Monthly Archives: February 2016

Thoughts on Movie Pricing

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Tyler Cowen quotes Ashok Rao,

Is the fact that I’m browsing on iTunes at all enough of an information signal to segregate the market?

I believe that this is the answer. If you go to a movie theater nowadays, that is as good as putting a sign on your forehead saying, “I have inelastic demand.” In a world where price discrimination explains everything, you can expect movie ticket pricing to err on the high side.

On the question of why there is not a price differential for higher quality movies, I have the following thoughts:

1. The best analysis of the economics of movies can be found in The Big Picture, by Edward J. Epstein. Pretty much everything I know about the topic I learned from reading that book.

2. One thing I took away from Epstein is that a lot the revenue that goes to the industry comes from tie-in sales (think Star Wars toys) and popcorn sales. The movie per se has more limited revenue potential.

3. Should better movies cost more because they are more expensive to make? Actually, the relationship between the amount spent making a movie and the quality of the movie is not terribly strong.

4. If you think that it should be the cost of distribution that drives the cost of movie tickets, then, well, the cost of showing a good movie is no higher than the cost of showing a bad movie.

5. From the theater’s point of view, it is perfectly rational not to charge a premium for good movies. The theater does better to increase popcorn sales by raising the quantity instead of trying to increase revenue per ticket by raising the price.

6. From the theater’s point of view, it is perfectly rational not to offer discount tickets for bad movies. Because the biggest cost of seeing a movie is opportunity cost, cutting the price is not going to induce many people to watch a movie they don’t want to see. Would you waste the time to go to a theater and watch a movie just because it was half price?

The Goldwater Debacle

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I have finished reading my advance copy of Yuval Levin’s The Fractured Republic. I am confident that when I make up my list of most important books of 2016 that it will be included. Unfortunately, it does not go on sale for another three months.

Levin attempts to interpret extended periods of economic, cultural, and political history in terms of broad themes. Given that such an effort takes huge risks (of which he is aware), I think he does a very creditable job. But these sorts of high-level analyses are always subject to quibbling over details.

One such detail concerns Lyndon Johnsons’ Great Society. Levin–and he is hardly alone in this–sees the legislation of 1965 as a natural product or capstone of an era in which the Federal government took on increasing responsibilities.

I want to push back and to stress the idiosyncratic and accidental nature of the Great Society legislation.

1. Johnson never succeeded in selling his program to the public. The public’s attitude toward the Great Society was predominantly scornful and cynical. Grace Slick, before she became the lead singer for Jefferson Airplane, was in a band called The Great Society. It was not an homage.

2. The left had very mixed feelings about Johnson. Many northern liberals were put off by his southern accent. They were still in mourning over Kennedy and many were put off by Johnson’s lack of the Kennedy charm and grace. Also, by 1965, Vietnam was cutting deeply into his support among liberals, particularly younger ones. And there seemed to be a disconnect between the term Great Society and the urban unrest that was starting to erupt. Rather than wishing to share in the glory of the Great Society, many liberals saw it as an exercise in Johnson’s ego and parliamentary wiles.

3. What made the Great Society possible was the landslide victory that Democrats won in 1964. In that sense, we owe the Great Society to Barry Goldwater. His nomination shattered the Republican Party. In today’s terms, think of an effect on the Republican establishment somewhere between a Cruz nomination and a Trump nomination. Moderate Republican voters stayed away in droves in 1964, and in those days coattail effects were much stronger. As a result, the disaster of 1964 decimated Republicans up and down the ballot. There are those on the right who like to romanticize the Goldwater insurgency by saying that it “paved the way for Reagan.” What it actually paved the way for was Democratic control of Congress that remained well entrenched into the Reagan era and beyond. It was the class of 1964 that passed the Great Society programs and that made them impossible to repeal even when Republicans re-took the Presidency.

It can be difficult to predict the consequences of one’s preferred candidate winning a nomination or an election. That is one reason to agree with Tyler Cowen that you should be careful what you wish for.

Small Polities are Better Polities

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In the WaPo, Amber Phillips reports on a survey of trust in government.

Gallup found that an average of 64 percent of residents in the smallest 10 states have confidence in their state government, a fairly high number. Again, the reason may be that in smaller states people live similarly and thus have similar wants and needs the government can more easily address.

Thanks to a reader for the pointer.

The next time someone tells you that we need to be more like Denmark, you should say, “Break up the big states!”

One of my longstanding beliefs is that smaller polities are better polities. Imagine that we broke up any state with a population larger than ten million, and suppose that we then gave states full domestic policy autonomy. The federal government would be tasked with providing for the common defense, but do not with promoting the general welfare.

What is the Stock Market Watching?

