# Can We Develop Less Wasteful Price Discrimination Techniques?

Request: discuss any literature on and/or speculate wildly about ways to make price discrimination more efficient.

One component of pd is often arbitrary time wasting. Could that be equally effective but more socially useful? Instead of clipping coupons, complete some mechanical Turk task requested by a charity.

Or watch khan academy videos for coupons might effectively achieve the same useful discrimination without actually wasting time (might require some irrationality).

Basically, what’s the total friction cost of current pd schemes? Is that waste totally unavoidable?

On the literature in general, everything I know about price discrimination I learned from Alex Tabarrok (standard disclaimer!), so probably the best I can do is point you to his graduate IO syllabus, which contains a nice list of price discrimination articles.

Fmb is right that price discrimination often imposes costs. In addition to the costs that it imposes on consumers, sometimes producers bear extra costs to be able to price discriminate. The Cowen and Tabarrok principles text discusses the example of HP printers, which are built to force you to buy HP ink, facilitating a cheap-printer, expensive ink price discrimination strategy. The strategy works because HP has a patent on the printer head, and it builds the head into the ink cartridge rather than into the printer. It would be socially efficient for it to be built into the printer, but we instead dispose of perfectly good HP printer heads every time we swap out our ink cartridges.

How about if instead of the disposable printer head strategy, HP relied on cryptography in the printer and the cartridge to authenticate genuine HP ink and reject non-HP ink? It would be imperfect, and hackers would surely find a way to break the system, but it might work well enough. After all, this is how video game console makers prevent a lot (but not all) video game piracy. Sure, you can buy a chip to mod your XBox, but most people just pay the high price for games. Similarly, maybe most people would just suck it up and pay a high price for ink.

One way we could bear fewer costs as consumers is if we were willing to part with more privacy. Governments tax you on the basis of your income (sort of like price discrimination), which you report to them. Universities charge you on the basis of your and your parents incomes, which you report to them. These are pretty substantial invasions of privacy, yet we tolerate them, and many people even seem to think that they are “fair.” This model could easily be extended to other industries, such as groceries. When you apply for your discount card at the grocery store, simply bring last year’s tax return to become eligible for bigger discounts. No more clipping coupons! I’m sure this suggestion (which I don’t necessarily support!) will stir the ire of privacy advocates, who would be quick to point out that loss of privacy is a cost. So it’s really just a tradeoff of one kind of cost for another. However, to the extent that your tax return more directly correlates with what firms want to know in the first place, it could be a more efficient kind of price discrimination even if we value our privacy relatively highly.

More generally, there are lots of ways that we can trade off one kind of cost versus another to effectively signal that we deserve the lower price. For instance, to the extent that we signal with dull time wasting, we can switch to shorter, more unpleasant expenditures of time. Tim Lee complains about spending ten minutes on the phone with Comcast lying to them to get a better price on broadband service. Having to lie, he says, imposes a psychological cost. But it seems better to me than spending 30 minutes on the phone not lying. Tim concludes that “Comcast’s price discrimination strategy is only socially efficient if we assume the aggravation consumers feel from haggling with Comcast isn’t important,” but this is false! It can be, and probably is, socially efficient despite this aggravation. In addition, cable companies probably also rely on information other than willingness to have an unpleasant phone call: they know what neighborhood you live in, your credit score, your service history, and whether you have an HDTV. These do not impose very many costs.

Ideally, you would want pricing to be based on something that is costless for low-value types and so costly for high-value types that they do not even attempt to get the low price. If, in equilibrium, there is no posing as a low-value type, then this form of price discrimination imposes zero social costs. If we accept that in many cases low and high willingness-to-pay are simply manifestations of low and high income, and that say, extreme obesity, is negatively correlated with income, then we should observe some companies offering “fat discounts” to some customers. I suspect that this would get politicized and hashed out in court, if it is already not illegal. And there is obviously something unappealing about creating an incentive, however small, to be so fat.

