The Mexican Drug Lord Oligopoly makes for an interesting problem

As my undergraduate career furthers I find my classes asking similar questions:

  • How do we maximize profits?
  • How to we capture consumer surplus?
  • How do we maximize welfare?
  • How do we minimize externalities?
  • How do we design the market so it is pareto efficient?

But here is a problem that no-one ever asks. How do we destroy a market?

Last winter break I was choosing a relaxing vacation spot that wouldn’t break the bank. Given the geographic proximity, Mexico was on my list. Thats until I brought it up with one of my aunts (and by aunt I mean my parents’ friend who is a woman – it’s an Indian thing to do). She’s a travel agent and told me about the perils of visiting Mexico. So I put it off for a later date in life.

Living in the Global Citizenship theme part of Crothers Memorial (our dorm), I was able to learn a bit about the Mexican drug trade from one of my residents. Turns out it really is as bad as I was told. Too many people are involved and it’s too unsafe for visitors to enter that region and its also very unsafe for people who have lived for generations in the areas where the drug lords are centered. Lots of lives have been lost and more than that a sense of safety has also been lost. I’m sure this is a very complicated problem, but this is my understanding based off a conversation I had:

There is a demand for drugs from the US (I actually can’t even say with certainty which drug, though I would guess it would be cocaine). And Mexican drug lords are willing to supply it because the revenue from the drugs is much higher than all associated costs.

Here are a few costs for the drug lords:

  • Its illegal, so they incur some cost by hiding or bribing or threatening law enforcers
  • There is competition in the market, and this is brutal competition in the sense that drug lords could be losing friends, colleagues and family due to the internal war
  • There is also the marginal cost of producing the drug
  • I guess there is also a cost associated with distribution to the US – ie. hiring drug mules or whatever method they use
  • I’m sure there are many more that I can’t think of given my primitive understanding

There are lots of externalities associated with the market that the drug lords are obviously not paying for:

  • Loss of civilian life
  • Destruction of the legal system
  • Loss of a sense of security in surrounding areas
  • Loss of GDP due to the fewer number of tourists (and I’m sure GDP has been hurt due to several other reasons)

It’s impossible for the government to even try to get the drug lords to pay for their externalities and solve the ‘market failure’. And even if it were logistically possible, I think the externalities are too high that no single price would justify the functioning of such a market.

So here is where the economists come in. How do you destroy such a market? The obvious framework to look at is do both a demand and a supply analysis.

From the supply side – it seems that if we were to increase the costs so much that few drug lords would participate in the market seems reasonable, but how do you do this? The costs associated with the loss of life within the organization and within their personal lives doesn’t seem to do anything for the drug lords. The government can’t do too much to curtail this illegal activity. Perhaps they could raise prices for goods such as fuel and ammunition (or whatever the drug lords use in production) to a point where the costs are too high, but then that has too many implication for civilians who are unfairly victims of such policy. Conversely one may think of increasing supply in the US to lower the prices for drugs – though this obviously wouldn’t fly.

What about the demand side? How do you get Americans to demand fewer drugs. I doubt educating intoxicated drug users will have a great impact. Though it would be interesting to see what the equivalent of fair trade drugs would look like. Perhaps set up more rehab centers? Or get cocaine users to switch to other drugs – though this again is not feasible.

I don’t have a good answer for how to destroy this market. If you do, send it to the appropriate authority, I’m sure they will reward you in some way.

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A lesson in Scalping Dalai Lama tickets

You may or may not know, but the Dalai Lama is coming to Stanford on October 14th. This is big news! Everyone wants to see him speak, the demand for tickets is so high that tickets were actually sold out 2 weeks after his visit was announced over the summer.

Now there are 3 types of tickets you should know about:

  1. Morning lecture tickets – sold for $20 to Stanford student (more to others)
  2. Afternoon lecture tickets – not being sold, but being assigned via lottery to Stanford students
  3. Conference tickets – a bundle of both the morning and afternoon lecture and a few other things – sold for $30

So to my surprise I got the following email on my dorm chat list:

On Thu, Sep 30, 2010 at 2:39 PM, John wrote:

Hey Guys,

Before I came to school, I bought two tickets to the Dalai Lama’s
Conference: Scientific Explorations of Compassion and Altruism. I
just found out that I will not be able to make it. It’s on Friday
October 15th 9am-4pm in MemAud. I bought the tickets for like $33 a
piece online, but I’m willing to go to 30. Email if you are
interested in the tickets. One or both.

Thanks,
John
______________________________

This is how out email conversation then played out:

—– Original Message —–
From: “Al-Karim Lalani”
To: “John”
Sent: Thursday, September 30, 2010 9:13:23 PM
Subject: Re: [crothers-grimm-chat] Dalai Lama Conference Tickets
Anyone?

