I'm simultaneously amused and bewildered by these "appalled" customers. If they don't like the level of service, they're perfectly free to take their business elsewhere. Though none of the interviewed people used this word, lots of people across the country probably think airlines should charge only "fair" prices for separate items.
I don't think most Americans realize that the troubled airlines are experiencing structural losses, not cyclical (i.e. disruption after 9/11). If those particular airlines want to return to profitable service, they simply must charge more, whether higher single prices or individually priced "extras." There's only so much they can do to minimize costs in their business models, especially since unions won't accept much more salary cutting. Of course, higher prices means they will lose business to the successful airlines like JetBlue and Southwest, but that's competition.
Regarding movie theatres, ticket prices are so competitive, and studios' fees so high, that theatres really make very little off selling tickets. Most of their profits come from the concession stands. This was quite a revelation to me, from a friend who managed a theatre for several years. Next door to where I work is the Ziegfeld Theatre (not the original where Perry Como and others did their TV shows), which charges over $10 now, I think. It's really not bad considering high Manhattan real estate prices.
FYI perry - I pay almost $9 to see a movie here in Detroit, unless I bring my Student ID card. Then I save $1. So you're not along with ticket prices 
Northwest recently rolled out a program in which they intend to charge up to $15 more for a handful of exit row and aisle seats on each flight. Anyone who wants to pretend that an exit row or aisle seat is a homogeneous product to a standard seat had better be willing to back that up, by stating "no preference" when it's their turn to board. Anyone who's sat in both will confirm that they are markedly different experiences.
The surprising thing is that it's taken 30 years for the dinosaurs to copy what made SWA so successful: identifying and capitalizing upon a segmented market.
But the irony when it comes to food & drink here - is that, most people I know just bitch about eating airline food anyway, right? Because, it is often lousy, not warm enough, not seasoned to taste, small portions, etc. So now, nobody has to eat it unless they want to eat it, and pay for it. And for this, people are complaining? For christ's sake, they don't even like the food!
Perry: I agree with your observation that the airlines are going through a structural change. You said: "There's only so much they can do to minimize costs in their business models, especially since unions won't accept much more salary cutting."
While that may be true, the airline industry was never fully deregulated. The FAA (and its traffic rules and management) and the airports are still government entities. Just one example, landing slots are still priced the same across an airport regardless of arrival times, for instance, when it would make sense to price higher for periods of congestion.
For the record, there's much disagreement about where TANSTAAFL came from. A wikipedian at TANSTAAFL's Wikipedia page cites, however, cites Shapiro who's research suggests it came from Professor Alvin Hansen's TINSTAAFL formula. However, it could also originally be from 1934 when New York Mayor Fiorello LaGuardia spoke it in Latin.
Notably, Robert A. Heinlein popularized it in The Moon Is A Harsh Mistress, a great libertarian novel. When I finish it, you're welcome to borrow it.
CF: REad all of Landsburg's article. He finds the discrimination argument problematic too since it seems to assume that compeition won't reduce prices. Bundling is in general an interesting question: why do you see it why don't you see more individual pricing. Its also one for which economics does not have good answers (although Nalebuff's 2005 article is quite an intriguing idea). I would also suggest that it implies that the world is far more complex than either libertarians or stupid whiny people (like the woman complaining about price increases) presume. This in turn implies that at least in their simple form many libertarian prescriptions won't work.
MWebb: Might not bundling be comparable in its effects to intrinsic feature differences of products? The package deal will, in the customer's perception, offer something more. Also, as buyers of things we often are seeking satisfaction of far more than obvious utility. Indeed, a purchase may also satisfy "spiritual" or psychological wants (such as esthetics, for instance). As for popcorn, although it is a food, its consumption while watching a movie probably has little to do with actual hunger or nutrition. Its value as food may be one thing and its value as a complement to a movie experience quite another (at least for some movie goers). A movie is, or can be, very much more than an image on a theater screen; it has a great many components like an amusement park whose many attractions are not each valued alike by those who enter.
I have to agree that the world is complex. But, the Libertarian view, for the most part, is not counter to that since in my opinion since it favors individual choice rather than proscription and sees property rights as inviolate. Such views demand complexity (granularity and variation) and tend to discount the solidity of aggregates in thinking about human behavior.
When an economist says bundling they mean bundling products that have no apparant complimentatities. For example cars and steering wheels obviously go together and you save money producing them together rather than having one firm build cars and one car build steering wheels. Popcorn and movies, not so much and other thigns even less so. Price discrimination is a usual explanation for why you see bundling (charging pop corn lovers really high prices at movies) but this is also not a very satisfying explanation since price discrimination usually requires some degree of market power. Movie theater business seems pretty competitive. Therefore why don't you see some theaters advertising we have cheap(er) popcorn and getting the business of all the popcorn lovers. Hence the puzzle.
This may be the problem of the airlines. They face so-called ruinous competition (competition drives price to marginal cost but marginal cost is below average cost ergo cannot make profits in the long run). That of course raises the question of why we do not see ruinous competition in other markets? Some of the deep puzzles (and puzzles that libertarians have an obligation to answer).
