Does growth result in more profit?

This article in the WSJ describes Wal-Mart's struggles to increase sales and what is happening to its profit. Here are some questions.

1. How would you evaluate the costs and benefits of "investment in wages, better stores, and e-commerce"?
   
2. How would you evaluate the costs and benefits of increasing the number of work-hours employed?
   
3. What are margins? " "In the near-term, [Simeon Gutman, retail analyst at Morgan Stanley] said, 'it's not a question of if margins are going to fall, it's a question of how far.'

Labels: Pricing decisions, all-or-nothing decisions, employment decisions

Building an ethical business culture

This answer says that the first step to building an ethical business culture is to "to go with your gut when hiring: look for a cultural fit, [Simon Webley, research director at the Institute of Business Ethics in London] said by email. No matter how big the company is, you can find out if a candidate shares your values by grilling him or her during interviews, Webley said." It also recommends 

1. Creating and publicizing  a code of ethics and including ethics training
2. Structure teams so that people are encouraged to work together
3. Lining up your compensation structure with collaboration
4. Act on your values

I have a question: "How effective are interviews at screening ethical people?"

Label: Aligning interests

Cost of capital

This article in the WSJ describes the difficulty of measuring economic profit.

Label: All-or-nothing decisions

All or Nothing

Robert Griffin III and the Sunk Cost Fallacy

This opinion from the NYT argues that the Redskins may be falling prey to the sunk cost fallacy. 

Occupational Licensing

This opinion in the WSJ argues that one barrier to upward mobility is overly restrictive occupational licensing requirements imposed by state and local governments. The writer thinks that governments should eliminate requirements when its cost to benefit ratio is greater than one.  

SUMMARY: Cost-benefit analysis and 'lookbacks' could lift the unnecessary burdens of occupational licensing. "A widely overlooked part of Paul Ryan's antipoverty plan draws attention to the problem of occupational licensing, and it rightly calls on states and local governments "to begin to dismantle these barriers to upward mobility." But how? The answer, we think, lies in the adoption of a rigorous cost-benefit test. That test would impose new discipline on what state and local governments do-and it would eliminate unjustified barriers to job creation and economic growth."

CLASSROOM APPLICATION: Students can examine the effect of state and local regulations on entry, competition, prices, and economic efficiency of industries. Students can examine occupational licensing for example.

QUESTIONS: 
1. What are "regulatory lookbacks"?

2.When considering whether to implement new regulations, is it important for legislators and regulators to examine the economic consequences of doing so? What are the relevant economic consequences? Why is cost-benefit analysis an appropriate methodology for evaluating government regulations?

3. Who suffers the most from occupational licensing requirements?

Reviewed By: James Dearden, Lehigh University

4. Who benefits the most from occupational licensing requirements?

Wednesday, January 30, 2013

Regulations and Rent Seeking

CNNMoney posted this article. It is a nice list of regulations that prevent entry and competition. It could be a nice way to introduce a discussion of the government's role in regulating market inefficiencies and the danger that government regulation becomes rent seeking. The example about taxicabs could also spur discussion about the entry and exit decisions and what determines the price of medallions.

Monday, January 21, 2013

Ice Cream Wars

Clip here for an NPR story on Ice Cream Trucks in Chicago. It touches on vertical relationships, rent seeking, incremental analysis, and collusion.

Friday, January 18, 2013

What can we learn about pricing from Lucy Ricardo?

Click here to view a clip from I Love Lucy on how (not) to set price. It is a good introduction for Bertrand pricing in an undifferentiated duopoly, strategy, whether a marginal sale is profitable, and the shut-down decision.

Want lots of rehabilitative therapy?

How Medicare Rewards Copious Nursing-Home Therapy
by: Christopher Weaver, Anna Wilde Matthews, and Tom McGinty
Aug 17, 2015
Click here to view the full article on WSJ.com

TOPICS: Economic Incentives, Health Economics

SUMMARY: For U.S. nursing homes, Medicare's rules can provide a financial incentive to increase rehabilitative therapy for patients who may not benefit from extra care.

