Lawrence Economics Blog

Creative Instruction

McOutsourcing in Moscow

Solid New York Times piece on McDonald’s in Russia. To wit:

The company celebrated a different milestone earlier this year by outsourcing the last product — hamburger buns — it had made at a proprietary factory outside Moscow called McComplex. It was built before the chain opened its first restaurant. Nearly everywhere else, McDonald’s buys ingredients, rather than making its own. But in the Soviet Union, there simply were no private businesses to supply the 300 or so distinct ingredients needed by a McDonald’s outlet.

Everything — from frozen French fries to pie filling — had to be made from scratch at a sprawling factory.

McDonald’s is always a good lens through which to view the 118 or so countries where it operates. In the 20 years since McDonald’s arrived in Russia, enough private enterprises have sprung up to supply nearly every ingredient needed to operate one of its restaurants.

Today, private businesses in Russia supply 80 percent of the ingredients in a McDonald’s, a reversal from the ratio when it opened in 1990 and 80 percent of ingredients were imported.

Fascinating stuff. I could probably write an entire final exam around that passage.

There’s No “I” in “Normative Codes of Coduct”

On the heels of our 450 test, there is an interesting post over at Organizations and Markets about some empirical work on Alchian & Demsetz’s team production problem. The issue at hand is, of course, how to enhance cooperative behavior.

We find that neither verbal framing with company cues nor the recruitment test have a significant effect on cooperation enhancement whereas the introduction of normative codes of conduct significantly boosts cooperation. This effect is even stronger when codes of conduct are combined with the recruitment test.

Looks like an interesting piece and a potential future classroom experiment.

No mention of the effects of firing the grocer, however.

Give Me a “TEA”

Don’t forget, the Economics Tea kicks off today at 4 p.m. in Briggs 217. “Free” cookies and discussions of maximizing behavior. If you are reading this, presumably your attendance indicates a well-specified objective function, whereas your absence is due to high marginal costs rather than an information problem.

If you find that amusing, then this will definitely be your kind of crowd.

Did Amazon Blink?

Looks like Amazon might have blinked.

Dear Customers:

Macmillan, one of the “big six” publishers, has clearly communicated to us that, regardless of our viewpoint, they are committed to switching to an agency model and charging $12.99 to $14.99 for e-book versions of bestsellers and most hardcover releases.

We have expressed our strong disagreement and the seriousness of our disagreement by temporarily ceasing the sale of all Macmillan titles. We want you to know that ultimately, however, we will have to capitulate and accept Macmillan’s terms because Macmillan has a monopoly over their own titles, and we will want to offer them to you even at prices we believe are needlessly high for e-books. Amazon customers will at that point decide for themselves whether they believe it’s reasonable to pay $14.99 for a bestselling e-book. We don’t believe that all of the major publishers will take the same route as Macmillan. And we know for sure that many independent presses and self-published authors will see this as an opportunity to provide attractively priced e-books as an alternative.

Kindle is a business for Amazon, and it is also a mission. We never expected it to be easy!

Thank you for being a customer.

More on the Amazon-Macmillian Fracas

Excerpts from a very illuminating discussion:

Greed, no doubt, exists on both sides, living as we do under capitalism, but greed alone doesn’t explain the dispute. Yes, Amazon wants to sell e-books for $9.99 or less, and Macmillan wants Amazon to sell them for $15 or less. But as Macmillan’s CEO John Sargent explains, in a statement released today as an advertisement to the book-industry newsletter Publisher’s Lunch, Amazon and Macmillan aren’t at the moment fighting to see who can make more money on a book sale. They’re fighting to see who can lose more money. This is a very peculiar battle.

,,,

Most publishers have until now sold their e-books to Amazon for the same wholesale price that they sell their hardcovers–roughly half the hardcover’s list price. It is up to a retailer like Amazon whether to sell the book to consumers at its list price, as printed on the inside front flap, or at a discount. With e-books, Amazon has usually offered a discount so low that it actually loses money. That is, Amazon buys for $12 an e-book whose hardcover list price is $24.95, and then Amazon sells the e-book to its customers for $9.95.

…

Macmillan has probably been selling its e-books to Amazon at the wholesale price of about $12, and Amazon has been selling them retail for about $10. Macmillan says that it would like to sell its e-books at the wholesale price of about $10.45, and have Amazon sell them for the retail price of $14.95. In other words, Macmillan was offering to earn $2 less per e-book. Amazon, however, insisted that it would prefer to take a $2 loss on each e-book, instead, and became so indignant over the matter that it has now ceased selling any Macmillan titles, print or electronic. Macmillan’s proposal is known as the “agency model” for e-book pricing, and the company probably only dared attempt it because Apple has promised that it will sell e-books for its new tablet on exactly those terms. (Amazon has said that they’re willing to accept the agency model, starting in June, but only if an e-book’s list price does not exceed $9.99.)

…

Thank you, Mr. Shatzkin.

