Nice Guys Finish Last? You Can Bank on It

Remember when you were growing up in elementary school, and the teachers made pretty much everything a competition versus your peers in order to keep your attention and teach you valuable life skills? Perhaps it was determining who got to walk at the head of the line on the way to lunch by who did the best on a quiz, rather than deciding based on height (which I, at 6’3” would have preferred). These incentives were used to motivate us to work harder in order to have a chance to reap the rewards, as well as to convey a sense of “fairness” about the process which would otherwise be seen as a process involving either favoritism or randomness (or both) on the part of the teacher. As economists, we recognize how valuable such incentives can be as a motivational tool. The (unintended?) consequence of all of this competition among school children is that the common refrain, “he cheated!” rings out across the schoolyard on a frequent basis. And why shouldn’t some children test the boundaries, immediately discovering whether the costs of cheating outweigh the benefits, as they are caught and sent to the back? Thus, the incentive to cheat is greatly restrained by the swift doling out of a penalty moving you to the back of the line. The added benefit is that those students who don’t cheat aren’t relegated to the middle or even the back, due to the immediate punishments of the wrongdoers.

Things work out well in the school competition scenario described above, but with a slightly different set-up of incentives things can quickly go awry. This appears to have been the case for Wells Fargo, as the bank was recently fined $185 million due to the discovery that many of its employees had “cheated” by opening fake accounts in order to receive bonuses associated with meeting sales goals. It has been widely acknowledged that there have been winners and losers as a result of this practice. There are the account holders who never consented to having new accounts opened in their names, but were still charged fees associated with those accounts. Wells Fargo has agreed as part of the settlement to refund those approximately $2.6 million. There is the Wells Fargo Unit Leader who oversaw the “cheaters,” who left with $125 million just after news of the scandal broke. This is akin to a teacher getting credit for her students’ impressive test scores, only to find out later that the students had cheated. And of course, there are the 5300 employees who were eventually fired for “cheating” by opening the fraudulent accounts.

But there is one affected group which has largely been ignored in this situation; the Wells Fargo employees that simply chose not to cheat. Unlike the schoolchildren in the example above, the offending employees who cheated were not caught and reprimanded immediately, but rather over a five-year period that culminated in the recent ruling. Throughout those five years, there were thousands of Wells Fargo employees who played by the rules, and didn’t open fraudulent accounts. Because the penalties weren’t immediate, these honest employees were relegated to the middle/end of the metaphorical line. Where are the articles calling for these “nice guys” to be compensated for lost bonuses that they may have rightly earned had everyone played by the rules?

To be fair, even the honest employees would have benefited some from Wells Fargo’s success before the cards came tumbling down. If they owned stock in the company, they would have seen the rising value as the company appeared to be performing better than it actually was. If they are still holding that stock, however, those gains would have quickly dissipated this week. It could also be argued that some honest employees were only able to be retained by Wells Fargo over this period due to the company’s relative success. However, the flip-side of that coin is that some honest employees may have been fired for not meeting elevated sales goals that would have been lower had the cheating not occurred.

The problem here is that the lag in punishment for cheaters leads to what amounts to an immediate punishment for non-cheaters, which is never fully rectified. Wells Fargo has even announced that they are removing the sales goals in an effort to restructure incentives, but they aren’t going as far as to retroactively compensate the “honest” employees according to the new pay structure. They are now “Taking appropriate actions—including disciplinary‚ to address those who have served our customers in ways that were counter to our ‘Vision & Values,’” but make no mention of addressing those who served customers honestly and by the rules.

From an economic perspective, it is important to consider that people are rationally motivated by incentives, but that they may not realize or consider the negative impact that their actions have on others. However, this does not mean that the negatively impacted group should be ignored or forgotten. It’s important not only to punish those who cheat, but also to be sure that those who play by the rules get their turn at the front of the line.

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.

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!