Fmb makes a good point: it would be great if proof of low willingness-to-pay could be based on public goods production. For this to work, the public good would need to be something that can be produced effectively by low-value types and is preferable to just working, earning more money, and spending the extra money on the good. No American is going to collect litter for an hour to save $2 on groceries. Unfortunately, I think this fact puts a ceiling on the gains that we can really expect from better price discrimination techniques. If low-value types were that much better at producing public goods than they were at producing market goods, they would probably be compensated for that value some other way already. If not, they are better off just producing market goods and spending their extra income at the higher price. That’s one reason that wasteful modes of price discrimination stick around. # A Straussian Reading of *Launching the Innovation Renaissance* This is a post that I promised to write several months ago; I hope that in spite of its tardiness, you will find that it contributes much to the issues of the day. You may recall that Tyler Cowen included hidden meanings in his short ebook, The Great Stagnation. It turns out that he is not alone. Tyler’s Marginal Revolution co-blogger, Alex Tabarrok, also has an esoteric style. Whereas Cowen points us to the future by looking at the recent past, in Launching the Innovation Renaissance, Tabarrok points us to the more distant past by ostensibly talking about innovation in the future. Underneath all the sensible-sounding evidence-based arguments for reform is a hidden, retrograde manifesto that establishes Alex as one of today’s leading reactionary thinkers. In case you think I am making this up, let me start by noting that the book literally begins over 700 years ago, in 1296. “From father to son, to son again, the architects, stonemasons and artists of Florence labored with love and devotion to produce the greatest cathedral the world had ever known” (26). Since that time, things have gone mostly downhill, as the institutions that made medieval Florence great have foundered. The questions that Tabarrok wants you to ask yourself are these: “When I go to work, do I labor with love and devotion? Am I producing something of transcendent value, like a cathedral, or am I just doing a mundane job? How can we go back to a simpler time of less turbulent change and greater personal meaning?” Of course, Tabarrok cannot dwell on the medieval period throughout the book without giving away his occult hypothesis to even his slower readers. Consequently, he discusses several different eras of the past and how they are superior to the present. For instance, lamenting the modern patent system, he writes, “As early as 2,500 years ago the Chinese were breeding new roses, and Confucius tells us that the emperor had hundreds of books about roses and rose breeding in his library. The world did not appear to lack new roses even though, until 1930, no roses were ever patented” (83). This is a telling metaphor. The “old roses,” the old books, the old ways—they are just as good as, if not better than, the new roses. Not only was the past a simpler and more satisfying time, the excesses of the modern world are deeply disturbing. One can almost feel Tabarrok recoil in horror as he relays the story of the OncoMouse, a genetically engineered monster. To the modern mind, this is a great advance; but a careful reader can discern Tabarrok’s deep reservations about this kind of coarsening of the value of life. He notes that mice “share 95 percent of their genes with humans” (205). It is bad enough that people might conduct experiments on creatures that are 95 percent human; must we also play God with these close cousins of ours by modifying their genes? And must we, of all things, patent them?! Tabarrok is perhaps at his most persuasive when he points out that the deterioration in American education is caused by ill-advised “advances” in the rights of women: One of the reasons for the poor performance of U.S. education is that teacher quality has declined significantly over the past four to five decades. In the 1970s smart women became teachers. In fact, in 1970 about half of all college-educated women were teachers…Many smart women have exited teaching and entered the professions because of declining discrimination in the professions… (454) It seems obvious—is it even worth pointing out?