Big Apple Stirs Up Bezos’ Hive

A few months ago we saw Amazon and Walmart and Target engaged in some aggressive price competition in the sale of on-line books. I haven’t heard to much on that front of late, so I assume that the dust has settled and those firms will fight another day. Amazon is back in the thick of things, this time aggressively defending its Ebook turf from the encroachment of Apple and its new iPad.

The book world is all a flutter. Here’s a note from one of friend of mine, who has intimate knowledge of the sordid dealings of the book world (edited for content; these book people drink like journalists and swear like sailors):

So this ebook pricing conflict is getting serious. Amazon has pulled all of Macmillan’s titles from its store — physical, ebook, etc. — in response to Macmillan wanting higher prices for some kindle editions than $9.99. So, for example, you can’t buy any Picador titles. That’s a lot of bestselling books.

[I’m not certain I agree with Amazon’s actions here]. To dictate $9.99 for all books and instill that price point in readers minds as the only appropriate ebook price is just ridiculous — especially when they’re losing money on every kindle edition they sell of a hardcover book.

And this:

So it’s about Macmillan trying to switch over the agency model of pricing, which is what Apple is offering with their new ibookstore. It makes a lot more sense than the distribution model that Amazon uses for ebooks.

Nothing like a good old fashioned price squabble to keep things interesting. I’m looking into the details of this “agency pricing” model and of course will let you know when I find out.

Stay tuned to this space.

Update: This stuff is so delicious I just want to take a big bite out of it. It appears to be more of a market power argument than a transaction costs argument. And it appears this may well have all come to a head with or without the iPad.

Thanks to my source, “The Big Stick,” for the tips.

The Rise and Fall of Investment Banking: Theory of the Firm Edition

For those of you taking a break from trivia to study for a 450 Exam, Daniel Gross gives a broad brush account of the importance of ownership structure and agency issues. Here’s the basic argument: (1) investment banks go public (i.e., allow members of the public to buy ownership shares); (2) raising equity capital allows banks to expand and compete with international considerations; (3) growth in size correlated with a growth in clout, whereby banks effectively “captured” regulators; (4) growth in size led to acute agency problems, whereby management plundered shareholders a la Berle and Means.

Whew, that was fast.

Reading Group (?): Innovation and the Gales of Creative Destruction

A number of faculty members have formed a reading group for issues of innovation and entrepreneurship. Fittingly, it is called the Innovation and Entrepreneurship Reading Group.

Our first book is Thomas McCraw’s award-winning Prophet of Innovation: Joseph Schumpeter and Creative Destruction. Schumpeter is a central figure in entrepreneurship and innovation scholarship, and is closely associated with the idea that entrepreneurship drives economic growth. He describes innovation as a “perennial gale of creative destruction,” whereby new ideas and products destroy and displace the status quo. Hence, innovation is not unambiguously good thing, as by its very definition it creates classes of winners and losers.

Schumpeter provides the conventional framing of the innovation process as a triumvirate — invention, innovation, and diffusion. Invention is simply the development of a new idea or technology. He argued that inventions were not the story, and that innovation was associated with creating value of the idea. By this definition, innovation is not restricted to technological phenomena. An organization can be innovative by restructuring or doing things in a different way, provided, of course, that there is some value added.

If you are interested, check The Moodle for more information. Or you can contact me directly. I would be happy to spend some time with any student or group of students interested in discussing the book.

Market Failure and Drug Approval

Here’s a question for you true believers out there, is there a market failure rationale for FDA approval of pharmaceuticals and medical devices? And, if so, what is it?

Well, that’s exactly the question that Daniel Klein and Jason Briggeman of George Mason University asked more than 300 economists with expertise in health economics, the FDA, information and uncertainty, and regulatory policy.

They asked you, too, and you can check it out by participating in this 25-minute interactive exercise.

For those of you without 25 minutes, here’s a snippet:

Due to pre-market approval, drugmakers face costs, delays, and uncertainties that suppress the development of new therapies. Famous studies of the introduction of beta-blockers showed that many tens of thousands of American deaths could be attributed to the delay between approval in Britain and in the United States. Scores of other drugs have been delayed that plausibly would have saved many other lives. But pointing concretely to delays in the approval of well-known drugs can only illuminate a potentially larger problem: the extra costs and uncertainties imposed by the pre-market approval process may prevent the development of many drugs. Those losses–of not-developed drugs, of wouldhave-been benefits–are impossible to identify or quantify, but they are no less real.

I would be very interested to hear your thoughts both before and after your take the survey.

What Should We Expect of Our Central Bankers?

Ben Bernanke’s reappointment as Chair of the Federal Reserve Bank remains in the hands of the U.S. Senate. Many are calling for a negative vote. I (and Ed Glaeser in the linked piece below) beg to differ and would like to point out that central bankers are not and should not be in charge of solving all the ills of the economy nor can they create all such ills.

http://economix.blogs.nytimes.com/2010/01/25/in-defense-of-bernanke/#more-49539

This Means You!

