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a blog from young economists at Nova SBE


Is waiting in line Pareto efficient?

“Our willingness to wait reveals the value we place on the object we’re waiting for”—Charles Stanley

On the opening day of Ikea Matosinhos, the first 100 individuals to arrive at the store with an item of antique decoration received an Ikea gift card worth 100 Euros. Also, in June of 2014, a well-known Spanish brand, Desigual, gave to the first 100 half-naked customers who arrived early to their new store in Berlin two items of clothing. Situations like this are very common, but what is really interesting is to think about them in economic terms: what happens when we wait in line for hours to get something for free?

Let’s think about this in a Pareto efficient sense. A situation is Pareto efficient “if there is no way to make any person better off without hurting anybody else.” Intuitively this would mean that if there is some way of making some group of people better off, it should be done. So, regarding the second example, for instance, why shouldn’t the brand offer cloths to 100 individuals on the condition that they would have to be the first ones to arrive at the store?

Firstly, there is a cost of receiving the brand’s cloths or accessories, namely the cost of waiting in line. In this context, we move from the economic concept of “willingness to pay” (i. e. the maximum amount an individual is willing to sacrifice to acquire a good) to a similar one: “willingness to wait”, which is no longer measured in monetary terms but in hours. The customers are willing to wait outside the store in order to be the lucky ones to receive the cloths because they really want to earn the brand’s cloths and because they value them. In contrast, individuals who do not value this brand’s cloth won’t wait. So, the willingness to wait of the latter individuals is lower than the willingness to wait of the first group of individuals.

Secondly, there is the possibility that the individuals that waited in line sell the items they got to the ones that were not willing to wait because of the aforementioned fact: the individual’s willingness to wait is different. This leads to an inefficient allocation of the items, since willingness to wait does not deplete all gains from trade (i. e. there would be some individuals willing to trade the cloths after the cloths have been allocated). Consequently, a Pareto efficient outcome is not possible, because this doesn’t represent equilibrium. There is someone who is willing to supply an extra unit of the good at a price that is less than the price that someone is willing to pay for an extra unit of that good. Generally speaking, these two persons could be better off.

Finally, we know from Microeconomics that when we allocate a good using a price set in monetary terms, in equilibrium, the money paid by the demanders provides benefits to the suppliers of the good. In contrast, what we conclude from the example above is that allocating a good using waiting time will benefit neither the supplier nor the buyer, since waiting in line imposes a cost on the consumers of the good and provides no benefits to the suppliers, in this case, the brand. Consequently, waiting in line can be seen as a part of the relative price. Moreover, waiting in line results in a loss of economic efficiency, since people who wait in line pay a price but no one else receives a benefit from the price these people pay!

#755

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Tale of the Naïve Consumer and the Wicked Minibar

Exhausted and dehydrated, the tourist arrives to his hotel room. He looks around and sees the classic minibar waiting. He walks across the room hesitantly, only to confirm as he opens it that the prices are exorbitant, and he finds himself thinking yet another time “Two euros?! I can literally cross the street and find a water bottle for fifty cents! Who buys this stuff?” The answer to this might be the naïve consumer, as we will see in this blog.

Hotels compete to offer the lowest possible rates to their consumers. In order to being able to offer the best possible discounts and capture sensitive-price consumers, they have to find other sources of revenue, which take the form of hidden charges or “shrouded fees”. How does that work? Let’s assume the cost of the supplied room is 150€. In addition, let the cost of the minibar be 10€.  If the hotel charges 30€ for the minibar, in perfect competition it would have to charge 160-30=130€ for the room (total cost needs to equal total revenue). The hotel room can be priced below marginal cost and the price of the add-on is above marginal cost. Our tourist, being what we will call the sophisticated consumer, will actually reap the benefits of the below marginal cost room fee without paying for any water or peanuts. But that’s not the case of every consumer.

As it is known, in perfect competition market agents are rational and there is perfect information, so firms have no incentive to “hide” prices. However, if there is consumer myopia, firms will try to exploit that. We can find two types of consumers – the sophisticated and the naïve. While the sophisticated consumer is well informed and smart about prices, markets and quality, the naïve consumer is the one that, by buying what’s inside the minibar at the high price, is subsidizing the low-priced room and making the sophisticated consumer better off.  Additionally, the naïve consumer doesn’t take the price of the minibar into account when choosing a hotel room, whether the sophisticated consumer looks for the lowest priced room with the most add-ons (not only minibar but dry cleaning, parking services, you name it), that he can gladly substitute away by bringing his own water and snacks to the room.

And so it seems the sophisticated consumer is fine and hotels should be fine as well. In fact, if the number of naïve consumers is sufficiently high, there is an equilibrium. And although we might be tempted to say that naïve consumers would have an incentive to deviate from this situation, this is not necessarily true – if we incorporate elements such as uncertainty about prices outside the hotel, the fact that the  minibar products are available at late hours when outside shops might be closed , or even that some minibar supplies would be hard to find outside the hotel, we end up concluding that this consumer can be perfectly rational in his decision. At the end of the day, it’s all about individual preferences.

Inês Gonçalves, 743


Do failed health systems in Africa make epidemics inevitable?

