August 21, 2016

Should a Gold Medal be Awarded in Ticket Scalping?

It’s pretty exciting to watch Michael Phelps, Katie Ledecky, or Usain Bolt race their way to victory on TV each night during the Olympic Games. Think of how much more exciting it would be to witness the experience live in Rio, with the crowd surrounding you jumping and chanting and cheering with every kick, stroke, or step! As with pretty much everything in life, there are some people who would find this experience to be much more valuable than others… and they would be willing to pay for it!

The problem is, there is a very limited number of seats in each venue, so not everyone can get a ticket that wants one. The question then becomes, how should the tickets be distributed in order to maximize total welfare? If we take the Coase Theorem at face value, then it really shouldn’t matter who gets the tickets initially, as they will always end up with those who value them most. The process of reselling tickets in a secondary market is called "scalping." In fact, when people engage in this trade, surplus is created and society overall is better off. The conclusion that these trades will take place, however, relies on one particular assumption which is not always valid in this circumstance: the assumption that transactions costs are low.

Let’s assume, for example, that the Olympic Committee is in charge of the initial distribution of all 100 tickets to the Men’s 100m final race that Usain Bolt is sure to dominate. They don’t want the world to tune in and see empty seats in the stadium, so they are sure to set the price for tickets low enough to ensure a sold-out stadium. We can assume that the charge the minimum price that they need to receive in order to not lose money on the event. Thus, no producer surplus is collected in this scenario. The problem is that at this price, 150 people want to buy the 100 tickets that are available. So by what mechanism does the Olympic committee allocate these tickets? It seems that, as may be expected, some are allocated to those who have some special involvement with the event (athletes’ families, event organizers like the man discussed in the article mentioned above, etc…), and then the vast majority of tickets are made available online. Is this an optimal way to distribute tickets? Let’s take a look at some graphs to see.

First, let’s look at how much surplus would be generated if the 100 people who valued these tickets most highly just happened to be the ones who received them in the online distribution. The surplus generated under this scenario is shown in the purple area in the first graph below.

 What if, instead, it was the 100 people who valued these tickets the least, but were still willing to purchase them at the price set by the organizing committee (persons 50 - 150)?
As can be seen in the example above, the area of Consumer Surplus is much larger if the tickets are allocated to the 100 people who value them the most. But there’s no guarantee they will be the ones to get through the online ticketing system first.

This is where the Coase Theorem kicks in. The 50 people who value the tickets the least would be willing to sell their tickets to the 50 who value them the most, and at a price that those high-valuers are willing to pay! In fact, they may even be willing to pay a small fee to help match those with tickets with those who to purchase them. Sites like Stubhub, BANDWAGON, and the NFL’s Ticket Exchange have been created to provide this information and, in exchange, try to capture some of this surplus.

The problem is, not only can it be costly to try to find and buy tickets to the event you want to attend, sometimes it is illegal to resale tickets to these sorts of events. For instance, check out this article on an Irish International Olympic Committee executive who recently was “accused of plotting with at least nine others to sell tickets above face value.” Laws like this prevent welfare enhancing trade from taking place, so why would they even exist in the first place?

It is true that there is a fair amount of risk involved in purchasing a ticket in a secondary market. The ticket could turn out to be counterfeit. Many sites offer a money-back guarantee if a counterfeit ticket is purchased, which helps users develop enough trust to use the site (and pay a small fee) rather than purchasing a ticket in person or not buying a ticket at all. Knowing you’ll get your money back is great, but there is an additional cost incurred by those who travel to the sporting event and have been waiting for weeks or months to see their favorite athletes compete, only to be turned away at the date on the day of the race. Penalties for selling counterfeit tickets attempt to address this, but enforcement of those penalties has a cost as well.

Are there any better ways to allocate these tickets, which may avoid some of these costs? One option may be to offer the tickets via an online auction! An auction could sell each seat (or each section of seats) at a different price. If run properly, this method could approximate perfect price discrimination. The result would be a graph that looks very similar to the first graph above, but with the surplus accruing to the producers rather than the consumers. The question is, would the cost of setting up and running this auction reduce surplus by less than all of the costs of the secondary market discussed above. Also, we can’t forget that people may well change their preferences in the time between when the tickets are first allocated and when the event takes place. The change in preferences will cause some people to enter the market, and some to want to sell their tickets after all, so a secondary market may still be beneficial.