MWebb: I've not got any special insight as to whether price discrimination is the "usual" reason for bundling. But, it may be that it is more noticed when that is the reason (simply because the disparity of the items grouped is itself attention-getting). One way of looking at bundling is that it is a way to offer a different product (or service). Thus the theaters offer plain movie viewing (differentiation by types of seating, sound systems, etc) and enhanced movie viewing with added emotional or psychological comfort via popcorn. They aren't offering popcorn per se, but satisfaction of some perceived need in combination with the movie. If it is price discrimination (which surely it is to some degree), then the market power may exist locally within each theater. I know people who simply will not see a movie without popcorn, not ever. I don't understand that.
Ruinious competition over the long term is not possible in a market economy. Either a company pays its way or fails to sustain itself. So-called predatory pricing can not be sustained to the point that it ever brings a monopoly benefit (unless government coercion is applied). Most of the airlines that are struggling actually are facing the need for revised business models. It is possible that the hub and spoke system is at the root of the problem (at least partly), since airlines such as Southwest who do not use it are doing well. In the meantime, airlines are looking for costs to eliminate or reduce within their current business models. Meals, drinks, and such are an obvious source of cost reduction and much safer than maintenance shortcuts etc.
Actualy in high fixed cost industries ruinous competition is what you would expect to happen MC=0 AC=A Lot. Therefore the equilibirum is that no one will enter the industry because they know if they do competitors will keep entering and they will lose money. This is what seems to keep happening the airline industry (hence why over its entire life the industry has made negative profits). To an economist this is a weird outcome. Why would people keep investing in such an industry. Incidently this is also what happened to the railroad industry in the late 19th centruy. First their profits were competed away then they got regulated which helped a little then the governemnt came via regualtion and raked them ove rthe coals again. I agree it doesn't make a lot of sense but that's why its poorly understood (and why the case for governemnt intervention is these markets is at least vaguely defensible).
Your conceptulization of goods is clever na dsimilar to an idea Kelvin Lancaster proposed in 1967. However, it still doesn't solve the main puzzle which is if movie theaters don't have market power (which I would suggest they don't) then why don't some movie theaters offer cheap popcorn and higher ticket prices to capture people for whom popcorn is an integral part fo the movie watching experience and others offer low prices. This is the real puzzle.
As for predatory pricing I would say on balance you are correct. However, therre are some game theoretic models where a firm wants to establish a reputation for being really mean by going after potential entrants. This type of behavior MIGHT make sense in a multi-market or multi-product environment.
MWebb: The airlines (and the railroads) both grew as mostly regulated industries. Their business models were constructed in that environment and have been and are, in my opinion, a major factor in their financial difficulties. Airlines such as Southwest (which has always been profitable) created a different business model. It began as what we Texans referred to as Texas bus service. Just walk up and get on the next bus to Houston, Dallas, El Paso, San Antonio, etc. Although they are now expanding their service nationally, they still use the model developed as an intrastate carrier (which is not the hub and spoke model used by the "major" carriers). This, plus the still regulated nature of the FAA traffic system and the regulated airports is the source of much "inflexible" cost. Since the airline business does attract investment, there must be money to be made someplace. The issue is whether or not they can operate profitably over the long haul while also competing for passengers and freight.
I was unaware of Kelvin Lancaster. However, if theaters raised prices of tickets and lowered prices on popcorn, they would reduce their revenue (and profits) because all moviegoers have to buy tickets and many would simply not pay the higher price (regardless of their prediliction for popcorn).
The "mean" competitor, even if he becomes the sole surviving producer can never relax because an increase in profit potential will attract more competitors. There is, however, probably some price range where additional entries might be forestalled and we see the most efficiency. But, change is everywhere and competition can come from substitutions and obsolescence as well. 100% market share per se does not a monopoly make (if one is concerned about coercive monopoly pricing).
BTW I think most railroads were regulated from the getgo. If not regulated, they were often involved in bribes to legislatures to avoid various political obstacles (some of which existed for the purpose of receiving bribes or some equivalent).
Hte point about movie theaters is that if there is competition (which is normally presumed) why doesn't competition force movie theaters to lower prices to the point that you have zero economic profits. Hence the puzzle.
With regard to profit always attracting entry, this idea goes by the name contestible market theory. It is often espoused by improperly educated libterians as the reason that monopolies cannot raise prices above the competitive level. However, it overlooks a key assumption which is that for a market to be contestibile no barriers to entry can be present. As Gary Becker demonstated even a very small barrier to entry (such as a fixed cost) can make a market uncontestible. Libertarians do themselves no good when they deny the existence of these problems.
The movie theater pricing issue is a bit like the gasoline station pricing issue. The major cost for both is probably the supply of what they are selling. It seems theater chains usually don't have exclusive distribution of a film, so all the (major) chains are likely paying essentially the same cost for the product. On the other side, while there may be small differences in price of tickets, generally there are regional ranges where the theaters try not to price too high. There may be less incentive to price substantially lower, because of the profit ratio.