Individual behavior plays a central role in the disease burden faced by society (Kessler/Zhang, 2014). Seldom has this impact of health behavior on society and also on economy been so strongly evident as at the current Ebola crises in West Africa. The BBC Africa Debate in Ghana discussed the role of the weak health system in West Africa and its challenges to cope with Ebola. The discussion included inter alia representative of the Ghana and Liberian governments, of the WHO and of Medicine sans Frontières, as well as the audience, representing the voices of (educated) common people but mostly doctors and nurses, faced by the problem.

Two central problems haven been clear due to the discussion. First, the weak health system in some West African countries is mainly not a problem of lack of equipment or capacity constraints but one of unhealthy public behavior. In West Africa, population strongly deviates from rational health behavior, causing negative externalities. Second, in this setting of a weak health system, the intervention of government is highly necessary. However, not only did the government action fail to stabilize the health system, but rather caused an atmosphere of mistrust.

In countries mostly hidden by Ebola, Guinea, Liberia, Sierra Leone, the population is not taking the standard requirement to protect against the spread of the disease. Families want to take care of Ebola infected or passed family members themselves instead of visiting the hospitals or sterilisation centers. They do not consider, that while washing or burying their beloved they could get infected. Prevention care like washing hands or not eating from stand sides are considered time costly, so people are not seeing the benefits and are therefore not engaging in this behavior. How important preventative care is shows in Nigeria which claims, after six week of no cases, to be free of Ebola. In Nigeria, the population is aware of the severity of the disease and behaves in accordance by e.g. not shaking hands with each other. This behaviour causes positive externalities to the whole society and resulted in the defeat of the epidemic.

What responsibility does the government have in this scenario? A question asked to each countries representative in the discussion, mutually answered with “none”. No wonder why not only the lack of a public communication system causes irrational behavior, but also the mistrust in governmental information’s and actions. In Liberia, the government reacted to the irrational behavior of the population with a temporary legal punishment for every unreported Ebola case which caused no impact to cope with Ebola. In Sierra Leone a recent three day lockdown of the population has been used to hand out bars of soap, to inform on how to prevent infection and to survey household to discover new cases. 130 unreported cases of Ebola have been found, showing the lack of trust the general population has for government actions in hospitals and sterilisation centers.

In conclusion, the BBC Africa Debate resulted in:

It was a very hard task for West African government to defeat Ebola from the beginning, because the epidemic was unknown and needed a long time to be discovered. However, the weak health system in Guinea, Liberia and Sierra Leone, resulted in further difficulties to cope with it. The central problem is thereby the irrational behavior of individuals caused by uninformed decisions and mistrust in government actions. This behavior results in negative externalities, making it impossible to handle the spread of the virus.

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Uncertainty and the Black Swan Theory

Uncertainty touches most aspects of life and economic activity. Decision making under uncertainty and dealing with the unknown has motivated academic research in an effort to understand its multidimensional aspects and implications.

The Black Swan Theory, exposed in The Black Swan – The Impact of The Highly Improbable, a work of Nasim Taleb, is one of those efforts, and its approach to uncertainty and the unknown attracted the attention of the international academia.

This theory presents a critical look on the works over uncertainty of the mainstream economic thought, such as the Expected Utility Hypothesis, developed by Bernoulli and revived in the 20th century. Under this hypothesis a test is made to a consumer who faces a decision between a finite set of mutually exclusive options, each option with a finite and clearly defined set of possible outcomes, and each outcome with a certain known probability. The representative consumer will then chose the option which maximizes his expected utility.

The Black Swan theory turns this framework of analysis upside down. It states that these sterilized models, close to mathematical perfection, are a domestication of the uncertainty with a low descriptive and predictive validity. It falls in what Taleb defines as a ludic fallacy. As Taleb exposes, “In the casino, you know the rules and you can calculate the odds”[1]. This casino uncertainty only exists under an anthropogenic set of rules and tricks such as the rational actors and utility maximization. But people have been shown to make inconsistent choices and systematic “irrational” errors, and Taleb uses the Empirical work of Tversky and Kaneman to show it.

To expose the multidimensionality of uncertainty, Taleb resorts to two hypothetical worlds, the Extremistan and the Mediocristan.

In the Mediocristan, all the uncertainty is domesticated. It is often a physical quantity, which gravitate around a certain range. Adding one person to a 60 people sample will not change significantly the average height of the group, even if it is an outlier. The measures are not scalable, one cannot add zeroes to her income with no greater work. A doctor or a craftsman who wish to raise his labour income, disregarding efficiency changes, needs to work more

In Extremistan the quantities are informational, they have no physical boundaries, “one single observation can disproportionately impact the aggregate”[2]. It is a winner-take-all-world. Incomes are scalable, a stock broker may lose or win a fortune in a day.

The inaccuracy of maximized expected utilities is in its mediocristian’s logics, out of the extremistan world we live in. A world whose history was written by successive Black Swans[3], the phenomena which gives name to the theory. Sterilized Mediocristian’s uncertainty has a poor connection with the real one. Close to everything in social reality is a product of rare but consequential events, and real life does not inform you about the odds. The uncertainty sources are unknown and maximized expected utilities are theoretical abstractions absent form real life.

