Highways as Club Goods

One innovative method of reducing excess congestion on highways is the addition of All Electronic Tolling (AET) lanes. Unlike general-purpose lanes which give cars (or in the case of HOV lanes, only high occupancy cars) free access, AET lanes charge users a toll that varies based on the current number of other users. Each vehicle that passes under the electronic toll-collector reduces the total cost of the highway’s maintenance. However, the rate at which tolls are collected slows as congestion increases and, from the consumers’ perspective, as total benefit decreases. Pegging tolls to real-time congestion, therefore, allows the profit-maximizing toll operator to optimize the number of “members” in its “club” by discouraging prospective members from overcrowding.

The proliferation of AET lanes on major U.S. highways demonstrates the applicability of Buchanan’s theory of clubs to real-world problems. Whereas Samuelson viewed non-rivalry as the defining characteristic of public goods, Buchanan focused on their non-excludability. To the extent that surveillance technology allows operators to identify and report free riders, AET lanes are less than fully public goods and, thus, feasible as private operations. Additionally, Buchanan observed that such “club goods” are only partially non-rival because “as more persons are allowed to share in the enjoyment of the facility, of given size, the benefit evaluation that the individual places on the good will, after some point, decline (Buchanan, 1965).” Roads, though not perfectly rival, are clearly subject to this constraint. While an individual motorist would never use a road if he was liable for its full costs, sharing those costs with an infinite number of other motorists would totally eradicate the road’s value. AET congestion-based pricing resolves this dilemma by communicating the true marginal cost of lane use that an additional user would impose on current users. By removing the mirage of perfect non-rivalry, such pricing forces prospective users to balance these costs with the benefits they expect to derive from consumption. By transmitting these real-time cost fluctuations, AET lanes can reduce their congestion to levels approaching N*. 

California, given the 55 electoral votes that come with it, would seem to play an important role in determining who becomes President. Earning 270 electoral votes constitutes a simple majority and a seat in the Oval Office. Thus, the offhand intuition might seem to be that a vote in California is particularly important because winning California's votes alone places one just over a fifth of the way to 270 electoral votes. However, the notion that voting takes on greater importance in a large state such as California is untrue. As can be visualized in the picture (a screenshot I took during the 2012 Presidential election), the results of the state of California were called before a single vote had been counted, which represents that the probability of one's vote affecting the outcome is essentially zero. According to the theory of rational abstention, residing in a large state actually makes choosing not to vote even more reasonable. The expected marginal benefit decreases significantly in a large state because the utility differential from having one candidate elected over the other remains constant (it is a result of the candidate's anticipated policies and revenue-expenditures), but the probability of casting the deciding vote decreases significantly as population increases.

Moreover, as Johnson writes, "the probability that a single vote will affect the outcome is determined by ... the individual voter's expectations about the distribution of votes." In California, the probability that one's vote determines the outcome is infinitesimally small not only due to the state's large population, but also because it is not a contested state (if the vote is not tied, one has no chance to serve as a tiebreaker). The last election in which a Republican candidate for President won the state of California was 1988. Since then, the smallest margin by which the Democratic candidate has won the state is 10%. One might predict, therefore, that social pressure and the pleasure derived purely from the act of voting must be quite high in California in order to explain the votes that are cast in California despite the apparent irrationality of doing so. An interesting alternative, though perhaps unrealistic, is that the elections for the House of Representatives, which occur concurrently, are driving the turnout for the Presidential election rather than the other way around. Though the differential utility is lower than for the Presidential election, the value of P is far higher because the voting pool is minuscule compared to that of the entire state of California, which might result in a higher expected marginal benefit from voting in the election of the local Congressman than from voting in the election of the President.

Taxis vs. Uber - What Would Friedman Say?

