation answers the question of how many birds in the bush equal the value of one bird in the hand! For example, let's say birds were worth $10 each, the probability of catching a bird in a bush was 0.50, and there were zero fixed or variable costs involved with bird catching. In this case:
numBirds = ($10 + 0)/(0.50*$10 - 0)
numBirds = 1/0.50
numBirds = 2
Thus in that situation a bird in the hand is worth two in the bush, just like the expression tells us.
But what if there were fixed and variable costs involved with hunting for birds? What if you needed to pay a $5 fee to go bird hunting, and it cost you $1.00 per bird to get it ready for market? Then:

numBirds = ($10+$5)/(0.5*$10-$1)

numBirds = 15/4
numBirds = 3.75
So in this case a bird in the hand would be worth 3.75 birds in the bush.
Now what if, keeping the costs the same, the probability of catching a bird in a bush decreased to 0.25?:
numBirds=($10+$5)/(0.25*$10-1)
numBirds=15/1.5
numBirds=10
In this case a bird in the hand would be worth 10 birds in the bush.
So after all these mathematical gyrations you might think I'm being silly just like the GEICO commercial. Well, yes I am being silly but there are also valuable economic lessons to be learned here. You can replace "bird" with any other thing of value, and the simple economic model I have assembled here, as well as the wisdom of the expression it was based on, would be just as valid. The old saying examines one of the great conflicts in economic life: the sure thing vs. speculative gain. For more on that topic check out my article on the game show "Deal or No Deal".
The moral of the story is: to evaluate a decision, look at the probability of a favorable outcome, look at the variable costs, and look at the fixed costs.

False Quantity Discounts and Chocolate Bunnies

2011-04-24T23:25:00.000-07:00

Almost two years ago I wrote an article about drugstores offering false quantity discounts. By false quantity discount, I mean that if the price tag said "10 for $10" you didn't need to buy a quantity of 10 to get the discount. You could buy one for one dollar, two for two dollars, eight for eight dollars or any variation thereof. This dishonest and lazy policy struck me as harmful, not so much to customers, but to the retailers' revenues. Under a system of false quantity discounts, assuming customers believe what the price tags say (though I'm sure many are savvy to the policy by now), if a customer chooses to buy fewer than the (false) required quantity, the retailer needlessly loses money on the transaction. These customers are willing to buy the item, but unwilling to buy it in such a quantity that, they think, would earn them a discount. But when they get to the cash register, CHA CHING! they get the discount anyway. These surprise discounts reduce revenue. And the retailers who have their Point of Sale systems set up like this are leaving money on the table. To illustrate the foolishness of such a policy I'll tell you about my shopping expedition to a Rite-Aid the other day. At Rite-Aid there was a sale on chocolate bunnies. "2 for $3" it said:
Knowing there was a chance that this Rite-Aid didn't have a POS system sophisticated enough to handle a real quantity discount, and hungry for a bunny, I bought just one item. And just as I had guessed, this wasn't a real quantity discount, just a re-setting of the price to $1.50 per unit. Here's the proof:

(Disregard that I was also buying earplugs and a glasses case that, as it turns out is not intended for my gender. Chocolate bunny is line three.)
As you can see, not only was it unneccessary for me to buy two rabbits to get the discount, but I also got that one rabbit cheaper than advertised. This begs the question: why would a retailer ever sell something for cheaper than advertised? I've heard of bait and switch, but this is like bait and switch in the customer's favor. The only reason for a policy such as this must be that some retailers choose not incur the costs of implementing and maintaining more detailed POS system that can handle a quantity discount. Not knowing what the costs are, I can't judge whether this is the right or wrong choice. All I know is that such a policy lowers revenue.

So yes, my savvy shopping prevented me from buying an extra chocolate bunny I didn't really need, just to get a discount I would have received anyway. But this article is not about me. This is about the customers who go to Rite-Aid thinking they would need to buy two bunnies to get the discount, choose to buy just one bunny instead, and then get the discount anyway. These customers are willing to give up more of their money, but the retailers who follow this lazy policy are choosing not to take it. What's up with that? I've seen a few drugstores and grocery stores who have POS systems that implement real quantity discounts. I'm sure in the long run this will help them to do better than companies taking the dishonest and lazy path. Dishonest and hardworking? That can work. But dishonest and lazy is not a recipe for success.

Why Bubbles are Bad: The Long Term

2011-04-08T11:37:00.000-07:00

Thinking about the word "bubble", describing bouts of speculative mass hysteria by investors creating a self-fulfilling prophesy of rising asset prices out of line with an asset's fundamental value, I've realized that the analogy of "bubble" is not perfect. In one very important way a speculative bubble is more like a sponge. Like sponges, speculative frenzies soak up investment, taking it away from what is truly value-creating. But never mind the metaphors, the point is that when investment gets pumped into one sector that, as it turns out in retrospect, was downright bubblicious, other actually valuable sectors get ignored, and this has significant consequences for the economy in both the short and long term.

