17_reinventing_the_bazaaar.md

Reinventing the Bazaar

What is a Market?

A market for something exists if there are people who want to buy it and people who want to sell it.:

• Decision-making autonomy is key...They are free to make decisions—to buy, to sell, to exert effort, to invest—that reflect their own preferences.
• Their choices are not completely free though: they are constrained by the extent of their resources and by the rules of the marketplace.

Markets Are Inescapable (and Markets in Everything)

• Rwandans in refugee camps in Zaire (now the Democratic Republic of Congo), having commercial activity. Some eighty-two thousand businesses mushroomed in the camps by 1995, according to a report by the United Nations High Commissioner for Refugees.

• Markets sprang up, similarly, in prisoner-of-war camps during the Second World War. The prisoners traded their Red Cross rations of food, cigarettes, and clothing, according to R. A. Radford.

  • Food prices rose whenever a new group of hungry prisoners arrived. In the early days, prices ... food delivery, but later the prisoners began to hold stocks of food, which smoothed

• Alcohol consumption end of the Prohibition era was still about two-thirds its pre-Prohibition level.

• 1500 listings on ebay under the heading “Victorian tradecards”—which, it turns out, are a nineteenth-century version of junk mail.

Market Design

• Market design consists of the mechanisms that organize buying and selling; channels for the flow of information; state-set laws and regulations that define property rights and sustain contracting; and the market’s culture, its self-regulating norms, codes, and conventions governing behavior.

• A workable platform has five elements:

  • information flows smoothly
  • property rights are protected
  • people can be trusted to live up to their promises
  • side effects on third parties are curtailed
  • competition is fostered.

Transaction Costs

• Two types of information costs:

  • search costs: the time, effort, and money spent learning what is available where for how much. .
  • evaluation costs:
    • The quality of the goods for sale is often not immediately apparent, and the buyer may have to go to some trouble to evaluate it.
    • Monitoring work costs time and money.

• price dispersion measured by the difference between the highest and lowest prices charged for a particular item as a percentage of its average price, the typical dispersion, according to one study, was 37 percent for books and 25 percent for compact discs. reasons =

  • shoppers are lazy
  • can't observe quality

• market of lemons:

  • Imagine it costs a seller $1.00 to supply a quart of high-quality milk, and $.60 to supply a quart of watered down milk. A typical buyer would willingly pay up to $1.20 for good milk and $.80 for inferior milk. In either case mutual gains could be obtained from trade. If the buyer could recognize the milk’s quality, both buyer and seller would benefit from a sale at a price somewhere between $.60 and $.80 for the low-quality milk and between $1.00 and $1.20 for the high-quality milk. If the buyer is unable to distinguish quality, however, both grades of milk would sell for the same price. Suppose all vendors look alike to our buyer, and he believes that 60 percent of them water down their milk. Then the most he would pay for a quart of milk is $.96, and probably less. (The arithmetic of this is that there is a 40 percent chance the milk is worth $1.20 to the buyer and a 60 percent chance it is worth $.80, so on average it is worth $1.20 0.4 + $.80 0.6, which equals $.96.) But this situation is not sustainable. It costs $1.00 to supply the good milk.

  • Gresham's law --- low-quality drives out high-quality

• search cost and competition.

  • must buy X
  • cost of prod. = $5
  • your cut-off price = $10.
  • if 1 seller, you pay $10.
  • if search cost = 0, eval. of quality costs $0, etc., you see bids by several merchants, you pay $5
  • if search cost != 0, price-cutter gets less compensating boost in sales.
  • math error: if search cost is say .10 per sample and there are 50 sellers and 1 seller is selling at $10. expected return per search = (1/50)*$5 or 10 cents.
  • the price cutter brings the price back up to the extent he doesn't see compensating revenue
  • merchants sell at $15 knowing everyone else is doing the same
  • upshot: small transaction costs can cause big effects

• solutions to search and eval. costs (should include whether or not someone will pay up):

  • repeat business relationships
    • concern for future.
      • from poor econ.: payoff from reneging > cost, a reason why ROSCA doesn't get big
  • brand names---can charge for assurance of quality
    • mcdonald's -> work on consistency
  • trademarks
  • showy offices
  • advertising---apparently celebrities cue company's confidence that it will recoup its money
  • yellow pages
  • consumer reports, etc.
  • real estate agents
  • contracts, enforcement from governing associations, gov.

• Solutions for people who don't pay

  • publicize info. on people who don't repay loans. ala GoFish.
    • can be a service
  • The enforcement of contracts and the prevention and settling of disputes etc.

