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.

The Latent Demand for Pizza

Some time last quarter I happened to see an economic supply and demand diagram on the whiteboard on the third floor. I regret not taking a picture of it but it basically outlined that there was a shortage of free pizza in our hall and that our Resident Assistant (RA) was going to make up for it since he does play the governmental role on our floor. The diagram was actually wrong in the sense that it actually showed a successful market, but what was the essence of that flawed diagram is what I will outline below.

If you haven’t taken any economics, here is an intro to basic supply and demand:

Below is a diagram for the market for pizza on a given school night. Local eateries on the Stanford campus such as the Axe and Palm and Late Night at Stern will sell pizza to you, or rather will supply pizza to the market. The higher the price of pizza, the more they would prefer to sell given that they can make a greater profit. Hell, if the price of a slice of pizza rises I’d even begin making some and selling it to other students. This phenomenon is embodied on the upward sloping supply curve: higher prices => suppliers would like to sell more pizza

Then there is the demand side, how much pizza we students (in this case the students on the east side of campus) demand at a given price. Demand works in the opposite direction. Higher prices means that fewer students will purchase pizza (I wouldn’t pay $20 for a slice of pizza, but I would buy two slices if it was $2). Hence the downward sloping supply curve.

But have you considered the demand for free pizza? How many slices of pizza would you consume if it cost you absolutely nothing? Yes, you may fantasize about dominoes delivering as many boxes to your door. Would you ask for 5 boxes? 10? Infinity?

I am pretty sure that this amount is finite if we impose the constraints that you have one hour to eat all this free pizza. Even if you can consume 20 boxes in one hour, I’m pretty sure that your demand for pizza is less than that. If you’re a girl looking to carve out a beach body for the summer, you probably would eat no more that 2-4 slices of pizza if it was free. If it was me, I’d eat no more than 6 slices in an hour. Why is that? Well after the 6th slice I’d just feel so grossed out from eating pizza I’d just stop eating. Economists would describe this as me experiencing a negative marginal utility for consuming the 7th slice of pizza. (Btdubz, utility is an economists way of saying happiness or satisfaction from consumption).

So my demand for pizza when it costs nothing is free food. This is my latent demand for pizza. And if we sum up the number of slices everyone on this side of campus desires when pizza costs nothing, then we can find the total latent demand for pizza:

Does this scenario remind you of anything? Maybe the comparison isn’t as clear, but think of all the events that occur on campus that advertise free food. Why exactly do they advertise the free food component of their event? To tap into this latent demand and to get a higher turnout at their events.

Does it work all the time? Not really, what ends up happening is that even if they have 1000 slices of pizza, not 1000 people (assuming each person eats 1 slice) will turn up. Why is this? I posit that this pizza is not completely free.

There is an opportunity cost to spending an hour at some event about ‘education’ or ‘identity in the west’ (assumption: I derive no marginal benefit from this event); I could be spending my valuable time doing homework or watching Grey’s Anatomy instead! There is also a slight transportation cost, and this is more of a discomfort cost, I’m less likely to haul myself all the way to west campus at 9PM unless someone is flying me there in a helicopter. So in essence, this market of “free” pizza does clear, the people who attend these events are those that feel the marginal benefit to them of the free pizza is greater than or equal to the cost of attending the event. There really is no such thing as a free lunch (or snacktime!).

Additionally:

This also means that when there is a cost for pizza, the demand curve may no longer be a straight vertical line (perfectly inelastic). If its something like a transportation cost then there is only a fixed cost and the curve should still stay vertical but shift in instead. However, if there is a variable cost (like opportunity cost for each minute it takes you to consume a slice of pizza), then the curve will shift downwards and the curve will no longer be vertical, it will be like a regular demand curve.

So if you are an event organizer, how do you draw in more people? Here are some of my recommendations based on sound economic principles:

  1. More effective marketing. This one is intuitive, the more people that know about your event, the higher your attendance.
  2. Have an event that has a gives attendees a higher marginal benefit. If President Obama is going to be speaking, I’m going to be fighting with my best friends for the last ticket, if its some no-body from Wisconsin, then your pizza better be good.
  3. Reduce the opportunity cost of attending the event. Sometimes shorter events are better, no need for a day long conference when it doesn’t need to be.
  4. Reduce the transportation cost of the event. Think ‘central locations’.
  5. Have better food. The real and latent demand for Chipotle or In n Out is much greater than it is for stale fries.