TVHE

Over at Worthwhile Canadian Initiative, Nick Rowe suggests that central banks should find something else to discuss instead of interest rates.  The analogy provided is that of oligopoly competition: namely how the Cournot-Nash and Bertrand games have exceedingly different outcomes, even though the only superficial difference is that one game involves choosing output and the other game involves choosing price.

However, in the same way I don’t believe the difference in these games is just the product of “framing”, I am not sure if the call to arms against using interest rates as a focal point is necessarily that compelling.

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The California Energy Commission, in all their wisdom, have decided that the best way to encourage energy conservation is through imposing compulsory energy efficiency standards on TVs – in other words they are banning what they deem to be ‘energy inefficient’ TVs. They are the first state in the US to implement such a measure.

The aim of the intervention is to reduce electricity demand and hence avoid the need to build new power plants to meet this demand. In this sense, the Commission perceive the building of power plants to be a negative externality, presumably as the cost of building is reflected in the per-unit price of electricity for all users.

I take issue with this ‘externality’. For example, if a lot of consumers suddenly started demanding ‘Thierry Henry is God’ t-shirts, such that the price increased, should I feel aggrieved that the action of others is affecting the price I must pay for such a worthy product? No, that is how the market works.

Putting aside my scepticism, let’s assumes that the externality is a genuine one. What might be a superior way of discouraging consumption?

Bans are a blunt tool. From an economic efficiency perspective, you should first try and use prices to incentivise behaviour. High demand for electricity is only ever a problem over relatively short periods. For example, in New Zealand the peaks occur on weekdays in the morning as people wake up and in the evenings as people go home. In hotter climates, the peak typically occurs at the hottest part of the day as air-con works its magic. Hence one might try to charge higher prices at times of high demand to discourage consumption (and hence avoid the need to invest in new power plants). There are electricity meters that are capable of facilitating such differentiated pricing and indeed they are being rolled out in California as we blog.

Under the differentiated pricing scenario, consumers are paying the ‘true’ cost of electricity, so even if they continue to consume at high levels, one should be indifferent to building a new power station as the externality has been internalised.

The obvious perverse incentive that arises from the ban is that consumers will simply purchase their televisions out of state, knowing that they can get a better range of TVs to better suit their individual needs at more cost-effective prices.

It is far more preferable to keep consumer choice open and simply make consumers fully pay for their choice through efficient pricing (assuming that an externality exists in the first instance).

According to Kiwibank, the other banks profit maximise:

Most banks are only interested in making as much money as possible out of their current customers, Kiwibank chief executive Sam Knowles says.

Now the actual stuff Sam Knowles says, for example the context of the above quote is really that Kiwibank is trying to build market share (since there is a significant transaction cost for consumers moving around the market) while the other banks are satisfied with their share, and so will be extracting surplus – in other words Kiwibank is keeping prices lower now to “invest” in the future.  Furthermore, I agree with him when he says:

New Zealand should work towards customers having a bank account “for life” and if they want to change banks “you can go and get it done” without any hassle,

As this would improve competition.

However, I just thought it was funny that the quote at the start of this post was the first paragraph in the article.  It is as if the newspaper thought there was something novel in the fact that banks act like everyone else.

Is someone trying to be ironic when they say that a new chain store that sells close to expired stock cheaply is a bad idea because it will “cause obesity”. Adolf at No Minister is right here when he says that these guys are doing the right thing, and that the critique on the grounds of obesity seems out of place (ht Kiwiblog).

If people want to eat enough and put on some weight that is their decision. After all WTF is an “obesity epidemic” – I didn’t realise people could gain weight just from looking at me after I’ve eaten

Say that there is an externality from obesity – well then we should try to solve that, not regulate the supply of food. No the idea of an externality may lead to a “fat tax“. Poor information for consumers might drive us to label foods in better ways. But there is no value to be gained from refusing to allow competition in supermarket sales.

Truly, these people that focus on obesity DO NOT CARE about the happiness of people – they only care about the fact that they don’t like obesity. It makes me sad

And if you try to defend these claims on a basis similar to “people don’t know what’s good for them” I suggest you just write down what you just thought and read it …

It seems that the debate about the fundamental “theory of the firm” is going on. Now there are issues with the theory of the firm, things that economists have been busy plugging away on for a long time now – but the critique that Steve Keen has put forward is not one of these issues. In this post I will attempt to discuss his push to change the Cournot model, which I don’t agree with. This will give us scope to discuss perfect competition another time.

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In a recent post, Paul Walker criticises the idea that “deadweight loss wouldn’t exist if we had a government monopoly”. He is right but in another idealistic sense the idea of no dead-weight loss is also correct right.

If the government acts as a monopoly we will still have dead weight loss, as it comes from the “loss of surplus” relative to the situation where “surplus” is as large as possible (given demand and the monopolies cost structure).

But if government blatantly sets price equal to the marginal cost of the last unit dead weight loss will melt away. This does not imply that profit is dead weight loss in any sense of the word, and it does not tell us that the solution will be “dynamically efficient” (where is the incentive to invest, to develop), but it does tell us that a government that is behaving this way could achieve the “perfectly competitive” price and quantity.