CLASSROOM APPLICATION: Using marginal benefit and marginal cost, students can evaluate the influence of financial incentives on medical decisions. They can also evaluate how economists could determine whether nursing homes are providing inefficiently high levels of care.

QUESTIONS: 
1. (Introductory) Does the Medicare payment mechanism for physical and occupational therapy provided by nursing homes described in the article account for the benefits of the care?

2. (Advanced) Would it be feasible for Medicare to design a payment mechanism for providing nursing home physical and occupational therapy that accounts for the benefits that individual patients would receive?

3. (Advanced) Use marginal benefit and marginal cost to analyze a nursing home's choice of the amount of physical and occupational therapy for a patient covered by Medicare? With Medicare's current payment system in place, why would a nursing home potentially set a resident's physical and occupational therapy at exactly 720 minutes per week?

Reviewed By: James Dearden, Lehigh University

Labels, Rational actor, moral hazard

Subway

Subway's Salad Days Are Past 
by: Julie Jargon
Aug 14, 2015
Click here to view the full article on WSJ.com

TOPICS: Strategy

SUMMARY: Subway, suffering through its biggest slump in years, is testing just how sprawling a fast-food chain can get before it becomes too big.

CLASSROOM APPLICATION: Students can evaluate the decision by a parent company like Subway whether to sell new franchises and the decision whether to own outlets or franchise them. Students can also evaluate the factors that have caused a decline in Subway's revenues.

QUESTIONS: 
1. (Introductory) What factors are causing Subway's reduced revenues?

2. (Advanced) How does a parent company determine the optimal number of franchises to sell? Consider the statement, "Subways aren't cannibalizing each other and that restaurants in the most Subway-dense markets actually have higher average sales."

3. (Advanced) Why have fast-food companies like McDonald's and Wendy's been selling corporate-owned outlets to franchisees?

Reviewed By: James Dearden, Lehigh University

Labels: Strategy, Organizational architecture

Pricing decisions

http://qz.com/481830/how-will-chinas-fastest-growing-smartphone-brands-ever-make-money/

--

Edward Millner
URL: sites.google.com/site/EdwardMillner

Big data

This story from the BBC describes how Pizza Hut Restaurants UK is using data. Here are some good quotes.

1. "It's easy to see results and take the wrong read of them"
2. "The answer ... is to run control experiments, much in the same way that they test for the efficacy of new drugs."
3. "'We saw 40% growth in some of our really big investments, which was truly transformational,' says Mr Platt. 'Before we started, average customer spend was about £9, now it's around £11.'"
4. "Data analytics and continuous testing help us to draw the right conclusions from evidence - something that humans are not naturally good at."
5. We are prone to "cognitive bias", or wonky thinking, because we don't weigh up the evidence correctly or ignore it altogether, swayed by our prejudices, emotions and lack of logic."

Ranking employees

This article reports that the effect of public rankings of employees depends on whether the culture is individualistic or collective. I wonder how the rankings affect compensation.

Dilbert on economists

Data analytics @ Google

This article in Slate describes Google obsession with data analytics.

Arbitrage

The Web's Most Maniacal Bargain Hunters

by: Greg Bensinger
Apr 13, 2015
Click here to view the full article on WSJ.com

TOPICS: Microeconomics

SUMMARY: Retailers fret about "showrooming," where shoppers scan bar codes in stores and seek better deals online. But now there is a twist.

CLASSROOM APPLICATION: The article offers a great example of arbitrage in action, deemed "reverse showrooming." Armed with price-checking apps, individuals purchase low-priced items in stores. They then resell the items on Amazon, at a profit. "Industry insiders call the practice retail arbitrage. It's more art than science, because prices are often lower online. Tricks of the trade include scoping bargain racks, shopping on senior discount day, buying unusual sizes and anticipating high demand. Software developers offer price-checking applications that help calculate potential profit, after shipping costs and online commissions."

QUESTIONS: 
1. (Introductory) Define arbitrage. Is the practice of purchasing low-priced items in stores and then reselling them at higher prices online an example of arbitrage?