—that the simplest way to improve teacher quality is to bar women from entering professions like law, medicine, and business. This bit of subtext, needless to say, is completely lost on Alex’s less attentive readers. Another problem with the modern world, according to the esoteric Tabarrok, is that people no longer have respect for the station in life in which Nature has put them. In a word, people are uppity. This causes countless problems, not least of which is higher education. “College has been oversold, and in the process the amount of education actually going on in college has declined as colleges have dumbed down classes and inflated grades to accommodate students who would be better off in apprentice and on-the-job training programs” (525). If only we could return, says Tabarrok, to a time when people knew their place. Launching the Innovation Renaissance represents Alex Tabarrok standing athwart history, yelling “Back up 700 years!” You may think that these ideas are unlikely to gain much traction. Nevertheless, I think they have great relevance in today’s political debate. In fact, although Alex has not yet publicly endorsed a presidential candidate, I bet I can predict who he will be supporting. # Zero Marginal Utility Goods Standard consumer theory says that rational consumers will select their consumption of goods A and B such that $\frac{MU_A}{P_A} = \frac{MU_B}{P_B}$, with of course the tiny disclaimer that for some pairs of goods, there will be a corner solution; that is, for some goods A and B, some consumers will optimize not according to the preceding expression, but by consuming zero of either good A or good B. Now, is that really a tiny disclaimer? Don’t we each get zero marginal utility from most goods? I made this point on Twitter yesterday and got this reply from Alex Tabarrok. Now, it’s true that in a world of discrete goods, when price is high, that will result in a corner solution. But sometimes marginal utility is just really low, zero, or even negative due to storage and disposal costs. There are some things that even most billionaires do not buy. I pointed Alex to a squirrel yard statue, which I found by searching “knick knacks” on Amazon.com (it was the fourth item). He yielded. This resulted in a fun game of finding weird, zero-marginal-utility stuff online. Among other good items, Adam Ozimek found Vanna Speaks, Adam Gurri the Misty Mate Pet Misting System, and Jim Ulbright a life-size Anubis statue. What can we learn from this exercise? I think there are a few things. First, while it’s fun to have a laugh at some of the weird products on the market, somebody is buying at least some of this stuff at least some of the time. I was memorably reminded of this because when Daniel Lin nominated gold lamé MC Hammer Parachute Pants as a ZMU good, Adam Ozimek vociferously disagreed. He ended up buying a pair for himself. It’s tempting to think of the economy as supplying goods we all want to everyone (in uneven proportions of course), but it’s important to remember that the economy also supplies goods that most of us would not want to the few people who want them, including ourselves. This is not a trivial problem and it may not be solved smoothly through time. Fischer Black built his theory of the business cycle around the idea that it is difficult to match today’s production to tomorrow’s tastes, but it is also difficult to find the right buyers for today’s products. Second, there is a direct analogy from the goods market to the labor market. Once you concede that most goods provide zero marginal utility to most consumers, you almost must concede that most workers provide zero marginal product to most firms. The math is the same. The ZMP hypothesis, therefore, is not some extraordinary claim that defies common sense. Just as matching weird goods to weird people is hard, matching some workers to the right firm is hard. Nominal shocks can make this harder even in the absence of sticky wages and prices. People who have nominal debt change their consumption patterns when a nominal shock hits, and both people and firms can misinterpret nominal shocks in the short run per the Lucas Islands model. In the face of changing consumption and production patterns, Black’s Noise plays a role, and when the consumer-product matching problem is hard, the firm-worker matching problem is that much harder. Again, this is true even if wages and prices are totally flexible, and even if you support NGDP targeting (I do). Oddly since these ideas owe much to Hayek, some Hayekians are slow to accept the ZMP hypothesis. Don Boudreaux at Cafe Hayek tells a comparative advantage story to rebut ZMP that is completely devoid of firms and therefore employment, in which all parties have perfect information and do not need to discover patterns of production. But ZMP is on the march; Karl Smith, a diehard New Keynesian, is starting to make some pro-ZMP noises. So when you start to think that ZMP is a weird claim, just remember ZMU goods. I myself am not expecting to have much difficulty remembering ZMU goods. One is on its way to me. Tweeter @fbaseggio has bought for me the squirrel yard