Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't (29 page)

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Authors: John R. Lott Jr.

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12
Ben Stein, “Don’t Beat Up Big Oil. It’s Just Doing Its Job,”
New York Times
, November 20, 2005.
13
The actual statement by Menken was “There is always an easy solution to every human problem—neat, plausible, and wrong.” H. L. Menken, “The Divine Afflatus,”
New York Evening Mail
, November 15, 1917
14
Some of the discussion in this section is based upon John R. Lott, Jr. and Russell D. Roberts, “A Guide to the Pitfalls of Identifying Price Discrimination,”
Economic Inquiry
, vol. 29, no. 1, January 1991: 14-23
15
David Asman, “Why We See Less and Less Life-Saving Breakthrough Drugs,”
Foxnews.com
, January 5, 2007 (
http://www.foxnews.com/story/0,2933, 242098,00.html
), and John R. Lott, Jr. and James Glassman, “The Drug World’s Easy Riders,”
Wall Street Journal Europe
, Wednesday, July 23, 2003.
16
Meghan Daum, “$4k Cat Is Nothing to Sneeze At,”
Los Angeles Times
, October 7, 2006, and “Hypoallergenic Cats for Sale,” ABC News, October 6, 2006 (
http://abcnews.go.com/Nightline/story?id=2537618
).
19
I checked the prices at the supermarket near my home, Genuardi’s, which is owned by Safeway. The situation there was similar: cola costs less than carbonated water across the board. For two-liter bottles, the cheapest seltzer
was a Safeway brand costing $1.49, while Coca-Cola Classic sold for ten cents less. Safeway’s own cola brand, Go2 Cola, normally sold for $1.49—the same price as their Seltzer—but was temporarily discounted for Genuardi’s members to just eighty-eight cents. Another brand of seltzer, Vintage, also normally went for $1.49, but was on sale for $1.09.
20
John R. Lott, Jr. and Russell D. Roberts, “A Guide to the Pitfalls of Identifying Price Discrimination,”
Economic Inquiry
, vol. 29, no. 1, January 1991, 14.
21
After all, New York City had 24,600 restaurants as of September 2006. (David B. Caruso, “NYC weighs ban on artificial trans fats,”
Chicago Tribune
, September 27, 2006).
22
John R. Lott, Jr. and Russell D. Roberts, “A Guide to the Pitfalls of Identifying Price Discrimination,”
Economic Inquiry
, vol. 29, no. 1, January 1991,18-19. I would also like to thank my cousin Jim Lyden, who has managed two different Outback Steakhouses, for helpful discussions on these topics.
23
Ibid.
25
Another puzzle is the requirement that consumers have to spend a Saturday night at their destination in order to receive the discount. This is typically explained as an example of price discrimination against business travelers, but it may only be a form of peak load pricing if those who stay over Saturday night travel on Sunday, the quietest day of the week. The puzzle remains as to why there is not an explicit discount for returning on Sunday, but this is also a problem for the price discrimination explanation.
26
John R. Lott, Jr. and Russell D. Roberts, “A Guide to the Pitfalls of Identifying Price Discrimination,”
Economic Inquiry
, vol. 29, no. 1, January 1991.
27
Rhode Island Gas Prices (
http://riroads.com/everyday/gas.htm
).
28
National Petroleum News Factbook, Des Plaines, Illinois: Hunter Publishing Co., (1987). An Associated Press story in July 1986 showed a similar pattern: “Regular unleaded gasoline at self-service stations costs about 80.13 cents a gallon, compared with 1.0994 at full-service stations, and premium unleaded costs about 95.01 cents a gallon, compared with $1.1965 at full-service stations.” Associated Press, “Gasoline Prices at 7-Year Low,”
New York Times
, July 28, 1986.
29
People would undoubtedly claim monopoly power if the price spread between full-and self-serve regular and premium unleaded were reversed. The explanation provided here would ask one to look at the number of gallons sold on average per customer.
30
John R. Lott, Jr. and Russell D. Roberts, “A Guide to the Pitfalls of Identifying Price Discrimination,”
Economic Inquiry
, vol. 29, no. 1, January 1991: 14-23.
