July 25, 2017

Credit for Trying - Is Banning Transactions Fees a Win for the Consumer?

Take a second and think back to the last time you bought something that was on sale. How great did it feel? It’s easy to recognize and appreciate deals when you get a better price for something you were going to buy anyway. But how do you feel when the tables are turned, and you’re charged extra to buy something?

For example, when you go to the gas station to fill up your SUV, do you pay with cash or credit? At most stations, the price that you pay per gallon when using cash is different than the price per gallon for using credit. Either way, you’re getting the exact same gasoline, so how do you perceive this difference in price? If you see it as a mark-up or extra fee for using credit, you’re probably not a huge fan of the price differential. On the other hand, if you see it as a discount for using cash, you may view it favorably, and would be unlikely to want to see the discount removed.
When you purchase something, you often weigh 
the cost and benefits of using cash vs. credit
(Photo credit:
It is with this in mind that this article from The Telegraph, across the pond in the UK, caught my eye. The article was written by The Telegraph’s Consumer Affairs Editor, who chalks up a new law banning charging many credit card fees as a clear victory for consumers. If the title of the article, “[e]nd to rip-off credit card fees…” doesn’t make this position clear, the description of these “rip off” fees as being “used by shops, restaurants and travel firms to make extra profit at the direct expense of customers choosing to pay by card” should remove all doubt. But is the removal of these fees truly a clear “win” for consumers, at the expense of the greedy shops, restaurants, and travel firms?

Let’s begin by considering a portion of the quote above. These fees are charged to customers who are “choosing to pay by card.” This implies that the customers have other options (usually cash), but find paying by card to be preferable for some reason. Presumably, either they find using credit more convenient, or they may receive some cash back or points for using their credit cards. No matter the reason, some citizens chose to pay in credit despite the fee, and others chose to avoid the fee by paying in cash. Essentially, you’re free to sort into the group (cash or credit) that you feel is the best deal for you, after taking the fees into account.

Now what happens if you ban the ability to charge credit card transaction fees? If you’re a consumer, perhaps you’re hoping that the cash price will stay the same, and the credit price will be lowered to match it. Those who previously paid in credit would now be better off, since they still get the perks (convenience, points, etc…) of using credit, but for a lower price. If this scenario were to play out, even those previously using cash would be as well off, if not better off. Some of them may even choose to switch over and begin using credit cards for their purchases! Consumers would clearly be better off, and the costs would fall on either credit card companies or those greedy shops, restaurants and travel firms. The problem is, this scenario has some assumptions that aren’t likely to play out in the real world.
How do you view the price difference in
paying for gas with cash vs. credit?
(Photo credit: 127driver via Wikimedia Commons)
The issue with the scenario above is that it assumes the cash price will stay constant. It’s like assuming that if gasoline is currently $2.00/gallon when using cash, and $2.10/gal when using credit, that all gas would be $2.00/gal after the fees were banned. But it’s costly for gas stations and other stores to offer the payment option for credit cards. They even have to pay fees to the credit card companies for facilitating these transactions. If gas stations can’t pass along these fees to consumers, they have to find some other way to not lose money on the transaction. In this example, gas stations will do one of two things. First, they may increase the price of gas for everyone, let’s say to $2.05/gallon. While those consumers using credit cards are now better off, those who still use cash are clearly worse off, as they are helping subsidize the purchases of their credit using neighbors. The other possible result of the ban on fees is that vendors may choose to cease offering credit cards as a payment option all together. In this case, those who previously used credit cards are clearly worse off, as they used to have to choice to use either cash or credit and chose credit, but now must choose their second best option.

The lessons in the example above could easily be extrapolated to apply to all sorts of shops and firms. It’s easy to see that a law which essentially limits the choices of the consumer is not necessarily a clear “win” for all consumers, or even the average consumer. Viewing the issue as a discount for using cash rather than a penalty for using credit allows us to see more clearly the true costs and benefits of such a regulation. Perhaps The Telegraph is giving lawmakers more credit than they deserve.

July 18, 2017

Prognosis Negative - The Dual Drivers of Electricity Price Variability

How great would it be if someone paid YOU to consume their goods or use their service? For instance, what if instead of having to pay to go see a new hit movie, you not only got into the theater for free, but were even given a few dollars in compensation?

People love to complain about their power bills being too high, 
but what if you actually got paid for using power!?
(Photo credit: Max Pixel)

This is exactly what would occur if prices were negative for a good, but it’s a fairly rare occurrence. Why? For most goods, the Supply curve doesn’t cross below zero (or even marginal cost (or even minimum average cost for a given firm)). This means that even in the most competitive markets, suppliers are free to either leave the market or just not sell their goods to you, if they can’t get a high enough price to make selling them worthwhile. A negative price doesn’t usually satisfy this condition, so you may wonder if it is ever something we would observe in a real-life marketplace.

It would be unexpected for movie theaters to pay 
consumers to go see new blockbuster films.
(Photo credit: LuisJ3000 via Wikimedia Commons)

As it turns out, we do observe negative prices for goods from time to time. As you may have guessed from the title of this article (unless you were thrown off by the Seinfeld reference), the market for electricity will at times end up supplying electricity for negative prices. A few unique characteristics of this market lead to such an occurrence. These characteristics include:
  •          The inability to store the good for long periods of time
  •          Markets that are often segmented and closed-off from other parts of the country
  •          Varying levels of subsidy to different types of electricity generation
  •          The impracticality of shutting down or scaling back electricity generating operations for short time-periods

When considering all of these peculiarities together, it is not surprising that at times more electricity will be generated than people want to consume, resulting in a negative price. What is most interesting, however, is how fittingly electricity generation provides a “powerful” example of how there are always two sides to a market.