• Unemployment exists, for example, not simply because there are too few jobs, but also because transaction costs in the labor market prevent some employers and job seekers from connecting with each other.

• Sutton: stock exchange at Wall Street. Earlier stock trading happened haphazardly via word of mouth of newspaper. Sutton created a 'stock exchange'---sellers and buyers would assemble at one place and one time and Sutton would auction off.

  • Sutton charged a commission, which was then undercut as others started holding these markets.

  • 21 prominent brokers came together to create a new auction. Agreed to transact on fixed fees and only among themselves.

    • setup rules: merchants defaulting on contracts were barred.

    "In 1792, one John Sutton, sensing an opportunity, organized a securities exchange at 22 Wall Street, which was then a muddy lane. Sellers would bring in their stocks and bonds each morning, and at noon Sutton would auction them for a commission. then they would hold their own sales, offering the securities at lower commission rates and taking business away from Sutton. This practice soon became self-defeating, as it meant too few securities

    To solve this problem, twenty-four of Wall Street’s most prominent brokers agreed to form a new auction. They would trade securities at fixed fees. Membership in the stock exchange was restricted and lucrative, so the brokers were able to regulate themselves on the sanction of Members who defaulted on contracts were barred. Nonmembers who reneged on contracts with members were blacklisted."

Competition

• Being able to veto any deal does convey some bargaining power, but not necessarily much. Competition curbs power.

• for effective competition, buyers should be able to easily compare choices

• the price under competition is the second lowest price for that is when the competition stops

  • same w/ auctions

• In the late 1980s, television rights for all of English soccer were negotiated for £2.5 million. Then, an upstart television provider, BSkyB, injected some bidding competition, to such an extent that in 1992, contracted with it for £45 million per year; in 2000 the bidding for a three-year deal rocketed to £537 million per year.

Property Rights

• Top Down or Formal

  • Government’s role in market design is the defining of property rights.

  • South Africa passed a law in 1997 to make essential medicines affordable by compulsory licensing

Ownership

• Right to residual returns where residual = anything beyond what the owner has committed to employees or creditors.

• Explains why small biz. more innovative than larger biz.

  • In large biz., head of division's upside capped at some number.

• Growth in prod. in China due to switch to ind. ownership

  • prod. in '78 apparently lower than in '49
  • Xiaogang
  • 83 --- ind. farming consistent w/ socialism
  • total rural poor declined by 170M b/w 78 and 84 --- WB
  • no direct ownership still. people are contracted out the land. initially for 3 years and then for 15 years.

Trust

• 5th century b.c., Croesus starts issuing gold and silver coins of guaranteed purity

• Moneyback guarantee (likely invented by Potter Palmer, the founder of Marshall Field and Co.)

Market Support

• Entire sectors of a modern economy are devoted to organizing transactions. The retail and wholesale trades and the advertising, insurance, and finance industries exist not to manufacture things but to facilitate transacting. These activities ... accounting in the United States for one-fourth of the gross national product.

Uncertain Value

• value of a product = private + common (what you think others will pay)
  • in auction, people may overestimate common value -> winner's curse
  • in an open auction, people learn what X is worth to others.
  • in closed auction, people bid lower to avoid winner's curse
    • fix that by using second price

Auctions

• Dutch Auction: As each lot of flowers is towed by, the clock’s hand starts at a high price and rotates through lower prices until one of the bidders stops it with a push of a button.

• Closed -> second-price

• Open > Closed

  • bid reflects your + other people's info.

• Efficiency -> Fixed end time

  • ebay allows people to set the max they are willing to bid
  • amazon: if last second bids or sniping, auction closing time pushed further out until 10 min. with no new bids

• Open issues -> shill bidding -- get someone else to bid up prices

• To solve trust

  • ratings, escrow account services which hold money till X delivered, appraisal companies, etc.

• Simultaneous ascending auction:

  • Used for selling rights for wireless etc.
  • Licenses are inter-dependent
  • Multiple auctions open for diff. licenses and all auctions remain open till there is bidding on any one. Bidding happens in rounds.

• Dango is the name given in Japan to a negotiation among bidders to decide which firm will get the job. The designated firm submits a high bid and its “rivals” bid still higher, maintaining the illusion of competition. For the firms this is a congenial way to do business. Under dango each firm knows that it will eventually “win” a contract, without having to go to the trouble of competing, and dango spares the firms the discomfort of low prices.

  • "According to tax agency data, the Japanese construction industry each year spends $5 billion or more on entertainment."