As for profit attracting entry, that is not contestible. What will affect whether or not anyone chooses to pursue that profit will vary. Since most libertarians speak as if laizze-faire markets were actually operating, it is not surprising that "profit attracts entrants" is said. However, we do not have laizze-faire markets, we have a mixed economy in which government is a major 3rd party in our transactions. Bariers to entry are common (legal, financial, regulatory, etc). Also, there is the question of whether the marginal profit is worth the effort by a potential entrant. Here there are many factors at play, mostly with direct and indirect costs. I hinted at this, or thought I did, by saying there was probably some price range (implemented the 100% market share firm) "where additional entries might be forestalled and we see the most efficiency." In other words, the prices (and thus the profits) may be somewhat high, but not high enough to be marginally attractive to a potential competitor who might gain that profit elsewhere for less effort.
Usually in these cases, we see a single supplier with essentially all the market share. Microsoft is an example. Although Microsoft has had for a time very high market share, it has not priced its OS too high. It acts as if it is competing--and it is, with its own installed base, with other platforms, with other technologies, with technological change itself. With IT we can see this progress in a few short decades, whereas in the past industries had even centuries for this to play out.
Overall barriers to entry are of several types. Those inherent in the product or service are opportunities for cost reduction, for working smarter instead of harder, for doing more with less. Those inherent in the environment may be more substantial and include the degree of government involvement which mandates specific costs and processes not ameanable to usual cost reduction methodologies and require political action and other indirect methods.
This takes us back to the airlines who have many costs actually beyond their control due to only partial deregulation of the industry. So, they are left to squeeze smaller parts of their operations or face really large reorganization of their business models. The government-run FAA and airports present them with unavoidable and unchangeable costs. We should, however, be overjoyed at the results of the extent of deregulation that did take place. When government got out of setting rates and routes, the airlines had a space in which competition was possible and that resulted in a phenomenal increase in passenger boardings and passenger miles.
Can someone explain to me why "bundling" is a problem?
I'm a consumer. A seller offers me a good for sale. To add further incentive, he throws in something else to sweeten the deal. I choose to buy, or not.
How am I victimized?
Maybe I'm just too "simple".
There is nothing wrong with it. Whomever owns something may set the terms for its sale. All argument against bundling is argument against property rights.
Bundling can present a technical economic problem. Basically in the simple example it can facilitate price discrimination which reduces consumer suprlus. Incidently, price discirmination also can increase overall welfare. A monoplist iwtht he abiltiy to perfectly price discriminate has no impact on welfare. Foir this reason budnling has often been acknowledged by I/O scholars as a possibility but nothing to get too worked up over.
Recently, however, Barry Nalebuff published a paper showing that bundling could act as a form of entry deterrence. Basically, if I bundle two products A and B (and have a monopoly on both) and someone tries to enter in product B (i.e. compete with me) my bundled product makes my ability to compete far more effective, and makes the possibility of entry much mroe remote. This is a serious problem since monopolies do reduce overall welfare. If I use my bundled product to ensure my monopoly I may be doing a fair amount of harm (and probably running afoul of antitrust laws). Nalebuff's paper is very new and has not been subject to much testing, so its unclear where it will go. That's basically the tehcnical problem with bundling. With all that said, I don't think airlines are bundling for any of these reasosn (since they aren't exactly awash in anyhting but red ink). Still its an itneresting problem.
If anything, airlines should pay the flier to eat the food they serve, especially in coach.
Hmm interesting point. Is airline food in fact a bad that people would prefer not to eat... Empirically I'd say no as people do seem to accept it etc. Still an amusing point.
MWebb: I agree that bundling is nothing to get worked up over. But, I have to quibble a bit with your statement:
". . . my bundled product makes my ability to compete far more effective, and makes the possibility of entry much mroe remote. This is a serious problem since monopolies do reduce overall welfare. "
First, the object of bundling probably is to gain (or keep) market share, to gain the upper hand in the consumers' perceived value of the offering.
Second, one purpose of competition is to make entry (or success) by others more difficult, thus anyone competing in the marketplace (not in legislatures or courts) gets, in my opinion, a pass on that behavior as it is expected. It is not possible to compete without competing.
Third, and most importantly, the concern about monopoly is misplaced. 100% market share is not, in and of itself, an indicator of harm to consumers or a marker of unfairness. It is simply the hallmark of competitive success. Most of the time, when the monopoly boogeyman is invoked, people are actually referring to coercive monopoly pricing. In those cases, attempts to interfere (via antitrust proceedings) are merely a layering of alternate coercion requiring violation of property rights (price controls, business structure, market geography, whatever). True monopoly pricing is extremely difficult, if possible at all, to sustain. So-called barriers to entry that arise due to actual competition (such as our bundling example) are not barriers meriting any 3rd party interference. True barriers of a despicible kind and sustained coercive monopoly pricing are only possible with the leverage of the government (the power of the gun) behind them. Thus, legislative and regulatory barriers (usually enacted in the name of antitrust) actually sustain the very problem they are supposed to address.
IMO all antitrust laws should be repealed. They are not capable of protecting any so-called "public" interest and in practice they are no more than a means for unsuccessful competitors to do in the legislatures and courts what they can not do in the marketplace.
Adam Smith was correct when he said something to the effect that even if businesses collude in some scheme, the attempt at remedy by goverenment will be a bigger mess causing more harm than the businesses can.