In his paper, “The Role of Government in a Free Society,” Friedman argues that monopolies restrict output and voluntary exchange. Friedman reasons that by limiting the availability of alternatives, monopolies inhibit freedom of exchange as well as stigmatize innovation. Friedman’s point is a salient issue today in regards to recent debate about whether or not the popular app “Uber” should be allowed to exist in cities such as D.C. that have pre existing regulations which essentially monopolize the taxi industry. In many cities, there is a ceiling imposed that limits the number of cabs allowed on the roads. This causes taxi licenses, or medallions, to trade for up to $600,000. The high price tag can be justifiable given the fact that the number of cabs is set, and barriers to entry are very high due to this essentially government-created monopoly. The industry has recently been challenged by technology as competitors such as “Uber” have infiltrated the market. Uber allows its users to book a driver and pay for the fare all with the use of their smartphone app as well as allows the consumer to choose the type of car and driver based on ratings. This causes Uber drivers to compete with each other, which ultimately benefits the end-consumer. Nonetheless, the DC Taxicab Commission is doing everything in its power to keep Uber out of the district. Many of its arguments against the popular app stem from the high price of a license that existing taxicab drivers and corporations have paid. Ironically, this high cost is a direct result of the very same government regulators that use it as an arguing point against Uber.

Friedman’s insights we discussed in class are clearly applicable to the issue, as the taxicab industry in many cities is as close to a government-created monopoly as you can get. Freidman would reason that by preventing alternatives to exist, legislation to uphold the existing monopoly would disadvantage consumers by inhibiting voluntary exchange and preventing innovation. It is clear that this is exactly what has happened within the industry up until this point- the existing industry does not give the consumer much freedom of choice and it lacks technological updates and options in a world that is becoming increasingly digital. Friedman would maintain that this industry is insensitive to the dynamic world because it is a publicly regulated monopoly and therefore there is little incentive to innovate to changing demand. It is for these reasons and the fact that this monopoly is not natural that Friedman would view the issue as one that should be settled in the market place, not one in which the government should play a role. Allowing Uber to enter the marketplace would be healthy for consumers who would benefit from competition, promote innovation within the industry, and allow voluntary exchange to flourish.

Split or Steal? Game Theory in Action

In the third round of the British game show "Golden Balls," two contestants face off with a pot of winnings between them. They are each given two golden balls with the word "split" or "steal" written inside each (giving them each two options for the behavior regarding the money). The rules are simple: if they both choose split, the pot of winnings is split equally between them. If either chooses steal while the other chooses split, the "stealer" receives all of the winnings. If they both choose steal, neither receives any money. This situation is structured very similarly to the classic "Prisoner's Dilemma," which we studied in class, but with one key difference: in the classic example, if one player defects, the other player is better off defecting as well (rather than cooperating)—and therefore the dominant strategy for both players is to defect, so there is a single Nash equilibrium of defect/defect. However, in the Golden Balls situation, if one player steals, the other player gains nothing by stealing also; no matter what he does, he receives nothing. Thus, there is the weakly dominant strategy of stealing, and the three Nash equilibria are the configurations where at least one person steals. In other words, both players have an incentive to steal, but no incentive to split the pot.

In this clip from the show, something pretty remarkable happens. One of the players convinces the other that "no matter what," he is going to choose to steal. He asks his partner to choose to split the pot, giving the "stealer" all the winnings, and then trust him that after the show he will give him half his winnings. Through this tactic, he essentially narrows the options facing his opponent to just two: either split, and hope that his opponent is kind enough to give him money after the show, or steal, and they both get nothing. Although there is nothing binding here (so the strict payoff matrix would not change), through the introduction of psychological manipulation and new incentives one opponent induces the other to choose to "split," as the lesser of two evils. As you will see, this strategy works: the man on the left chooses to split, knowing that this is his only chance of getting any money at all, and his opponent does an about-face and chooses to split as well, so they both split the money. His strategy all along was to find a way to force his opponent to choose to split not out of altruism and fair-mindedness (as is usually necessary, and usually fails), but because of the economic incentives at play.