[1] Taleb, Nassim Nicholas (2010), The Black Swan: The impact of the highly improbable, Penguin Books

[2] ibidem

[3] A black swan is a rare and unpredictable event with an extreme impact, and which may seem explainable in a retrospective analysis. Events such as the rise of the internet, the Perestroika, or the 9/11 are examples of black swan events

750, Gonçalo Pessa


The Microeconomic Value of Internet

Internet is just everywhere at anytime. Teens constantly look to their parents and ask themselves “When they were of my age, how could they live without internet?” How could they live without Facebook, Google or Wikipedia?”. In truth, how much is internet or its platforms valuable for us? How would be our life today without it?

Economists used these questions to calculate the value of internet and its applications, not without some difficulties first. Trying to quantify how internet changed our life is hard because many changes had no price, another problem is that measuring the value of a good is much harder than measuring its cost, due to the question “How would be our life today without it?”. Two methods to measure the monetary value of a good or service are the “compensating variation” and the “equivalent variation”. The compensating variation estimates the maximum amount we would be willing to pay to have the good, while the equivalent variation estimates the maximum amount we would be willing to accept to let go of the good.

One way to measure the value of online search would be to measure how much time we save compared to the methods that we used before Google, those ones like searching in big books in big libraries. University of Michigan researchers found that answering the question “In making cookies, does the use of butter or margarine affect the size of the cookie?” using a library took 22 minutes (ignoring the time of going to the library that can be substantial) while answering them using Google took 7 minutes, approximately. Google saved 15 minutes. Hal Varian, chief economist at Google, converted this time to dollar savings using the average wage, and estimated $500 per adult a work year, $1,37 a day.

Now that the cost of getting questions is so low, we ask a lot more questions. In other times, we would just go to the library if the question was really important. Hal Varian took this effect into account and used it to estimate a “demand curve for questions” as a function of the “cost of getting answers”, he obtained $1,37 per day. (i.)

Another way to calculate the value of internet is through the consumer surplus. The consumer surplus is “an economic measure of consumer satisfaction, which is calculated by analyzing the difference between what consumers are willing to pay for a good relative to its price” (ii). Shane Greenstein from the Northwestern University and Ryan McDevitt of the University of Rochester calculated the consumer surplus generated by the spread of broadband access (that includes the surplus generated by internet services, for which the consumers pay for the broadband). If a person in 1999 paid $20 a month for internet access and in 2006 paid $17, there would be a consumer surplus of $3 per year. The researchers estimated that in 2006 broadband was generating $39 billion in revenue and $5 billion in consumer surplus a year. But this numbers probably underestimate its value, internet in 1999 was not so valuable as in 2006, thanks to new platforms like Facebook and Google. (iii.)

There are other ways to estimate the value of the internet and the services it provides, but those others methods will probably underestimate its value, principally because they do not take into account its long-term value. In the future, the big human step of passing to have access to all information ever produced will be considered a turning point in human history and the economic advances generated by global access to all information will be considered the true value of the internet.

Marli Fernandes


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The Norwegian Wine monopoly – all bad or economically beneficial?

In Norway there is a state owned wine monopoly, Vinmonopolet, which has a monopoly on all beverages containing more than 4,75 % alcohol. As we know, monopolies tend to give higher prices and the alcoholic beverage prices in Norway shows that Vinmonopolet is no exception to this. Eurostat studies actually show that Norway is the most expensive country in Europe for alcoholic beverages with prices 259 % higher than the average price in Europe. Although Norway is more expensive than the average for most goods, the price of alcoholic beverages stands out. As a lot of consumers rage about the high prices and the inconvenient opening hours of Vinmonopolet, we should ask ourselves if Vinmonopolet is all bad, or if it is actually economically beneficial for our society.

To get a deeper understanding of this question, we first state the obvious: with alcohol come problems. When people get intoxicated, they hurt themselves and others and cause damage more easily. In the cases of alcoholism, people are also less likely to contribute to the community. The question to ask is therefore: who will pay for these negative effects of alcohol? Who will pay the hospital bill for the reckless intoxicated guy falling down the stairs? Who will make sure the alcoholic old man has a house and enough money to support himself?

In a lot of countries, the individual him/herself will pay the hospital bill, and there will be no social government to support you with a house and monthly income when you are not able to work. Thus, the consumer him/herself pays (at least close to) the actual costs of alcohol consumption. However, this is not the case in Norway. Since every Norwegian is entitled to free health care and governmental support if we cannot work, the cost of one man’s abuse of alcohol will be a cost of the society. The tax payer’s will have to cover the medical bill of the guy falling down the stairs, and the house for the old alcoholic man. Hence, the consumer of the alcoholic beverage does not pay the true cost of consumption, but pushes some of these costs onto the society.

In the case of Norway, this means that if we had an open market for alcoholic beverages, the consumer would pay enough money to cover the seller’s economic profit, but he/she would not cover the cost that society incurs when alcohol is consumed. The economic logic behind the monopoly is therefore to reduce the consumption and negative effects of alcoholic beverages through high prices and restricted availability, and to make the consumer pay as much of the actual cost as possible. From an economic perspective, the wine monopoly can therefore be a good thing for you and me as tax payers in a social country. If it is the most efficient way to reduce the negative effects of alcohol will be another discussion.