Dealing With Externalities

• Vickrey (of the auction fame) proposed congestion tax

  • hard to set the tax exactly right

• Coase: define property rights and let people trade

• Emissions trading:

  • government sets quota. trade. major success.
  • sometimes NGOs buy the credits and hold them inactive

• Picking winners when strong externalities (railway tracks)

  • http://raven.stern.nyu.edu/networks/brewer.pdf

• Externalities ~ fishing etc.

  • part of the problem is that many gov. subsidize fishing -> overcapacity -> "So heavy is the subsidization that, according to the FAO, $90 billion is spent each year around the world to catch $70 billion worth of fish"
  • solutions:
    • social norms
    • quotas

Patent Economy

• Anti-ulcer: 10% increase in price 7% lower demand

  • if you have monopoly (patent), you can price much above the prod. cost

• Patent/Copyright is legally sanctioned restraint on trade

  • a license to overcharge
    • e.g., For books still under copyright, like The Grapes of Wrath and For Whom the Bell Tolls, the list price of the American paperback edition is $12 and up. Books out of copyright, like Tom Sawyer and Pride and Prejudice, have a list price of around $5 in mass-market editions and around $8 in higher-quality paperback editions.

• Spending on software, etc. didn't increase substantially when patent laws for software brought into place in 1980s

• Business methods became patentable in 1998

  • one-click
  • 'reverse auction' by priceline

• Alternate ways to spur innovation

  • research tournaments. innovation need not be 'complete.' think DARPA challenges.
  • patent buyout

Managing Sports --- No good solution

• returns ~ f(competitive, star_power, home_team)
• If team level, say we start with one weak team, it may harm gate tickets for everyone else. it can be that the total payoffs for the teams are lower.
• fixes:
  • rookie draft in Am. football, worst team gets the first pick
    • ineffective as rich teams buy best players.
  • reserve clause, bound the player for the career to a team (baseball)
    • ruled illegal as limited player salaries. ineffective.
  • salary cap (NBA and NFL)
    • transfer or earnings from players to owners
  • revenue sharing
    • NFL does most.
  • multiple divisions w/ relegation
  • transfer fees
    • not v. successful

Puzzles of Advanced Capitalist Economies

Primacy of Non-Market Transactions

Even in the most market-oriented economy, a majority of transactions do not actually go through markets. * Unpaid work: full-time homemaker in the United States, by one estimate, produces outputs that if priced would be worth about $17,000 per year. * Gov. work like police + road building --- about a fifth of most modern economies * Within firms: more transactions happen within firm that across firms * Well over 50% of the GDP is worker comp. in the U.S. * Employees' earnings—which represent transactions inside the boundaries of firms and other organizations—account for 71 percent of Americans' aggregate income.

Primacy of Large Corporations

• In the US, plants with fifty or more employees account for over 80 percent of total manufacturing employment. In Thailand they account for 30 percent of manufacturing employment, and in Indonesia and Ghana, 15 percent. Richer countries have larger firms

• Corp > Public owned

  • Following privatization, most firms (though not all) charge their customers lower prices and offer better service than state ownership. Output per worker is higher (by about 20 percent on average), as are investment spending (by about 5 percent on average) and profitability (by about 4 percent on average).

• But still inefficient:

  • Principal Agent Problem

  • Middle managers have an interest in husbanding information. A study of large U.S. corporations found that divisional managers built slack into their annual budgets by understating expected revenues (by using low price and sales estimates) and overstating costs (by inflating personnel requirements, proposing unneeded projects, and failing to report the adoption of cost-lowering padding, which was lower in years when operating conditions were adverse, averaged 20 to 25 percent of the divisions’

  • Of the major cases of fraud suffered by corporations, according to a survey of senior executives in fifteen industrialized countries, one-fourth are perpetrated in-house by the firms’ own managers.

    • ...top executives of CUC International, a hotel, car rental, and real estate franchising firm. In the biggest accounting fraud ever (according to U.S. authorities), costing investors $19 billion, they inflated earnings and projected earnings in order to keep the stock price artificially high.

• Corporations are as big as nations. Alphabet's revenue is ~ 35B. So why is it reasonably productive when planned nation state economies are not?

  • Some market incentives, bonus schemes, etc.