Peter Temin has a new NBER paper on one economic historian’s view of the current debacle. Here’s the abstract:

This paper discusses parallels between our current recession and the Great Depression for the intelligent general public. It stresses the role of economic models and ideas in public policy and argues that gold-standard mentality still holds sway today. The parallels are greatest in the generation of the crises, and they also illuminate the policy choices being made today. We have escaped a repeat of the Depression, but we appear to have lost the opportunity for significant financial reform.

Let me know how this one turns out.

The Citizen Kane of Macro Battle Rap Videos

Do you find that your friends lose interest when you start discussing the nuances of Keynsian and Hayekian views on boom-and-bust cycles? Well, this might be just the video to help you get your point across.

The messages seem to align with my admittedly-limited understanding of macro theory, and I’m pretty certain Russ Roberts knows more about these issues than I do. And it has received critical kudos from Alex Tabarrok.

Catchy, too.

I’ll look forward to hearing this blaring in 120 and 320 in the coming years.

Enjoy!

Kasparov Goes Mano-a-Mainframe

Gary Kasparov talks about his experiences going mano-a-mainframe on the chessboard in the latest New York Review of Books. Here’s a tasty bit discussing when the programmers finally prevailed:

It was the specialists–the chess players and the programmers and the artificial intelligence enthusiasts–who had a more nuanced appreciation of the result. Grandmasters had already begun to see the implications of the existence of machines that could play–if only, at this point, in a select few types of board configurations–with godlike perfection….

The AI crowd… was pleased with the result and the attention, but dismayed by the fact that Deep Blue was hardly what their predecessors had imagined decades earlier when they dreamed of creating a machine to defeat the world chess champion. Instead of a computer that thought and played chess like a human, with human creativity and intuition, they got one that played like a machine, systematically evaluating 200 million possible moves on the chess board per second and winning with brute number-crunching force…

It was an impressive achievement, of course, and a human achievement by the members of the IBM team, but Deep Blue was only intelligent the way your programmable alarm clock is intelligent. Not that losing to a $10 million alarm clock made me feel any better…

Here in the economics department, we believe people and firms make choices among alternatives. Of course, it can be both difficult and costly to identify all those alternatives ex ante.

Great read.

Management Consulting Summit

Twelve students and four professors just finished lunch with five Lawrentians who have become successful consultants. During the three hours before lunch, we learned a lot about consulting, about careers in the consulting world, and about how Lawrence students can get their foot in the door. Students who came got invaluable advice and made connections with Lawrence alumni. If you weren’t there, you missed out–make sure you come to the next event on the banking industry on February 13th (Saturday of reading period). And you might want to take a look at the Pyramid Principle by Barbara Minto.

The Times, They Aren’t a Changin’

Speaking of the New York Times, you might have heard the buzz that they are going to begin charging for content. Will that save them? Well, as one critic put it, “Do you like getting pecked to death by ducks?”

It’s a pretty interesting piece, integrating some aspects of market structure, competition, innovation, and, yes, organizational adaptation.

Apple doesn’t even announce its tablet, and suddenly Amazon flips the deal on Kindle royalties to comport with Apple’s app world. Yup, yesterday Amazon said publishers would get 70% of revenue instead of 30%. Sure, there are caveats, you can read the fine print, but the point is Amazon could see the Apple juggernaut coming and adjusted. Where’s the adjustment at the “New York Times”?

Check it out. You might learn something along the way.

Just Think How Much They’d Be Worth With Tasteful Uniforms

Have you ever wondered how much a sports team is worth to the community? Many people think about direct benefits in terms of jobs, sales of novelty headwear, Economists typically find that on net, such benefits aren’t very big, or are even negative.

One thing that has been tough to measure is the value that individuals place on having the team, and a recent piece in the Southern Economic Journal has done just that for the Minnesota Vikings. According to a piece in the Wall St Journal,

Sports teams sell their facilities as economic-development projects that create jobs and generate tax revenue. But a slew of studies have shown that publicly subsidized stadiums–usually paid for by selling bonds and paying the cost and interest with tax revenue-rarely return the money governments put into them. Teams continue to argue, often successfully, that they are worthy of subsidies because they are a source of civic pride and purpose.

But what is that worth? Economists Aju Fenn and John Crooker tried to answer the question in a study published in July 2009 in the Southern Economic Journal.

The two used “contingent valuation methodology,” which is a nerdy way of saying they surveyed people and used statistical models to turn the answers into an average price Minnesotans place on the Vikings.

The result: The Vikings’ “welfare value” is $702,351,890– $530.65 for each of the roughly 1.32 million households in Minnesota.

The study was conducted in 2002, and the figures are not adjusted for inflation (or for the recent acquisition of quarterback Brett Favre)

The contingent value method was pioneered by environmental economists, trying to get at the value of non-market amenities, from clean air to a day of fishing to preserving the Arctic from oil development. It relies on, of all things, estimates of the compensated demand curve. So for those of you laboring through Econ 300 right now, this is one application of that whole “prices rise and we give you just enough income to keep you on the same indifference curve” business.

One of the major criticisms of the method is that it’s easy to talk the talk about what you’d be “willing to pay,” but it’s a much different thing to actually plunk down the cash.