1992


Oil taxes and the Credit Impôt Program in France

On the economic policy in France, a powerful tool is used : the TIPP : « Taxe Intérieure sur les produits pétroliers », interior tax on oil products.
In the end of December 2003, this tax represented 60 percent of the price of oil in France. Hence, the average price of « sans plomb 95 » (one brand of oil) was 98.7 euros total taxes, 23.6 euros without taxes. The taxes TIPP represented 75.09 euros.

This TIPP provides a good percentage of the budget of the government. The expenditure on oil was inelastic in prices, the government can increase the price without risks. This tax has the advantage to reduce the interior consumption of oil, that implies on the reduction the energy dependance vis a vis of the others natural sources of energy.

Now, we can analyze the impact of this tax with a program of tax credit in France,”Le credit impôt”. This is a particular program to help and boost the consumption. It’s a rebate is a total or partial reduction performed on the amount of tax payable by the taxpayer : it differs from an abatement or exemption that affect the tax base, or reduced participant tax calculation .

Figure 1:

IMG_8268

The initial budget constraint is AB, and the consumer maximizes its utility under the indifference curve U2 by consuming the level of goods in C, buying 1200 liters of oil and expends 13 800 euros for another good.
If the tax is equal to 50 cents by liter, the price increases of 50 percent, shifting the new budget constraint to AD.
With the elasticity of price of -0.5, the consumption will decrease of 25 percent, from 1200 to 900 liters, represented by the point E maximizing the utility under the indifference curve U1. For a increase of 1 percent of the prices of oil, the quantities demanded decrease of 0.5 percent.
However, the program of credit credit impôt influence this effect.
For example, the surplus by person of the tax is equal to 450euros (900 liters x 50 cents per liter), each consumer receive a credit impôt of 450 euros.

How this increase on income can affect the consumption of oil ? The effect can be show graphically by shifting the curve of the budget constraint.
Which quantity of oil our consumer will be buy now ?
The elasticity of income of the demand of oil is on average equal to 0.3. Because 450 euros represents the increase of 3 percent of income (450 euros/15 000 euros=0.03 ), we can conclude that the reduction fiscal increases the consumption of 0.9 percent (0.3 x 3 percent) of 900 liters, or 8.1 liters.
The new choice of consumption maximizing the utility on H reflect this. With the program of credit impôt, the tax could reduce the consumption of oil to 291.2 liters, from 1200 to 908.8 liters. The elasticity of income of the demand of oil is relatively « low », the effect of income of program of credit impôt is dominated by the effect of substitution,(The substitution effect is one component of the effect of a change in the price of a good upon the amount of that good demanded by a consumer) and the program with the credit impôt decrease a lot the consumption.

A tax on oil good is putting in application when the consumer buys initially 1200 liters of oil on the point C. After this tax, the budget constraint shifts from AB to AD and the consumer maximize its preferences by choosing the optimal point E, with a consumption of oil equals to 900 liters. However, when the surplus of this tax is redistributing for the consumers under the form of credit impôt, the consumption increases to 9O8.8 liters on the point H. Despite this credit impôt, the consumption of oil by the consumer decreases and the level of satisfaction decreases also.

The figure 1 shows that the tax program on the oil products tends to increase the poverty of the consumers who has a low income, because H is under the indifference curve U2. Some consumers with a low income have a real surplus from this program if for example, they consume on average less oil than the group of consumers which the consumption determined the credit impôt.
In conclusion, by the introduction of this tax, the effect of substitution induces the poorest consumers.

So, we can ask us, why introduce this type of program ? Nowadays, the aim is to reduce the dependance of natural energy and to promote the protection of the environment and find a new way to have less pollution.

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The Australian Social Security System

Many experts point to Australia and its mandatory system of funded pensions as a model for other countries to study, but how does it really work?

The retirement income provision in Australia is involved into a three pillar arrangement comprising Age Pension, Superannuation Guarantee and other long term savings through property shares and managed funds.

The Australian Age Pension is a welfare program targeting old-age poverty. It is given when retirement income and assets provided under the other pillars exceed statutory thresholds. In this way, it is a means-tested program, meaning that eligibility depends on the current income or assets of the elderly, ensuring that government transfers are received by the poorest aged, generating significant redistribution.

Age Pension is payable to women and men aged 65 years and over. A higher pension is payable to a single person than to married couples; this tries to solve the fact that married couples usually have higher social security wealth than single people, but it can create moral hazard problems, couples might get divorced or stay single in order to have a higher pension.

Most Australian retirees source of income today is age pension, but this will change over the next decades as more Australians reach retirement with longer periods of Superannuation Coverage (the legislation that imposed Superannuation Guarantee was just approved in 1992).

The Superannuation Guarantee (or Super as Australians call it) emerged in response to lengthening retirements and a general demand for more ample retirement incomes. Government initially expanded the Age Pension, but to boost retirement incomes, increase national savings and control the growth of government expenditure (indeed, guarantee the sustainability of social insurance) it created the Superannuation Guarantee.

The Super mandates employers to contribute a percentage of the worker’s earnings to a superannuation fund of the choice of the employee (9% every month); if they fail this, they will be subjected to the Superannuation Guarantee Charge. It applies to all employers and employees from 18 to 65 years old. Contributions are fully vested (meaning that the member has right to all accrued benefits), fully preserved (the benefits must remain in a fund until the retirement) and fully funded (today’s savings are invested in various assets in order to pay future benefits). Retirees can opt by lump sum pensions or an annuity with tax/transfer incentives to encourage income streams.