I theorize that the amount of long-term havok a bubble unleashes on an economy is directly related to how long that bubble survives. Let me explain. If a bubble is around briefly, it's impact will mostly be limited to those who directly traded in the bubbly asset. But when a bubble thrives for years at a time, as was the case with the housing market in the 2000s, people not directly involved with the buying and selling of the asset have time to react and make fateful long-term investment decisions based on skewed bubble-induced perceptions. When I say the word "investment" I am not just talking about Wall Street. Every person in the world makes investments whenever they sacrifice something in the short term in anticipation of greater value in the future. Going to the gym is an investment. Planting seeds in the ground is an investment. And importantly for our discussion of bubbles, getting an education or putting years of labor into a certain professional field, is an investment. Unfortunately these long term investment decisions are often at the mercy of bubbles.

A bubble with staying power is a huge collective distraction. People gravitate toward numerous bubble-spawned careers, investing their precious years and dollars in them. During the housing and financial bubble of the 2000s, a great number of our best and brightest were whisked away from careers in engineering and medicine, and into the bubbly financial sector. According to The Harvard Crimson, in 2007, 47% of jobs taken by new Harvard grads were with consulting and financial firms. The bubbly influx of cash into these sectors allowed firms to hire extensively, and from the college graduates' perspective, seeing successful financial professionals popping up around them, finance was where the money was. One study of the financial sector by economist Thomas Phillipon at the Stern School of Business, using a statistical model, estimated that on average, bankers in 2006 were overpaid by 40% over what fundamental variables would precict. And wouldn't you like to be overpaid by 40% too? But the carnage occurs once the perceived value of the bubbly asset realigns with its actual value. At this point many of those who had found careers in the bubbly industry get sacked, and having spent years of their lives chasing an economic mirage, it becomes harder for them to contribute to the economy with real value-creating activity. Post bubble, huge sections of the labor force are stuck with skills that are no longer needed. And then what does the economy get? Higher structural unemployment, (the worst kind), and an economy unable to deal with the real challenges of its age.

To give another historical example, the most absurd Monty Pythonesque asset bubble I can think of occurred from 1634 to 1637, when Holland was struck with a collective frenzy for tulip bulbs. This speculative rush elevated the price of some rare types of tulip bulbs to monumental sums of money. The price of the coveted "Admiral Van Eyck" bulb increased from 1,500 guineas in 1634 to 7,500 guineas in 1637, which at the time was the price of a house. Of course a crash in prices followed shortly after. But for those three years, i'm sure it was very lucrative to be in the tulip industry. If such a bubble were to happen today we'd probably see commercials for money-grubbing trade schools on TV saying "Get in on the fastest growing career: Tulip Merchant." It sounds absurd in hindsight. Bubbles always do. But it always seems like a good idea at the time.

I guess the moral of the story is, in all economic behavior, from choosing a stock to buy to choosing a house, to choosing a career: Don't Believe The Hype.

Sources:

http://sternfinance.blogspot.com/2008/11/are-banker-over-paid-thomas-philippon.html

Olivier Blanchard, Macroeconomics, Fourth Edition, 2006, Pearson/Prentice Hall , Pg. 328 http://www.thecrimson.com/article/2008/6/22/harvard-graduates-head-to-investment-banking/#

Can You Make Sense Of This Chart?

2011-03-28T00:12:00.000-07:00

Have you ever seen a commercial for some kind of financial service showing people on computerized trading platforms with more blinking lights and features than the Starship Enterprise? Or have you ever watched CNBC and been sensorially overloaded by the massive array of ticking stock data and colorful charts? It all looks very fancy and impressive, but it's just that: fancy and impressive. These images of sophisticated trading systems are designed to perpetuate the myth of the financial superhero, looking at his charts, making trades, producing miraculous results. Real successful investing is a lot less exciting. Sure, it would be fun to be a financial superhero, recognizing patterns in the market that all others didn't see, clicking your mouse and nailing down huge, market-beating profits. This is the fantasy that companies like E*Trade want customers to believe in, and it was one E*Trade commercial I saw months ago that prompted me to write this article in the first place. The commercial plays like a manifesto for active investment strategies. "Sitting, waiting, hoping. That's a recipe for failed investing," says the commercial's voice-over, heard over an image of a flatlining EKG screen, I suppose to emphasize that passive investment strategies are dead, or will kill your portfolio.

But is this true? No. Sitting, waiting and collecting dividends can often be more profitable than speculation. In fact, my understanding is that in general, long term buy and hold strategies are far more lucrative than frantic trading based on price fluctuation. Just ask Warren Buffett. To quote the world's most successful investor "I realized technical analysis didn't work when I turned the charts upside down and didn't get a different answer." So, if that negative view of chart-watching is held by such a successful investor as Warren Buffett (and the majority of academics in the field of finance) why do we see so many charts on commercials for E*Trade?