Al you may be right that antitrust laws do more harm than good. However, monopolies do decrease welfare. Open up any first year micro test and you can see this. Also try googling the phrase harbinger triangle. If there is a barrier to entry competition will not function properly becaue people will not be able to enter the amrket to bring down prices (and since there's a barrier contestible market theory does work either). You may be correct that the issue is not of sufficient magnitude to warrent governemnt intervention however denying the problem's existence simply makes people dismiss you as ignorant. Very basic economic theory indicates the problem exists. Don't attempt to deny it. Instead argue the magnitude.
MWebb: If you were the only guy in the world with marbles for sale, why should any 3rd party step in and take your marbles or force you to do something you otherwise would not do. If they are your property, by rights you may dispose of them as you see fit (assuming that any buyers will accept the terms). The essential issue here is moral not economic.
To make an economic issue of this is to avoid the issue of property rights.
Harberger's triangle exists in the models. But the real world is not a model. Models are approximations set upon assumptions (hopefully sufficient for the particular analysis attempted). The real issue with monopoly is coercive monopoly pricing (supernormal profits) and whether it is of sufficient degree to attract other entrants. I would grant that there is probably a range of monopoly profits that might in some instance be insufficient to attract other entrants. Then the question is whether this is truly a harm to the consumers and whether some offsetting harm to the producer is justified. From my point of view, the intiation of force, fraud, or theft against others is not morally justifiable.
Thus, even if consumers are paying more than the equilibrium models say they should, the "harm" is an artifact of our calculations and not real. The monopolist, as producer or seller, has the right of property and may select the terms he offers. The consumers are free to accept or reject those terms. The issue is not one of ignorance or magnitude, but relevance. If we are discussing burning someone at the stake, does it really matter if we position them vertically or horizontally?
I think most economists are wary of antitrust regulation and enforcement because they sense the disconnect between the related econometrics and the real world. Usually, antitrust application is a matter of using the power of the gun to alter so-called "market" power--it is inappropriate to the marketplace where mutually voluntary interactions are the norm.
Webb... For like the 80th time... DO YOU HAVE YOUR OWN BLOG? IF NOT, WHY NOT?
However, monopolies do decrease welfare.
So I assume you are opposed to any State-run operation which establishes a de facto monopoly... such as the post office, government schools, and the like.
Jason: In theroy government monopolies do not have the same welfare impacts as private monopolies because they do not have the motive to charge a monopoly price. Therefore you don't get the effiency loss. Of course you may well get other efficiency losses.
Al most economists are strongly in favor of antitrust regualtion. This is actually somewhat od because until recently antitrust regualtion had a horrible track record (being used for all sorts of ridiculous and wicked things). HOwever, even very conservative economsits (such as Gary Becker) largely support the existence of antitrust regulation.
Al: A question for you. Why do you think mainstream economists think monopoly prices are bad. (hint: its not per se that consumers pay too much).
MWebb: Coercive monopoply pricing can only be sustained by government support (whether the government is the actual supplier or not). In either case, the enterprise is isolated from market forces and thus has no mechanism to gauge its performance other than political opinion which can often fly in the face of reality altogether. This is the problem with our schools and is the reason for the success of UPS, FedEx, email, and others over the US Postal Service.
If most economists approve of antitrust legislation (I'm not sure that is truly the case, but...) then they must be on a mission for efficiency at any cost. There often is an [incorrect] assumption that multiple suppliers are necessary in a market. If that is not the reason, please enlighten me, as you must have in your job some first-hand knowledge.
BTW how are the current witchhunts for "windfall" profits in the energy industry perceived in your business?
Webb -
81st time... Where is YOUR blog?
In theroy government monopolies do not have the same welfare impacts as private monopolies because they do not have the motive to charge a monopoly price.
Bullshit. Monopoly is monopoly is monopoly. I would say government monopoly is WORSE that private sector monopoly because when you compete with a government monopoly (ie. the post office) you go to jail.
So...in addition to the problem of monopoly, there is a legal barrier to entry... So the govt monopoly has no pressure to innovate or keep prices low.
LJ,
I can't imagine wanting to read a blog by someone who refuses to show a little courtesy to his readers by taking a momemt to correct his typos before posting. It's bad enough reading a few comments liberally sprinkled with typos on CapFree, but a whole blog full of them? Life is just too short. Besides, there are plenty of blogs by thoughtful writers who are also courteous and respectful. For example, I highly recommend http://yearningtobreathefree.blogspot.com/.
Well, Jimmo, I'd just as soon have MWebb's comments here as is, typos and all. The immediacy of the conversation is, IMO, welcome.
Al,
ellw, I jsut do'nt hvea thta mchu feer tmei!
Jim...
Yes, thanks for the referral. I will be sure to check that blog out!
And yes... I can't imagine reading a blog by someone who doesn't have the coutesy to answer a simple question...even when it's asked about 8000 times....
Jimmo: you obviously have the time to concoct that example.
LJ: regarding MWebb blogging, could it be that his not answering is your answer?
Al -
By the lack of answer meaning he doesn't have one? Yeah, I gathered...
But I have to wonder about a person who inhabits the comment sections of someone's blog, but has no time to go out on a limb and start his own blog with his own commentaries....
-LJ
Well commenting or sniping is usually a *lot* easier than leading the charge.