2. (Introductory) Are people who purchase low-priced items in stores and then resell them at higher prices on Amazon taking advantage of Amazon shoppers?

3. (Advanced) Does Amazon benefit from the practice of retail arbitrage?

4. (Advanced) Based on the anecdotal evidence in the article, how does the online competition for a product affect the prices set by retail arbitragers?

Reviewed By: James Dearden, Lehigh University

How do consumers ressond to high prices?

This story shows that the quantity demanded of handbags is lower when price is high and higher when price is low. Students often claim that firms can increase demand for a product by increasing its price and making it a more exclusive brand. This story is a counterexample to the claim.

Supply and demand in action in the hotel industry

This article describes the pricing dilemma facing hotels and reports statistics about hotel prices. The article also points out that removing a substitute (short-term rentals) increases the price of hotel rooms.

Price elasticity of demand for soda in Mexico

This article in Wired reports on how an increase in the tax on sugary drink affected the consumption of such drinks.  Here are some questions.

1. What your best estimate of the price elasticity of demand for soda in Mexico based on the report?
2. Is the demand elastic or inelastic?
3. If the price elasticity of demand is constant, how much would a 20% increase in price reduce consumption?
4. Is demand by low-income consumers more or less elastic than the demand from high-income consumers?
5. What does Kelly Brownell, a public health expert at Duke University who studies obesity, mean when he says, "A 10 percent tax is 'right at that cusp of where you might start to get changes in consumption'."
6. Would leakage make the demand for soda in Berkeley more or less elastic than the demand in Mexico?
7. What is your best estimate of the cross-price elasticity between the price of soda and the consumption of bottled water based on the report?

Aligning interests @ Amazon

This article from the NYT describes the corporate culture at Amazon.

Here are two articles that report on how Amazon responded:

1. http://www.nytimes.com/2015/08/18/technology/amazon-bezos-workplace-management-practices.html?_r=0
2. https://www.linkedin.com/pulse/amazonians-response-inside-amazon-wrestling-big-ideas-nick-ciubotariu

Here is another report: http://www.bbc.com/future/story/20150818-how-algorithms-run-amazons-warehouses.

Here is a response to Bezos: http://qz.com/482080/dear-jeff-bezos-i-wish-you-had-asked-for-my-feedback-sooner/.

A blogger's post on the topic: https://signalvnoise.com/posts/3917-ceos-are-often-the-last-to-know.

Here are 5 questions that came to my mind as I read the articles.

1. Does the culture and compensation scheme align well the interests of employees with interests of the owners?
2. Does the culture and compensation reward employees who take risks or those who strive from more certain outcomes?
3. Would you want to work at Amazon?
4. The article in the NYT mentions that "Amazon is driven by data." What examples does it give of how Amazon uses data in its compensation scheme? Does it give examples of how something other than data affects the compensation of employees? 
5. Is Organizational Level Ranking driven by data?

A debate over motivation

Are monetary rewards effective?

• In this video Dan Pink argues that monetary incentives are bad motivators. He says much the same in this is  video of his TED talk. 
• Mark Fidelman challenges the assertions by Dan Pink in this article. . 
• This video is Paul Solman's story on Pink. 
• Here is an article from Time that claims to identify 9 things that motivate better than money.
• In this article authors at Wharton argue that monetary rewards typically boost productivity by 42% to 49%. They also point out flaws associated with monetary rewards.
• At around the 5:00 minute mark of this video, Edwards Deming talks about what he sees as the flaws of annual performance evaluation and merit raises.
• In this article, an author at Stern argues that any performance measure is flawed and concludes that we need to work constantly to improve what we have and to exercise judgement when we attempt to apply whatever we have.

If you want my thoughts, please read on.

Monetary rewards AND non-monetary rewards matter. I often engage students in a discussion of motivation and how employers can align the interest of employees with the interests of employers or owners. I stress the importance of rewarding desired behavior or results and not rewarding undesirable behavior or results and that creating a compensation scheme that does both is difficult. I also point out that things other than money matter. A firm that is functioning well will use both monetary and non-monetary rewards to reinforce desirable behavior and will use each predominately when and where that method is most effective.  