It's because E*Trade has something to gain. The company gets a fee for every trade their customers make. So it's only natural for E*Trade to try to convince its customers that profit opportunities slip through their fingers every second they are not trading. Because trading volume is the source of E*Trade's revenues, it would like its customers to treat investing like a video-game, or perhaps a slot machine. If customers keep pulling that handle, E*Trade makes money. Hence the fun looking interface and colorful graphs.

The new features of E*Trade's online trading platform supposedly provide the user with expert advice and analysis to help them "seize opportunities" (Cut to fancy charts and buttons!). E*Trade says this advice is unbiased, and I hope that's true. But judging from the pop-finance mumbo-jumbo of their commercials, I'd take E*Trade's advice with a big grain of salt. Perhaps a container of Morton's. Admittedly I'm no investment expert, but common sense and some finance textbooks have told me that no human being could extract usable information from the massive amounts of effectively random price data running across the screen on a fancy trading platform or CNBC broadcast. Perhaps a superhero could. But as we are merely human beings, it might be better to put the charts aside, sit back, relax and collect some dividends.

Here's a link to the E*Trade commerical if you're interested.

http://www.youtube.com/watch?v=3i_FG2jw1bs

An Increase in the Supply of Embarrassment

2011-02-21T12:10:00.000-08:00

Since the advent of mass communication technologies, it has gotten a lot easier to be embarrassed. Especially in the age of Youtube, TIVO, cameraphones and widespread video surveillance, if anyone does something embarrassing, there is the potential for a viral phenomenon spreading that embarrassment across the globe.
So should everyone live in a constant state of fear of messing up in front of a camera (e.g. Cristina Aguilera and "the twilight's last reaming")? Don't worry, here comes economics to the rescue!

Economics is the study of the allocation of scarce resources. It's an fundamental principal in economics that when a resource becomes less scarce, each unit of the resource will be individually less valuable. Just think of a world where bountiful apple trees grew on every street corner. How much would people be willing to pay for apples? Not much, because they could just grab them off of the nearest tree.

As it turns out, the internet is a bountiful tree of embarrassing moments ready to be picked. So is embarrassment a resource that people buy and sell? Yes. Though websites like Youtube and Break.com are ostensibly free, every day millions of people exchange their time for the opportunity to watch funny videos, often of real people embarrassing themselves. (To be honest, this is one of the main reasons I watch Youtube. Forget about videos with actors and scripts, I think there's nothing funnier in the world than game show bloopers.) So if the embarrassment of others is a resource that is bought and sold, what would happen if the supply of embarrassing moments captured on film were to greatly increase? Just as with an increase in the supply of apples, if embarrassing videos become less scarce, each embarrassing video would become individually less valuable.

And this is exactly what has happened. Because of Youtube and other technological developments, consumers now have unprecedented access to viewing others' embarrassing moments. But this increase in supply must interact with consumers' demand preferences, and this can be represented with a basic supply and demand model. Because internet users do not pay a monetary value per viewing, we cannot speak simply of price as we could in the market for apples. However each internet viewer does place an individual measure of value on each viral video he/she watches. Likewise those who submit videos get satisfaction based upon the number of hits a video receives. The price that viral video viewers give up and suppliers receive as revenue, is hard, if not impossible to quantify, but the behavior is identical to the supply and demand for any other good. So just to give the general idea, here's a graph depicting the supply of and demand for embarrassing viral videos, with P being that unquantifiable value of satisfaction that people receive from both submitting and watching these videos, and Q being the quantity of videos available:

As you can see, the supply curve has shifted outwards as technology makes a greater quantity of embarrassing videos available. This increases the quantity viewed from Q1 to Q2, but also decreases the value that people place upon each individual embarrassing videos from P1 to P2. This can be very intuitively understood. If there were suddenly twice as many videos of, say, ballroom dancing accidents, each individual video will be less special to each consumer. There are only so many ballroom dancing accident videos consumers will be able to watch within their schedules. With an increased supply, the level of cultural saturation each individual viral video achieves is nothing like the earlier days of the internet. With an increase in supply, viral videos as a whole become more prevalent, but each individual video becomes less distinctive and culturally valued.
So what does this economic reasoning mean for those who have been and will be embarrassed by viral videos? Basically it's good news. While new technologies have made it so much easier to be embarrassed in front of a global audience, the abundance of supply will keep the cultural value of each embarrassing moment low, to the point that new videos may not have the universal appeal of earlier ones that became global phenomena. This decrease in cultural value and recognition in turn makes each embarrassing viral video less embarrassing. For this reason, people, especially public figures who are constantly in front of cameras, should not live in fear of slipping up and becoming the next embarrassing viral phenomenon. Excessive carefulness can be a hazard, especially in politics where the cameras are always rolling. People should act naturally as ever. Because in the future, as the internet continues to churn out mountains of content, the public's reaction to a possible viral phenomenon may just be "meh".