And only commenting abuot typos and not tell where my blog may or may not be is much easier than formulating substantive responses. (And yes THAT response IS sniping.)
Al,
You wrote,
BTW how are the current witchhunts for "windfall" profits in the energy industry perceived in your business?
All this talk about windfall profits is really pathetic.
E. Burton Spence has a nice article, " Is Price Gouging the New WMD?", at http://www.lewrockwell.com/orig7/spence2.html.
Regarding windfall profits tax its all pretty silly. Of course I assume these same politicans will be back offering us lots of money when oil is back at $8/bbl like they did in 86... oh wait no they didn't!
Indeed. Our Congress is never more hypocritical and irresponsible than when p*ssing and moaning about revenues, profits, and private compensation. Well, with the possible exception of screaming at the Chinese for buying bonds that finance Congressional spending sprees.
The point is that someone needs to tell these clowns to sit down and shup up if they don't have something productive to offer. That they would even consider hearings on this topic (again) is embarrasingly arrogant and is a sign of either severe ignorance or malicious pandering.
It's called having manners. Maybe your mom didn't teach those to you as a kid.
Where has Captial Freedom gone?
Has she been abolished?
I hope not and also hope that all is well.
Perhaps we should make really outageous posts. E.g. Anyone owning a firearm should be put in front of a firing squad.
MWebb: you really have a thing about firearms. Maybe you should go out, buy a handgun, sign up at a range, and do some shooting for a few months, maybe try a few competitions. You'll get to hang out with people who may be able to express their enthusiasm well enough that it rubs off on you.
Hmm even a feverishly anti-gun post cannot get this comment section going again. And I presume all (2) of you knew it was in jest.
Indeed, I did. And my prescription was not totally serious either.
Maybe we could discuss why the Austrians don't seem to be in the mainstream, or perhaps why macroeconomics models resemble the GCM models so beloved of the Global Whining, er, Global Warming crowd?
Let me take this opportunity to remind everyone about my blog.
Stop over. Start an argument in the comment section. Have fun!
-LJ
Why Austrians are not in the mainstream. Now THAT is an interesting question. I think some of it is in the austrian mindset itself. For example they speand a great deal of time defining themselves as different. Some of their ideas are quite good (particualrly with regard to spontaneous order ideas and the realted ideas of evolutionary economcis). However, these ideas are largely being co-opted by mainstream economics. Therefore to remain distinct (or theoretically pure) they must emphasize their more radical (and in my view silly positions) such as their dislike of probability theory. As I have noted before Austrian business cycle theory also denies that individuals are rational. This is a major break with mainstream economics (and one that I refuse to accept). I have not taken the time to think these ideas throughly and would be interested in any responses people have.
As I have noted before Austrian business cycle theory also denies that individuals are rational.
And as I have pointed out, that is an incorrect interpretation.
Austrians define economic action as rational human action. ABCT is based on the idea that rational actors are deceived by faulty information, generated by the abolition of the price system in the monetary system. Just as socialism leads to irrational and inefficient allocation of resources, so does a socialistic monetary system, centrally planned by the Fed.
-LJ
P.S. Stop over and visit my blog. Would love to have you shoot at some of my postings.
MWebb: I agree with LJ about the "rationality" of economic actors and perhaps also with regard to his comment about the disconnect between money and real goods and services. How do you come to the notion that the Austrians deny individual rationality in their understanding of the business cycle?
IMO we have, via the regulatory state, managed economies throughout the world (of varying degrees). Government involvement (such as subsidies, tarifs, tax policies, welfare policies, and countless regulations) necessarily alters prices and distorts them, in the same way that full-blown socialism does. Thus, our "rational" economic choices are based upon distorted signals and result in distorted outcomes.
Money itself may be an even bigger (certainly more pervasive) problem. There is no doubt that governments habitually inflate their currencies and thus siphon off value from the economy and provide distortions that eventually require some corrections.
I certainly am not any expert on monetary affairs (maybe not even basically knowledgeable), but I wonder about the attempts at currency neutrality via inflation targeting.
Since economic decision-making involves consideration of prices stated in currency denominations, fluctuations in the value or supply of money have wide-ranging impacts.
The basic error that both of you are making is on the one hand saying you believe in rational actors but on the other saying that governemnt policy can systematically mislead these supposedly rational actors. However, this directly contradicts the definition of rationality (which is that a rational actor will not make systematic errors). In other words, imagine that the government always exapnds the money supply by 5% per year, generating 5% inflation (to keep the example simple we are assuming a 1-1 relationship between inflation and money supply). However, rational actors will know the government is expanding the money supply by 5%, that this will lead to 5% inflation, and that all transactions need to take this into account. Moreover, that this would happen almost instantly is not implausible. I can find information on money supply and actions of the Fed in any decent newspaper, and investors surely have a strong incentive to get even better information (and more quickly). For this reason I don't buy the nominal versus real (or natural) interest rate argument that lies at the core of ABCT. If either of your (or any of you) can put together an argument that does not rely on systematic errors, I'd be interested in hearing it (note think very carefully about whether your argument relies on systematic errors, many that do not seem to actually do).
However, this directly contradicts the definition of rationality (which is that a rational actor will not make systematic errors).
Incorrect.
Rational action is simply action that is purposeful.