August 14, 2016

Dynamic Pricing and Menu Costs - Taking a Shot

When you’re planning a trip to McDonalds for dinner, you have a pretty good idea of how much any item you’re planning on purchasing is going to cost. In fact, you would be pretty surprised if you arrived at McDonalds and an item on the “Dollar Menu” suddenly cost $1.37, or even $0.74. McDonalds keeps its prices fairly stable, and in doing so, two things happen. First, you’re able to decide whether driving your family to McDonalds for dinner today is preferred to going to Applebee’s, or Five Guys, or preparing your own burgers on your backyard grill. The second thing that happens is McDonalds is able to print up signs and advertisements that list the items (usually with a picture that looks much more delicious than what you’ll eventually receive through a drive-through window) along with the prices and how great of a deal you’re getting! These signs and advertisements act to increase demand for McDonalds’ products by informing more people of their availability and luring them into the market.

Wouldn’t it be crazy if the price for a hamburger and fries changed before you got to the restaurant; or if the price changed while you were standing in line? That’s exactly what’s going on at a bar in San Diego, as described in this article. The Blind Burro has adopted a system that allows for the price of the tequila it sells to change at any moment, based on how many people are ordering the brand and, presumably, how much is in stock. Known as dynamic pricing, this method allows the bar to raise the price of tequila brands that are selling well that night, sensing the higher than expected demand for the beverage.

“This is an outrage! They’re taking advantage of their customers!” you may protest. “They lure you into the bar and then jack up the prices, forcing you to pay way more than expected!”

However, don’t forget the flip side to this arrangement. If you’re willing to drink a brand that’s not selling well that night, you’ll be enticed by falling prices and a great deal! Plus, it’s always important to remember that no one is forcing you to exchange your hard earned dollars for tequila or any other drink. In fact, it’s not just “trade” that makes everyone better off (or technically at least no worse off), but rather voluntary trade. This idea hinges on the idea that if you aren’t gaining from the trade, you won’t rationally take part in it. You can always walk away without purchasing the drink.

“If this dynamic pricing idea is so great and economical, why isn’t it more prevalent?” Actually, in a lot of ways it has been around for a while. For example, you don’t always pay one constant price for the goods you buy at the grocery store. The price is adjusted through things like sales and coupons. A more appropriate example in this context may be the infamous Happy Hour (unless you’re in Boston or a handful of other areas where they are outlawed). Even restaurants engage in a similar practice for some items, listing “market price” on a menu for the seafood “catch of the day.”

All of these tactics are a form of what economists call “price discrimination,” which sounds terrible but can actually be quite beneficial in increasing overall surplus. The surplus is increased because people who value the good most highly are able to purchase it, while those who place a low value on the good don’t buy it if the price is too high. Because the amount of each brand of tequila in a bar each night is relatively fixed, the preferences of who buys the tequila matters a lot.

Imagine one shot of José Cuervo Gold tequila were listed on a traditional menu at a price of $3, which is the lowest price that the bar is willing to sell the beverage in order to not entirely give up their profit. The bar has stocked 10 shots worth of this particular brand for the night. Also, imagine that the first guy who walks in wants to buy at least ten shots for him and his friends, and they’re all willing to pay no more than $3.25 for those shots. Luckily, the bar has them in stock, and happily sells him the 10 shots. The consumer gets surplus of $0.25x10 shots = $2.50 and the bar gets no surplus.

Then, 20 minutes later another person walks up to the bar who is willing to pay up to $5.00 for each of those 10 shots, but is turned away because the bar is now out of stock. If the bar had been able to adjust prices, they could have set the price higher (at say $4.50) to start the night. The first person would have been deterred, but the second would have been able to buy the shots! In this scenario, surplus to the consumer would be $0.50/shot x 10 shots = $5, and the bar also gets $1.50/shot x 10 shots = $15 above the minimum price they were willing to sell the drinks for. Of course, without dynamic pricing the bar could still set the price at $4.50, but the bar would then worry that if the second person never walked in that night, it wouldn’t sell any at all. So dynamic pricing allows for the flexibility that increases surplus in this scenario from $2.50 to $20.00!

