Markets in Everything and Incentives Matter

Markets in Everything

I was intrigued on Memorial Day weekend by a show on the Discovery and Science channels called Oddities.  The half-hour show features the owners, Mike Zohn and Evan Michelson, of an “antiques and oddities” shop in New York City called Obscura as they haggle with buyers and sellers of some mighty strange stuff.  Mighty strange.  I thought bloggers were strange.

Belly lint art.  Rotting teeth.  Articulated animal skeletons.  Diseased brain cross sections.  You name it.

A number of times sellers walked into the store with some strange thing and I thought, they’ll never want that.  But then the owners offer pretty good sums of money for it.

If they don’t know what it is, they call in experts who usually “are really into this stuff” to get a better opinion on the going market rate for such oddities.

It’s interesting to watch.  I appreciate getting the insight into the haggling process.  For example, a sideshow performer worked Zohn and Michelson down on the price of a bed-of-nails sandwich (performer lies on his back on one bed-of-nails and then places another bed-of-nails, tips to nips, on his chest for people to stand on) from an old Coney Island sideshow by laying on the bed of nails and letting  Zohn and Michelson stand on top of him while he was in the sandwich.

Generally the sellers seem to be folks who have somehow acquired something strange from an inheritance, garage sale or something like that, and don’t really know what it is.  The buyers generally seem to be artists, performers and very specific collectors.

Incentives matter

One artist, who specializes in art from body functions and parts, was looking for something new.  Zohn pulled a large glass jar filled with rotting teeth from a top shelf.  He explained that dentists donated teeth that they pulled from patients to dental schools so dentists-in-training could practice filling cavities.  Somehow they came across this jar.

The artist loved it.  She and I both thought they would be happy to get rid of the whole jar for a price.  While hugging the jar she asked, “How much for this?”

Apparently there is a healthy market for rotting teeth.  “We sell those by the tooth.  You can pick out five or six teeth for $100 or so.”

This made me think back to Russell Roberts’ book the Price of Everything.  After an earthquake, one big box retailer raised prices on flashlights.  Some consumers saw this as price gouging.

But, the other side of the story is the higher prices caused better resource allocation.

Stores that didn’t raise prices were sold out of flashlights soon after the earthquake.  The value of flashlights had increased, but prices hadn’t, so the first few customers bought out the entire stock whether they really needed them or not, leaving no flashlights for customers that came in later.  The flashlights were allocated on a first-come, first-serve basis with all the spoils going to those who got to the store first.  People who came in later and really needed a flashlight could feel good that the store didn’t raise prices on flashlights, but they still wouldn’t be able to to buy a flashlight.

When the big box retailer raised prices, it caused people to more carefully consider their purchase, resulting in some people who may have already had flashlights, to pass on the flashlight purchase leaving more flashlights on the shelves for those who truly needed them.

Apparently, the same principle was at work on the rotting teeth.

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.

“The Price of Everything” by Russell Roberts

The Price of Everything: A Parable of Possibility and Prosperity

This book is my new reading recommendation for folks who want to dip their toes into basic economics.  I will continue to recommend Thomas Sowell’s Basic Economics, but I think Russell Roberts book will be a good precursor to Sowell’s book.

I’m testing it with some friends now and will see how it goes.

I enjoy Russell Roberts work on the blog Cafe Hayek, the EconTalk podcast, the rap video The Fear of the Boom and Bust and his paper on the causes of the financial crisis.

I put off reading this book because it’s economics told through a fictional story and I was little leery of the fiction aspect. I shouldn’t have been.  It’s a great read and the fiction is good.  The story is compelling and the economics discussions in the book are interesting.  I read it in three days.

Russell Roberts comes from a free market perspective, but in my experience with his other work he is fair in capturing the opposing viewpoints and addressing the real concern, he does so in this book as well.

Anybody who has had an economics discussion with friends will likely appreciate the discussions Ruth Lieber has with her students and Ramon.

At $10 for the paperback, this is a steal and makes a great gift for anyone with a mild interest in economics or politics.