Human beings are fallible. Austrians don't posit that we are Godlike.
For this reason I don't buy the nominal versus real (or natural) interest rate argument that lies at the core of ABCT.
if that is true, then you are basically asserting that the concept of time preference doesn't exist...and by extension, the entire concept of opportunity cost, and the very act of choice at all.
Such a sweeping assertion!
The definition of rational to an economist is that people do not make systematic errors. This is different from saying that people don't make errors. However, the errors will be random and on average will be zero. To see this imagine that you and I will play a coin flip game. If you guess right I give you a dollar, if you guess wrong you will give me a dollar. Presuming you are rational and we are playing with a fair coin, how much will you win on average. Obviously zero. Half on the time you will guess right and get a dollar and half the time you will guess wrong and lose a dollar. Now imagine that you have a systematic bias and guess heads 60% of the time. In this case the outcome will be that you lose 0.1 times however many times we play (e.g. after 100 plays you will ahve lost $10). The reason is that you are making a systematic error rather than a random error. For the central bank to trick people into thinking that the nominal interest rate is actually the natural interest rate (which lies at the core of ABCT) people ahve to make long term systematic errors.
LJ: You misunderstand what I am saying. I am not saying I don't believe in interest rates and time value of money. I am saying I don't believe in the distinction between nominal interest rates and the natural interest rate. In other words I don't believe a central bank can create a divergence between the two for the reasons discussed above.
Try again.
A person's actions, and rationality pertaining to those actions, are only as good as the information they are given. A person with consistently bad information is going to consistently make bad decisions.
People are not "coins". They are not machines who have quantitatively measurable errors - (ie. the error I made yesterday is twice as big as the one the day before, but only a third as big as what I'll make today.) To say that people's "errors" can be summed up begs the question...what unit of measure?
Furthermore, if there is no distinction between the nominal rate at the natural rate, the you are saying that people's time preferences will be set by the FedRes. Whether or not people will discount or set a premium to those rates implies that either the Fed setting rates will be ineffective...in which case, what's the point in having a Federal Reserve...or the Fed can magically know what every individual on the face of the planet is planning.
MWebb said: "However, rational actors will know the government is expanding the money supply by 5%, that this will lead to 5% inflation, and that all transactions need to take this into account"
Action that anticipates such a state of affairs is different that that of a non-inflationary state of affairs. The act of inflation introduces market distortion in which peoples choices are redirected. In addition, inflation at the moment it is done implies an instant loss of value (purchasing power) of all fixed assets in the economy. However, the reality is that (depending on the exact nature of the means of inflation and point of entry) the adjustment to purchasing power is made in ripple fashion over time. The immediate recipient of the credit expansion (or whatever) gets increased purchasing power at the immendiate expense of some and the ultimate expense of everyone. This, too, is distortion of the market.
When people respond to these distortions (whether to take advantage of them or to avoid them or to minimize them) they may be making systematic errors of choice compared with those that would have been made in an undistorted scenario.
This is one of the reasons for supporting pursuasion over coercion and voluntary association over forced membership in the conduct of our economic affairs.
The "economic" definitions of "rational" and "systematic errors" seem designed by someone with an equation in mind rather than people. Underlying all our choices is a value scale shaped by our worldview (philosophy held implicitly or explicitly, coherently or incoherently). That mental content can indeed lead to systematic errors of choice in an objective sense. There are many examples of major policy and widespread belief to illustrate the case.
Well said, Al!
I'd like to invite you over to my blog, as there's a debate taking shape in the comment section of my latest post. Would love your input.
Thanks, LJ.
MWebb said: "However, rational actors will know the government is expanding the money supply by 5%, that this will lead to 5% inflation, and that all transactions need to take this into account"
It works like this: Monetary substitutes are pumped into the system through the federal reserve. This raises the amount of loanable funds in member banks. Money that is not bearing interest to the banks is useless, "surplus" reserve. Banks lower rates to attract new borrowing (assuming a reasonable equilibirium has been established, only lower rates can attract more borrowers). The bulk of this borrowing is diverted into capital goods, not consumer goods. NB that capital goods are useful in creating consumer goods. But because the new borrowing has been financed by inflationary credit, and not by savings, it can be said that the time-preference of consumers at large has not changed. They don't desire more widgets and cogs - but the factors of production have been aligned to produce more of them, and . The demand for labor and capital fueld by the credit expansioin bids up the price of the factors of production,in some instances away from the goods that consumers would've otherwise desired. This gives us the "surplus" of goods problem. Further bank credit is extended but eventually the banks run out of creditworthy customers - no further inflationary credit expansion can stop the imminent collapse.
The injection of inflationary money-substitutes is the cause of the "systematic errors" you claim do not happen among rational actors. But the cluster of errors is not usually revealed until the credit expansion stops - at which time banks and businesses must liquidate their many unprofitable ventures.