The question now is whether dynamic pricing will become much more prevalent, infiltrating all sorts of bars, shopping centers, movie theaters, and fast-food restaurants all across the country. I would argue that, even with technological advancements, it would take a lot of time for individuals and businesses to get used to prices changing so frequently. While making some tasks easier, others like planning a vacation would be much harder to budget for. There are some gaps that could be filled by writing contracts and purchasing insurance ahead of time, but these options come at a cost as well. However, I’d still argue that implementing this pricing system in some areas is worth a shot!

August 2, 2016

No 'Free Parking' in Real-Life Monopoly?

It’s a tradition as old as consumerism itself. You’ve mastered the art of procrastination, and it’s now Christmas Eve and you have yet to finish buying presents for your loved ones. Unless you’re lucky enough to live in a city where Amazon offers same day shipping, you’re going to have to venture out into the cold to shop at an actual store. But everyone knows you don’t venture out to just any store for Christmas presents, you head to your local shopping mall! The problem is, everyone else has the same plan, and you find yourself circling the parking lot for hours, looking for a place to leave your car before the stores close or sell out of Tickle-Me-Elmos.

Wouldn’t it be great if there were a way to deter others from using up all of these parking spots that you find so valuable? Well one mall in Colorado is attempting to do just that. According to this article from an NBC News affiliate in Colorado, the Cherry Creek Mall in Denver has decided to begin charging for parking in its surrounding lots and garages. In terms of economics, we can speculate on why this change was made (and whether it’s a good or bad idea) from a couple of different perspectives.

It’s possible that the mall is charging for parking spots specifically to improve the use experience on days like the one described above, where the fixed quantity of parking spots available is exceeded by the number of shoppers looking for them. The mall may consider that happier shoppers who are willing to pay a bit to park may also be the types of shoppers who will spend more in the stores inside.

The mall is more likely to be making its decision using a profit-maximization framework. Clearly, assuming some people continue to choose to park at the mall for more than an hour (the first 60 minutes will be free), the mall will be bringing in more revenue from parking than when parking was free. The first question, however, is how many customers will be turned away by the new up-front fixed cost of shopping at the mall, and how this will impact the sales of the mall’s tenants? The mall is hoping to gain more from charging people to park than it will lose through a decrease in the prices it is able to obtain from charging stores to lease spots within the mall. These factors are influenced both by the elasticity of demand for parking, as well as the elasticity of demand for tenant space in the mall itself.

The elasticity of demand for parking is a measure of how many fewer people will park at the mall, if the price of parking increases. It is largely dependent on how many substitutes people can find for parking at the mall. These could take a variety of forms. If people are mainly parking at the mall now to shop at the mall’s stores, then substitutes could include parking elsewhere and walking or riding over to the mall to shop, parking and shopping at other malls or shopping centers, or even staying home and shopping online. There may also be people, however, who use the mall’s parking facilities as a free way to store their car close to downtown Denver, and then travel into town via public transportation or carpooling. These people may choose to instead park closer to downtown, or to find a lot farther out which is less expensive. It will depend on the cost of other parking and transportation options available to them.

It is clear from the mall’s ability to increase prices that it is not in a perfectly competitive market for parking in the area. This is because, while the potential substitutes above exist, many consumers will find spots close to mall (especially garage spots) to be more valuable/higher quality than spots in nearby areas. With this limited monopoly power, standard analysis will show that raising prices and restricting quantity can maximize profits for the monopoly, although it would likely decrease overall welfare, as those previously parking at the mall for free who now don’t park there at all lose Consumer Surplus in the amount of what they would have been willing to pay to park in the mall lot (more than $0 but less than the new price).

So did the mall make the best choice for how to handle its parking situation? This largely depends on what its other options were. Another solution that may have been considered, and may limit the backlash from the public to some extent, would be to have stores validate parking if a purchase is made. This would allow the mall to more directly target the two different groups of people who are looking for parking spots; shoppers and commuters. If the mall is able to raise the price of parking for commuters, but keep the parking free (through reimbursement) to shoppers, it can improve upon any issues with congestion and a shortage or spots without giving up too much revenue from its store tenants. So if you live in the Denver area, keep in mind that while the new parking fees may be irritating now, they could save you a huge headache when you’re already back at home with family and friends on Christmas Eve, instead of sitting in a snowy parking lot for looking for a spot.