Its a new age where everything is out there for all to see. But that gets boring after a while, doesn't it?

EBT (food stamps) and Fast Food: Implications for Market Demand

2011-01-28T10:34:00.000-08:00

At some point in 2010 I started noticing different fast food restaurants in California, both in the SF Bay Area and Los Angeles County offering to accept payment via EBT (Electronic Benefits Transfer for food stamps programs). This is a change from the prior rules wherein EBT could only be used for unprepared food e.g. from the grocery store. Now under different programs such as Los Angeles County's Restaurant Meals Program, it is now possible to use food stamps to get fast food, e.g. pizza from Pizza Hut. Before I get into the possible positive and negative effects of this change in policy I want to explain the effects of this change on the market equilibrium for fast food.
In short, this change in policy creates a kink in the demand curve for fast food, as low income EBT recipient customers increase their demand, while demand by higher income customers does not change.
Consider two fast food buying customers. Person A earns an income that disqualifies him from EBT. Person B earns a low enough income to qualify for EBT, and has chosen to receive those benefits.

Here is person A's demand curve:

You can see that if fast food was practically free, Person A would consume 20 meals per month. Also notice how, because he has the budgetary capacity, at a price of $12 per fast food meal, Person A would still buy a small quantity of fast food per month at this high price.
Now consider Person B's more modestly budgeted demand curve. This is person B's demand for fast food meals before the change in policy that allows him to purchase fast food with EBT.

Notice how at a price of $12 per meal Person B will not buy any fast food meals. This is beyond his budget at this point. So what happens to Person B's demand curve when suddenly he can use EBT to purchase these meals? This change in policy will shift his demand curve for fast food to the right, because he will now be more able to purchase fast food meals at various prices. Here's his new demand curve:

We have now seen the effects of this change in policy on two individuals, one on food stamps and one not. But what about the market demand curve? And what does this mean for market equilibrium (the point where the quantity demanded equals the quantity supplied)? Let's find out. Because the market demand curve is the summation of all the individual demand curves, just imagine adding together all the demand curves for all the Person A-s and Person B-s of the market. Let's say the demand and supply curves before the policy change look like this:
The market price is at P1 and the quantity sold is at Q1. Suddenly the county government for this market allows EBT to be used to buy fast food. What would this do to the demand curve? Because higher income, non-food-stamp recipient customers like person A can affect the entire market demand curve, from the highest prices to the lowest, and lower income food-stamp recipient customers like person B would tend to only affect the lower parts of the demand curve, when EBT is suddenly allowed for fast food purchases, it is only the lower parts of the demand curve that will shift outward (in reality the change would probably not be this prominent but I have made it prominent just for demonstration). Here is the new market demand curve:
The result is a kink in the demand curve pushing out at the point where most food stamp recipients would be priced out of the market. Assuming the supply curve is below that point, this increases the equilibrium price to P2 and the equilibrium quantity to Q2. Thus this policy is a good thing for fast food companies, increasing their revenue by the amount of:

(P2*Q2)-(P1*Q1)

So what is the significance of the kink in the demand curve? Probably nothing in today's market, because fast food prices usually stay so much in the lower level that the portions of the demand curve higher than the kink will not come into play. In effect the shift is probably more like a shift of the entire demand curve, because the upper reaches may not even matter for equilibrium. However, if there were suddenly massive supply shocks in the inputs for the supply of fast food, e.g. global potato crop failure, the price might go high enough that more and more Person B-s actually get priced out. Let's hope that doesn't happen anytime soon. Nonetheless it's interesting and worth noting that (at least according to my reasoning) the whole demand curve does not shift, just the lower portion.

Now that I've looked at my graphs, what do I think of this policy?

I'm conflicted on this issue. Fast food is usually bad for you (except for the notable example of Subway). Nonetheless, a food stamp recipient can find food that is just as bad at the local grocery store. There is nothing in the law to prevent a food stamp recipient from using EBT to eat nothing but sticks of butter and Captain Crunch cereal. Also, for homeless food stamp recipients, lacking kitchen tools, buying prepared food can be the easiest way to get a hot meal. The issue here is how paternalistic does one want their government's social welfare programs to be? There is no demand and supply diagram that can easily find the best answer to this question. From my political preference, I am more on the side of allowing EBT purchases of prepared food. Not all of the poor will give themselves heart disease because of this policy change. Some will. But really this is a seperate issue. More nutritional education, (Public Service Announcements etc.) is the key to getting people to demand less junk food in the first place. Thus the "invisible hand" would force fast food companies to offer better choices. Ever since the movie "Super Size Me", I think we've already seen this happening.