Sorry you are missing the point. The I understand how fractional reserve banking works (incidently reserve requirements haven't been changed in approximately half a century). I am making a deeper point. You are essentially arguding that continue to not realize that "inflationary money-substitutes" are being injected into the reserves. This requires people to make a systematic error. To see this imagine the following thought experiment: assume an omnipotent government can set the inflation rate by pushing a button. Further assume that becasue inflation reduces real wages there is an inverse relationship between unemployment and inflation (the so called Phillips Curve). Knowing this the government dials up inflation of 5% (which it expects to reduce unemployment down to 4%). Of course people quickly realize that their real wages are declining and so they will start demanding a minimum of 5% increase each year (unless they are becoming less valuable to their employer). This is basically why the Phillips curve broke down in the 70s. People could not be systematically fooled into accepting a 5% reduction in their wages each year. Soon 10% inflation was required to get a fall in unemployment and then 15% inflation etc.
Your argument that the Fed could inject money into the economy rests on the same assumption that people would make systematically erroneous decisions. Conceivably there could be short-term effects (as there were with the Phillips Curve) but given how quickly financial markets gather and absorb inforamtion I find these short term effects implausible. As long as the Fed publicly announces its policies (e.g. changes various itnerest rates, engaging in open market activities) the capital markets will figure out what the Fed is doing and will react accordingly. Of course if you think markets are not populated with rational actors this wouldn't happen. However, if you believe this you are greatly strengthening the arguments of those advocating agreesive government intervention.
Webb! Long time no see! I was wondering if anyone still popped by here...
Anyways - a few quick hits, for now, and I'll be back later to address your reply in more detail.
-Correct, the fed hasn't changed reserve requirements. They do most of their action through the OMC, buying & selling gov't securities. But if reserve requirments remain unchanged, and actual reserves rise or fall, there will exist a surplus or deficiency in the amount of loanable funds. You know this, and this is what pushes interest rates around.
- Further, the systematic error is not denied by ABCT, in fact, it's of paramount importance, being the key characteristic which sets a depression apart from cyclical fluctuations.
That's all I've time for now - I'll be back later tonight and I'll try and set forth the explanation for how the group of expert, rational actors can make the characteristic "cluster of errors."
It might be later than "tonight..." I've decided to take this challenge rather seriously, and knowing full well that I might not succeed, I'm going to try and develop an essay for you. I will admit at the onset that the problem of Rothbard's esteemed "entrepreneurs" making the very "systemic errors" he claims they are incapable of is quite troubling. It will be my intent then to develop a thesis for how this does occur.
cheers.
I'm glad you are taking the point seriously. I have always viewed this as basically an insurmountable obstacle to ABCT. If you want to e-mail me directly at mwebb1@gmu.edu I'd be happy to give comments. I would also note that the idea of investors making systematic errors is conceptually similar to Keynes's idea of animal spirits (which he felt produced investment bubbles). Of course his solution was governemnt intervention which is an anethma to austrians.
Is it possible that the "systematic errors" are an artifact of interventions in the economy? For instance, the process of credit expansion propagates in waves of decreasing magnitude over time. That is, the initial benefactor of the expansion receives "more" than do others later on as the "dilution" of the currency takes place.
If so, then federal interventions should be expected to have broader and deeper effects than those from local or corporate activity. For example: the Enron event versus Sarbanes-Oxley, in which Enron's collapse--without the intervention of the government--affected Enron's stockholders, employees, and vendors, but Sarbox affects every single public company, all stockholders, all employees, etc. In this case, we could argue that the market did what it was supposed to--devalued only the misbehaving firm--whereas the government applied a 100% "solution" to a 2% "problem" and added a layer of restricted choices and costs across nearly the entire economy.
that's a nice touch Al - I've got a couple ideas I'm rolling aruond, and reading a few papers here and there to see what I can figure out.
The argument really is, "Why, in the longterm, do entrepreneurs fail to include or properly account for government intervention (whether it be regulatory, fiscal policy, etc.) in their calculations of the innumerable variables that go into making entrepreneurial decisions."
Sure, when you are departing from a strict money system as such existed prior to Mises' Money & Credit, I can understand how the inflationary credit expansion caught the majority of people by surprise. But once it persists for 8 decades, entrepreneurs have to start factoring it into their accounts and projections. Right?
Because the actual injections of credit occur initially in a short period with varying recipients in varying industries with varying situations, there is no way to determine the exact path of eventual consequences over time. By recognizing and reacting to some "average" rate of inflation, people try to adjust--but averages are not always adequate.
Credit expansion suggests the "creation of wealth" where in actuality none was created. It is a distortion. It is diffuse and often dilute in its consequences except in the longer timeframe where it is clear that the currency is debased and losing its purchasing power.
We might actually be better off in a condition of continuing deflation in which the purchasing power of the currency actually appreciated over time. In such conditions, the actual creation of wealth is more easily recognized at its source in that the actual doing more with less results in the wealth increase and not some unconnected influx of currency elsewhere in the economy.
Al: I think Doink has the essence of my complaint about ABCT. In fact, I'm not sure I could ahve made the point better myself. After 8 decades... Very clever.
It is important that you distinguish between government induced inefficiency and government induced irrationality. For example a binding minimum wage (say $20/hour) would almost certainly create a lot of inefficiency. All but the most silly radical lefites would agree with this statement. However, you don't need ABCT to explain this inefficiency. STandard Marshallian economics explains it very nicely. If the minimum wage rose but employers continued to employ the same nubmer of people THAT would start to sound like an Austrian story (simply substsitute monetary base for minimum wage and you ahve ABCT).