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The Bernank applies statistical analysis to the way the stock market has reacted to oil prices. Pointer from Mark Thoma.

Amni Rusli points to a Merrill Lynch study of how markets watch central banks. Pointer from Tyler Cowen.

Am I the only one who thinks that the stock market should be watching the election season, and that it should be tanking even more than it already has? On the Democratic side, the defining issue of our time is rich people making too much money and not paying enough of it in taxes. And the government not providing enough freebies to everybody else.

On the Republican side, the defining issue of our time is immigration enforcement. I cannot get on board with that. Are immigration laws even the most important of all the laws that are loosely enforced? I don’t see speed limits being strictly enforced on the Beltway. I don’t see recreational drug laws being strictly enforced on college campuses.

My point is not that I think we should be moving toward strict enforcement of speed limits and drug laws. My point is that “But it’s illegal!” isn’t the argument-clincher on immigration enforcement that a lot of people think it is.

I am not the type of person who is going to say, “inequality and immigration must be important, because so many people think so.” Instead, I am just going to say that the people who are voting to express themselves on those issues are, in my opinion, flat-out wrong.

I don’t think of myself as a defender of the political establishment. But when see where Sanders supporters and Trump supporters are taking this campaign, it’s enough to make me want to send valentines to Mitch McConnell and John Boehner.

What are the issues I worry about? Our country is sleepwalking toward a fiscal meltdown, as the past debts and future unfunded liabilities get larger every year. We have piles and piles of regulations, without knowing whether they are aligned with or working against their intended objectives–but I strongly suspect it’s the latter. We have a substantial share of the population that is poorly integrated into the productive economy and having most of its children out of wedlock. Our response to Islamic terrorism consists of random flailing overseas and massive inconvenience to innocent people at home, so as not to appear to be engaged in the dreaded “profiling.”

But those issues have been crowded out by inequality and immigration. If other investors shared my view of the political environment–and some day they might–stock prices would be less than half of what they are today.

Prizes Have Not Worked Well

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Timothy Taylor quotes from a paper by historian B. Zorina Khan.

industrial prizes faltered in part because of their lack of market-orientation, and even the democratic nature of economic institutions in the United States could not overcome such drawbacks in administered prize systems.Judges had to combine technical and industry-specific knowledge with impartiality, but even the most competent personnel could not ensure consistency; decision-making among panels was complicated by differences in standards, interpretation, capture, and risk-aversion. Such difficulties tended to lead to haphazard decisions, or were often overcome by simply making the award to the person or the firm with the most established reputation. Juries were not immune to the effects of outright bias, capture, cognitive dissonance, lobbying, and “marketing.” Prizes tended to offer private benefits to both the proposer and the winner, largely because they served as valuable advertisements, with few geographical spillovers. Winners of such awards were generally unrepresentative of the most significant innovations, in part because the market value of useful inventions would typically be far greater than any prize that could be offered by private or state initiative.

Suppose that the commercial value of an idea is highly uncertain before it has become embedded in a business product or service. This leads to what we might call market-valuation errors. You can think of many examples of companies that have come out with products that they thought would be successful but failed to excite consumers.

With a prize fund, these market-valuation errors are borne by whoever puts up the prize fund. For example, if the government creates a prize fund for somebody who develops a better wind turbine, but the wind turbine still fails to penetrate the market, then the taxpayers take the hit. Instead, if the wind turbine inventor is given a reward in the form of a patent, then it’s the inventor who suffers if the turbine fails in the marketplace.

Going from patents to prizes serves to separate two functions: guessing the value of a potential invention; and coming up with the invention. Separating those two functions may not be such a good idea.

Adam Smith raised this concern. See David Henderson’s response to Taylor’s post. Henderson writes,

Essentially, the problem is a central planning problem. A government that gives prizes has to know what to give prizes for. It could give a big prize for something that matters little or a small prize for something that matters a lot. It’s hard to know in advance. Patents, as Smith points out, solve that problem.

As Henderson indicates, patents are problematic also. They are susceptible to other forms of errors by governments.

Uncovered Interest (Dis?) Parity

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Timothy Taylor reads a semi-annual update from the Fed, and is struck that

A divergence has emerged in the interest rates of advanced market economies, between the US and UK on one hand and the euro-zone and Japan on the other.

He produces a chart showing that the ten-year bond rate is about 150 basis points higher in the U.S. and the UK than it is in Germany or Japan. Years ago, Jeff Frankel adapted the Dornbusch overshooting model to say that this sort of thing would imply that the dollar and the pound are expected to fall about 1.5 percent per year for those ten years. This would make those currencies about 15 percent overvalued relative to the “long-run equilibrium,” it that is what we can call the exchange rate expected 10 years from now.