A problem with the Super is the low preservation age (55) together with the rule that workers need to leave the labor force to access funds, creating an incentive to retire early and increasing the risk of inadequate income late in life. There is even one more benefit to early retirement in Australia. Earning tax bites more severely in the ages of retirement; by retiring, Australians can avoid paying this tax; the net result is that people in Australia lose money by working past age 55. This social security system that penalizes additional work beyond the retirement age ends up being very costly. The Australian government will rise the low preservation age to 60 in 2015, but it should also adjust the system to reward work at old ages in order to mitigate the moral hazard effect of social security.

Currently, most source of income for retirees is Age Pension, current generations of workers need to save money for their own retirement while they need to support the current generation of retirees. Since the Age Pension is funded by general revenues and if the government decides to increase revenues to finance the system by increasing taxes, it will offset the saving benefits promised by privatization, Australians will be increasing national borrowing and saving with no effect on capital stock. If the government achieves in the next decades the goal of providing Age Pension just to a few percentage of the population, this problem will disappear.

Indeed, the Australian social security system seems more sustainable than most part of social security systems in developed countries, but it is without doubt that some changes are needed and just time will say its viability.

Marli Fernandes


Rewards and Incentives in the Workplace

When comes to the nature of the human behaviour, there are two types of motivation: intrinsic and extrinsic motivation. They play an important role when talking about rewards and incentives in the workplace.

Extrinsic motivation means that the individual incentive comes from external factors, such as the well-known cash awards and bonuses received by the employees.

On the other hand, intrinsic motivation refers to a stimulus that comes from within each person. For instance, having an exciting job. It is related to each individual deep-rooted desires and what he wants to achieve. And because we are not all the same and every person has different intrinsic motivations, it is important for employers to know the employees. In fact, understanding how different employees can be different motivated will enable firms to better categorize their own needs.

The relationship between employers and workers may be seen as an agency agreement where the employer plays the role of the first part (the principal), and the employee plays the role of the second part (the agent). For that reason, motivating the employee means solving the problem of the agency theory. To prevent the agent of the moral hazard, the agency agreement should offer the second part the best option he can get. When the agent avoids (or neglects) the best effort he can make, it is said that he is doing a shirking strategy. That is why the agency agreement and the principal should assure that the agent does not intend to do the shirking strategy. There is also another problem concerning the agency agreement which is weather the two parties have asymmetric information. In which concerns motivations, this problem reinforces what was mentioned before about knowing well the employees. In order to know if their effort to motivate the agents is being translated in their performance, employers can use performance measurement techniques

Although common sense makes us think that employers can only deal with extrinsic motivation type, it is becoming commonly accepted that workers can also motivate their own employees intrinsically. It may be more complex to do so, but certainly it will improve the agency agreement and it will benefit not only the employer but also the employee.

All of what was mentioned before leads us to a central question: What do employees want from work? Money is probably the first thing that crosses our mind. And in fact, work is about money. That is why fair wages and payments are the cornerstone of worker’s happiness. But people want more from work than only money. Talking about that, it is important to credit Frederick Herzberg, author of the Two-Factors Theory (1968). In his theory, Herzberg refers that individuals are not content with “low-order needs” (such as minimum salary levels). They want to accomplish more sophisticated and “higher-level” needs: achievement, recognition, responsibility, advancement, and the nature of the work itself. This is what really distinguishes jobs and what should be implemented in each individual workplace. Motivate the individual, intrinsically or extrinsically, has much to do with a firm performance and consequently with the firm’s profit.

N 746

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Public good turned bad?

The Public-Private Partnership Program (PPP) of the Philippines was established as a flagship program to achieve the Philippine Public Investment Program. The program intends to provide the public with adequate, safe, efficient, reliable, and reasonably priced infrastructure and development facilities while affording the private sector a level playing field, reasonable returns and appropriate sharing of risks.

One of the biggest privatization projects of the government is the extension of the Light Rail Transit (LRT). Since its operation in 1984, LRT is a metropolitan rail system serving Metro Manila area. It is operated by the LRT Authority (LRTA), a government-owned and controlled corporation, under the authority of the Department of Transportation and Communications. The LRT has been one of the cheapest and quickest ways to travel within Metro Manila, and with the heavy traffic around the area, more and more commuters are opting to take the LRT, thus, resulting to congestion. With the growing demand, the government said it can no longer solely cover the costs for its operation and maintenance, and provision of new train coaches; therefore, the need for partnership with the private sector.

The project aims to provide rapid and reliable access to and from the densely populated residential sub-urban communities south of Manila, and the various strategic commercial, industrial, and educational districts in Metro Manila. According to the Public-Private Partnership Center, savings in travel time and costs will make the mobility of people and goods in the area significantly faster and less costly. The project aims to increase average weekday ridership from 560,000 to 820,000 passengers in 2015.

With such improvement, as stated by the administration, many are still unfavorable of the proposition and privatization of the LRT. The government’s core argument for fare hike proposition is that it can no longer subsidize the system, thus the need for private investor cooperation. However, the regulatory risk guarantee clause specified in the contract draft states that infrastructure can only be paid for from user fees or taxes. When government commits to allow investors to earn their return from user fees, it is important that that commitment be reliable and enforceable. The President articulated, during his speech at the PPP Summit, that if private investors are impeded from collecting contractually agreed fees – by regulators, courts, or the legislature – then the government will use its own resources to ensure that they are kept whole. Then the question of where will the government collect the funds for the LRT’s guarantee subsidy arises. The national budget deficit is still huge, and the government remains heavily indebted with more than Php 5.38 trillion in outstanding debt.