statue. I’m looking forward to installing it in Alex’s office when he isn’t there. # Hail Neal Stephenson! *Snow Crash* Comes to Life Via Roderick Long, this New York Times article documents the fascinating case of Gurgaon, a quasi-anarchic city of 1.5 million people in India. While the city is subject to state and national law, there is no municipal government to speak of. Services are provided by an archipelago of private communities. In between the private communities there are miserable slums (this is India, after all), but life inside the communities is good. Alex Tabarrok also has a good post offering commentary with which I largely agree. See also The Voluntary City, coedited by Tabarrok. As I read about Gurgaon, I could not help but think of Neal Stephenson’s 1992 postcyberpunk novel Snow Crash (Kindle version). Snow Crash envisions a future in which most people live in sovereign gated communities called burbclaves, or in the big business version of the same, franchises like Mr. Lee’s Greater Hong Kong. The US government still exists, it just has no power and little territory. Gurgaon is on its way. Builders of the private communities there, such as Tata Housing, have properties in other Indian cities. This is a lot like the franchising that Stephenson imagined. There are other parallels between Snow Crash and reality. In the novel, the US government has gone bankrupt and had to resort to hyperinflation—quadrillion dollar bills circulate, alongside private currencies. The private currencies in Stephenson’s world are issued by popular franchise communities; they are not decentralized peer-to-peer currencies like Bitcoin. Nevertheless, it seems that a number of governments around the world are in the process of bankrupting themselves through overreach and dysfunctional politics. We may all learn more about private currencies in the near future. In the novel, there is a flourishing private intelligence industry. Several of the characters are freelance intelligence gatherers for the CIC, the private commercial successor to the CIA. So far, the analogous real-world “private intelligence” organizations like Wikileaks and Anonymous are non-profit, but can for-profit variants be far behind? Or maybe Google is the CIC. Google Earth, for instance, resembles software described in the book, and it has long been alleged that Google has CIA ties. Finally, there is The Raft, a flotilla of thousands of boats fastened to a former aircraft carrier and each other that functions as a floating city. Seasteading anyone? N.b. that an actual Raft as described in the book would not work. The chop of the ocean would cause the boats to smash each other to bits. So a seastead is the closest possible real-world analog of this element of the novel. Are there other ways in which Snow Crash is coming to life? Readers are advised that although this post did not contain major spoilers, commenters may need to reference important plot elements to add to the analogy. If you haven’t yet read Snow Crash, beware, and remedy that problem soon. # Peace through Political Assassination? Bryan Caplan writes three compelling posts on the common-sense case for pacifism. The short version of his argument is that it’s wrong to kill innocent foreigners (“collateral damage”), especially when the gain in doing so is not clearly large, as it is not in many wars. This seems like as good a prompt as any to write about an idea I have toyed with and failed to dismiss over the past few years. Instead of going to war against a country, why do we not simply put a price on the heads of the leaders of enemy governments? Depending on whom you ask, this is currently illegal by executive order. Ford, Carter, and Reagan all ordered that, “No person employed by or acting on behalf of the United States Government shall engage in, or conspire to engage in, assassination.” This seems to have been relaxed if not officially rescinded by the Bush and Obama administrations. In any case, assassinations are plainly constitutional, since the US Constitution explicitly authorizes Congress to issue “Letters of Marque and Reprisal,” and it seems implausible that an executive order can overrule an explicit power of Congress. A small bounty, I believe it was$25 million, was offered by the US for information leading to the capture of Osama bin Laden and other high-level Al Qaeda officials. The problem with such small amounts is that they do not induce entry into the intelligence-gathering industry. It may cause a marginal defector to turn up information, but it does not entice new firms to form in pursuit of the bounty. Something on the order of a billion dollars would probably have done the trick; note that this is still a much smaller amount than the US government has actually spent in the hunt for bin Laden.