Debate over Health Care and Insurance

Two recent articles, one from John Goodman in response to an article by Nickolas Kristof, illustrate well two approaches to the debate over health care and health care insurance. Goodman's article contains some sound economic analysis. However, his portrayal of Kriostof's stance is incorrect. Kriostof does not say that health care is free nor is he an unabashedly strong supporter of Obamacare. They both agree that the current system of health care and health care insurance is broken. So do most Americans. Goodman argues that the solution requires that the patient make more decisions, not the government or insurance companies.

Manipulating Markets

The Guardian has published a pair of articles (first and second) about charges that large energy companies manipulated energy prices. The charges appear to center on "attempts to distort the prices reported by the company" which "are critically important because many wholesale gas contracts are based on them and small changes in the price can cost or save companies millions" (first). I left with several thoughts.

The second article quotes a third article to point out the importance of incentives. "[T]he entire system is'dependent on consenting adults and traders not talking up their book but that is inevitably what happens.'"

Second, having prices tied automatically to a "reported" average creates opportunity for mischief, especially if the average includes only a subset of all trades. 

Third, the initial charge was that traders had artificially depressed prices. Whether you gain from a price increase or a price decrease depends on which side to the market you stand. 

Forth, the divergence of interests is why buyers rarely collude with sellers. The first article seems to miss this point when it states, "the vast majority of the stuff we use to heat our homes and run our businesses is sold "over the counter" between two parties, who can, if they wish, conspire to make mischief." I can see how someone holding a book to buy oil at reported average can benefit by agreeing to sell some oil at sub-competitive prices if the contract reduces the reported average; but, this is hardly a conspiracy between the buyer and the seller. 

Twinkie Economics

Here is a nice opinion piece from the WSJ that uses the Rational Actor Paradigm to explain the negotiations between Hostess and the teamsters and Hostess's subsequent decision to file for bankruptcy. It also highlights the goal of nearly every teacher that students learn to think.

Mankiw's 10 Principles

Click here to view the Stand Up Economist's take on Mankiw's 10 principles. Ph.D. economists find this to be really funny.

Examples of rational actors

Hidden Cost of the ACA

The following memorandum illustrates one of the hidden costs of the Patient Protection and Affordability Care Act, aka PPACA, ACA, or ObamaCare. The Senior Vice President and Chief Operating Officer at Virginia Commonwealth University sent it to me because I employ hourly workers in my role as Chairman of the Department of Economics. The gist is that hourly workers must not work more than 29 hours per week. The incentive for the policy is that the ACA requires employers to provide health insurance to employees who work 30 hours per week or more. Thus, any hourly worker who used to work 35 hours per week will see their hours cut by at least 6. I doubt that the folks who passed the ACA wanted to reduce the hours worked by part-time hourly employees.

Here is the memo.

--

To Vice Presidents, Vice Provosts, Deans, Directors and Department Heads:

We have received guidance from the Governor's Office regarding an amendment to the Commonwealth of Virginia's Manpower Control Program and the anticipated impact of the federal Patient Protection and Affordable Care Act (the Act) on state agencies, specifically wage (hourly) employees.  The amendment mandates that wage (hourly) employees not work more than 29 hours a week on average over a 12-month period.  This action is needed now to mitigate the potential financial impact of the Act on the Commonwealth, which takes effect January 2014.

Cabinet Secretaries will report quarterly to the Governor the number of new wage (hourly) employees hired within their secretariat by agency.  This information will determine which wage (hourly) employees meet the definition of "full time" (i.e., employees who work 30 hours or more a week to be eligible for health benefits under the Act) as based on a retroactive baseline measurement period the Commonwealth must presume at this time began January 1, 2013.  Please note that violations of the Act carry ongoing penalties assessed for impacted individual employees and may be significant.  Budget language specifies that agencies are accountable for compliance and are responsible for all costs related to violations of the Act.

