Gas prices

A common quandary that perplexes many folks is fluctuating gas prices.  Whenever gas prices increase quickly, I typically hear something like the following:

  1. The cost of the current stock of gas in the underground tank at the gas station was bought at a lower price.
  2. Rising gas prices do not change what the gas station paid for that current stock.
  3. The gas station could keep the lower pump price and still have cleared a nice profit on that stock of gas.
  4. Why do they raise the price?  It must be greed.

I have something for folks who have not got past this quandary to think about.

Let’s say you bought a rookie baseball card for pennies.  Years later, that rookie develops into a future hall-of-fame player and is loved by a large fan base.

Ten years from when you bought that rookie card, you discover you have it and look up the market value and find that it is now worth $50.

You tell a friend that you have the card.  He wants it.  What do you consider to be a fair price?

You tell your friend the price is $50 since that’s the market value.  He might argue that it only cost you a few cents and even with inflation, the cost of the card to you in today’s dollars is $1.   He might offer to pay you a storage fee of $0.10 per year, which brings the total offer price to $2. Does he have a fair argument?  Are you motivated by greed for not agreeing to sell it for $2 and wanting $50 instead?

While you are negotiating a price with your friend, the player tragically dies in a car accident and you find out the next day that demand for his memorabilia has increased substantially.  You see his rookie card is now selling for $400 on eBay.

Remember, you only paid a few cents for the card and you have not agreed to a final price yet.  Do you accept your friend’s offer of $2?  Do you stick with your original asking price of $50?  Do you raise the price to $400?

If you choose the second or third option, you are behaving identically to the gas station owner and you are not being motivated by greed, but rather by your opportunity cost.

By selling the card to your friend for $2 you would give up the opportunity to sell it for $400 and you are giving your friend that opportunity. You recognize that what you paid has little bearing on the situation.  You also recognize that you would be giving your friend $398.

Now, let’s revisit the gas station.   The gas station owner fills his underground tank for $10,000 and sets a price that will earn him $11,000 once all that gas is sold – a tidy $1,000 profit.

A fire takes out a major refinery and the price of gas on the commodity market jumps.  The gas that cost the the owner $10,000 last night is now going for $15,000 on the commodity market.

Let’s say there’s a local law that requires the gas station owner to not change his price until he sells out of this batch.  He can sell the gas to his customers and make $11,000 or he can call his supplier and have them come pump the gas out of his tank and sell it back to them for $15,000.  Which would you do?

Macro economics is like magic? Close to it.

F.A. Hayek regarding the ‘Austrian School’ of economics, from The Fatal Conceit (p. 98):

By its stress on what it called the ‘subjective’ nature of economic values it produced a new paradigm for explaining structures arising without design from human interaction.

By “subjective” Hayek means that the value of the things we trade — the morning newspaper, a Coke, a haircut — is determined subjectively by each of us.

By “structure”, I believe Hayek means a system of prices by which a potato’s price becomes relative to how much time it takes you to earn enough to buy it.

All of the prices reflect the subjective values we all place on these items and these prices are discovered through the experience of human interaction and trading these things, not by anyone setting the price.

I’m reminded of an example in Russ Roberts’ The Price of Everything, when the econ professor Ruth asked who set the price of a home she plans to sell.  The seller, answered her students.  Ruth responds, so if I have a house that’s in a neighborhood where like houses normally sell for $800,000, I can set the price for $1.2 million and expect to get that price?  Who really sets the price?  Nobody.

Hayek continues:

Yet, during the last forty years, its [the Austrian school] contributions have been obscured by the rise of ‘macro-economics’, which seeks causal connections between hypothetically measurable entities or statistical aggregates.  These may sometimes, I concede, indicate some vague probabilities, but they certainly do not explain the processes involved in generating them.

Here’s the good part (emphasis added):

But because of the delusion that macro-economics is both viable and useful (a delusion encouraged by its extensive use of mathematics which must always impress politicians lacking any mathematics education, and which is really the nearest thing to the practice of magic that occurs among professional economists) many opinions ruling contemporary government and politics are still based on naive explanations of such economic phenomena as value and prices, explanations that vainly endeavour to account for them as ‘objective’ occurrences independent of human knowledge and aims.  Such explanations cannot interpret the function or appreciate the indispensability of trading and markets for coordinating the productive efforts of large numbers of people.