I honestly don't know what the best policy is in this case. All I can say is, from just looking at the demand and supply curves, this is a great policy for fast food companies' profit margins. It is also bad for the profit margins of grocery stores who no longer have a monopoly on EBT food transactions.

How Not to Package Your Product

2011-01-24T16:36:00.000-08:00

What's wrong with this picture?

Okay, I admit it. This article is not my best example of hard hitting in-depth economic analysis. Its more an excuse for me to post a funny picture I took at a Walgreens today, (kind of like my last article about that bizarre viral billboard campaign). However, I will say that this picture, taken from the package of a bargain plug-in video game console, is a great example of how not to package a product. Just one more quality-control step could have prevented this confusing and humorous design choice. Sometimes all it takes is a second pair of eyes to notice something like this.

Or perhaps this wasn't a mistake. In the rush to bring this bargain product to market, the packaging team might not have had time to take (or photoshop) a picture of a kid playing the game plugged into a backseat television screen, and whoever gave the go-ahead on the package design just said "eh, that's good enough." Whatever the case, the result is a barrel of laughs!

But I'll take this a step further. I think this kind of mistake is emblematic of the "death of the proofreader" a phenomenon brought about by the advent of spelling and grammar checking software. I am not an anti-spellcheck luddite, but it's just a matter of fact that before spellcheck and grammarcheck, a second pair of eyes was a necessary part of copy writing for packaging and other media. But that second pair of eyes can be expensive, and for many tasks, digital checking can be superior. However, problems arise because computers cannot easily deal with the meanings behind words. For example, to a spelling and grammar checker the sentences "They had a fight" and a corresponding typo "They had a fig" are equally valid. It would take a proofreader to recognize that error, just as it would take a proofreader to recognize that the kid in the second picture is playing his game on a tv stand, which is rather hard to do in a car.

(I sure hope there are no typoes in this article.)

Weirdest Billboard Ever?

2011-01-13T22:03:00.000-08:00

I was driving in West Los Angeles today when I came across a billboard so strange I could hardly believe my eyes. From a distance I could see the words "Win a Free Booby Prize", next to an image of a voluptuous woman. At first I thought this was some kind of off-color strip club or plastic surgery advertisement. Boy was I shocked when I drove closer and saw that that the woman on the billboard had a blurred Jesus face!!!!!

So, why does this belong on an economics blog? It does because this is a great example of today's trend towards "viral" marketing. The makers of this billboard, whether they are plastic surgeons or eccentric Christian missionaries, are counting on people like me being so baffled by this ad campaign that they will go to "freeboobyprize.com" to find out what the heck is going on. And by posting this picture and writing about this I am playing right into their hands. But I can't resist. It is too bizarre to ignore.

This may turn out to be a success for whatever organization put this billboard up. I'm certainly curious. And if it is a success, there may be imitators with even more shocking and baffling billboards. But to return to a theme I've been talking about a lot lately, this type of bizarro billboard campaign would probably only be successful a few times. Imitators would face diminishing returns as the novelty of such ad campaigns wore off among the public.

So what is Free Booby Prize? I'm curious, but perhaps not curious enough to go to their website, because then I would officially be a sucker to this billboard.

How Did My "Saw 3D" Prediction Hold Up?

2011-01-02T17:53:00.000-08:00

A few months ago, I wrote an article using regression analysis, (let me rephrase, simple and not-so-scientific regression analysis) to predict the box office results of the seventh Saw movie, "Saw 3D". The quantitative model predicted a gross of $17,047,984 in line with the diminishing returns witnessed with each of the last five sequels. But I disregarded this figure in favor of a vague prediction that the film would be much more successful than that, due to its being released in 3D. As it turns out, my vague and non-commital prediction came true. Saw 3D grossed $45,710,178, which was about 20 million dollars more than its non-3D predecessor, and much more than the model predicted. This movie bucked the trend of diminishing marginal returns for sequels and the introduction of 3D into the franchise is probably the reason.

So does this mean that new Saw movies will be successful as long as they are released in 3D? No. 3D film itself will probably succumb to diminishing marginal returns soon, and by the time halloween rolls around this year, experience may have shown that the 3D fad is as dead as John the Jigsaw Killer. In which case it may be more profitable to take this franchise straight to DVD.

A Strategy Guide for my Economics-Based Video Game

2010-11-10T12:47:00.000-08:00

Recently I have gotten really interested in computer programming. Right now I am learning the Java programming language, and have used it to create a simple text based game called Cake Wiz. You may ask, "What does this have to do with economics?" Actually it has quite a lot to do with economics. The game I created is a business simulation game, where the player runs a bakery. I've written this article to explain the economic principles behind the game. Before I give too much away, you might want to play the game first. You can access it here:

http://www.bfximageworks.com/alex/

(And here's a screenshot. On the page, press the "click here" button to start your game. I wasn't clear about that.)