Critiques argue that the privatization of the public transportation system would punish the public with exorbitant fees and increase government debt. The government may argue that the private sector will have to carry the costs (eg operation and maintenance) but if firms won’t be able to gain profit from the partnership, the government will have to subsidize the firm’s loss in order to meet the agreed upon revenue; hence, transferring what was used to be a subsidy to the commuters to private firms.

The government’s intention of creating a more efficient public transportation system can be improved with the establishment of public-private partnership. However, the government has to lay out a contract that would not compromise and burden the public in order to ensure private firm’s cooperation. The LRT, as a mode of mass transportation, is a public investment imbued with public interest. It was designed and intended to provide a reliable, efficient and affordable system of transportation for the public. Its true measure of viability should depend on the social gains it creates for the people and not the profits to private firms.

N 714


Studying online helps the education market.

From the microeconomic theory, we know that education is to be considered as a quasi-public good, which implies positive externalities in the market. The traditional answer from the government to correct this problem is to subsidize the schools. In this way, the price of education will be lower and the demand for studying will increase matching with the social optimum.

It is time to update this old scenario with the technological change led by internet that occurred in the academic arena, the introduction of the so-called MOOCs (Massive Open Online Courses). The MOOCs are usually free online courses provided by the same universities or other institutions, which charge the online students just at the end of the course to get the certificate (http://www.thecrimson.com/article/2013/10/2/edx-id-verified-certificates/).

The MOOCs are born with the aim to open the door of the education to new categories of students such as pensioners, workers, housewives etc. in order to democratize education (http://www.aacu.org/diversitydemocracy/2014/winter/jaggars). In particular, those consumers, which rely on the lower tail of the demand curve. In words, the students whose ability to pay, and consequently the expectation of a service’s quality, are lower. Therefore, on one hand the demanded quantity for education increases, on the other hand the expected quality of the service gets lower. Nevertheless, how suggests F. Hollands from the Columbia University, “MOOCs may be an effective learning mechanism for highly motivated, self-directed learners who have strong reading skills and high bandwidth internet access”, not really democratic though (http://www.unescobkk.org/fr/education/ict/online-resources/databases/ict-in-education-database/item/article/can-moocs-help-democratize-access-to-education/).

The introduction of these free learning platforms leads to an increase in the supply of education, thus the students will have access to more educational services for the same price, no matter which category they belong to. The new optimal allocation in the market will be given by a new increased supply (comprehensive of MOOCs) and a greater societal marginal benefit. It could be affirmed that since the supplied quantity becomes greater the price should be higher as well; therefore, the new allocation does not represent a sustainable optimum. It has to be considered though that, in the reality, the difference between the old equilibrium price and the new equilibrium prime is approximately nil. This is due to the economies of scale that the universities have offering the MOOCs. For every new student the costs decrease (http://johnhcochrane.blogspot.pt/2014/02/mooconomics.html). Hence, the MOOCs could be used as a more efficient instrument to correct the initial market inefficiency given by the externality related to the nature of this quasi-public good, which is education. This could lead to a reduction of the deadweight loss in society’s welfare.

However, an increase in the number of graduates, leading to higher unemployment rate, could also diminish the societal marginal benefit of having more students (http://www.ncpa.org/sub/dpd/index.php?Article_ID=24463). Yet there are some evidences that e-students are most interested in the course itself rather than in the certificate. For instance, 95% of the students enrolled in the online courses offered by Harvard and MIT dropped before getting the certificate (http://www.bloomberg.com/news/2014-01-21/harvard-online-courses-dropped-by-95-of-registered-study-says.html).

The MOOCs represent a new solution, which still needs to be improved in terms of targeting the offer to categorized users and in terms of building the right incentives in order to reach a more efficient solution. Moreover, the population does not seem to be prepared to use effectively this new instrument. Yet such innovation can be used to provide educational services in developing countries where still there is the majority of the population does not have access to this market.

Francesco Cestari – 731


Monopolies, not as bad for consumers as you might think.

“Economic progress, in capitalist society, means turmoil.” Joseph Schumpeter

Each good has its own set of buyers and sellers, which constitute the market of that good. One very special kind of market structure is what is known as a monopoly. A monopoly is basically a market structure where there is only one firm producing in the market. This particular situation gives the producer (the sole supplier) in question full power over the quantities provided or the price it establishes. There are a lot of examples of monopoly, from the Portuguese electricity market monopoly power of EDP in the 20th century to Monsanto’s dominance of the US seed industry.

This monopolist will not choose to supply the market in terms of quantity or price randomly. As it is the sole firm on the supply side, it will take on this advantageous situation to choose one that, in theory, most benefit it; theoretically the one that gives the highest profit. To do so, it usually sets a higher price compared to the one that would be verified with normal competition conditions at the cost of less units sold. This is will make the firm better off as it will largely increase its profits. Conversely, consumers will buy less of that good and will pay a higher price. This will make them worse-off under these circumstances.