31
This section is based upon Robert G. Hansen and John R. Lott, Jr., “Profiting from Induced Changes in Competitors’ Market Values: The Case of Entry and Entry Deterrence
,” Journal of Industrial Economics
, vol. 43, no. 3, September 1995, 261-276.
32
Brooke Group Ltd
. v.
Brown & Williamson Tobacco Corp
., 113 S. Ct. 2578 (1993).
For a discussion of the American Airlines case and the Federal jury’s decision to acquit, see Neuborne, Ellen, “Lawsuit could curb price wars,”
USA Today
, August 25, 1993. Continental and Northwest Airlines sought more than $3 billion in damages from American Airlines. They alleged that a price war that American instigated in 1992, where they reduced coach fares by an average of 38 percent and eliminated most discounts, was an attempt to drive them out of business.
Not everyone was satisfied with this decision. Alfred Kahn has argued that “The way big airlines respond to competition from start-ups could objectively be described as predation.” Richard Tomkins, “When Fares Aren’t Fair
,” Financial Times
(London), February 10, 1998.
Two papers that provide empirical evidence of predation are Malcolm R. Burns’s paper about American Tobacco (“Predatory Pricing and the Acquisition Cost of Competitors,”
Journal of Political Economy
, 1986) and Granitz and Klein on Standard Oil (“Monopolization by ‘Raising Rivals’ cost’: the Standard Oil Case,”
Journal of Law and Economics
, 1996. 1-47). See also my book,
Are Predatory Commitments Credible
, (Chicago: University of Chicago Press, 1999).
33
It should be noted that predation is not a factor in the phenomenon of large chains like Wal-Mart, Target, or Home Depot driving small mom-and-pop stores out of business. The success of these companies in eliminating smaller competitors stems from their huge selection and especially their low costs, which enable them to charge lower prices than small, independent stores. These low prices are permanent; the chains do not lower prices to drive out competitors, and then subsequently raise them once they no longer face competition. Therefore, these are not examples of predation.
34
Ibid., Chapter 1. See also Robert H. Bork,
The Anti-trust Paradox: A Policy at War with Itself
, (New York: The Free Press, 1978) 39-40.
35
Matthew Josephson,
The Robber Barons
(New York: Harcourt, Brace, 1934), 205. For a longer discussion of this and other examples, see my book,
Are Predatory Commitments Credible?: Who Should the Courts Believe?
, (Chicago: University of Chicago Press) 1999.
36
The predator must be a publicly trade firm for this tactic to be successful. Additionally, the maneuver is most successful when the predator is a non-diversified company.
37
Levitt and Dubner,
Freakonomics
(2005 ed.), 67.
38
The Lemons argument has actually been around for decades, though the person who first brought up the concern realized that there could be strong forces to solve the problem. See George Ackerlof, “The Market of Lemons,”
Quarterly Journal of Economics
, August, 1970, 488-500. There are other papers that have found evidence that the market solves this lemons problem (Eric W. Bond, “A Direct Test of the ‘Lemons’ Model: The Market for Used Pickup Trucks,”
AER
, 72(4), September 1982, 836-840, and Wimmer and Chezum, “An Empirical Examination of Quality Certification in a ‘Lemons Market,’”
Economic Inquiry
, 41(2), April 2003, 279-91).
40
The study was conducted on September 27, 2006.
42
This assumes that the car is in “excellent” condition.
43
Steven Levitt and Chad Syverson, “Market Distortions when Agents are Better Informed: The Value of Information in Real Estate Transactions,” University of Chicago working paper, January 2005.
44
Stephen Dubner, “The Probability That a Real-Estate Agent Is Cheating You (and Other Riddles of Modern Life),”
New York Times
, August 3, 2003.
45
Levitt and Dubner,
Freakonomics
, revised edition, 49, 64. The authors claim that “The fear created by commercial experts may not quite rival the fear created by terrorists like the Ku Klux Klan, but the principle is the same.” The chapter is entitled, “How is the Ku Klux Klan like a group of Real-Estate Agents?”
46
Levitt and Dubner, revised edition, 66.