What does this mean for VCU?  Effective immediately, the university is adopting a prudent staffing approach, as recommended, and is implementing wage (hourly) employment restrictions.  Specifically, supervisors must immediately inform their current wage (hourly) employees that they must not work more than 29 hours a week on average over a 12-month period.  Human Resources is working with your personnel administrators on communicating this information to supervisors, timekeepers and hiring managers.  I appreciate your support for and strong encouragement of these compliance measures in the university's daily business operations.  For more information, attached are frequently asked questions (FAQs).  Please provide these FAQs to your supervisors, faculty and staff.  You can also link to the FAQs at http://www.hr.vcu.edu/pdf_docs/FAQs_29HourRule.pdf. 

This opinion argues that government policies contribute to low employment rates for low income groups by creating high effective marginal tax rates.

Phil Mickelson stated that he has changed his behavior in response to recent increases in taxes and promised more "drastic" changes. 

Is Voting Rational?

In this article George Will examines why voter turnout has declined. The money statements are: "Because the likelihood of any individual’s vote mattering is infinitesimal and because the effort required to be an informed voter can be substantial, ignorance and abstention are rational, unless voting is cathartic or otherwise satisfying." He continues by stating that people inclined not to vote will tend not to register to vote unless the cost of registering is zero or negative (a fine?). 

http://online.wsj.com/article/SB10001424127887323894704578113120622763136.html is an interesting article on the effects of a "fat"tax in Denmark.

The efficiency of social pressure

This article from the WSJ discusses the importance of social pressure in motivating behavior that reduces energy consumption. It points out that the bounded rationality of consumers makes the cost-benefit analysis difficult; they often fail to calculate accurately the future cost savings. It states that social pressure matters and can be an effective way to create intrinsic rewards for "good" behavior. Financial incentives also matter: the article has a good example of how customers responded to a message telling them that they would get lower rates if they shifted consumption to off-peak hours and "Plenty of shifting happened." 

The article asks, "Why would a landlord spend money on energy improvements if the benefit flows only to the renter paying the utility bill?" Could the landlord capture the saving accruing to the renter when the renter's utility bills decrease? If so, how?

Rational actors and organizational architecture

Why are some economics departments shrinking?

Here is a blog talking about the reduction in size of the Department of Economics at the University of Florida. It tries to use an analogy that treats Departments or Schools within a University as independent countries. Another approach, described here, argues that the reduction stems from a transfer price that is so low that the downstream unit wants to reduce the quantity produced and points out the incentives that exist when the transfer price is "too" high. 

As an economist, the news depresses me. U of F had an outstanding economics department. It makes me wonder about how best to structure the organization. Is a University best structured as a set of independent countries or should the University use a funding formula in which revenues accrue, at least partially, to the unit that paid the cost? If so, what is the best transfer price? Another option is for the Business Dean to apply the Coase Theorem and to ask the Dean of the College to pay for the positive externality the B-school is creating for the College. As an economist, I hope that the difference between the value of the economics offerings to the College and the sum of their incremental cost and the transactions costs is positive and that a mutually beneficial price exists.

Challenger

The Challenger disaster is a great example to illustrate how bad organizational structure contributes to bad decisions. Challenger exploded 73 seconds after liftoff on January 28th, 1986. The explosion killed Francis "Dick" Scobee (Commander), Michael Smith (Pilot), Judith Resnik (Mission Specialist), Ellison Onizuka (Mission Specialist), Ronald McNair (Mission Specialist), Gregory Jarvis (Payload Specialist), and Sharon Christa McAuliffe (Payload Specialist - Teacher in Space). Christa McAuliffe was slated to be the first teacher in space for the Teacher in Space Program. The accident occurred because O-rings between two sections of the booster rocket became brittle as a result of low temperatures the morning of the launch. The O-rings then allowed hot gases to escape, resulting in an explosion. (Preventing the accident is not “rocket science”. A former student told me that his engineering teacher explained accurately to the class the cause of the accident about 15 minutes after it occurred.)

1. What questions would you ask when trying to determine why the shuttle was launched in unsafe conditions?
2. Based on the answers and discussion in class, what solutions would you propose?