In other words, macro-economics is really the use of math to relate things that may not really exist.  This is a hard one for people to accept.  After all, GDP is GDP isn’t it?  It’s real?  Those statisticians and economists know what they’re doing, don’t they?

What’s real are the trades between you and others.  What’s real is the thought processes that went your mind that led you to make those trades, as well as the thought processes that went through the minds of your trading partners.

GDP is not real.  The thought processes exist somewhere — in our minds.  GDP is a number printed on a page.  What that number means doesn’t exist anywhere.

Allocation Through Pricing

Several years ago a friend got me hooked on the annual tradition of buying Beaujaolais Nouveau in November.  This red wine is made from the grapes of this year’s harvest and is shipped out across the world on the third Thursday in November.

It was fun.  For a few years we went together to purchase the wine.  It made for a nice story on Thanksgiving.  And, it was cheap.  I think I recall paying around $5 a bottle for the wine.  But, you had to get there within a day or two or supplies would run out.

Another friend asked me if I bought the Beaujaolais this year?  “No.”  “Why not?”

My first answer was, well it has become too mainstream now.  Everybody knows about it.

Then I thought for a second and continued…

“And, they raised the prices.  At $5/bottle, I’d buy 2 or 3 bottles.  Now the prices are around $10 – $14.  I guess it wasn’t worth it to me.  I have other wines I enjoy more for that price.  Also, I notice you don’t have to get there on day one now, supplies last with the higher pricing.”

I thought back to the story of flashlight pricing at Big Box retailer in Russell Roberts’ The Price of Everything.

After an earthquake, Big Box raised prices.  Of course, that made everyone mad, yet Big Box was the only place in town where you could get what you needed (p. 71).

[Ruth – Econ professor]: “On the night of the big earthquake, there aren’t enough flashlights to go around. At the usual, everyday prices, people want to buy more flashlights than there are flashlights on the shelves, agreed?”

[Ramon – outraged consumer]: “Yes.”

“Given that there aren’t enough flashlights to go around, who should get them?”

“That’s easy.  The people who need them the most.  Not the people who already have one.  Not the people who have lots of candles.  Not the people who are going to sleep most of the night anyway.”

The conversation continued.  Ruth asked how you would decide who needed the flashlights the most.  She points out the problem is knowledge.  You could interview people and see who makes the best case, but Ramon is skeptical that people might not tell the truth.  Ruth adds that along with flashlights you would need to make the same decisions for candles, diapers, portable generators and items to numerous to have any hopes of being effective.

[Ruth]: “If you leave prices alone at their regular everyday levels, who gets the flashlights and the milk and the generators?”

[Ramon]: “The people who need them.”

[Ruth]: “I don’t think so.  If you leave prices alone, the people who get the flashlights are the people who get there first.  When you went to Home Depot, the stuff you wanted was already gone.  But at Big Box, anyone who wanted a flashlight could have one.”

[Ramon]: “If they were willing to pay for it.  That made it harder on the poor people…”

[Ruth]: “Agreed. But for thousands of people, there were flashlights waiting for them.  Remember that knowledge we wanted to have? The knowledge about who needed flashlights the most? When Big Box raises the price of flashlights, someone who had candles at home decided to do without the flashlight and left it there for you on the shelf.  No one had to interview either of you. The higher price induced both of you to act as if you had been interviewed.  The person with the candles, by refusing to buy the flashlight at the higher price, was saying, I’ll pass on buying a flashlight. I’ll leave it for someone who needs it more. But no one begged him to do the right thing or passed a law that would have to be enforced or interviewed him to find out who needed it the most.  The higher price made sure you got the flashlight, that seems pretty just to me.”

With the higher price on Beaujaolais, I decided to pass on it and leave the 2 to 3 bottles I would have bought on the shelf for someone else who valued it more.  I would make due with other wines and without the stories of drinking this year’s harvest.

If you’re still curious about poor people not being able to afford flashlights and would like to know more about what Ruth Lieber says, I encourage you to get a hold of Roberts’ book and read it.

As for me, I’m thinking about buying extra flashlights, batteries and a generator while the prices are reasonable.

George Lopez Agrees With Louis CK

I saw George Lopez live last night.  Very entertaining, though he seemed a bit punch drunk and bitter from a divorce.

A common theme in Lopez’s act was how well we live compared to even just a generation ago, which reminds me of the comedian Louis CK’s “Everything’s Amazing and Nobody’s Happy.”

