Not So Dismal

Making Economics a Little Easier to Understand

Posts Tagged ‘Prices

Stop the Bailout Train

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In response to today’s Politico Arena question, “Does McCain’s ‘Homeowner Resurgence Plan’ announced at the debate make sense?” (Text of plan from the campaign’s website can be found here.)

The problem with the McCain campaign’s proposal is that it favors certain types of investment (namely, housing and real estate) and does so with taxpayer money. What compensation is to be given to those that own Apple or Google stock, with both companies’ market capitalization nearly sliced in half in the past year? Will there be a bailout for stock market investors that were “misled” into buying at prices that make the investment seem unpalatable today?

Government assistance in guaranteeing low interest rates is still an affront to the free market, but a more necessary and less harmful one. It is true that many homeowners were misled into accepting deceptive mortgage terms, and many families may be willing to continue to pay down the original principal of the loan if their payments at the very least do not go up from here.

Free market adjustment of mortgage values should be encouraged, too. Homeowners have every right to simply walk away from the mortgage they signed. The banks that hold these loans will often be very willing to rewrite mortgages to lower values on their own accord, rather than assume the responsibility of the property and be left with a house they may not resell for a long time.

Involving the federal government in yet another facet of a problem that, at its origin, is the result of artificially low interest rates will only serve to increase the national debt, lower the dollar’s prestige, and accelerate the rate of inflation, only further penalizing those that continue to pay their mortgages or invested in assets other than real estate.

Written by caseyayers

9 October, 2008 at 8:08 am

Convenience of Money

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An interesting piece by Tim Harford, the author of The Underground Economist, appeared in Slate Magazine last year that discussed price rigidity, using a classic example. The price of a bottle of Coca-Cola remained at a nickel for over Glass Bottles Always Taste Betterseventy years, an incredible fact given the long-term inflation of so many other prices, including those of its main ingredients. Yet Coke was hard-pressed to raise the price in order to stabilize their margins because of the vast leap between a nickel and a dime. Indeed, the next-highest denomination resulted in a full doubling of the price of a bottle of the world’s favorite soft drink. In the 1950s, when a price change was absolutely necessitated, Harford tells us that the, “…boss of Coca-Cola wrote to his friend President Eisenhower in 1953 to suggest, in all seriousness, a 7-and-a-half cent coin.”

This may seem like a bit of a comical notion, but the lack of flexibility in US denominations did adversely hurt Coke, allowing its time-honored competitor Pepsi the chance to use their famous slogan, “Costs a nickel, worth a dime.” A similar situation faces soft drink bottlers and various other vendors today. Across the country, it appears that prices are being pushed past $1.00 for a 20 Oz. bottle and $0.50 for a can en masse. While prices obviously differ from place to place, the new ceiling for cans tends to be around a dollar, indeed a doubling in price.

No Coke, PepsiBut the fact that it costs twice as much isn’t the issue anymore. Indeed, even the poorest among us would rarely be found complaining about the average price of a can of pop/soda/insert-your-regional-slang-here. The problem now is what I call “convenience of money”. While $1.00 is a nice, round figure, bottles are left in an odd predicament. In most cases, $2.00 would be seen as too high of a price, and on an ounces-per-dollar basis would be less of a value than a dollar can. Prices for bottles have fidgeted often around the $1.25 point. Even though this is much more reasonable than $2, I would surmise that Pepsi and Coke’s sales don’t show as large of a difference between $2 and $1 as they show between $1 and $1.25 due to a demand curve bent as if by gravity to the easiest combinations of monetary denominations.

The problem is that blasted quarter. People just don’t carry change like they used to, and while there may be a few $1 bills in their wallets, the likelihood of being able to finish the transaction with a quarter is much smaller. Indeed, in this day and age, it is a $1.25 bill that Coke and Pepsi should request from the US Mint, rather than the 7 1/2 cent piece of old.

Broadly speaking, it might be even better for the soda companies if dollar bills were to simply be taken out of circulation, replaced with dollar coins entirely. The Mint has tried again and again to get people to switch over voluntarily to a higher-denomination coin. Yet the embattled green portrait of George Washington survives with nary a scratch.

Dollar-scanning machines tend to break down more often than their coin-only counterparts and can become an issue when dispensing return funds when more than one dollar bill has been submitted. Vending machines have already mostly been converted to accept dollar coins, whether they are of the Susan B. Anthony, Sacagawea or Presidential variants (all share the same size and weight). Coinage loves company, as well; having dollar coins on hand makes it more likely that smaller coins will again find their way to people’s pockets, making $1.25 not so awkward a price, after all.