47
The amount of the difference cited by Levitt has changed over time. The original paper by Levitt and Syverson (“Market Distortions when Agents are Better Informed: The Value of Information in Real Estate Transactions”) put the difference at 3.7 percent, but in
Freakonomics
Levitt and Dubner quoted it at 3 percent, and the book’s revised edition pegged it at 2 percent.
48
There were a few very important measures that were missing from Levitt and Syverson’s estimates. For example, their empirical work and discussion looks at only the final sale price that property receives and ignores the impact that being an expert has on the original purchase price. Additionally, they did not have a measure of square footage for the house. If realtors happen to own slightly larger houses, this alone could explain the difference in prices. It might also explain the length of time on the market, because their results indicate that larger houses in terms of more bedrooms, other rooms, and bathrooms tend to be on the market longer.
49
Melody Jameson, “Changes in Real Estate Arena Prompt Focused Approaches,”
The Observer News
(Florida), November 9, 2006.
50
Ian Ayres and Steven Levitt write that “The car owner who installs LoJack internalizes only 10 percent of the total social benefit, however, implying that LoJack will be undersupplied by the free market.”See “Measuring Positive Externalities from Unobservable Victim Precautions: An Empirical Analysis of LoJack
,” Quarterly Journal of Economics
, February 1998, 43-77.
51
Unfortunately, Ayres and Levitt were unable to provide to others their primary data on the number of LoJack devices installed in cars. An attempt to test whether there was a drop in auto thefts did not confirm these original claims. John R. Lott, Jr., “Does a Helping Hand Put Others at Risk?: Affirmative Action, Police Departments, and Crime,”
Economic Inquiry
, April 2000, 257.
52
A check with State Farm, Allstate, and GEICO insurance indicates that this pattern is still true as of November 2006. For example, here are some statistics by state for Allstate, the nation’s second largest auto insurance company—Connecticut: no state mandate, no Allstate discount for LoJack (Carol A. Sarabia, Associate Examiner, Connecticut Insurance Department); Florida: state mandated discount of 10 percent, Allstate discount of 10 percent (Valerie, Consumer Service Agent, Florida Office of Insurance Regulations, 11/6/06); New York: state mandated discount of 15 percent, Allstate discount of 15 percent (Car Alarms and Car Insurance in New York, Transportation Alternatives. Campaign Memo. April 28, 2004); New Jersey: state mandated discount of 20 percent, Allstate discount of 20 percent (New Jersey Administrative Code, 11:3-39, obtained via Michie’s Legal Resources,
http://www.michie.lexisnexis.com/newjersey
); Pennsylvania: state mandated discount of 10 percent, Allstate discount of 10 percent (Chuck Romberger, Director, Property and Casualty Bureau, Pennsylvania Insurance Department); and Oregon: no state mandated discount, no Allstate discount (Greg
Ledbetter, Senior Consumer Advocate, Oregon State Insurance). This pattern is also true for State Farm Mutual and Progressive Casualty Groups. State Farm, Allstate, and Progressive were the three largest insurance companies in 2005. (
http://www.iii.org/media/facts/statsbyissue/auto/
).
The quote is from Ian Ayres and Barry Nalebuff, “Stop, Thief!”
Forbes
, January 10, 2005 (
http://www.forbes.com/forbes/2005/0110/088_print.html
). The authors point to one insurance company, Liberty Mutual, that gives “large discounts” to those with LoJacks: “A study by Ian Ayres and Steven Levitt showed that each dollar spent on LoJack resulted in $10 of reduced car theft. Alas, this doesn’t make the device a winner for insurers with less than 10% of the market, because most of the benefit will accrue to their rivals. Even so, Liberty Mutual gives a large insurance discount to LoJack users, even where it isn’t required by law.” This would imply that if LoJack was effective, then the largest insurance companies would be the ones most likely to give a discount. However, the opposite is true. (Liberty Mutual is only the ninth largest insurance company.)
53
Telephone interview with Amy Kelly, GEICO Sales Agent, October 16, 2006 (1-800-861-8380). See also a publication from Transportation Alternatives on Car Alarms and Car Insurance in New York that quotes GEICO as claiming that they do not support LoJack discounts because “it does not prevent the initial theft.”

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