He harped on how good our kids have it and showed that he’s a good economics thinker by asserting that we’re raising our kids as dependent wimps and that probably won’t end well.  We are the broken feedback loop.

One story he used to illustrate the point is how he baby-proof our homes to prevent our young children from getting hurt.  This is me, paraphrasing:

We put rubber on the corners, we plug the outlets.  When I was a kid, if we were walking around with a butter knife, adults encouraged us to stick it in the wall socket.  We’d shoot across the room and as we’re lying on the floor recovering the adult would come over and tell us to use our brains.

Kid walks into the kitchen and asks, “Is that pan hot?”  Adult: “You tell me.”

He talked about how we don’t even think twice about spending $30 here and there to buy our kids stuff now.

Back then $30 was a lot of money.  Heck, today it’s a lot of money.  We give our kids so much.  We didn’t have that back then.   We climbed trees, played marbles and doctor!

One line of Lopez’s reminded me of a Tony Blair, and perhaps Churchill quote: “You can take a true measure of a country by looking at the number of people trying to get in and the number trying to get out.”

Lopez:  “America is a great country.  You can tell because a lot people try to sneak in and not very many want to sneak out.”

And, I agree with Lopez on immigration.

Most immigrants come here to work and earn a better life than they had by doing jobs that Americans don’t really want to do.  Let them.

We all benefit from immigrants and most of us are too dumb to realize it.

I think the the biggest immigration problem we have is that our government places artificial limitations on the number of immigrants to admit and it creates other artificial barriers to them becoming legal, like the minimum wage.

Unfair Trade Practices

Don Boudreaux of Cafe Hayek wrote a letter to the Milwaukee Journal-Sentinal about Senator Russ Feingold’ statement that “unfair” trade practices have led to the destruction of 64,000 jobs in Wisconsin.

Nobody thinks 64,000 people losing jobs is great.  But, what people like Feingold don’t consider is that there’s a positive offset to that which is much greater.  The problem with the offset is that it’s unseen, while a worker losing his or her job is easy to visualize.

What if Feingold said we have lost 64,000 jobs in the buggy-whip industry because we have allowed folks to purchase automobiles?

While this statement is essentially the same as Fiengold’s statement, it wouldn’t carry nearly as much punch for two reasons.

First, my statement identifies the workers as buggy-whip makers.  Second, it identifies the benefit as something people can clearly see as a positive trade-off.  We get cars at the expense of the of a few buggy-whip making jobs?  I feel bad, but I’ll take the car, thank you.

Boudreaux does an excellent job at identifying the workers and making folks think about the unseen effects that offset the 64,000 lost jobs in the last paragraph of his letter:

So Sen. Feingold’s accusation that freer trade is “unfair” simply because freer trade results in some workers losing particular jobs means that he must also regard as “unfair,” say, anti-smoking campaigns.  After all, such campaigns tempt consumers away from buying cigarettes and, sadly, result in job losses among tobacco-industry workers.

I would have changed “anti-smoking campaigns” to “anti-smoking laws”, which I think are more analogous to “unfair” trade practices.

Similar to the buggy-whip example, most people intuitively make the trade-off when presented with more information, even those with what Thomas Sowell calls the unconstrained vision.  Oh.  If we have to give up a few tobacco industry jobs to save a few lives, so be it.

We Can Now Afford Gardens

This EconLog Everything’s Amazing, Nobody’s Happy post today from Arnold Kling ended with Kling observing:

Today, we take specialization and trade for granted. We get ticked off when the government “fails to create jobs.” Yet the unemployed do not revert to growing their own food, sewing their own clothes, and dipping their old candles.

That reminded me of recent Ellen show (yes, I’m a fan) where she showed off her new garden and expressed her delight in its bountiful, fresh produce.

While watching, it occurred to me that just how wealthy we really are.

We use to grow our own food out of necessity.  Then, through trade and specialization we became better off and didn’t have to grow our own food anymore.   Really what happened was that the opportunity cost of growing our own food became so great that we didn’t do it.  We could get more food by doing what we did best, whatever that may be.

Now, we are so well off that we can grow our own food again.  There’s nothing better for Ellen to do than to pay* someone to plant and tend a garden so she can enjoy fresh produce.  What use to be a necessity that was tended by our own hard labor is now a luxury item, like having a pool or hot tub.

