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Posts Tagged ‘economics’

A Fine is a Price

A famous paper of the same title studies a natural experiment that tests this hypothesis. They found this pre-school in Israel where parents were perennially late picking up their kids. The pre-school instituted a fine that parents would be charged if they were late. And lo and behold, the parents were late picking up their kids since they rationalized the fine as a price (for additional babysitting), which made them feel less guilty about being late.

I bring this up because the NFL spent most of this season very publicly fining players, particularly defensive players, who made dangerous tackles/plays. Till last year, while a few fines were handed out, it was mostly a ‘please don’t do this kind of thing or we might frown on you’ kind of thing. Now, they are fined 25k to 100k depending on the egregiousness of the violation.

So here’s a simple test of the “fine is a price” theory. Top defensive players, raking in large contracts can clearly afford a fair few of these fines without any fiscal repercussions- the fine isn’t really much of an additional deterrent over their desire not to hurt a fellow player. Journeymen in the defense making the league minimum contract (~800k a year) can’t really afford these fines- for them this fine is a deterrent.

So, is the ratio of Goddell-attention-grabbing hits by star defenders to those by regular players up year on year?* If yes, I’d submit, we have independent confirmation that a fine is indeed a price.

*Our own thoughts, without any systematic data collection is that this did happen. Our recollections are skewed by the late hit artist that is James Harrison of the Steelers, and of course our own Julius Peppers’ hit on Aaron Rodgers in the latter half of the NFC championship game.

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Long term strategic excellence is not hallmark of the airline industry. Their wince-worthy choices are a staple for MBA case-studies on winning the battle and losing the war. E.g. the old joke- Q: How do you make a small fortune in the airline industry? A: Start with a large one.

Recently, after some he-saidshe-said, American Airlines fares no longer appear on Orbitz or Expedia. To the world this appeared a time-perfected shoot-yourself-in-the-foot move. To academic economists, this was a cunning ploy to use the Diamond paradox in their favor. The truth, as always, lies somewhere in the middle.

The Diamond Paradox in English- standard price competition leads to low prices. But suppose we add a small search cost. A company can now raise its price by a small amount, since people would rather pay the slightly higher cost than pay to search. The competition can now raise it’s price as well. But our original company can now raise prices again- and so on. This ‘raveling’ stops when all companies are at the monopoly price, even though we have competition with only a small search cost.

The AA play is not to be only available on AA.com- indeed they were the pioneers behind the idea of a computerized global distribution system originally. My explanation: They want to use their newer direct connect feature to better sell ancillaries, e.g. baggage, seat upgrades etc on online travel sites. This removes an asymmetry: the old GDS’s are just not built to handle it, the direct websites (AA.com, Delta.com are). Since most of their lowest base fare customers come from these online websites- selling them these add-ons is critical. Cutting double marginalization- incidental benefit.

Why do I think it isn’t a Diamond paradox play? North American airlines are low on cash. Unilaterally withdrawing from a cash generator is a bad idea- the competition is happy to watch while you haemorrhage. Airlines’ actions are always short-term cash generating- and as a “push up search costs for everyone” strategy, it definitely isn’t.

And why do I think it isn’t a classic shoot yourself in the foot move? Oh it probably is, it just has a subtle, almost plausible logic to it. As always.

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A central idea in revenue maximizing pricing is price discrimination- try to get more money out of the people who are willing to pay more. On this topic alone, tomes have been written, careers and fortunes made, court cases filed, more fortunes lost and so on. However, price discrimination needn’t just be about making more money. If the people who want to pay more are the same as the people who value the good more, the resulting allocation is societally efficient. Two obvious ways it goes wrong: i) people who value a good more might not have the money to pay for it, and ii) using money can seem, well, grubby.

So we do all sorts of second best things- e.g. get people to stand in line for concert tickets. That way the fans who really want to see the concert are the fans who’ll probably stand in line. If time is money, then it’s resulted in a loss to them, but somehow this seems societally better. And there’s the resale problem – people who don’t care for tickets, but have no value for time, will stand in line and later scalp the tickets to people who do care and are short on time.

So how do you get around this, at least a bit, without using money? The geniuses at Google gave us a new answer during the launch of  their Chromebook laptop. The laptop, and they’re looking for a few thousand people to test it before commercial launch later in the year. How do you make sure the people who get it are people who want it/ will use it, without charging them?

So first, when they launched it, they put out this promo video.

Seems rather innocuous, but then look closely at the 2:23 mark of the video. There’re some equations on the greenboard in the background. Turns out if you solve them, and find the value of x, it’s a long string of 1s and 0s. Do some more code solving, and you get the URL http://www.goo.gl/speedanddestory . It’s a secret URL to a secret form. First person to fill it out got the laptop…

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Someone shopping for a car loan online recently found something reasonably clever afoot at Capital One’s website (assuming of course that this was by design and not due to a website programming error)- Capital One offered a lower rate when he was using a Google Chrome browser, and a higher rate when he used Mozilla Firefox (Safari and Opera use resulted in interest rate offers between the Chrome/Firefox watermarks).

Many of you visiting this blog will recognize this as third degree price discrimination, which the arbiter of truth of our times (Wikipedia) defines as varying price by a customer attribute, which is used as a proxy for ability to pay. The examples you’ll see in your ‘standard’ economics textbook will refer mundane examples like student or senior citizen discounts. Capital One is the only one that I know of visiting the brave new frontier of price discrimination by conditioning on technology choice. While we’re at it, I figured I might as well suggest other ways to achieve better outcomes by conditioning on people’s technology choices. Here’s a few that came to mind:

  1. Overcharging customers who visit from a laptop running Windows XP + IE 6. They’re clearly highly paid consultants/ bankers whose IT department won’t let them upgrade.
  2. Extra TSA attention for anyone in the airport carrying a Nokia phone- they’re clearly not from around here.
  3. Obviously, undercharging @gmail.com and overcharging @hotmail.com on mortgages (see: The Oatmeal)
  4. Student discounts for anyone whose browser history includes collegehumor and/or icanhazcheezburger and senior citizen discounts for anyone whose browser history includes mapquest.com

 

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