(Special thanks to good friends Steve and Bennique Blasini for letting me use a page of their business' website for my silly game. They are brilliant special effects artists and if there are any hollywood producers out there reading this: hire BFX Image Works if you ever need some computer graphics done for a film.)

In my game, the player makes four decisions every business day at the bakery:

1. how much cake mix to buy, based on a price that fluctuates.

2. how many cakes to bake from the mix, keeping in mind that cakes expire after two days but cake mix does not expire.

3. how much to spend on advertising

4. what price to sell the cakes for

Without giving away all the secrets how the game works, I will say that the number of cakes you can sell every day is based on four very important concepts in business and economics:

1. The price elasticity of demand. This is a measure of the change in the quantity demanded in response to a change in price. Except in rare cases of "snob appeal", people will demand less of a good if its price is higher. So in the game, if you start selling your cakes for a higher price, not only can the quantity sold fall, but your total revenue might fall if the price increase does not offset the quantity drop. You also might lose unsold cakes to spoilage.

2. Diminishing marginal returns. In this case, I'm referring to diminishing marginal returns of dollars spent on advertising. This basically means that you can spend too much on advertising. At a certain level of spending, every extra dollar spent on advertising may not have as powerful an effect as the dollars spent before it. To explain, imagine that one out of every 20 commercials on TV was for the "Shake Weight." This would probably greatly increase sales of the Shake Weight over not advertising at all. But if 20 out of 20 commercials on TV were for the Shake Weight, what effect would this have? TV viewers would probably say "I get it already!!! Enough with the Shake Weight!!", and the effect of the extra 19 commercials would undoubtably not be worth the extra cost. So keep this in mind when choosing your level of advertising spending in the game.

3. Inventory Management. In my game, and in business in general, you don't want to accumulate a lot of inventory that will go to waste, especially since goods like cakes expire with time. But on the other hand, you don't want to run out of inventory, which will cause you to miss out on extra sales, and possibly lose disappointed customers for good.

4. Randomness. In my game, as in business, you may find there's an unexplained, random element to your circumstances. You should change your behavior to hedge against the effects random fluctuations in demand or the cost of productive inputs.

So basically, the key to doing well at my game is using trial and error to find the right pricing, advertising level and inventory level to make a good profit in the face of randomness.

Hope I didn't give too much away and that you enjoy my game as much as I enjoyed programming it.

The Economics of Frontal-Bus-Squishage

2010-11-03T16:43:00.000-07:00

Have you ever gotten onto a city bus and immediately been stuck in a huge cluster of people at the front of the bus, when there is plenty of space, and maybe even seats in the back? I have often struggled with this curious phenomenon, and my inner economist seeks a reason for, and maybe a solution to this problem. I have come to the conclusion that the problem of front-of-bus squishage can be easily understood through an examination of the unique costs and benefits that riders face in different parts of the bus.

When people think of prices, they often think only of money given in exchange for something else of value. But everything of value has a price, often not paid in money, but with other assets, such as personal space, comfort or dignity. Personal space is the asset that bus riders often give up when they are crammed together in the front of the bus, even when there are unused assets towards the back that could make everyone’s ride more pleasant.
Why do these assets go unused? After careful consideration, I've realized that bus blockage situations happen because of two things:
1. The bus riders who would most benefit from the extra space on the bus are those who would face the most costs in acquiring it. And,
2. Bus riders who would face the least costs in acquiring more space on the bus are those who would least benefit from more space.
To put this more simply, those who can more easily access the extra space have less need for it. Thus the extra space in the back goes unused.
Allow me to explain.
Envision an empty bus. As riders get on the bus, they immediately take the seats. Once all of the seats are taken, riders have no choice but to stand. In the absence of external forces, people will tend to want to stay put. In more common usage this can be categorized as "laziness". Because of this law of behavioral inertia, riders who come onto a bus with no available seats, rather than moving immediately to the back to clear space for new riders, will tend to stand in the front, relatively close to where they got on. There is, when entering a non-crowded bus with no available seats, no direct and universal incentive for bus riders to move further back, and because of this, as more riders get on the bus, clusters of frontal-bus-squishage form. And because of the different costs and benefits facing bus riders at different parts of the bus, once they form, these clusters are hard to break up. To help explain, take a look at this diagram I have artfully put together:

The diagram singles out two bus riders, person A and person B. Person A is stuck in the middle of a cluster of people (zone A), while person B is at the edge of the cluster, (in the spacious zone B). In this formation, Person A would greatly benefit from the extra space at the back of the bus, but would face the costs of squishing past three people in order to get there.

If you think the word "cost" is inappropriate to describe what person A faces here, ask yourself: do you enjoy squishing past people in thick crowds? Probably not, both for your sake, and out of a polite desire not to squish others. Thus you would face a cost in getting from zone A to zone B. The unpleasant squishing would be the price you’d pay for more space.