On the one hand, such type of static analysis of monopoly markets, i.e., analysis done in contemporaneous terms, leads to the idea that competition is better than having just one firm and that more firms on the supply side will produce lower prices in the market, thus making consumers better off. Because of this, there’s competition law and market regulation in many countries in the world, believing that market inefficiency brought about by the monopoly can be corrected via governmental intervention. Examples of such intervention may be, for instance in our case, liberalising the electricity market in Portugal or enacting stricter regulations on Monsanto’s activity.

One of the most well-known legislations regarding market competition is, actually, one of the oldest ones. The Sherman Act Law passed in the US in 1890 paved the way for governmental overseeing of market structures in modern economies preventing mergers and acquisitions that can lead to nefarious firm concentration. By doing this, governments ensure that prices of goods are naturally driven down by competition forces, benefiting consumers overall.

On the other hand, do monopolies actually cause welfare losses? The static analysis referred to in previous paragraphs do not take into account future implications implied to the monopolised market structure. Joseph Schumpeter believed, for example, there was a high correlation between market power and innovation. Let us take for instance the example of pharmaceutical drugs. One of the main incentives to innovation and invention of new drugs and ways of producing them is patents. Patents give to the owner the exclusive right to produce, use and sell the patented drug. In this sense, the patent owner becomes monopolist of the patented drug. Nevertheless, this monopoly situation provided by the patent is not permanent. Patents are usually limited in time in order to take into account the costs of short term market inefficiency associated to the monopoly.

To come up with this new drug, the pharmaceutical had to incur into large costs of R&D. It did so because it had the incentive of possessing monopolistic profits after the invention, acting differently if that were not the case. The profits provided by the monopoly enable the pharmaceutical to support new R&D costs, maintaining the momentum of innovation. Another aspect of patents is disclosure. That means that the details of the invention must be made available to general public. This type of knowledge spreads beyond the pharmaceutical sector, reaching all the economy, benefiting it as a whole. Since knowledge is key to technical progress and technical progress is one of the main ways to promote economic growth, we can argue that although monopolies, in the short run, are associated with welfare losses, they may be at the core of economic growth in the long term, due to their role in R&D and creation of new goods. An undesirable situation in the short term may then lead to a better future economic standpoint.

In conclusion, the global effect of monopolies on consumers and the economy is ambiguous. The inefficiency it causes, verified in the static analysis, contrasts with the sub sequential dynamic efficiency it promotes on the long term. Hence, antitrust policies, competition law and the patent system should be devised so that innovative capacity is not harmed while protecting consumers.

References:

Varian, H. R. (2010). Intermediate Microeconomics: A Modern Approach, W.W. Norton & Company.

Gonçalo Pinto

#720


Excise Tax: a good or a bad decision?

In the last few months, Portuguese Government has been considering the imposition of an excise tax on products that are harmful for the consumer’s health. A well-known Portuguese newspaper stated that according to the Ministry of Health, this is not only a budget measure, but also a way to fight against health problems. In fact, why these types of taxes are used, and which are its effects?

An excise tax is an inland tax applied on a good produced for sale. These taxes are indirect in the sense that the producer or seller is expected to recover the tax by increasing the price to consumers. However, an excise tax is different from a sale tax or a value added tax (VAT) and we can distinguish in three ways:

  • An excise typically applies to a restrictive range of products
  • An excise is typically more aggressive, representing a higher fraction of the retail price of the targeted products
  • An excise is a per unit tax, costing a specific amount per unit, whereas a sales tax or a VAT is an ad valorem tax, and proportional to the price of the good.

Regarding the news that came out, the excise tax can serve political ends by producing significant revenues at a lower cost and also discourage consume of harmful products that otherwise individuals might over consume in the absence of such a tax. Beyond the Portuguese motivations, there are other reasons to use this kind of taxes. One is to impose tax burdens on those who benefit from government services and the other is to control externalities.

Since Government wants to avoid the consumption of this kind of products, the long run effect of an excise tax is a decrease on the supply of the commodity in which the tax is levied. Consequently, the price that consumers have to pay will increase. We can observe the effect on price and quantity on the following graph:

imagem

Regarding the tax incidence, while the excise tax is imposed on producers, the tax burden may be shared between consumers and producers. The burden of an excise tax depends on elasticities of demand and supply: if demand for a taxed good is elastic, and supply relatively inelastic, then the burden is borne by sellers, whereas buyers bear the burden of a tax on a good or service with inelastic demand and elastic supply.

Regarding the advantages of this tax we can focus on three main points. One is addressing to a healthier society in the sense that discourage people to consume harmful products or at least not do it as often. Second, higher taxes mean higher government revenues which can go toward education, better roads, and also for the healing of the sick. Lastly, it can help in reducing international smuggling. On the other hand, there are also disadvantages related with the implementation of an excise tax. Those who are against sin taxes believe that they should be allowed to make their own decisions regarding what “vices” to consume or not. Second, many argue that sin taxes hurt the poor more than high income individuals since an extra euro tax on a pack of cigarettes eats up a higher percentage of income for a low income individual than it does for a wealthy person. Contradicting the advantages mentioned above, sin taxes may also result in lower revenue in the long-run because people can find alternative ways to consume such products and may induce smugglers to bring cheaper products.

