Today's cartoon

A little good news in these dark days

Just found this story about firms returning call center jobs to the US due to higher costs from returned equipment and sending engineers to fix simple problems. It seems that with the high unemployment rate and relatively low cost of labor there should be an explosion of hiring in depressed places like Detroit, Flint, and Dayton. Instead companies, the ones whose CEOs claim to be visionaries, only look at the upfront costs and not on the impact of customer dissatisfaction. The initial savings from paying low wages is decreased when suddenly warrnties are being paid out because the customer service people cannot explain how to fix things, customers return items because they cannot understand what the person on the other end is saying, etc. Maybe some businesses will figure this out instead of the usual short-term thinking.

Introduction to two-tiered pricing

In response to the question over differences between Wal Mart and Costco, I will introduce a new concept to explain differences in the pricing scheme between a traditional retailer and a discount club. The difference comes from the way prices are set to increase the propensity to consume for customers.

For a traditional retailer, their goal is to price with a difference of the cost and a percentage markup to cover the fixed and variable costs and have a profit. This markup is usually variable and can be none if the firm seeks to engage in loss leading to take out a competitor. Such a phenomenon occurs often with the opening of a new major retailer, since they can spread the losses out over many stores, so the damage to the company overall is negligible compared to the increased market share from removal of competition.

In contrast, a discount club store operates on a different pricing mechanism. By selling near cost, Costco or Sam's Club offers higher savings (known as consumer surplus) compared to the price they would be willing to pay for the same item in a traditional store. As a result, if the discounter only sold at cost, they would go out of business since the profit motive would be removed and they would lose money since the fixed and variable costs would make them lose money. To counteract this reality, the discounter makes up for the difference in consumer surplus by charging a membership fee which creates a small profit and covers the operating costs. As a result, the membership fee is usually tiered to a point where all consumer surplus is removed from all but the highest volume purchasers, so the consumer is not better off shopping the discounter than anywhere else. Naturally, some consumers, such as those with large families gain some consumer surplus, but the pricing including the membership fee precludes most consumers from benefitting economically, so the firm still realizes profit. This type of pricing is known as two-tiered pricing, and is done to ration things for which different classes of consumers have different levels of elasticity.

Great Cartoon

First Post of the New Year

After spending many hours trying to figure out what is the proper name for this year, I felt a renewed desire to post. The upcoming year will be very interesting economically, as the results of the massive bailouts start to trickle down to the economy as a whole. However, since the year is new and the market has not traded in the new year yet, I decided to post one last story over the last year.

As any reader of this blog knows, the issue of whether the Federal funds rate being artificially low between 2002-2006 or whether lack of regulation caused the downturn has been central. Today the New York Times has a story quoting the Fed chairman as stating that weak regulation of lending practices caused the housing bubble. According to Bernanke, a surgical approach to lending problems could have stemmed the crisis in its infancy. However, the two problems work in tandem to create an atmosphere of irresponsibility.

For example, a bank has money to lend at very low rates, so in order to make a profit it must clear out a lot of loans since the dividend income is reduced. Magically, the banks suddenly have this brilliant idea that they can make loans with one hand and then resell the debt on the loans to another. Making matters even worse is that this is done with common deposits, since the Gramm-Leach-Blilely Act allowed commerical banks to take over investment banks without oversight of their operations. Additional regulations such as the Community Reinvestment Act further forced lending to be more plentiful during the boom, so banks made loans that would not have been made had the financial oversight arms of the government done their job. In short, both low interest rates during a boom and lack of cohesive regulation doomed the economy to a massive correction.

Farewell to the year of the bailout

Now that 2009 has come and mostly gone, we can all feel a little bit older and a little bit more indebted. This year saw the stimulus package, the first trillion dollar annual deficit, and the worst unemployment in a generation. Hopefully with the new year some sense will be restored to the financial principals of this nation.

What to look forward to in the new year?:

The tallest building known to man will be opened
The Winter Olympics in Vancouver
The World Cup in South Africa
The final Space Shuttle mission
The Boy Scouts of America turn 100
The Decennial Census
The Midterm Elections on November 2


Here's to hope in 2010

One instance where centralization is beneficial

Amidst many stories about continuing unemployment, Tiger Woods and his seven mistresses, and the mindless stories about the shopping season, I found an interesting story courtesy of Bloomberg. In this tale of wonder, a country sees impending trouble from overinvesting as an economy recovers and decides to take action, limiting the amount of lending in the coming year to avoid an investment bubble. This country has a neighbor who lived across a pond and saw the same thing several years ago, but instead gave out extra money thinking that everyone would contiue growing forever. In fact, this neighbor actually lowered interest rates when the economy was booming, while removing any regulations on risky investing in collateralized debt obligations and mortgage-backed securities.

Can you believe the first country is China and the second is us?

The moral of the story is that some regulations make sense if there is irrational behavior going in a market. The first message should be that when an economy grows the amount of money needs to grow slower to prevent inflation. Doing the opposite, ie lowering interest rates during expansion, overheats the economy and causes bubbles to form as riskier and riskier moves become necessary to "beat" the market since inflation cuts down on real gains. The second message is that the completely unregulated financial world in the US is not something the rest of the world is emulating us on, and it is to our detriment that we continue down a course of lax regulation and unfree trade while the rest of the world does not.