It would actually be a sign that we are becoming less well off if people stopped tending (or have others tend to) to their gardens.

Come to think of it, Arnold Kling would make an interesting guest for Ellen Degeneres.

*I use the word pay loosely here.  The segment showed other people building her garden for her.  She may not have paid them directly with money (or she might have), but she did pay them with something – air time perhaps.

Walter Williams Says it Well

Another gem from Walter Williams, Economic Myths, Fallacies and Stupidity.  Here are some excerpts I enjoyed.

George Orwell admonished, “Sometimes the first duty of intelligent men is the restatement of the obvious.” That’s what I want to do — talk about the obvious.

How about the criticism that businesses are just in it for money and profits? That’s supposed to be an anti-business slam but upon simple examination, it reflects gross stupidity or misunderstanding. Wal-Mart owns 8,300 stores, of which 4,000 are in 44 different countries. Its 2010 revenues are expected to top $500 billion.  Why is Wal-Mart so successful? Millions of people voluntarily enter their stores and part with their money in exchange for Wal-Mart’s products and services. In order for that to happen, Wal-Mart and millions of other profit-motivated businesses must please people.

Continue reading

On Success

If I need a statistician to tell me whether something worked or not, it didn’t work.

That’s a sentence that I think I came up with, but I wouldn’t doubt that I lifted it off someone and can’t remember who. Until proven otherwise, I’ll take credit.

This sentence came from my years working with statisticians employed by managers of for-profit companies to find out if something they tried worked or not.

My sentence ruffles the feathers of statisticians.  Many statisticians understand the limitations of their trade, but many  don’t.  Many non-statisticians don’t either.  When managers use statisticians to determine the effectiveness of a project, beware.

To me, the project needs to offer what I call a clear advantage.  I should be able to look at the results and clearly see that what I tried was better.

Continue reading

Do Your Preferences Agree With Your Local Policitians’?

The market for health care was once organized to meet the needs and preferences for people using the service.  For a long time, this market has been becoming more organized to meet the preferences of politicians.  This week’s legislation makes it more so.

Unfortunately, few understand what these words mean.  That’s too bad.

An example might help.  Consider the market for food, which is more essential to living than health care.  This market is still very much organized to meet the needs and preferences of people who buy food.

There are many different ways to assess the success of this market.  Some measures might include food availability, options for people at all income levels or size of waist lines.  The problem with such measures is that they reduce a rich environment filled with many variables down to a few metrics.  These measures can’t capture things like the delight caused by enjoying a favorite snack or that little bit of extra value enjoyed by a few based on a slightly different version of a product (Michelob Ultra vs. Michelob).

Now consider what might happen if the food market was overtaken by government.  The politicians in charge might decide that a single factor was most important.  Maybe high food availability.  For  many people this sounds reasonable.  Who’d be against  high food availability?

What these people miss is that reorganizing the food market to deliver on this goal has trade-offs.  A trade-off may be that a politician decides we need to dedicate less shelf space to beer to have more shelf space for wholesome foods like apples.  Again, to many this sounds good.  The politician will likely cite the destructive results of alcohol abuse and remind us that an apple a day keeps the doctor away.  Few people would likely disagree with this reallocation of shelf space.

To free up the shelf space, politicians must decide to eliminate a version of Michelob.  They decide to keep Michelob because it sells more than Michelob Ultra.  Very smart people those politicians.  The people who preferred Mich Ultra are out of luck.

What’s missed by many people in this seemingly justifiable reorganization of the food market is that the previous allocations of products and shelf space were a result of consumers expressing their preferences through their actual purchasing patterns.  In other words, this is what customers wanted – even if they didn’t know that explicitly.

While a politician may be able to sell us (even those who prefer Mich Ultra) with fancy talk about how more shelf space need be dedicated to apples and less to beer, that doesn’t change the fact that customers valued the space higher with Mich Ultra.

This reallocation will result in surplus in apples and beer shortages.  Stores will have a difficult time giving away the extra apples and beer lovers will be disappointed because they will have a hard time find beer to buy.

Instead of recognizing that food availability worked better before when consumers expressing their preferences through prices and buying patterns with grocery stores and food makers responding accordingly, some do-good politicians will convince us that his new version of shelf space allocation will solve the problem.  He’s a smart dude.  He went to an esteemed college (though nobody will ask him which class he learned to be better at choosing for others what they are capable of choosing for themselves).  He just needs more of your money to implement the change.  We all nod our heads in agreement.