I first learned of the negative prices in this market while reading an article in 2015. At the time, it was fascinating to see prices below $0 for a good, but for the particular scenario described it was easy to figure out why it had occurred. In this instance, the supply of electricity in the short-run was relatively fixed and inelastic (due to the reasons outlined in the bullets above). As such, and price changes would likely come about due to shifts in demand. This was exactly the case. During periods of extremely low demand for electricity, the inability to store or substantially reduce the production of electricity at low cost meant it was cheaper to take a loss by selling it for a few hours at a negative price than it would have been to completely stop generating power.

What made this story even more interesting, is when I came across this article recently discussing the upcoming total solar eclipse. The article is all about how the eclipse is a very rare event, but will still have a large impact on the amount of power being generated that day, due to the drop in ability of solar panels to convert the sun’s rays to energy. What I found most interesting in this article, is the following:

“The onslaught of wind and solar resources is already regularly contributing to wild swings in power supplies across grids, sending wholesale electricity prices below zero on some days.”

I was struck by this particular sentence, because it is describing negative prices in the electricity market for completely different reasons than the article discussed above. That is to say, even if demand is stable, the type of technology used to produce and supply power (e.g. renewable energy sources like solar and wind) can have such inherent variability in productive capacity that supply can shift in substantial ways. In this case, it is the supply-side of the electricity market that is sometimes leading to negative prices.

The important takeaway from all of this is that there are two sides to a market, and it is the unique characteristics of the market you are looking at in space and time that will determine the degree to which supply and demand work together to determine prices. People often have the tendency to focus on one or the other, but it’s best to remember to stay “plugged-in” to information about both.

July 14, 2017

Who Watches the Watchmen? Rick Perry, CBS, and Basic Economics

Life would be pretty boring if we were only allowed to form opinions on and discuss matters that we had studied extensively. Often times, part of learning about a subject entails making somewhat shaky declarations on how you think something works, and then having others with more knowledge explain through gentle nudges how and why you weren’t quite right. However, it takes a fair amount of confidence to not only make a statement on a subject you’re only tangentially familiar with, but to try to actually explain the concept to others. It takes even more confidence to be willing to publicly correct whoever made the statement, calling him or her out on the misinformed opinions that were presented. All of that being said, a large part of why I created was specifically to point out misinformation in the news, as it pertains to economics. So while it’s difficult to try to correct someone’s claims, I usually won’t fault someone for trying. This past week presented a glaring exception.

Last Thursday, the internet was abuzz with pretty much everyone who has ever taken an introductory economics course (and as you’ll see, maybe some who haven’t) calling out Secretary of Energy Rick Perry for an incorrect explanation of economics principles that he delivered while visiting a coal plant in West Virginia. The quote in question was in Secretary Perry’s misapplication of a fundamental building block of economics; Supply and Demand.

(Photo credit: Gage Skidmore on Flickr)

According to reports, Perry stated “Here’s a little economics lesson: supply and demand. You put the supply out there and the demand will follow.” This statement does not agree with traditional economic theory. It implies that anything that is supplied in larger quantities will invoke larger quantities being demanded. If this were true, you would find that when your business was having trouble finding buyers for your huge warehouse of fidget spinners, and sales had stagnated, you should just produce many more fidget spinners to solve the problem.

(Photo credit: Pexels)

When I first became aware of this statement, I wondered if it had flown under the radar enough to be featured in a story of its own on this blog. Fortunately, when you’re in a high profile position like the Secretary of Energy, many people appear to be watching to point out when you don’t get your ‘little economics lesson’ quite right.

(Photo credit: Wikimedia Commons)
One such outlet that was quick to jump on the story was CBS News. The site featured this article, which correctly pointed out that Perry’s explanation of the concept of Supply and Demand was pretty far off. The author of the article, unfortunately, did not stop there. The journalist went on not only to point out that Perry’s explanation of this economic concept was incorrect, but to try to explain this concept in her own way, as follows:

“The gist of the theory is, if the supply for a product is low but its demand is high, the product’s price is likely to increase. If a product’s supply is high and the demand for a product is low, however, the product’s price is likely to drop.”

While attempting to point out one person’s blunder, the journalist makes a mistake of her own. The problem is, the price for a product is determined (in general) by the equilibrium reached at the point where Supply and Demand intersect. At this price, the Quantity Supplied = Quantity Demanded, and the “market clears”. It would be correct to say that a product with relatively high demand or relatively low supply would have a relatively higher equilibrium price, and vice versa. However, the only way to get a change in price (to have the price “increase” or “decrease”) would be to observe a shift in Supply, Demand, or Both.  Thus, if a product’s supply is high and the demand for a product is low, the product is likely to have a relatively low price, but the price wouldn’t be expected to “drop”, as Supply and Demand aren’t changing.

It’s important to call out blatant misinterpretations of bedrock economic principles. However, as we learned this week, if you’re going to go further by trying to explain the concept for yourself, it helps to be sure you got it right.