Another tactic has been to switch to plastic: more and more machines include credit card swipers on the front, which allow consumers to either swipe their RFID-enabled card or their old-fashioned magnetic strip to purchase some edible goodies. Overseas, cell phones are often used for transactions, with the final tab simply added on to a phone subscriber’s bill at the end of the month. Both methods take the actual money out of the equation, leaving only the true price for customers to consider; having a quarter on hand isn’t a part of this purchasing decision. While these alternatives do carry transaction costs, a price point of, say, $1.35 for credit card purchases vs. $1.25 for cold, hard cash would not scare away many customers looking for a caffeine fix. Or, perhaps, not having to be as concerned about machine break-ins, drivers having to carry around so much coinage and cash and technicians having to fix the mechanical pieces required to process the money would present a large enough savings to vending companies to make the transaction costs a wash.

One caveat is that higher prices still carry a psychological barrier to customers. Especially in these smaller denominations, people have been taught to think in coins. Perhaps $1.35, then, is a larger leap for some people than it honestly should be. Certainly $1 seems like a much better value than $1.15 would be, for example. But alternative payment systems strip away the physical tie to this price psychology and affords companies more flexibility in adding more balance-sheet “bounce to the ounce”.

Written by caseyayers

8 October, 2008 at 4:00 pm

On the Subject of Texas Tea

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Originally posted in April of 2006, this piece hopefully still provides some useful information today.

Let’s do a little rundown on gas prices and the like. Not only might it be educational for everyone involved, but it’s indirectly helping me feel prepared for my Economics exam later today.

So Why are Gas Prices so High?

There are several reasons for this.

  • Worldwide Demand is Increasing
    For a while, the United States has been far and away the largest consumer of oil. That- perhaps odious- record is on its way out the door. India and China, the world’s two fastest growing economies (ours being the bronze medal winner by any fair standard) have spurred a massive demand for oil in that part of the world that was not once there. Think of China for a minute. When you picture the Chinese people in the city, how do you see them getting around? In the past, the answer has always been bicycles, right? No longer. Regardless of the social oppression weighed on its people by the Chinese government, China’s people have gotten financially more wealthy in the past decade, to the point where luxuries like automobiles are becoming an imminent reality for millions. The same goes for India. That’s just a minor example, though. Think of all the factories in India and China, and imagine what they run on: oil. And oil isn’t just for energy. It is refined or used in producing lubricants of all sorts- from the things that make machines work all the way down to Vaseline- as well as CDs, carpeting, and a million other things. Simply put, as the whole world wants more stuff- China and India in particular- the price of oil will continue to rise.

  • Refinery Capacity is too Low
    Another contributing factor is the fact that we have a very limited number of ways to turn that black stuff out of the ground into car-friendly gasoline. To do so requires heavy refining, as well as mixing the oil with any number of chemicals for efficiency or environmental reasons. Here’s the problem: we haven’t built a new refinery capable of making gasoline since the 1970s. It’s pretty absurd to think that demand for oil hasn’t risen in the last forty years. It’s even more absurd that supply has been bottlenecked by these old refineries.

    So why haven’t we built any new refineries?

    The environmental types would have you believe that the Earth’s imminent demise is only one more oil refinery away from happening. Of course that notion in itself is absurd, but let’s take a more common sense approach to the situation: if we haven’t built any of these refineries since the 1970s, they must be pretty broken-down and dirty places, right? Of course. The pollution levels are very high from these facilities. Common sense tells me that decades of research would allow us to make a far cleaner-burning refinery today, one that would actually help the environment in comparison with what is running now. So let’s say, just for simple math, that a refinery built this very moment would only release half as much pollution to make the same amount of gas as one of the old refineries does. Great! Let’s build twenty of them. As we turn the new refineries online, we simply turn the old ones off. Same amount of pollution, double the capacity. Using the same reasoning, we could build, say, fifteen of the new refineries. That would actually lower the pollution levels from refineries by 25%, while still raising capacity by 50%.

    You said other things make the gas expensive as well. These chemicals?

    Yep. Ethanol’s a prime candidate for discussion. A lot of people look at Ethanol and see the great “ANSWER” to oil. Ethanol is made from corn, switchgrass, agricultural waste and many other types of plants. The process to create ethanol is very similar to making beer. In fact, Coors has an ethanol plant in Colorado, believe it or not. Ethanol burns cleaner than gasoline (though not much) and is theoretically unlimited. After all, if it comes from corn, we can simply grow more corn when we need more gas, right?

    Not so fast.

    First of all, ethanol is very expensive to make. The only reason it is surviving on the market at all right now is because the federal government has given billions of dollars in subsidies to farmers and ethanol producers to lower the price to the point that it can begin to compete with gasoline in some areas. Secondly, we can’t make enough. The idea of simply growing more corn sounds great at first, but the problem is scarcity. Just like there’s a limited amount of oil in the ground, there’s a limited amount of ground. It would take somewhere around three times ALL the arable land in the United States to grow the corn required to keep up with demand for ethanol if it replaced oil entirely. Lastly- and here’s the kicker- a large amount of oil is used to make ethanol. Think of the tractor that the farmer uses when tending to the corn, the machine that husks it, the truck that drives it to the refinery, the power plant that keeps the refinery going, the truck that takes the ethanol to the distribution center, et cetera. The sad fact of the matter is it takes almost a gallon of oil to make a gallon of ethanol, and ethanol is no more efficient when used later on. All that is happening is we’re paying for the oil twice over with ethanol- once for the oil needed to make it and again for the ethanol itself.