The purpose of this long post, which I hope was worth the read, is that game theory oftentimes works on the premise that the two sides cannot communicate—or, at the very least, they cannot change the incentives of the payoff matrix, so it's difficult to escape the inexorable pull of the dominant strategy and subsequently end up in a Nash equilibrium. This show illustrates that actors in the game can at times use communication, persuasion, and personal trust to influence the incentives in the payoff matrix and reach the "unstable" strategy of cooperating together. I'm not sure what implications this might have for the field of economics, if any, but it's at least interesting to contemplate.

Be Wary of the Negative Externality

The clamor behind green energy continues to spread as a cleaner alternative to fossil fuel. However, I wish to extend a simple recommendation to such advocate: be wary of the negative externality.

Paradoxically, the so-called "clean energy" creates several negative production externalities. A Chicago based firm, McCann Appraisal LLC, found that wind turbine noise frequently causes sleep disturbances and other health concerns. In addition, numerous studies measure losses in property value ranging from 20% to 60% in communities worldwide. In fact, Denmark passed a law in 2008 with a clause mandating compensation for a loss of value in real property caused by the construction of wind turbines.

What is the role of government in this scenario? Lets return to the Danish law from above. The government intervened and enforced compensation for damage inflicted on society. But out of the five hundred and fifty one claims from people living near wind turbines, the average complainant received $8,478, a value not even near the actual amount of damage incurred on property owners.

What if the Danish government used a Coasian solution to internalize this externality? Ronald Coase contends that a market solution will lead to an allocatively efficient outcome if property rights are established and there are no transaction costs. In this example, the Danish government could simply grant property rights to homeowners rather than the energy company. Therefore, if businesses wanted to pursue the construction of wind turbines, they would have to receive permission from nearby homeowners, who would likely require some sort of compensation for the damages they would incur. This compensation would reflect a market value, and it would perhaps be more just towards the property owners than a government dictated amount. The Coasian approach may encounter the fee rider  and holdout problems in some larger communities, but it may be the best solution for many of the smaller, country communities being hurt by the wind turbines.

Alternative Energy, A Solution to Negative Consumption Externalities

Pollution is one of the most explicit examples of a negative consumption externality. In The West Wing Season 6, Episode 5, the Whitehouse Deputy Chief of Staff Josh Lyman, while test driving an SUV, totals a Prius. The authors of the show set up this episode to discuss the problem of negative consumption externalities. Negative externalities are produced when people drive cars that emit large numbers of fossil fuels. Gruber discussed three: environmental externalities, increased damage to roads, and safety externalities. In this scenario, the private marginal cost equals the social marginal cost but the private marginal benefit is higher than the social marginal benefit. This is because the drivers who consume the cars that produce negative externalities do not have to pay for the damage done to those around them. The amount of damage done to other people is the marginal damage.

In this clip, the Deputy Chief of Staff is discussing possible energy alternatives with experts. He is given this project after the media writes a story about his running into the Prius. The government is seeking ways to deal with negative consumption externalities, specifically the  environmental impact of fossil fuel emissions. The goal of the government is to have firms provide to consumers goods that produce less negative externalities. The experts that Josh meets with in this clip work to create solutions that close the gap between the private marginal benefit and the social marginal benefit.  With government incentives, firms are more likely to produce goods that are more environmentally friendly as opposed to those goods that produce negative externalities. As a result, when consumers use these goods, the marginal damage will be less because the products will produce fewer negative externalities.

Argentina's Holdout Problem

A little background to the issue: in the end of the 1990s and early 2000s, Argentina’s economy was facing severe difficulties and the government was unable to make interest payments on sovereign debt issued in 1994. In 2005 and 2010 Argentina restructured its debt, ultimately negotiating the value of their bonds down 70%. Approximately 93% on bondholders accepted the Argentinean offer. 7% of bonds were not renegotiated, however. Most of these bonds were owned by hedge funds that purchased the debt while it was very distressed i.e. following the default but before the restructuring. These same hedge funds have been fighting Argentina for full payment since then and have gained a lot of press lately as "holdout creditors" or Vulture Funds (as Argentina prefers).