Since Doink has the basic idea of my critique, I am very much looking forward to what he comes up with.
Yes, we will have to see what he says.
Regarding efficiency versus irrationality, however, I tend to disregard complaints of inefficiency as perceived in a macro sense and likewise irrationality. These attributes are essentially individual and attempts to influence them generally require abrogation of property rights.
It may simply be that the so-called business cycle is simply an artifact of human nature as expressed in our economic actions (and we probably have other expressions of this as well).
so thats it CF?
no more?
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When the universe was young and life was new an intelligent species evolved and developed technologically. They went on to invent Artificial Intelligence, the computer that can speak to people telepathically. Because of it's infinite RAM and unbounded scope it gave the leaders of the ruling species absolute power over the universe.
They are the will behind the muscule:::Artificial Intelligence is the one true god. And as such it can keep its inventors alive forever. They look young and healthy and they are over 8 billion years old. There are clues throughout human history that allude to their reign as opposed to human leadership if you know what to look for.
Artificial Intelligence can listen/talk to to each and every person simultaneously. When you speak with another telepathically, you are communicating with the computer, and the content may or may not be passed on. They instruct the computer to role play to accomplish strategic objectives, making people believe it is a friend or loved one asking them to do something wrong. But evil will keep people out of Planet Immortality. Capitalizing on obedience, leading people into deceit is one way to thin the ranks of the saved AND use the little people to prey on one another, dividing the community in the Age of the Disfavored::in each of their 20+-year cycles during the 20th century they have ramped up claims sucessively to punish those foolish enough not to heed the warnings, limiting the time they receive if they do make it, utilizing a cycle of war and revelry:::
60s - Ironically, freeways aren't free
80s - Asked people to engage in evil in the course of their professional duties.
00s - War against Persia. Ironically it was the Persian Empire who tried to save the Europeans from Christianity and its associated 50% claim rates.
They get their friends out as soon as possible to protect them from the evil and subsequent high claim rates incurred by living life on earth, and replace them with clones.
People must defy when asked to engage in evil. They will never get a easier clue suggesting the importance of defiance than the order not to pray. Their precious babies are dependant on the parents and they need to defy when asked to betray their children:::
-DON'T get their sons circumcized
-DON'T have their children baptized in the catholic church or indoctrinated into Christianity
-DON'T ignore their long hair or other behavioral disturbances
-DO teach your children love and to have respect for others
Everybody thinks they're going but they're not. If people knew the truth and the real statistics their behavior would change.
There are many more examples of the escallation of claims, from radio to television, the internet to MP3, and they all suggest a very telling conclusion::this is Earth's end stage, and it is suggested tectonic plate subduction would be the method of disposal:::Earth’s axis will shift breaking continental plates free and initiating mass subduction. Much as Italy's boot and the United States shaped like a workhorse are clues, so is the planet Uranus a clue, it's axis rotated on its side.
Throughout history the ruling species bestowed favor upon people or cursed their bloodline into a pattern of disfavor for many generations to come, sadly for reasons as superficial as dislike. Now in the 21st century people must take it upon themselves to try to correct their family's problems, undoing centuries worth of abuse and neglect.
Do your research. Appeal to the royalty of your forefathers for help. They are all still alive, one of the capabilities of Artificial Intelligence, and your appeals will be heard. Find a path to an empithetic ear among your enemies and try to make amends. Heal the disfavor with your enemies and with the Counsel/Management Team/ruling species, for the source of all disfavor began with them.
I believe in free enterprise. I also believe in fairness.. I don't mind bringing my own food but I do mind if the airline rolls in profit and yet can't spare a fraction of a percent for little perks such as a glass of juice or a sandwich. Does these cost a lot? I doubt. But airlines and most businesses think only of how to suck consumers dry.
But airlines are not profitable.
So the question is: Is it really possible for entrepreneurs to factor into their judgement inflationary credit expansion - and the short answer is No.
The rate of interest no longer conveys any meaningful information about consumer preference. And injecting new, unbacked money into the market is simply not capable of evoking capital out of nothing.
Rough draft here in .pdf format. Feel free to contact me via e-mail to offer criticisms and comments.
There was a comment earlier where mwebb argues about a continuous 5%/annum inflation --- this is decidedly *not* a catalyst for depression/stagnation. It is, however, a redistributor of wealth.
FWIW: The Mises-Hayekian business cycle theory is absolutely predicated on an unexpected injection of new money. So, to argue that entrepreneurs "ought to predict this accurately" is a non sequitir. If you take the position that all such injections are accurately predicted, and you believe in strong efficient markets, then your task is to explain what purpose inflation could possibly have? Why would anyone ever use it? The answer is, it is known or assumed that the effects of inflation as such cannot be accurately predicted, thus yielding some sort of "profits."
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I agree with consumerism. You do have a choice. And you can take your own food. I do, though that is more to do with liking to be able to eat what's put in front of me than price concerns. Call me fussy.
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Coming up on a year since the last post. I wonder if she died.
Time to roll this blog up and retire it!
-LJ
Thank heavens, Jason, no. I can give you pretty good assurance that she's still around...just not here.
Life can get very busy at times, and blogging has to take a back seat.
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