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Faculty Freebies and Price Discrimination April 3, 2017

Posted by tomflesher in Examples, Micro, Teaching.
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Despite its nasty-sounding name, price discrimination is interesting and beneficial to some consumers. (Of course, when we move away from equilibrium to make someone better off , we usually make some other consumers worse off.)

Textbook publishers face a classic case where price discrimination would be useful: they want to charge students high prices for their textbooks, but because professors have the power to require a textbook of their students, they want to get professors on board as easily as possible. That usually means lowering the price of the book for professors (to make it easy to get); I get tons of free books every semester.

Publishers don’t want those free books to get into students’ hands, though – that means either a student didn’t pay for a book because a virtuous professor gave a freebie away, or the student paid, but paid an unscrupulous professor for a book the professor got for free! If a student is going to pay for a book, the publisher would rather get a cut of it.

Goods that are difficult to resell are easiest to discriminate on. Publishers have, for a long time, printed “INSTRUCTOR’S REVIEW COPY – NOT FOR SALE” on books. That has some effect, but you still have the possibility of paying for a book on Amazon or AbeBooks.  One way to keep students from buying these books is to sink money into online resources, which are tied to students’ identities. That way, even if the student buys a used copy of the physical text, they still have to pay for access to the online resources. Still, not every instructor uses those, so this isn’t foolproof.

One publisher, Cengage, has taken an additional step with Greg Mankiw’s principles book: not only does it say “Compliments of N. Gregory Mankiw” on the front, along with the usual “Instructor’s Edition” language, it has my name embossed on the cover. “Specifically prepared for” is printed, and “Thomas Flesher” is stamped into the front cover. (Of course, I prefer Tom, but you can’t be too picky with freebies.) This is a pretty clever means to keep me from reselling the book, at least unless I have a high name value. I can easily imagine a student wanting to purchase a book specifically prepared for Dean Karlan or Paul Krugman, for example, if either of them still teaches Principles using Greg’s book. (I doubt it, since each of them has his own.)

Either way, Cengage is trying to protect what’s likely its largest profit-producer by minimizing the number of free copies students can use.

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The Do-Nothing Alternative March 16, 2015

Posted by tomflesher in Examples, Micro, Teaching.
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Consider the following situation: You are at a casino. You have a crisp new $100 bill in your pocket and an hour before your friend arrives. There are several options available: blackjack, poker, and slot machines. Each has its advantages and disadvantages. Blackjack offers a 45% probability that you will double your money over the next hour, but a 55% probability you will lose it all. Based on your understanding of statistics, you know this means you should expect to have about $90 at the end of the hour. Poker is a better proposition – since it is a game of skill, you have a 60% chance of earning an extra $50 (for a total of $150), but a 40% chance of losing all of your money. That means you can expect to have about $90 in your pocket at the end of the hour. Slot machines, to go to the other extreme, are a highly negative expected-value proposition. You stand a 1% chance of winning $1000, but a 99% chance of losing all of your money. As a result, you could expect to have about $1 in your pocket at the end of the hour.

Thinking like an economist, you quickly winnow your options down to blackjack or poker, since you cannot abide such a risky proposition. Then, however, you’re stuck – the expected values are the same. Which game is it rational to play?

Similarly, consider this problem raised in a freshman course on ethics: You are on your way out of a coffee shop carrying a double shot of espresso and a $1 bill you received as change. Two homeless people, one man and one woman, each step toward you and simultaneously ask you for the dollar. Since you don’t have any coins, you cannot split the value between the two people. Who should you give your dollar to?1

What do these two situations have in common? In each of them, you are attempting to choose between two options that result in negative consequences for you. In the gambling scenario, you have two options, each with the expectation of losing $10. In the coffee shop scenario, you have two people each asking for $1. In neither case is there a compelling reason to choose one option over the other. The underlying assumption, though, is that we must choose an option at all.

The do-nothing alternative is often (but not always) a hidden option when making choices. For example, in the gambling scenario, you have the option to literally do nothing for an hour until your friend arrives. This leaves you $100 with certainty. In the coffee shop scenario, you have the option to politely refuse each person’s request, leaving you free to keep your dollar. Not every situation allows a do-nothing option; for example, a baseball manager faced with the option of starting his worst starting pitcher or a pitcher who is usually used only in long relief cannot opt to simply start no pitcher. However, a voter who is disgusted with all available candidates may bemoan his “forced” vote for the lesser of two evils without acknowledging that he has the option simply not to vote at all. The do-nothing option is often low-cost but has low returns as well, making it a great way to avoid choosing the best of a bad lot, but a lousy choice for a firm seeking growth.

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1 This was met with considerable debate about the probability that the homeless woman had children.

Anecdote Alert: Do restaurant deposits depress attendance? January 1, 2015

Posted by tomflesher in Examples.
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Last night I spent New Year’s Eve at one of my favorite restaurants, Verace in Islip, New York. I actually did New Year’s Eve there last year, too, and there were three very interesting changes. The upshot is that the restaurant, though it had a fantastic menu, was significantly less full than it was last year, and the crowd skewed slightly older.

First, the price of the dinner was $65 last year and $85 this year. That corresponds to about a 30% price hike. That might deter some people, but I’m skeptical. The price-elasticity of demand for restaurant meals is about 2.3, or very elastic. (That means that if the price of a restaurant meal changes by 1%, the quantity of restaurant meals sold would drop about 2.3%.) If that’s the correct elasticity to apply here, that would explain a 69% drop in attendance, but I’m not so sure that restaurant meals on New Year’s are as elastic as restaurant meals during the rest of the year. The well-known Valentine’s Day Effect causes price elasticity for certain goods (cut roses) to drop on Valentine’s Day, and since a meal at home isn’t a close substitute for a restaurant meal on a special occasion, I’m skeptical that this price change would explain the precipitous drop in attendance.

Second, the restaurant required a deposit this year – $50 per person, returned at the beginning of the meal as a gift card. This was my first hypothesis, but I’m not sure it’s much of an explanation. For one thing, I put down my deposit on Monday, so there was no real loss of value. $50 per person to hold a spot is well within the income for most demographics that you see at Verace most nights [more on this in a moment], especially since it operated as a credit on the bill. No dice here, really.

Third, this might be the big one – Verace is part of the Bohlsen Restaurant Group, which operates a couple of restaurants at slightly different price points. This year, BRG made a big deal of advertising different, keyed experiences at their different restaurants. Specifically, Teller’s was a much more expensive steakhouse offering, Verace was a meal only, but Monsoon – their lower-priced, Asian fusion restaurant – had a modular menu with options of $75 for a meal (a bit cheaper than Verace, but not much) and $75 for an open bar. The open bar and Monsoon’s dance floor almost surely made it more attractive to younger revelers. That also explains the shift in demographics – Verace’s younger crowd may have been cannibalized by another BRG restaurant.

In the alternative, our waiter’s hypothesis: The manager did a great job seating people. “This guy,” says he, “is a magician.” He may be, but I’m more interested in seeing Monsoon’s numbers.