Cigarette taxes

An Otago university study that was sponsored by anti-smoking groups found that cigarette taxes should be increased.  We know that an externality tax is a good thing, however 70% of the price of cigarettes is made of of taxes already.  The question then is, do we need more cigarette taxes to set the social cost of smoking equal to the social benefit, are we at the social optimum, or have we already gone too far. Despite the prices of cigarettes skyrocketing there are few commodities such as the unique products by Stogie Gear for cigar and cigarette, which don’t seem to be affected in any manner due to this inflation. Where the price is relative to the social optimum is an important question.  If the price of cigarettes is already at or above the socially optimal level, further cigarette taxes will be inefficient.

Now I have no idea where we are in terms of social cost and social benefit.  Ultimately, if the money from cigarette taxes can cover all the additional health expenditure from smoking, then the tax is sufficient.

People know they are killing themselves with cigarettes, so if that is what they want to do we should let them.  The problem is that they negatively influence other peoples health and put a drain on the health system by getting sicker than people who do not smoke.  If the tax on cigarettes already covers all this, then I don’t want them to lift taxes anymore.  The goal of the cigarette tax should be to cover the externalities of smoking, not trying to stop consumption completely.

Now tell me how cigarettes being an addictive good influences this analysis 😉 .  Bonus points for discussing how cigarettes may be complements to other externality creating goods.

Working out your level of attractiveness

I was having a discussion with my girlfriend yesterday on a blog post by Tyler Cowen. There are a lot of interesting points in the post, but the one that struck me and led to the discussion was:

“The median photograph of you is probably the best approximation of your physical attractiveness ”

The reason Tyler gives for this is that there is a random sample of photos taken of a person, so on average a photo will show what you look like. Compare this to the method we actually use to judge how good we look; the mirror. In the mirror we make ourselves look as good as we can, so it gives us an upwardly biased sample of how we look. So based on this, we should use photos to tell how good we look, a scary thought.

This is where the discussion between my girlfriend and me appeared. She said that the sample of photos was biased, as people often know there photo is going to be taken and act appropriately. We interpreted this in two different ways:

Matt: So the sample of photos is biased upwards, since people pose when they are having their photo taken. As a result, I look even worse then my average photo!

Rosie: It depends on the person. When Matt knows a photo is going to be taken he makes stupid faces. As a result, the sample of photos is biased downwards.

I don’t know. I don’t think any of this bodes well for my attractiveness. At least I have economics 😉

Economic scissors: Trial and error

Supply and demand, the economic scissors. This beautiful diagram explains a significant amount about how economists think:


Now from what I understand, when the two curves cross we have equilibrium. This sets a price where demand and supply are equal. When the price is higher we have a surplus of goods, here some of the firms in the industry can’t sell all their produce, and so they cut prices bringing us to equilibrium. When the price is below equilibrium we have a shortage of goods. In this case competing consumers are supposed to bid up the price until we get to equilibrium.

However, in western society we don’t like to bid up the price, we just sit around. The best example I have of this is my daily pie. I want a chicken pie, I go to the store and they only ever have one, and half the time someone else has taken it. Now instead I buy a curry pie. If the store knew that I also wanted a chicken pie they could have put one more in the oven and I would have paid a higher price, and we would both be better off.   Instead, they think that I have revealed a preference for curry pies and they keep on cooking them.  There is imperfect information here.

How are we supposed to solve the case of the pie, given that western consumers aren’t fond of arguing up the price when there is a shortage. Well I think that firms realise this, and through a process of trial and error they try to increase information, so that they can set the equilibrium price.

The example of this is supermarkets. In a supermarket there always seems to be one type of toilet paper on special. The different manufacturers take turns, lowering there price and sometimes increasing it by more than they dropped it the next week. In this case the firms are trying to discover what the demand curve looks like, they are trying to find out if there is a shortage of their product. Through this process the firm discovers enough information bring us closer to equilibrium, all in the name of maximising profits. How convenient.

If there is no free lunch why should we have free software??

I have always been skeptical of open source software, if Microsoft and all of their highly paid programmers can’t get it right, how can a bunch of guys who work on projects for free in their spare time do any better? As a recent convert to Linux I now realize how wrong I was. In fact I now have absolutely no use for any Microsoft products.

As an economist I believe that there will always be a role for propriety software though. To see why I think it is useful to examine what proponents of free software are striving for. With that in mind I have pulled the definition of “free” software off of the Free Software Foundation website:

  • The freedom to run the program, for any purpose (freedom 0).

