Marginal Cost and Benefit

It's about value received for the cost (not just the price). Airline costs, airline mergers and airline travel in generally have been in the news for the past several months. The industry is being hammered by rising fuel costs, and many companies have recently chosen to place charges on checked baggage or even get rid of in-flight snacks in coach, all in the name of reducing costs and improving profit margins.

But providing less service is not the only answer. Airlines could also find a way to provide more value for the price. Lack of service may be driving down revenue as travelers are beginning to either find alternative ways to travel, or alternatives to travel. This piece at airport-int.com would seem to indicate that flyer frustrations with the hassle and lack of service is a contributing factor to declining revenue. And as I've commented on another blog, simple honesty when dealing with the public at the point of interface could go a long way to reducing frustration. Add to that a pairing of authority with responsibility for front-line employees could reduce the problems that accompany planes stuck on runways for extended periods of time. (It's one thing to have responsibility - it's another thing to have the authority to do something about the problem for which you have responsibility.)

We often forget that competition can be done in a qualitative (value of product) way as well as quantitative (price). If the consumer gets more for the same price; it makes the product more attractive. And if quality improves enough, the consumer may be willing to pay more.

I understand that airlines put a lot of effort into providing high quality for the first-class experience, but the first-class passenger is subject to many of the same frustrations as coach-class when the flight is delayed or cancelled. And frankly, on most of the planes I've been on, the coach seats outnumber the first-class seats by a wide margin. The overall number of flights is falling because of reduced passenger demand across the board.

The alternative to applying marginal cost/benefit analysis and looking for ways to improve product quality is, I'm afraid, a return to the early days of the airline industry, when there were few flights (and few airlines) and only the rich flew. And I doubt you'll find enough rich people to fill a 777 flight from NY to LA on a daily basis.

I look forward to your comments.

There's a Reason They Call It the "Dismal Science"

While you're thinking about food prices, here's one more from The Big Picture to worry about. I questioned the source of the data - not because I think the projections are wrong (or right for that matter), but because I would like to know how credible the data is.

I do think resource use is an economic problem, with an economic answer. But as several of the people leaving comments to the post inferred, much of the concern may actually be about use vs. availability.

As always, I look forward to your thoughts.

Linkages....

There's an interesting story about gasoline prices in today's issue of USA Today. It does a good job of explaining how prices can differ between stations in close proximity, and the choices that a station owner may want to make, but often will find outside of his or her control. As I said, the article is interesting, but here are two others from the same issue that you can use with your students to see whether they can make some connections -- simple ones, to be sure, but there to be grasped.

The first story speaks to the idea that many retailers are stocking their stores. They believe that people are planning "staycations" instead of vacations. This decision makes sense in light of the rising price of transportation (i.e., fuel). The link here is clear. Higher fuel prices should translate to more people staying at home. People consequently will want to make that "staycation" as comfortable as possible.

The second story takes another step. If people are staying at home, they may be doing more backyard barbeques. And that means a shift in demand for all the accoutrements thereof, from hot dogs and buns to charcoal. The connection is simple, but your students should be able to see and explain how one change in the economy trickles through and affects a number of other decisions, choices and, subsequently, other prices.

And the retailers choices may represent a risk if they guess wrong and the American consumer just moves blithely ahead with more elaborate vacation plans.

I look forward to your comments.

Markets and Information

A basic premise in economics is that markets are more efficient when both parties have similar information. This allows competition to work and for the market to reach an efficient match of quantity supplied and quantity demanded. Now, rightly or wrongly, many people assume that the supplier or seller is generally presumed to have superior knowledge. One can argue whether or not this is a valid assumption, but I'm going to go with it for purposes of this post.

If the supplier does have superior information, then a tool that provides the demander or consumer with more information about the market should make for better competition a more efficient market. Such a tool can be seen at this site.

The site collects gasoline price information from volunteers around the nation and provides recent gasoline prices to help consumers determine where the "best" price might be. The most interesting portion is "below the fold" in the left hand column of the site. It's the gasoline temperature map and compares average gasoline prices, by county, across the nation. You can zero in and even find information by city or zip code. I've browsed around and the information is by no means complete. Outside of larger metropolitan areas, the information seems spotty at best, and totally absent in many cases. Nevertheless, it might be an interesting tool to demonstrate with your economics classes when discussing the value of information in the local market. It could also be used when teaching comparative shopping in a personal finance or consumer education course.

I've got a family road trip coming up this summer. I might even put it to the test.

I'd be interested in your thoughts about this as a teaching tool, and if you're a contributor to the site.

Access to Capital

As the year winds down the class tends to find it harder to focus on new material. For those of you teaching AP or IB economics, you may even face a situation where your semester has ended. After all, with the exams done there may be little real incentive for the students - aside from sharing your passion for the subject.

This brings us to today's topic of interest - microfinance. Economic development is one of those topics often left to the end of the text, and frequently the idea of building economies can be less than interesting. But the idea of microfinance - lending small amounts to people to start a small business is interesting. It was even good enough to garner the 2006 Nobel Peace Prize.

If you check out the video, you'll see that the Grameen Bank was formed as a not-for-profit organization. Another group that does similar work is Kiva.org. The story is quite consistent. Access to small amounts of credit can make a huge difference in the lives of the poor, allowing them to pull themselves out of poverty into situations of relative comfort or even affluence (by local standards).