However, this is all 100 level stuff that I don’t particularly care about. My interest lies with the “debunking of microeconomics” that Steve tries to achieve on Paul Walker’s blog.

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The owner of Montana Wines and New Zealand’s largest wine company, Pernod Ricard, is set to cull its contracts with wine growers in the Gisborne region.

This action is in response to falling demand for chardonnay and sparkling pinot noir wine, both domestically and internationally. Chardonnay exports reportedly fell 12-14% last year alone. The culprit? Chardonnay’s fairer sister, sauvignon blanc. Apparently we are seeing a significant supply-side ‘correction’, as producers respond to a structural demand shock – consumers’ changing tastes and preferences. Indeed, last year sauvignon blanc overtook chardonnay as New Zealand’s most consumed white wine.

Try as they might, Pernod Ricard have not been able to sway the mighty consumer to stick with the product they have contracted for, despite “new product development, innovative packaging, capital investment and changes in wine style”.

I know at least one TVHE author that might be a little disappointed seeing his favourite varietal taking such a pounding. As for me, well I’ll stick with my reds thanks.

Apologises for my long delay from the blog – I am afraid that it will continue for the next couple of weeks. I am on an economics adventure, trying to fight the beast of recession with sketchy logic and econometrics

However, I had to say something about this recent Westpac article on bank funding (ht Rates Blog).

At the end Westpac says that it, and other banks, have been pricing at average cost instead of marginal cost – so they have been pricing based on the cost of credit to them, not the cost of sourcing additional credit to make loans.

Now, according to Westpac the average cost is higher than the marginal cost, and all banks have seemingly agreed to do this even though since the marginal cost of credit is below the current “price” an individual bank could “defect” and make some money. Is it me, or has Westpac blatantly admitted to collusion here?

Westpac has said that it, and other banks, have implicitly agreed to set interest rates at a higher level than marginal cost – which I presume must be closer to the collusive price than marginal cost as otherwise it wouldn’t stick.

Now I didn’t think the banks were colluding, but if Westpac is willing to go ahead and admit it then …

[Note: to be fair I think long run marginal cost, which banks would actually need to set fixed rate loans based on, will be higher than marginal cost - and this would explain much of the difference. However, this isn't what Westpac said.  Also, I've ignored market power and the prevalence of fixed costs - again if they wanted to make these arguments go ahead, but do they really want to say that they used market power to keep prices above the marginal cost of credit ]

Apparently American clothing stores are cutting their plus-sized clothing lines at the moment, even as the average American woman gets larger. Why? Because the mean size isn’t the important one. There’s an excellent explanation here:

…it has to the do with the fact that the distribution of weights is skewed to the right. The costs of production result in a focus toward the modal body size, not the mean or median.

Basically, it costs more to make more sizes. The manufacturer wants to make the fewest sizes to fit the most people. Lots of people fit the small sizes. Large people span a huge range of sizes, so not many will fit each big size. Hence, it’s profit maximising to produce only the smaller sizes.

Weight distribution of American women

Recently the New Zealand electricity sector has been taking a bit of a hammering. According to a Commerce Commission sanctioned report, consumers have been overcharged by $4.3b over a six year period (how’s that for a headline!). More specifically, the report concluded each of the four big generators – Meridian, Contact, Genesis and Mighty River – has been exercising the power the market’s design gives them to command unjustifiably high prices, at least during years when inflows to the hydro lakes are low as they were in 2001, 2003 and 2006.

New Zealand has two markets in electricity – the wholesale market and the retail market. The wholesale market is where generators sell their production to retailers (often the seller and purchaser are one and the same). These prices vary significantly depending on the conditions of that particular period (for example, how dry Southern Lakes are or whether a generation unit is out service).

The second market is the retail market, where retailers sell electricity to consumers. Prices here are typically very stable, with consumers seldom exposed to the vast variation that takes place period-on-period in the wholesale market.

In the long-run, the prices in the wholesale market feed through to the retail market. In other words, if a generator/retailer found themselves short of generation and thus had to buy excess generation on the wholesale spot market at relatively high rates, they would eventually pass through these additional costs to their consumers in the retail market.

The report is essentially saying that generator/retailers were able to use their dominance in the wholesale market to push up prices during periods of constrained supply, which consumers then ultimately had to pay for in the retail market.

The report also says that pricing in the wholesale electricity market is, in the absence of dry periods, typically competitive. A very important point made in the report is that no market is ‘textbook’ perfectly competitive and this is certainly the case in electricity, given its unique characteristics (in particular the need for supply to continuously meet demand).

Indeed, I would say that the wholesale electricity market is working almost exactly as intended. Pricing is commonly competitive except at times of tight supply, when generators are able to reap higher rewards that incentivise continued investment in generation (which is extremely expensive) so that ever-growing demand can be met into the future. And the Commerce Commission determined that the generators’ actions were a “lawful and rational exploitation of the opportunities the market gave them”. I doubt you’d be able to make nearly as impressive a headline out of that though…