  • The freedom to study how the program works, and adapt it to your needs (freedom 1). Access to the source code is a precondition for this.

  • The freedom to redistribute copies so you can help your neighbor (freedom 2).

  • The freedom to improve the program, and release your improvements to the public, so that the whole community benefits (freedom 3). Access to the source code is a precondition for this.

As you can see they are referring to free as in freedom to modify and redistribute rather than free as in price. However this implicitly means that the software will be available for free as even if a price is charged for the software, the person who buys it is free to give it to all his friends for free and they can give it to their friends and so on.

When I put my economist hat on (let’s be honest, I never take it off) I think that if all software was free the quality of software would suffer. What does a developer of free software get for the time he puts into writing a new piece of software? Not really much more than kudos from the community. So there is a big trade off here, with free software the people are working on software use it themselves so they are able to detect problems and add new features very easily, but at the same time if there is no financial reward from developing software then people have the incentive to put their effort elsewhere. This problem is particularly bad for software that is extremely complicated or requires a lot of time to develop. In this case we either get a software that is no where near as good as the proprietary version or the amount of time required to develop the software means progress is very slow.

As an example I use a mathematical program called Mathematica for a lot of my work and haven’t been able to find anything anywhere near as good that is “free”. I am also an avid gamer and have noticed that the standard of open source games is pretty terrible which makes sense given the amount of time required to develop a game.

So while I am huge fan of Linux and open source software , I think that aiming for all software to be free isn’t a good idea as there are certain cases where this provides the wrong incentives.

The Halo Effect

I was reading the New Zealand Commerce Commission’s public release on the potential Warehouse merger with one of the two massive supermarket chains. On page 15, paragraph 81 of this document, Ian Morrice of the Warehouse mentions ‘the halo effect’. He states that this is a term that the Warehouse invented to describe what happens when a firm introduces a new product, with the aim of increasing consumer throughput, which will lead to an increase in demand for the original set of goods sold.

This concept makes sense as there is a transaction cost of going somewhere to buy something. So once you introduce groceries into a Warehouse store, people can now get groceries and general merchandise in the same place, lowering the transaction cost of buying a bundle of both types of goods. This allows the Warehouse to increase the price of general merchandise goods, and to increase the quantity of merchandise goods they sell.

Now I thought that the halo effect was a pretty cool term, so I decided to look it up on wikipedia. Much to my surprise the term existed well before the Warehouse used it. Not only did it exist, but it meant something a little different. In industrial organisation terms the halo effect is what happens to the consumers’ perception of a firm’s set of products when a new product is introduced. For example, Sony makes electronic stuff, like DVD players, that I think are pretty high quality. Now say that they make a battery that really sucks. If I use this battery and don’t like it, then I may also downgrade my perception of the quality of other Sony products. Implicitly, people use brands to proxy the value of a product. If a firm makes a shoddy product, consumers will use this as information about the quality of other products under the brand.

These two definitions are both important, but I think it is important to distinguish between them:

  1. Goods as complements: By putting more products under one roof, a firm can reduce the consumers’ transaction costs, allowing the firm to increase sales and prices for the initial set of goods.
  2. Goods as signal of brand quality: The quality and desirability of a new good sold by a firm can change consumer perceptions (and ex-ante expected values) about other products sold by the firm.

Now if you ever hear the term being used, you should ask the person to define exactly what they mean.

Emission trading: Fairness and efficiency

An article by Adolf Stroombergen (from Infometrics) discusses how NZ is going to meet its obligations under the Kyoto protocol.  First Adolf discusses the merits of a Pigovian tax as a way to cover our obligations.  One line I particularly enjoyed was:

“However, even if a tax has no effect on emissions, it is still fairer to put the cost of emissions on those who cause them than to put the cost on taxpayers generally.”

So damn true!  Having established what the government should do, he then goes on to discuss what they actually will do, an emissions trading system.  While a emissions trading system could, in theory, be as efficient as a tax, governments around the world have taken the strange measure of given out emissions permits for free, instead of auctioning them and using the money gained to pay off the Kyoto obligation.  The reason given for this in the article is that it is fair to compensate industries where investment has occurred only on the basis that producing carbon was free.

However, I think I see it a little differently.  If an established firm can only stay in business when carbon emissions are free, then they are socially inefficient.  So the only way the firm can stay in business is if it makes society bear some of the cost of their production decision.  That seems unfair to me.  As a result, I think that emissions permits should be auctioned by the government in almost all cases.  The only time I see scope for them to be given away for free is when we have an infant-industry, one which would be able to pay for the full cost of their production activity in the medium term.