The cycle will start all over again to generate new shortages and surpluses causing less food availability with fewer of our needs and preferences met, but because change was made, the politician will be able to spin victory and several years later a new politician will come along with his plan to fix things with more of your tax dollars.

His plan may be to use a different metric to measure success.  We’ve done nothing but that make food less available, so let’s switch to measuring options available at all income levels and the cycle begins again.

While politicians continue to use taxpayer dollars to tinker, very few people will understand that everything worked just find before politicians started meddling.

Doe this market sound familiar?  This meddling has been happening to K-12 education and the results aren’t great.  After decades there’s no agreement on how to measure success and few people realize that the truest measure of a school’s success is whether their student enrollment is growing or shrinking.

While we meet to politician’s desire to deliver on a single variable – make education available to to everyone – in many cases what’s available is a school that is so bad that only those with the least ability to make a choice send their kids there.

And, we all miss out on all the variations, quality, availability and a rich assortment of educational opportunities that the education market could produce if only it were allowed to serve the needs and preferences of the people sending their kids to school rather than the politicians who are trying to put a feather in their caps.

How to Get People to Respond to Other Peoples’ Desires

Three classic paragraphs from Chapter 1 of Thomas Sowell’s Applied Economics:

Politics and the markets are both ways of getting people to respond to other people’s desires.  Consumers deciding which goods to spend their money on have often been analogized to voters deciding which candidates to elect to public office.  However the two processes are profoundly different.  Not only do individuals invest very different amounts of time and thought in making economic vs. political decisions, those are inherently different in themselves.  Voters decide whether to vote for one candidate or another but they decide how much of what kinds of food, clothing, shelter, etc. to purchase.  In short, political decisions tend to be categorical, while economic decisions tend to be incremental.

Incremental decisions can be more fine-tuned than deciding which candidate’s whole package of principles and practices comes closest to meeting your own desires.  Incremental decision-making also means that not every increment of even very desirable things is likewise necessarily desirable, given that there are other things that the money could be spent on after having acquired a given amount of a particular good or service. For example, although it might be worthwhile spending considerable money to live in a nice home, buying a second home in the country may or may not be worth spending money that could be used for sending a child to college or for recreational travel overseas.  One consequence of incremental decision-making is that increments of many desirable things remain unpurchased because they are almost–but not quite–worth the sacrifices required to get them.

From a political standpoint, this means that there are always numerous desirable things that government officials can offer to provide to voters who want them–either free of charge or at reduced, government-subsidized prices–even when the voters do not want these increments enough to sacrifice their own money to pay for them.  The real winners in this process are politicians whose apparent generosity and compassion gain them political support.

It’s worth repeating that first sentence: “Politics and the markets are both ways of getting people to respond to other people’s desires.”

Keep that in mind as you go about your day and interact with others.  The stuff you buy, generally, is so readily available that you take it for granted.  There’s a reason for that.  Markets are excellent ways to get people to respond to other people’s desires.

Politics, on the other hand, is a different story.  In the remaining of the three paragraphs above, Sowell does a superb job of laying out part of the reason.  Categorical and economic decisions are different.

If I want to buy a cup of coffee, it’s cheap and available.  Because I’m willing to buy it, thousands of people from the growers in some far off land, shippers, roasters, the companies that make the brewing equipment, cups and lids and the people who brew it up for me all coordinate to give me what I desire — I didn’t even have to ask them.  There was no coffee czar or government task force on coffee to bring it to me.

Further, I can choose from an assortment of sizes, flavors, roasts, brewing methods and creamers to make it the cup of coffee I prefer, while the next guy in line can choose something very different.

Contrast this with things provided by the government.  A good deal of people have to agree on a one-size-fits all solution.  There’s very little room to take into account personal preferences.

What are the chances you’d get the coffee  you prefer if the only type of coffee available would be the one that everyone voted for or even just the one that sold the most?  If you’re not a coffee drinker, expand that example to all beverages.  What are the chances that you’d get the soda, martini, tea, juice, milk or energy drink you prefer if the government decided that we have too many beverages to choose from and we have too much of our “nation’s” capital invested in beverage producing resources, so we only need two beverages – water and 2% milk?