So person A, in order to benefit himself, and indirectly the people around him (in econ-speak, a positive externality), would pay a relatively high price for moving to zone B. Person A would need to press up against other riders, and awkwardly slide and slither through. This is a cost, as real to person A as the cost of a loaf of bread. Person B however, who is already at the edge of zone B, has plenty of space in front of him. And for the relatively low cost of simply moving his feet for a few steps, Person B could move further into zone B, and thus help lighten the blockage for everyone in zone A. But because person B is not being squished from both sides like everyone in zone A, he won't personally benefit much from moving towards the back. Person B's needs for space have largely been satisfied.

In the act of moving towards the back, Person A and other riders like him, face high costs and high benefits, while Person B and other riders like him face low costs and low benefits.

And there we have it. A cluster of front-of-bus-squishage. The cluster will break only if:

1. person B and/or others like him realize that they need to move back, or

2. if a few brave (or rude?) souls in Zone A decide it is better to squish past everyone to get to zone B, than to remain in the cluster. This is an altogether less pleasant solution than in 1, which involves no extra squishage.

So far there is only one tool in use that I know of for preventing or resolving the frontal bus squishage problem: Shame. The bus driver needs to shame the "person B"s of the world into moving back, usually by yelling "move back, everybody". (Even more effective is "I'm not moving this bus until you move to the back!") But maybe an automated system would be more effective. If money were no object, engineers could design a bus that uses sensors to detect clusters of frontal bus squishage. Upon detection, a polite yet insistant robot voice could ask the "person B"s to "please move back" over and over until the situation was resolved. If need be, it could also give them mild electric shocks until they do. Here is a diagram of how that would work:

(I sure hope anyone reading this has a sense of irony. For the record, I am not a psycho.)

But what about carrots rather than sticks? Adding extra benefits in exchange for moving to the back could work just as well, or even better than shame or electrocution. How about a free snack dispenser, or a gentle foot-massaging floor that activates in the back when the sensors detect a squishage?

All kidding aside, to solve this problem, the costs and benefits must be realligned, either by making it more costly to create a blockage, or more beneficial to prevent one. In econ-speak this would "internalize the externality." Snacks, electric shocks, or massages could theoretically all be used. But in reality, it seems we can only rely upon the shame that a good and forceful bus-driver can inflict on Person B. That, and hopefully, bus riders' courtesy to their fellow passengers will help too.

The Econ Geek's Guide to Deal or No Deal: an Empirical Study

2010-08-14T17:08:00.000-07:00

The game show "Deal or No Deal" is an econ geek's dream. Not only is it a thrilling spectacle for game show lovers, it is also a laboratory for studying human risk-taking behavior. For those who don't know the rules, on the show there are 26 numbered briefcases, each with a tag inside, showing an amount of money. The amount of money in each case ranges from 1 penny to 1 million dollars. The contestant first chooses one of the cases to take into possession, and then through the rest of the game, eliminates cases from the remaining 25, starting with 6 cases at once, then 5 then 4 then 3 then 2 then 1 at a time until all but the contestant's case is gone. As each case is eliminated, the amount it contains is exposed, thus letting the contestant know what amount is not in her own case. If the contestant eliminates all of the 25 cases, she walks away with the amount of money in the initially chosen case. The twist is that there is a "banker" on the show who after each round of elimination, offers the contestant an amount of money to stop playing. Because, superstitions aside, the choice of eliminating one numbered case over another does not matter, the only pertinent decision in the game is whether to take the deal or keep playing, (which makes the title of the show particularly fitting).

As the contestant continues to eliminate from the 25 cases, by inference, she gets a better idea of what is in her own case, and so does the banker. So if the contestant eliminates the case that has the penny, that's a good thing, because it means that the personal case doesn't contain the penny. If the contestant eliminates the million dollars, she knows that her personal case doesn't contain the million, and this is a bad thing.

For years I have watched this show, and wondered "how does the banker choose the amounts of each offer?" After quantitatively studying this (albeit with a limited sample of 64 offers from 9 complete games) I think I have come close to answering this question.

To understand how the banker makes his offers, there's one key mathematical concept to keep in mind: expected value. Expected value is equal to the sum of the values of all possible outcomes multiplied by their respective probabilities. It is the average amount of money per person that a large group of people would win on this game if they never took deals.

When one starts the game, the dollar values of the cases are as follows:

$0.01, $1, $5, $10, $25, $50, $75, $100, $200, $300, $400, $500, $750, $1000, $5000, $10000, $25000, $50000, $75000, $100000, $200000, $300000, $400000, $500000, $750000, $1000000

And the probabilities of each outcome are equally likely: 1/26= (approximately) 0.03846.