NO! This is a bad economic strategy. I need to give you a lesson on
bundling. You could be making money.

Al-Karim

On Sep 30, 2010, at 9:20 PM, John wrote:

haha i’m not trying to make money. I’m just trying to get rid of
them without losing so much

—– Original Message —–
From: “Al-Karim Lalani”
To: “John”
Sent: Thursday, September 30, 2010 9:20:55 PM
Subject: Re: [crothers-grimm-chat] Dalai Lama Conference Tickets
Anyone?

doesn’t this give you entrance into both the morning lecture and the
rathbun lecture at 2?

On Sep 30, 2010, at 9:23 PM, John wrote:

yeah i think. I can’t make it that day

—– Original Message —–
From: “Al-Karim Lalani”
To: “John”
Sent: Thursday, September 30, 2010 9:25:19 PM
Subject: Re: [crothers-grimm-chat] Dalai Lama Conference Tickets Anyone?

send out another email being like selling the DL morning lecture
ticket (value 20 bucks) and the Harry Rathbun Lecture ticket by the DL
that day (value $20) together for a total of 38 bucks

that way you make 5 bucks.

its called bundling.

On Sep 30, 2010, at 9:30 PM, John wrote:

I like it. You’re the man

From:     John
Subject:     [crothers-grimm-chat] Selling Dalai Lama Morning and Afternoon Lecture Ticket
Date:     September 30, 2010 9:34:18 PM PDT
To:     crothers-grimm-chat@lists.stanford.edu

Hey dudes & dudettes,

I have a ticket to the Dalai Lama morning lecture (face value $20) and the Dalai Lama afternoon lecture (face value $20) on October 15th. I can’t make it, so I’m willing to sell this bad boy for $38 all together. Email if you’re interested.

Thanks

From:     John
Subject:     [crothers-grimm-chat] Can’t sell the tickets separately so I’ll bring the price down to 30. Email. EOM.
Date:     September 30, 2010 10:13:35 PM PDT
To:     crothers-grimm-chat@lists.stanford.edu

From:     John
Subject:     [crothers-grimm-chat] Ticket gone :/
Date:     September 30, 2010 10:19:01 PM PDT
To:     crothers-grimm-chat@lists.stanford.edu

—– Original Message —–
From: “Al-Karim Lalani”
To: “John”
Sent: Thursday, September 30, 2010 10:33:37 PM
Subject: Re: [crothers-grimm-chat] Ticket gone :/

Its a sad day for economists.

From:     John
Subject:     Re: [crothers-grimm-chat] Ticket gone :/
Date:     September 30, 2010 10:37:41 PM PDT
To:     Al-Karim

demand for both wasn’t there. people wanted to buy just one. and I’m an engineer anyway 🙂

I was really excited when I thought John would make some money by bundling. But it broke my heart when that failed. Here are a few takeaways though:

  • The transaction costs of passing on the ticket from the morning lecture to the person who would attend the afternoon lecture were way too high for this to be feasible
  • Next time don’t bundle non-complementary goods (I guess people were choosing between one lecture and the other, ie. they were substitutes)
  • Have patience – this whole ordeal took place within an hour. I feel like someone would have bought it for a higher price had John waited a day.
  • And on second though, don’t try to rebundle a bundle. This was less of a bundling exercise and more of an advertising exercise where we tried to change a persons perception of the bundle.

Partial Equilibrium Persuasion

In one of my classes I had the opportunity to listen to a guest lecturer from someone who heads Stanford’s recycling department. She talked to us about recycling and why its important. And she came up with ‘Top Ten List’ for reasons to recycle (hopefully in a future post I’ll discuss why I dislike such lists). But the top two reasons on her list were: 1. Its good for the economy and 2. It creates jobs (a bit redundant I might say).

But her point was that when we recycle you employ someone to collect the waste, someone to receive it, someone to filter it, someone to process it, someone to sell it, and on on… she said around 10 jobs are created for each tonne of waste we recycle. Sounds like a good idea right? We recylce, and create jobs, a win-win for sure!

I hope my sarcasm was conveyed in that last sentence. This is too simplistic and a partial equilibrium analysis. Now I’m all for green-collar jobs and such, but lets say we didn’t have any extra unemployment (nothing above the rate of natural unemployment). Would this still be a good argument? If the economy is in a state of equilibrium such partial equilibrium analysis should only be taken with a grain of salt. If there is no involuntary unemployment, everyone has a job, so her second argument is total BS since a recycling program isn’t creating jobs but rather just reallocating labor from one job to the next. There is no net change in employment.