On humanitarian grounds, a bounty system seems like it would result in fewer innocent civilian deaths than the kinds of warfare nation-states have recently been conducting. But even if you do not have this intuition, never fear, we can insert into the bounty announcement a requirement that bounty hunters abide by the strictest standards of conduct or risk disqualification.

Would bounties be effective? There’s no way to know for certain unless they are tried, but my intuition is yes. Here is Helland and Tabarrok on bounty hunters in the criminal context. I certainly would not sleep easily if there were a large bounty on my head. And while I can imagine a hypothetical army without political leadership, this would plainly not result in the kind of warfare that modern states engage in.

So it’s possible that bounties on enemy political leadership would be cheaper, more humane, and more effective than going to war. Why don’t governments use this tactic? I have two public choice explanations.

First: rent-seeking by the professional standing military. In the US, Letters of Marque and Reprisal were used relatively often (to deal with piracy) until after the War of 1812, which resulted in a standing navy. If bounties are used extensively, what justification is there for a standing military? Very little. Therefore, the professional military has an incentive to discourage the use of bounties in order to capture a larger portion of the government’s budget.

Second: collusive rent-seeking by the international political class. If one government began to make extensive use of markets in political assassination, other governments would likely do the same. This makes all politicians worse off. International belligerence would result in the death of politicians, not in the death of grunts and civilians, which they regard as expendable. Looking out for #1 means upholding the tacit agreement not to take aim at political leaders, just as in previous centuries armies used to agree not to target officers. I prefer the tighter link between “live by the sword, die by the sword.”

My guess is that if a bounty system were widely adopted, military budgets would plunge and politicians would be less belligerent. If you have additional arguments for or against this proposal, I would love to hear them. And to the Nobel Peace Prize committee, you may use the “contact” link at the top of the page to get in touch with me.

# Miscellaneous Thoughts on the Fed

Everyone is interested in monetary policy and the Fed all of a sudden, so, what the hell, I’ll chime in too.

Here is my ranking of monetary regimes:

1. Depoliticization and denationalization of money. Free banking. The market selects a currency and banking is “regulated” in court under the common law of contract.
2. The Fed is a Sumnerian robot. It runs a market in quasi-velocity futures and a computer uses the market price to decide whether to expand or contract the money supply.
3. The status quo.
4. Congress itself “coin[s] money and regulate[s] the value thereof.”

Most people who want to abolish the Fed think that we can go from number 3 to number 1, but more likely, if we End the Fed, we’ll go to number 4. For all the exaggerated claims about how the Fed is turning us into Zimbabwe, number 4 would go much further in that direction than number 3 has.

If anti-Fed steps are to be taken, they should be along the lines of Ron Paul’s Free Competition in Currency Act, which weakens the Fed by eliminating legal tender laws and eliminates capital gains for alternative currencies. The capital gains issue is important because money is half of every transaction, and even if the value of money is stable such that there are minimal capital gains and losses, the amount of record-keeping that is needed to use an alternative currency is prohibitive. The bill doesn’t go far enough, though; the optimal currency may be none of the things that are exempted from capital gains taxes under the bill, and really the only solution is to eliminate taxation of capital gains entirely. Can you imagine the political uproar from our friends on the left?

People complain that since the inception of the Fed, 95% of the purchasing power of the dollar has been inflated away, but this is looking at the wrong derivative. When inflation is consistent and expected, rates of return adjust to compensate for it. As long as you are not holding most of your assets in currency or non-interest-bearing dollar-denominated accounts, steady inflation doesn’t matter. Inflation is a tax on people who hold literal dollars, which is probably not you unless you are a crime lord or a foreign dictator.

QE2 brings us slightly closer to the number 2 monetary regime above, and I support it on those grounds and those grounds only. If we had had the Sumnerian infrastructure in place in early 2008, it would be telling us to expand the money supply now, and therefore expanding it now is what we should do. I regret that it is being done on a discretionary basis, but you give policy advice in the policy environment you’ve got.

By the way, QE1 was not really QE, as Alex Tabarrok explained in 2008. The Fed started paying interest on reserves, which has the effect of massively decreasing velocity. The Fed needed to increase M to offset the decrease in V. Why the Fed would take such velocity-decreasing action in the middle of a crisis, I do not know.

Tyler Cowen writes this morning that if you want a countercyclical money supply, you must have a central bank. Tyler, this is false! I had a discussion once with a different Tyler in which we traced the effects of using shares of the S&P 500 as currency. Since the stock market is cyclical, money would appreciate in booms and depreciate in busts, just as it would if you had a decent central bank. The big downside would be a long-term deflationary trend, but nevertheless as a proof-of-concept it shows quite clearly that a countercyclical money supply is possible under a commodity currency.

For those who are opposed to monetary central planning, the real story is not QE2, but the looming disaster in the Eurozone, which is quite obviously not an optimal currency area. If they can get past the current crisis somehow, they will just be inviting the next one if they do not do something radical like banning all languages other than English. I’m still hoping that if the Greek collapse comes, it comes when I am in Greece next month.

The bottom line is that whether the Fed has been a failure depends on what you think the alternative is. The Fed made some big mistakes in the 1930s and in 2008-2009, but at least (1) we’re not Europe and (2) Congress is not in charge. I think that if we give in to populism, we are likely to get something worse than the Fed, not better, though if the populists want to start getting serious about monetary theory, I would welcome that.