Note that in the short run, interest rate differentials and expected currency movements are tied together by covered interest parity. If I can earn 1.5 percent more on U.S. one-year securities than on one-year German securities, and the futures market were to offer me a one-year dollar/euro contract that assumes no depreciation of the dollar, then I have an arbitrage play of shorting German one-year securities and buying American ones, while buying euros in the futures market to eliminate currency risk.

On a ten-year basis, it tends to be harder to cover your currency risk. So there is, at best, uncovered interest parity.

Tyler Cowen on Market Monetarism

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Tyler Cowen writes,

Surely there are other independent, ex ante signs for judging the tightness of monetary policy, rather than waiting for ngdp figures to come in, which again is citing a transform of the real gdp growth rate as a way of explaining real gdp.

He also links to Mike Munger, which led me to this post.

Read both in their entirety. I share their concerns with circularity in market monetarism.

Perhaps the market monetarists would answer that we will have an ex ante sign of the stance of monetary policy when we have an NGDP futures market. But in order to get a non-circular definition of tight money from market monetarists, must we wait for an NGDP futures market? Meanwhile, perhaps a worthwhile exercise for market monetarists would be to spell out the best way of inferring expected future NGDP from existing market indicators.

UPDATE: After I wrote this, but before I posted it, Scott Sumner wrote,

My focus when estimating the stance of monetary policy has generally been NGDP forecasts, not actual NGDP. And NGDP forecasts are available in real time, and hence not subject to the “waiting for ngdp figures to come in” critique above.

But that paragraph turns out to be disingenuous. He proceeds to disparage economists’ forecasts as not being market forecasts. He suggests that the spread between nominal bonds and inflation-indexed bonds is a better indicator of expected inflation than what you will find in a consensus economic forecast.

Overall, Sumner does show that he clearly understands that Tyler and other critics are asking for an actionable, forward-looking statement of the market-monetarist view of current conditions. And he comes close to providing it.

the current ultra-low 5-year spread [between interest rates on nominal bonds and rates on inflation-indexed bonds] suggests money is too tight for the Fed’s 2% inflation target. That doesn’t mean we’ll have a recession, but if the Fed wants to hit their 2% inflation target they need to ease policy. If they don’t, and if they fall short of their inflation target, then MMs will have been right.

Hillary Clinton’s Nevada Triumph

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The population of Nevada is about 2.8 million. According to the WaPo, Mrs. Clinton scored a resounding victory. She received 6,238 votes. 500 more than the other guy.

[UPDATE] Thanks to a commenter for pointing out my mistake:

Those are county delegate vote totals, not popular vote totals. Because the dem caucus process is dumb we don’t know how the popular vote broke down, but turnout has been estimated at 80k.

So maybe she got 50,000 votes? [/UPDATE]

Also, here is Tyler Cowen on what those who are surprised by the success of Donald Trump might have gotten wrong. Again, I give credit to Martin Gurri for getting it right. The public is revolting more, and more revolting, than we thought.

Manufacturing 3D Kool-Aid

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T X Hammes writes,

3-D printing, married with artificial intelligence and robots, will disrupt manufacturing globally. It will radically alter who makes what where. Rather than subcontracting the production of components to Southeast Asia, shipping those components to China for assembly, and finally shipping them to consumers, many manufacturers will produce locally and switch to just-in-time production schedules. This shift will eliminate shipping and inventory costs as well deal with the increasingly costly problem of intellectual property theft. Local production will result in major reductions in the globalization of manufacturing and thus change the economic element of the global strategic environment. As manufacturing returns to rich countries, it will deprive the nations of Southeast Asia of the opportunity to pursue export-based growth. Perhaps the greatest threat is to Chinese growth. Even as its growth settles to a new, lower, normal, China struggles to shift from an export-based economy to a consumption-based one. If China cannot make the shift before the additive manufacturing results in localized manufacturing, it will suffer major negative impacts on growth.

Read the whole thing. Speculative, as Tyler would say. If you would like to hear the guy speak, then tune in or attend on March 9. His topic will be new technologies of war. Possible preview here.

The F-35 is a poster child for the difficultly of reconsidering a program of record. Built in 45 states at a cost of $399 B for 2,443 aircraft and with expected lifetime operating cost of $1 trillion, the F-35 has powerful Congressional support. Further, U.S. doctrine and powerful service constituencies heavily favor these exquisite systems. This is natural since doctrine and preferences are usually based on experience and current U.S. experience is based on exquisite systems. These two powerful factors will make it difficult to dispassionately examine other options. However, we must do so soon. Our experience with the F-35 shows that the decision to pursue a different path needs to be taken before the new system gains a powerful constituency that insists it be built regardless of its capability.