IPOs

Hambrecht: open IPOs --- even in 2002 people were talking about this In a Dutch auction, a company reveals the maximum amount of shares being sold and sometimes a potential price for those shares. Investors then state the number of shares they want and at what price. Once a minimum clearing price is determined, investors who bid at least that price are awarded shares. If there are more bids than shares available, allotment is on a pro-rata basis--awarding a percent of actual shares available based on the percent bid for--or a maximum basis, which fills the maximum amount of smaller bids by setting an allocation for the largest bids

"Primitive" Markets

• The stallholders are not just retailers but also wholesalers: they buy in bulk to sell small quantities to consumers, and they aggregate small purchases for resale to other sellers.

• They organize the transportation of goods—not a simple matter in a country with inadequate roads and railroads—serving as intermediaries between widely scattered producers and consumers.

• They do some rudimentary manufacturing: crafting with beads and processing raw materials into foodstuffs, condiments, and cosmetics.

• They find recycling uses for cans, bottles, and newspapers.

• Assessing their customers’ creditworthiness and granting some of them credit, they take on the role of banks.

• Being illiterate, the stallholders must keep their business records in their heads, using impressive powers of memory. They make precise calculations of their input costs so as to keep track of their profits.

Pharma

• In profitability, the pharmaceutical industry ranked comfortably first in the 1999 Fortune 500 list of the top global companies. Its profits were 18 percent of revenues, putting it far ahead of the second-place industry, diversified financial firms, whose profits were 11 percent of revenues;

• The industry’s marketing costs in the United States are estimated to be more than $8,000 per physician.

  • pharmacia corp., which makes eye drops for glaucoma, in one year spent 2x the amount of marketing and admin. than research. (total money spent on marketing and admin = 40% of revenue)
  • GSK spent 37% of revenue on marketing and admin. and 14% on research in 2000

• If the key discoveries cited in biomedical patents, just 17% came from industry

• via the National Institutes of Health (NIH) and other federal agencies totaled $18 billion in 2000. Universities, foundations, and charities spent another $10 billion or amounts add up to more than the research spending of all the U.S. pharmaceutical companies, which was $22.5 billion.

• Gov. funded research

  • Of the key discoveries cited in biomedical patents, just 17 percent came from industry, according to a study by the National Science Foundation.
  • green revolution --- research from consortia of governments

Misc.

• "God is in the details," declared the architect Ludwig Mies van der Rohe. Tradespeople building to architects’ plans would habitually grumble that “the Devil is in the details,” and Mies van der Rohe was inverting their complaint.

• Futures market

  • 1260 in Nagoya, Japan. Futures in rice. Farmers can get paid before harvest.

• In a 1781 letter to his father, Mozart said, doubtless exaggerating somewhat, “Believe me, my sole purpose is to make as much money as possible; for after good health it is the best thing to have.”

• "Buying and selling is therefore a form of creation."

• People who comparison shop do a favor to everyone else. Sellers more likely to cut costs as they can gain revenue from such people.

• Govt. apparently once used lotteries to assign rights. For cellular auction, 400k applied. "In one not atypical case, some dentists won the right to run cellular-telephone service on Cape Cod; they immediately sold their license to a real telephone company, Southwestern Bell, for $41 million."

  • Switch to auction in 1993

• "Allah is the only one who sets the prices and gives prosperity" --- Mohammed

• The old Eastern European lament applied also in China: “We pretend to work, they pretend to pay us.”

• The U.S. Federal Highway Administration estimated that in 2000 the negative spillovers from driving—the costs of congestion, pollution, and accidents—totaled $446 billion. $108 B --- insurance premiums, etc. rest = externality. ~ 10 cents/mi

• students asked to divide $10. Breakdown of the bargaining, with both bargainers receiving nothing, was surprisingly common: it occurred in one-fourth of the negotiations. In the competition experiments (10 bids), the money was always successfully divided, and the bids were driven down to a few cents, meaning the seller got most of the money.

• Tokyo prosecutors in 1993 arrested Shin Kanemaru, the deputy prime minister, on charges of income tax evasion. They found in his office safe over $50 million worth of cash, bonds, and gold bars—donations that had come mainly from the construction industry—intended not for his personal use, according to Mr. Kanemaru, but to realize his “cherished dream of political reform.”

• Size of the shadow economy: in most countries, an increase in economic activity of 1 percent brings an increase in electricity consumption of about 1 percent. ...it has been estimated that Nigeria, Egypt, and Thailand have the world’s largest shadow economies, at nearly three-fourths the size of their official national income.

• In Indonesia, the Philippines, and Thailand, ten rich families control half of the corporate assets.

• China liberalization: state-owned firms were required to sell their output to the state at fixed prices. Under reform, this aspect of the plan stayed in place, but they were allowed to produce extra output to sell in markets. There were dual prices;