In Portugal, one believes that the effect of an excise tax will hurt the lower class in the sense that they have higher propensity to consume this type of products, which are cheaper. On the other hand, OECD states that these classes are those who benefit more from the health gains that come from here. Once the consequences are inconclusive, we have to wait for the decision of the Government.

#672


Technology transfer to developing countries

The issue of aid effectiveness in developing countries has increasingly become a central problem since the 1970s. Many development policies have been discredited because of their poor capacity to make radical changes in the countries. As many organizations and researchers have been trying to understand to which extent it is possible to consider economic aid as a clear and effective way for developing countries to alleviate their poverty, it is important to understand what obstacles can arise at a microeconomic level.

There are two ways through which international organizations can help developing countries: physical capital accumulation and human capital accumulation. These two approaches have, however, seemed to be successful only occasionally. Accumulation of physical capital refers to all the investments that aim at financial help, for example, in the fields of: new infrastructures, lower capital costs and easing the technological catch-up. All these policies can improve the capacity of developing countries by widening their market, and in turn increase imports and exports with the rest of the world.

Let’s for instance take the case of technology transfer to developing countries. Developing countries, through the acquisition and diffusion of technology can foster productivity growth. Imported capital goods and technological inputs can directly be used in the production process and can thus enhance productivity.

Nevertheless, most developing countries are forced to rely on imported technology in order to increase their productive knowledge. This often leads to inefficiencies that prevent the transfer of technology to be efficient. Such inefficiencies come from asymmetric information and market power.

There is asymmetry in the information of the providers, who knows the technology well, and the buyers (local population), who are not aware of the value of the good and therefore cannot estimate its importance beforehand. This inevitably leads to high transactions costs that do not reflect the value that local people attribute to these technologies. The companies that own the technologies, relying on their market power, will set a price that does not correspond to the marginal benefit of the consumer, which is the price he is willing to pay for that good. This way, the companies providing the technologies will maximize their utility but the social welfare of the developing country will decline.

Clearly, the inefficiencies mentioned above are only few of the possible distortions that occur when trying to invest in physical capital. It is well known that growth is subject to many other factors, such as: political stability, institutions transparency, level of inequality in income distributions and many others. Additionally, local governments and donors have shown problems in directing aid funds to the right purposes. On one hand, donors have often pursued political, economic and strategic interests in inter-country aid allocation reducing the effect of financial aid. On the other hand, governments of developing countries are often corrupted and financial investments hardly ever reach the needing sectors.

All in all, it is hard to find optimal policies able to minimize distortions and maximize the investments in technology transfer. A must for developing countries, in order to benefit from technology transfer, is investing in human capital. The problems in physical capital accumulation suggest that the benefits of technology transfer should be reached by other means, i.e. by the previously mentioned human capital, for example, through education.

# 745


Lipstick effect

Goods can be divided into several categories. One can roughly find 3 categories of goods: inferior goods, normal goods and luxury goods. Unlike the other two, the luxury goods category is utterly subjective, once what is perceived as luxury in one country may not be as so in another.

Luxury is a multifaceted concept. It depends on context, generations and nationalities, originating different kinds of consumers among luxury goods. Nevertheless, we can find some aspects of luxury that are common to all its products, such as high price, rarity, exclusivity, a connection with history and an even tighter one with art, an heritage, a close relationship with time, being both timeless and contemporary and above all, it must include a component of dream or aspiration desire. Likewise normal goods, when there is a rise in households’ income, the individual demand for luxury goods also rises. Indeed these are products that are not truly necessary but they do have a tendency to increase quality of life. 1

The lipstick effect is a theory that states that during a recession people tend to buy less costly luxury goods, also known as entry products. A good example of this is the lipstick itself. The concept behind this theory is that people still buy luxury goods but they tend to choose the ones that do not have a big effect on their budget.

According to The Economist “recessions mean that Ferraris stay in showrooms and designer dresses on shop racks, but lipstick bucks the trend: in difficult times, women buy more of it, since it is an affordable indulgence”.

In 1990 and 2001 recessions, while the overall employment was falling down, employment in cosmetics industry was rising. NPD Group, a market-research firm, backs that it is important to understand that lipstick theory is not about lipstick alone but instead it is more reasonable to talk about a ample category of beauty products, since this is the category that during recessions, against all expectations, increase sales. Has presented in The Guardian, L’Oreal revealed that sales during the recession year of 2008 suffered a growth of 5.3%, a year when the rest of the economy was suffering record declines in sales.

According to a paper called “Boosting Beauty in an Economic Decline: Mating, Spending, and the Lipstick Effect”  by researchers at Texas Christian University, the University of Minnesota, the University of Texas at San Antonio and Arizona State University, women tend to increase their expenditure on beauty products in proportion to the insecurity of the economy.

This phenomenon is not considered recent. The lipstick effect dates back to the 1930s during Great Depression, when sales of beauty products rose unexpectedly. Over the past two decades woman have reallocated their income from other elements, such as groceries and vacations, to beauty products. A bad economic situation is found to be related with the decrease in consumers desire to invest in products that are not related with appearance. Lipstick theory has holding through the years showing that consumers will buy luxury goods even if there is a recession.

1 Kapferer, Jean-Noel & Bastien, Vicent. (2009) The Luxury Strategy, 2nd edition. Kogan Page

Maria João da Silva

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