Now here is a controversy. A Mexican bank has gotten into the microlending business, and has found the arena to be quite profitable. Is that "right?" Some would say "no" because the stockholders/owners of the bank are making money from the poor. It's one more instance of the poor paying their precious resources to people who already are "rich." Others say "yes" because a commercial financial institution can bring more resources to the poor than a not-for-profit can. This means more of the poor benefit. And isn't bringing them out of poverty the real goal?

I can see both sides. What do you and your students think? Please share.

What I'm Reading

I'm going to start this review with an excerpt.

"Economic slumps would be associated with financial crises by means of the loss of discipline. Through the boom, banks would overreach and extend loans to riskier clients. The buoyancy of economic booms causes riskier creditors to approach banks for loans - a problem of adverse selection. Some banks succumb to the temptation to make loans to these creditors, perhaps in the belief that luck or a bank clearing house will see them through - this is a problem of moral hazard. Adverse selection and moral hazard ultimately earn their just reward. Decline in asset values causes a decline in the collateral for loans; therefore, banks tighten their lending practices. As the slump worsens, the banks with the riskiest clients turn illiquid and then insolvent."

Sound familiar? I was struck by how well this seemed to describe the run up to and unraveling from the sub-prime mortgage situation. What made it doubly impressive was that it was in the closing chapter of the book, The Panic of 1907: Lessons Learned from the Market's Perfect Storm by Robert F. Bruner and Sean D. Carr. Later in the same section, Bruner and Carr cite research that indicates

"financial crises will occur where 'financial markets are opaque, when regulation and supervision are poor, and when lending is based on collateral rather than expected cash flow...' "

The parallels between the Panic of 1907 and the credit crunch of 2007 are certainly there if one is looking for them. If one digs into the sub-prime market as it existed in the period leading up to August 2007, one could easily make the case that market was opaque (due to the innovative nature of some of the products), that regulation and supervision were poor (in part because no one was specifically charged with oversight of the mortgage origination industry), and lending was based on collateral (expected housing prices in what had been, up to that point, a rising market) rather than expected cash flow (the income of the buyers).

And while this book did not cover some aspects of the Panic that I had hoped would be covered, it was interesting and a quick read. The structure of short chapters, focused on actual people (J. P. Morgan plays a huge role in the tale), makes it fast-moving and personal instead of a treatise on macroeconomics and finance.

For those of you who teach American History or economics, or who are interested in the monetary history of the United States (the Panic of 1907 led directly to the formation of the Federal Reserve System), you could do worse than pack this in your travel bag as you head out for summer break.

I look forward to other views and comments.

China, Myanmar and Adam Smith

I love it when the "old ideas" have current relevance. Read what Adam Smith has to say about how we react to news of earthquakes in China. (Or monsoons in Myanmar?)

"Let us suppose that the great empire of China, with all its myriads of inhabitants, was suddenly swallowed up by an earthquake, and let us consider how a man of humanity in Europe, who had no sort of connection with that part of the world, would be affected upon receiving intelligence of this dreadful calamity. He would, I imagine, first of all, express very strongly his sorrow for the misfortune of that unhappy people, he would make many melancholy reflections upon the precariousness of human life, and the vanity of all the labours of man, which could thus be annihilated in a moment. He would too, perhaps, if he was a man of speculation, enter into many reasonings concerning the effects which this disaster might produce upon the commerce of Europe, and the trade and business of the world in general. And when all this fine philosophy was over, when all these humane sentiments had been once fairly expressed, he would pursue his business or his pleasure, take his repose or his diversion, with the same ease and tranquility, as if no such accident had happened. The most frivolous disaster which could befall him would occasion a more real disturbance. If he was to lose his little finger to-morrow, he would not sleep to-night; but, provided he never saw them, he will snore with the most profound security over the ruin of a hundred millions of his brethren, and the destruction of that immense multitude seems plainly an object less interesting to him, than this paltry misfortune of his own. To prevent, therefore, this paltry misfortune to himself, would a man of humanity be willing to sacrifice the lives of a hundred millions of his brethren, provided he had never seen them? Human nature startles with horror at the thought, and the world, in its greatest depravity and corruption, never produced such a villain as could be capable of entertaining it. But what makes this difference? When our passive feelings are almost always so sordid and so selfish, how comes it that our active principles should often be so generous and so noble? When we are always so much more deeply affected by whatever concerns ourselves, than by whatever concerns other men; what is it which prompts the generous, upon all occasions, and the mean upon many, to sacrifice their own interests to the greater interests of others? It is not the soft power of humanity; it is not that feeble spark of benevolence which Nature has lighted up in the human heart that is thus capable of counteracting the strongest impulses of self-love. It is a stronger power, a more forcible motive, which exerts itself upon such occasions. It is reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbiter of our conduct. It is he who, whenever we are about to act so as to affect the happiness of others, calls to us, with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it; and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration. It is from him only that we learn the real littleness of ourselves, and of whatever relates to ourselves, and the natural misrepresentations of self-love can be corrected only by the eye of this impartial spectator. It is he who shows us the propriety of generosity and the deformity of injustice; the propriety of resigning the greatest interests of our own, for the yet greater interests of others, and the deformity of doing the smallest injury to another, in order to obtain the greatest benefit to ourselves. It is not the love of our neighbour; it is not the love of mankind, which upon many occasions prompts us to the practice of those divine virtues. It is a stronger love, a more powerful affection, which generally takes place upon such occasions; the love of what is honourable and noble, of the grandeur, and dignity, and superiority of our own
characters."
HT to Russell Roberts at Cafe Hayek. Have a good weekend.