Addendum: I forgot to mention that I also enjoyed the Sources and Further Reading section of the book.   It was interesting to learn the back story on the inspiration behind certain elements of the story and I plan to work my way through the further reading Roberts suggests.  I’m already well into one of his suggestions.

Addendum II: Thanks to Professor Roberts for linking to this review on his blog, Cafe Hayek.  As he points out in that post, is discounting the price of the book by 40%.  At that price it’s worth considering buying a dozen or so to have them on hand to give to folks as econ discussions come up in the daily course of events.  “Here, give this a read…let’s talk about it when you’re finished…then pass it on. “

Gift Ideas

Are you looking for gift ideas for someone who falls in the moderate conservative to libertarian part of the political spectrum and might have an interest in popular economics or gaining a better understanding of how the political economy around them works?

You won’t go wrong with the following book choices.

  1. Basic Economics: A Citizen’s Guide to the Economy by Thomas Sowell
  2. Applied Economics: Thinking Beyond Stage One by Thomas Sowell
  3. The Armchair Economist by Steven Landsburg
  4. Economic Facts and Fallacies by Thomas Sowell
  5. Really, anything by Thomas Sowell is good.
  6. More Sex is Safer Sex by Steven Landsburg
  7. The Undercover Economist by Tim Hanover
  8. The Price of Everything by Russell Roberts

There are two books on the list I haven’t read yet, but will soon and I have read much other stuff by the authors and can vouch that these are good.

Update: W.E. Heasley offers these suggestions (I’ve read one of these and will add the rest to my reading list):

  1. Getting Off Track, John B. Taylor.
  2. Super Freakonomics, Levitt and Dubner.
  3. The Fatal Conceit: The Errors of Socialism, F.A Hayek.
  4. A Conflict of Visions, Thomas Sowell.
  5. The Federalist Papers in Modern Language, Mary Webster
  6. Anarchy, State, and Utopia, Robert Nozick.

For fiction, dave recommends Cryptonomicron and The Baroque Cycle by Neal Stephenson.

Also, I’d like to add one more to the list: P.J. O’Rourke on the Wealth of Nations.

Seduced by Sophistication

Russ Roberts, econ professor at George Mason University, podcaster of EconTalk, blogger on Cafe Hayek, writer the Keynes vs. Hayek Rap and skeptic of the econometric models wrote about the “science’ of economics in Saturday’s the Wall Street JournalHere’s some key paragraphs posted on Cafe Hayek.

If economics is a science, it is more like biology than physics. Biologists try to understand the relationships in a complex system. That’s hard enough. But they can’t tell you what will happen with any precision to the population of a particular species of frog if rainfall goes up this year in a particular rain forest. They might not even be able to count the number of frogs right now with any exactness.

We have the same problems in economics. The economy is a complex system, our data are imperfect and our models inevitably fail to account for all the interactions.

The bottom line is that we should expect less of economists. Economics is a powerful tool, a lens for organizing one’s thinking about the complexity of the world around us. That should be enough. We should be honest about what we know, what we don’t know and what we may never know. Admitting that publicly is the first step toward respectability.

I agree.

I also believe other fields that have recently (in the last 50 -100 years) adopted rigorous math also fall into the trap of thinking that their field is much more scientific than is really the case.  I call this seduced by sophistication.

Math provides a veneer of science to non-scientific things.  Such math is purveyed by economists, business consultants, investment managers, statisticians, psychologists, educators, medical researchers, nutritionists, climatologists and more to sell their services and peddle their influence.

I’ve witnessed this seduction firsthand in my career.  While there are some benefits to be gained from modeling, the danger comes in not understanding its limitations.   This mistake is made by people who should know better – the people running the models.

They confuse the models with the real world, rather than realizing the models are simplistic representations of the real world that lack effective treatment of some very important real world factors and relationships.

Nassim Taleb writes about such mistakes in his books The Black Swan and Fooled by Randomness.

Read up on Professor Roberts and Taleb’s writings.  Don’t let yourself be seduced by sophistication.