    But aren’t the oil companies taking massive profits on gas sales?

    Nope. You know that “obscene” profit of thirty-something billion dollars ExxonMobil made last year? Congressmen and Senators are calling that a travesty, unpatriotic, blah, blah, blah. Sure, I’d love to have $30+ billion dollars laying around, but the fact is that ExxonMobil and other such oil companies aren’t simply sitting on that money or filling swimming pools with $100 bills. In the last five years, Exxon has invested over $74 billion dollars in new oil finds. The fact is it is really expensive to start up a new oil pipeline or off-shore drilling platform, much less to find the stuff in the first place or turn it into usable gas. The fact of the matter is that every time Exxon simply GUESSES where oil might be, it takes over ten million dollars just to poke the hole in the ground to check. Even worse is the fact that we aren’t letting them actually go to where we know the oil is, like off of the west coast of Florida or that small patch of hell in Alaska.

    Here’s another point- the typical margin for gasoline sales is maybe 10% for oil companies. That means when you pull up to the BP or Shell down the street, even at three bucks a gallon, they’re only pocketing maybe 30ยข per gallon. Here’s the dirty little secret- the government, between federal, state and local, collects over fifty cents per gallon. That means that the government- remember, the ones calling the oil company profits obscene- are actually pocketing almost 70% more than they are. The government would claim that that money is needed to build roads. Without getting into a usage argument, I’ll agree with that, but say that the oil companies need their profits just the same to be able to invest in finding other oil supplies around the globe to make sure we don’t run out.

    But isn’t oil bad for the environment?

    Sure. I won’t argue that point. I get angry every time I see one of those dump trucks outside of UNF spew a tower of black smoke out of the top. However, what is the answer, exactly?

    Well, for those of you environmentally inclined, you should welcome the rise in prices wholeheartedly. The fact of the matter is that $3 a gallon is just about where hybrid cars begin to pay for themselves in gas savings. Hybrids obviously use less oil and are all much less polluting than standard vehicles. But are they the answer? No. Remember when I said that China and India are starting to drive? The fact is the number of cars on the roads of the world is increasing at such a rate that even if the entire country switched to hybrids this very moment, within ten years our oil consumption would be right back to where we are today.

    So what do we do to fix this once and for all? First of all, we need to start getting rid of our power plants that run on oil and coal. We replace them with nuclear power, as well as photovoltaic solar plants when the technology is ripe enough in ten to twenty years.

    Wait, isn’t nuclear power a scary thing that will end us all?

    I dunno. How about we ask Peter Moore, the founder of GreenPeace? The fact is that nuclear power is incredibly safe now, especially with advances in the technology made in the last twenty years. You know, the twenty years in which we haven’t built any nuclear power plants. Do you think the French, perhaps, are environmentally attuned? I do too; they produce almost all of their power through nuclear technology.

    So you were saying about how to stop using so much oil?

    Yes. Don’t interrupt me.

    Sorry.

    Right then. So the first step, as I said, is to get rid of those power plants. They take up a huge amount of oil and coal and release a lot of pollutants. Now what about our automobiles? I’ve already explained why ethanol is not an answer in any way, shape or form. So what’s the golden goose? Hydrogen. By 2009, the first hydrogen-based cars will begin rolling off of the lines from makers like GM. Running on a relatively simple chemical reaction, the only emission from the system is water. Cool, huh? Well, the only problem is they currently have the tendency to explode. Once GM and the others get the technology down, though, it has the power to truly make gasoline obsolete.

    So where can I fill up with hydrogen? I only remember seeing 87, 89, and 93 octane at the pumps last week…

    Good point. It’s a chicken-and-egg scenario, isn’t it? There’s no cars that use hydrogen, so why build the (very expensive) pumps? At the same time, why build cars that people can’t use?

    You’ll love the answer to this one.

    You know those record profits the “oil” companies are making? Companies like Shell are reinvesting a piece of those in promoting hydrogen technologies as well. Think about it from their perspective- they know oil’s days are numbered, so to remain a viable company, they have to lead the way to the future. So for each obscene billion dollars of extra profit, the “oil”- perhaps “energy” is a better term- companies are reinvesting that not only in finding new oil, but also in developing oil’s replacement. It’s all rather elegant, hm?

    That’s all very nice, but I’m tired of paying so much right now. What’s the deal?

    Well, I’m sorry. The fact is that if you’re not willing to pay the price, the Chinese and others are. Oil demand has risen with no subsequent rise in supply. The solution? Get mad. Start making people aware of the fact that we can’t even make any more gas than we are right now. Understand the fact that the government is taking a far larger piece of profit out of every gallon than the oil companies are. Thwart any legislation against “windfall profits” that are being used to develop cheaper and safer energy sources. And, sorry folks, just drive a little less.

  • Written by caseyayers

    25 April, 2006 at 11:34 pm