But her first point may be true, it could be good for the economy and society as a whole. That is only if people choose to actually gain employment in recycling professions. If people already have jobs, why would they move to a recycling-related job? For the vast majority of people a big incentive would be higher wages. And general production theory dictates that we pay wages that are equivalent to the marginal productivity of labor. So people will only earn higher wages if they their labor is more valuable and by the income approach we can see this reflected in a larger GDP.

The cobb-douglas production function for an entire economy is as following:

Where Y is GDP, K is capital, N is labor and A is any total factor productivity but most commonly referred to as technology. An increase in GDP due to recycling would be included in the A component since N has not changed but is more productive (lets assume that capital stays constant too or has negligible change due to recycling jobs).

But this is all contingent upon the premise that recycling related jobs are better paying than other jobs. But since there is such a variety of jobs that are related to recycling, its hard to say whether recycling will actually be better for the economy. For example, its easy to say that creating trash collector jobs isn’t going to be a great investment for our economy. But what if a bicycle-maker can produce more bicycle thanks to higher recycling of metal scraps, what if the firm is growing so rapidly it needs another high-paid manager. Such jobs will increase productivity of labor (assuming marginal productivity of labor is equal to wage) and help the economy. But its really hard to tell whether the sum of all jobs created by recycling is really better for the economy compared to the jobs people previously held. So until then I cannot give a definite answer.

In conclusion, yes recycling is good for the economy and in the current state with so much unemployment it could possibly create jobs. But the moral of the story is when people make such claims, do take them with a grain of salt because if the unemployment rate would not have been as high, this analysis may not hold.

The Economic Power of Costa Rican Taxi Drivers

So a while back (in the winter break) I visited Costa Rica with some family and friends. If you haven’t been, I heavily recommend that you do visit the country, its beautiful, the people are great and I love how raw and natural it feels. I would liken that capital city of San Jose to Nairobi, Kenya.

Now during my visit there, I happened to visit a great city called Monteverde, known for its amazing cloud forest. I would post up pictures but unfortunately I (rightfully) assumed that my sisters would take pictures on this trip and (wrongfully) assumed that I would get a copy of these pictures. However, an interesting phenomenon that occurred during my trip in Costa Rica was the way we bartered with various Taxi drivers. There were two events that really caught my attention:

1. My sisters and I were in the main town of Monteverde and we happened to need a ride to Playa Samara (a less touristy alternative to Manuel Antonio, and just the vibe you get from being there makes you scream “pura vida”). Now in this town, there were essentially 2 SUV taxis (Toyota Prado’s I think) that we were looking to take into Playa Samara. We approached one of the drivers to negotiate a good deal for the next day, but the man wouldn’t bargain. He was fixated on one price and was one hell of a negotiator. My sister walked away from him without a finalized deal, and I though I’d go talk to the other taxi driver instead. I walked up to the other taxi guy and noticed that he was asleep in his car, so as I walked back an began reporting to my sister what I had just seen, the initial taxi driver came to us spitting some Spanish phrases as fast as he could. Not that I could understand him too well, but I could tell he looked worried. He came up to us and announced a better price than before. And this is the price he charged us the next day when we left the beautiful city of Monteverde.

Now the interesting thing in this story is that all we as consumers had to do was assert our market power and show the taxi driver he didn’t have a monopoly. He must have seen me approach the other driver and probably thought that I was going to tell my sister the other driver had offered us a better price. It makes you think how often consumers can get ripped off for not asserting such market power. And it also makes you think how often we could have negotiated better prices by letting our suppliers know we were considering purchasing from others.

2. So later on that night I thought we would assert the same market power. I was planning on showing up the driver that would take us back to our hotel from a day of white-water rafting (heavily recommended by the way, one of the most exciting things I have ever done). Unfortunately that night in Monteverde there were no other taxi drivers so I couldn’t play the same trick as before, but not to worry, the taxi driver only needed to ‘think’ that we had other options. So we sat down in his taxi (a much smaller sedan this time) and told the taxi driver and asked him the price. He obviously overstated the price and like all intelligent customers we refuted his quote and told him that we had taken a taxi for much less that day and that we could just call up the same cab driver and he could take us to our hotel for the same price he did earlier. Much to my surprise, this was no ordinary taxi. He had a radio communication system built in and so he dialed in another fellow taxi driver from his car and asked her what the going rate for a cab ride from the city to the hotel was. Right there in front of us he had shown us this oligopoly agreement that all the taxi drivers had made, he told us there was a fixed price and all the taxi drivers in the city wouldn’t take us for less at this time of night. I’m guessing the guy who took us earlier wasn’t from the town and so hadn’t been in on the agreement, but I was not going to mess with this driver and get thrown out of his cab. I graciously accepted his price and we made our way to the hotel. The man had just demonstrated his superior economic power.

Moral of this story, assert your market power whenever you can. You’ll end up getting the best deal you can, and the market will be as efficient as it can, no unnecessary surpluses for anyone.