The holdout problem is one of the main critiques with Coasian solutions. The idea behind it is that if one party must negotiate with many actors in the opposite side in order to gain some right or benefit, the last actor to participate in negotiations (the holdout) gains tremendous leverage over the other party because he single handedly controls the overall success or failure of the negotiation. However, it may be difficult to understand how Argentina's holdout creditors have so much leverage, given that for well over 10 years they didn't receive any payments. The catalyst for this holdout problem was not the initial debt renegotiation, since that went on despite the holdouts' objections. Instead, holdouts gained their leverage in 2013 with a ruling over pari passu clauses on the bond offering, in which US Judge Grieza declared that Argentina could not pay its restructured bond holders unless it also paid its non-restructured (holdout) bonds as well. As a consequence, the hedge funds were able to setup a scenario where either Argentina paid them, or it would default in its restructured debt - that incredible leverage is what created a de facto holdout problem, something very different from the de jure issue that had been going on for more than a decade.

Interestingly, however, the fact that Argentina has a) defaulted, b) remained a "stable" society and c) continuously tried financial maneuvers to skirt US rulings, show the difficulty of actually using leverage as a holdout if there is no strong entity that can enforce the consequences of non-negotiation. Ultimately a holdout's leverage becomes meaningless if the costs associated with its demands are higher than the cost of non-negotiation, and when it comes to international law, those costs are rarely materialized, unfortunately.

Washington Redskins Jerseys

The consumption, or donning, of sports jerseys allow fans to demonstrate their support of a team. When they are worn in the geographic area closer to the team being supported to than any other, wearing jerseys allows identification with fellow fans and increases fan morale and team support in general. Jerseys are officially licensed and thus used as a vital source of revenue for sport leagues. In 2009, sales of merchandise in the National Football League, comprised of 32 teams, totaled $2.5 billion. NFL jerseys are purely private goods, as their use is both excludable and rivalrous. However, wearing a Washington Redskins jersey results in a negative consumption externality, just like Cain the Great Pyrenees dog; due to potentially racist connotations that could offend others around the person wearing the jersey, the private marginal benefit of the good, which is the utility derived from wearing the jersey, overstates the social marginal benefit. Consequently, there is a market failure because a quantity greater than the allocatively efficient output is consumed.

The outrage has grown throughout the summer: "Whether or not the name is intended to offend, it does.  The usages of the name and logo transcend cultural appropriation to the ranks of explicit racial disrespect." If we assume that the liability falls on someone wearing clothes to avoid offending others, then the Coasian solution would be to have the person wearing a Redskins jersey pay all offended parties. However, due to the extremely large number of affected people, a Coasian solution would prove difficult to implement; in particular, the holdout problem (the last person possesses all bargaining power and can request an exorbitantly high fee) would be difficult to overcome. Contrary to popular perception and despite vociferous calls for people to boycott the consumption of goods bearing the name Redskins, it is important to remember that, as is the case in the pollution example, the optimal quantity of production and consumption of something "bad" remain nonzero. 

The Anti-Vaccination Movement

Vaccines have been proven to protect from many diseases and infections. However, not all parents choose to have their children vaccinated due to personal beliefs regarding the potential side effects. But even the children who do not receive vaccinations benefit from the results, because the majority of their peers have been vaccinated and create a “barrier” against the infections.Vaccinations are thus a positive consumption externality. This results in a private marginal benefit curve that is below the social marginal benefit curve. As we have learned in class, the main issue which externalities cause is a misallocation of resources; in the case of a positive consumption externality, the market allocation is less than the output of allocative efficiency.

In some California schools, more and more parents are choosing not to vaccinate their children. This causes the difference between the market allocation and the socially efficient allocation to continue to increase. This has prompted school officials to seek a solution: “They produced handouts emphasizing the importance of immunizations and asked parents seeking belief exemptions to get counseling from a healthcare practitioner. A state law that went into effect this year makes this a requirement.” However, the number of those opting out has still continued to climb. Coase's solutions fail in regard to this issue because there is a large amount of people on both sides of the argument, making it hard to reach an agreement. Also, parents are likely to free-ride once the necessary threshold for immunity reaches 92%.