Watch the launch of the Challenger.

Remembering the mistakes of Challenger

Wikipedia has a good summary.

Here is another account of the decision to launch.

The schedule called for all contractors to recommend whether or not to proceed with the launch; level-4 contractors passed their recommendations along to their level-3 contractors, who in turn passed their recommendations along to their level-2 contractors. The level-2 contractors passed their recommendations along to mission control and the flight director there. Morton Thiokol was a level-4 contractor and reported to Marshall's Solid Rocket Booster Project, a level-3 contractor. “Temperatures for the next launch date were predicted to be in the low 20°s. This prompted Alan McDonald to ask his engineers at Thiokol to prepare a presentation on the effects of cold temperature on booster performance. [Alan McDonald  was Director of the Solid Rocket Motors Project for Morton Thiokol. NASA had contracted Morton Thiokol to build the Solid Rocket Booster used for shuttle launches.] … Thiokol's Engineering Vice President Bob Lund presented the conclusions and recommendations. … He read his recommendations and commented that the predicted temperatures for the morning's launch was outside the data base and NASA should delay the launch, so the ambient temperature could rise until the O-ring temperature was at least 53°F. … Marshall's Solid Rocket Booster Project Manager, Larry Mulloy, commented that the data was inconclusive and challenged the engineers' logic. A heated debate went on for several minutes before Mulloy bypassed Lund and asked Joe Kilminster for his opinion. [Joe Kilminster was an engineer in a management position at Morton Thiokol.] … Kilminster stood by his engineers. Several other managers at Marshall expressed their doubts about the recommendations, and finally Kilminster asked for a meeting off of the net, so Thiokol could review its data. … The managers seemed to believe the O-rings could be eroded up to one third of their diameter and still seat properly, regardless of the temperature. The data presented to them showed no correlation between temperature and the blow-by gasses which eroded the O-rings in previous missions. … Mason finally turned to Bob Lund and said, "Take off your engineering hat and put on your management hat." [Jerald Mason was a Senior Executive and Bob Lund was the Engineering Vice President, both at Morton Thiokol.] Joe Kilminster wrote out the new recommendation and went back on line with the teleconference. The new recommendation stated that the cold was still a safety concern, but their people had found that the original data was indeed inconclusive and their "engineering assessment" was that launch was recommended, even though the engineers had no part in writing the new recommendation and refused to sign it” (http://ethics.tamu.edu/ethics/shuttle/shuttle1.htm).

Organizations and People Involved

• Marshall Space Flight Center - in charge of booster rocket development
• Larry Mulloy - challenged the engineers' decision not to launch
• Morton Thiokol - Contracted by NASA to build the Solid Rocket Booster
• Alan McDonald - Director of the Solid Rocket Motors Project
• Bob Lund - Engineering Vice President
• Robert Ebeling - Engineer who worked under McDonald
• Roger Boisjoly - Engineer who worked under McDonald
• Joe Kilminster - Engineer in a management position
• Jerald Mason - Senior Executive who encouraged Lund to reassess his decision not to launch.

Asymmetric information and rational actors

Disney tightens up resort disability program

This article from CNN illustrates that the allocation method affects how people compete to obtain what they want. 

ACA / Obamacare explained

Click here for a humorous video that explains why health care is so expensive in the US and the effect of Obamacare on health care. It is a good introduction to the effect of incentives, moral hazard, the lemons market, and adverse selection even though some of the analysis is inaccurate. It also is illustrates the folly of passing a bill that no one has read.

Cost - Benefit Analysis of Buying Health Insurance

The article by George Will is critical of the Supreme Court's ruling that the ACA is constitutional. One interesting piece is the comparison of buying insurance and paying the fine for not buying. He argues that since the Court ruling requires that the fine be small in order to be constitutional, not buying insurance will be the rational choice for many people. 

This opinion says that the same. 

Another Negative Review of the ACA

This article describes recent evidence that the ACA is increasing health insurance premia and why the author had earlier predicted the increases.