So, the expected value, (in this case also just the average of all values because the probabilities are the same), is equal to:

$0.01/26 + $1/26 + $5/26 + $10/26 + $25/26 + $50/26 + $75/26 + $100/26 + $200/26, +$300/26 + $400/26 + $500/26 + $750/26 + $1000/26 + $5000/26 + $10000/26 + $25000/26 + $50000/26 + $75000/26 + $100000/26 + $200000/26 + $300000/26 + $400000/26 + $500000/26 + $750000/26 + $1000000/26 = $131,477

So, when you start the game, the expected value of your personal case, before any of the remaining cases are eliminated, is $131,477. What if, before you even started playing, the banker offered you $80,000 to not play the game at all? Would you take the deal? On average, taking this deal would get contestants much less than playing through all the way. But for reasons I shall explain later in this article, the banker usually makes offers that, just like this one, are significantly lower than the expected value of the case, and despite the low offers, very few contestants actually play through all the cases.

As one plays the game, and eliminates cases, the expected value of what's in one's personal case changes. Lets say that the contestant has eliminated 24 of the cases, leaving just the personal case and one other case in play, and that the only two possible values remaining are $0.01 and $1,000,000. Because the probability of either outcome is 1/2, the expected value of the contestant's personal case would be equal to:

$0.01/2 + $1,000,000/2 = $500,000

What if at this point in the game, the banker offers a deal for $250,000? Ask yourself: if you had a choice here between choosing your case, which might have a million dollars in it or might have a penny, or taking a deal for $250,000, what would you do?

Personally I would take the $250,000. This illustrates an important concept in economics: risk aversion. I am risk averse in this situation because I would choose a certain reward over an uncertain one, even if the expected value of the reward in the uncertain event is greater than the certain reward.

So in Deal or no Deal, the banker always wants the contestant to take the deal, right? Wrong. If contestants took the first or second deals there wouldn't be much of a show, and the network would need to bring on more contestants, and thus give away more prizes, to fill airtime. On top of this, the show tends to get more interesting as it goes along and people make the riskier decisions. For these two reasons, one related to the costs of broadcasting the show, and the other related to the benefits of having a more interesting show, there is an incentive to make lower offers to the contestants in early rounds to get them to play for longer.

The quality of an offer can actually be quantified. There's a measurement I use to find the quality of a deal relative to what cases are still in play. I call it the "Offer Quality Ratio", and here it is:

offer quality ratio = (offer amount)/(expected value of remaining cases at time of offer)

So lets say there are the following cases left on the board (by the way, this is from an actual episode): $1, $100, $50000, and $100000

and the contestant gets an offer of $27000.

The expected value is = $1/4 + $100/4 + $50000/4 +$100000/4 = $37525.25

So the Offer Quality Ratio = $27000/$37525.25 = 0.7195

In other words, the offer is around 72% of the expected value of playing to the end.

After the challenging task of watching TV for hours, I have collected data on 64 offers from 9 complete Deal or No Deal games. My results show that as contestants play the game, they tend to get rewarded with higher quality deals relative to what cases are still in play. From these 9 games, here are the average Offer Quality Ratios for offers in each round:

First offer: 28.9% of expected value, (Standard Deviation 15.8%)

Second offer: 42.8% of expected value, (Standard Deviation 15.0%)

Third offer: 47.7% of expected value, (Standard Deviation 13.6%)

Fourth offer: 54.8% of expected value, (Standard Deviation 12.2%)

Fifth offer: 65.1% of expected value, (Standard Deviation 17.8%)

Sixth offer: 65.0% of expected value, (Standard Deviation 16.1%)

Seventh offer: 84.0% of expected value, (Standard Deviation 17.3%)

Eighth offer: 90.6% of expected value, (Standard Deviation 18.3%)

Ninth offer: 97.6% of expected value (S. Dev 3% from a limited sample of just two offers)

Though I'm sure this study would benefit from a larger sample size, there are two conclusions I have drawn from it.

First, the quality of deals relative to what is on the board tends to rise as games progress. As you can see, the first offer tends to be incredibly low, and is usually not even worth considering.

Only the most risk averse contestants would take a first offer that's under 30% of expected value. As the game progresses, the managers of the show, weighing the costs of giving a bigger payout against the benefits of a more interesting show and more airtime per contestant, increase the quality of the offers.

Secondly, the standard deviation (the average amount of sample variation above or below the average value of all elements in the sample) of offers is significant, at around 15 to 20 Offer Quality percentage points, and remains rather constant throughout the game. This is either because there is an element of randomness built into the offer-determining formula used on the show, or there are hidden variables determining part of each offer. Maybe contestants are given a psych evaluation before the show that gives insight into their risk profiles? This would help the banker minimize payouts while maximizing the thrill of the show.

So, the moral of the story is, if you are ever on Deal or no Deal, fortune might favor you because of your boldness. Rather, I should say, the "banker" (and by that I mean the managers and producers of the show) might favor you with a good offer because you've made the show more interesting, and thus more profitable.