The Oligopoly Solution?


“The Oligopoly Problem” by Tim Wu in The New Yorker is a fascinating article to discuss with students, because the premise of the article is that oligopolies fleece the public, with T-Mobile as exhibit A, who at the time (2013) had just begun aggressively lowering prices on cell phone services.

It is a great irony that the T-Mobile story is cited as evidence that oligopolies are anticompetitive. But the author is right – for the first approximately 20 years of personal cell phones, the prices were high and the carriers were notorious for long contracts and steep termination fees.

So what changed to make aggressive competition the best move for T-Mobile after it had been playing along with the others for so long?

It can be difficult for oligopolies to act like a monopoly, charging high prices and treating customers poorly because if one firm offers better prices or better service they can steal customers from the others. The effect is that all the companies are pressured to act in a way that is more pleasing to customers. (This is an example of the prisoner’s dilemma problem.)

But in the early days of cell phone service, many new customers were buying their first cell phones, rather then switching from other carriers. That is to say, there was plenty of new market for the phone carriers and they did not need to concern themselves with stealing customers from other carriers. If this is the case, then we would expect to see market saturation around the same time as T-Mobile’s break.

Mobile Cellular Sub

Based on the graph above from the World Bank, in the two years (circled) before T-Mobile began its aggressive pricing strategy, the growth of cell phone plans had stalled at around 90-some cell phone plans per hundred Americans.

The Bureau of Labor Statistics index of wireless telephone service prices shows a modest decline in price after January 2013, and no major price fall until almost two years later. (Below in blue.) It makes sense that the average prices would lag, since T-Mobile is only one of several major cell phone service providers. It would take time for the other carriers to follow suit.

CPI Wireless Phone Services

But here is the remarkable change: though the price fell precipitously in 2014, the market share of each carrier stayed about the same. See below:

statistic_id199359_wireless-carrier-operator-subscriber-share-in-the-us-2011-2017T-Mobile edged in on Sprint a bit, but the price drop cannot be attributed just to T-Mobile’s (barely) increasing market share. Early in 2015, I got a call from Verizon (my longtime provider) informing me that they were cutting the price on my current plan by 40%. When I asked why, the representative informed me that they were trying to stay competitive and keep customers happy.

If increasing market saturation forced these firms to turn on each other, as the prisoners’ dilemma would predict, does this give us a framework to think about other new oligopolies? Just because an oligopoly is acting in a not consumer-friendly fashion in its early days might not be a reason to be concerned, as there will be more pressure to steal customers as the easier to acquire early adopters are already customers.


You Can’t Eat GDP, but Here is Something You Can Eat


Ration book

Every year as I begin Macroeconomics with my students, I am struck with the poverty of discussions about current macroeconomic issues – that the source of worries or enthusiasm are data sets (hereafter referred to as “aggregates”) that are far from what we actually want to measure, especially over small time periods. If our measurements like the unemployment rate or production are not reflections of how well-being and standard of living are changing, then why should we care about them at all?

My concerns are twofold: what is the purpose of measuring aggregates? and do the measurements that we use accurately reflect what we want to know about?

To the first, I can only speak for myself: the only reason I study and care about economics is because good economics (and thus good public policy) gives individuals more opportunities to live better lives. To pursue their dreams, create value for others, and use their creative human energies.

To the second, there is a story (that I first heard on the EconTalk podcast) about a man searching for his keys in the dark beneath a street light. A passerby asks the man if he lost his keys beneath the streetlamp, and the man responds, “Probably not, but the light is better here.” Macroeconomics is concerned with things that are measurable, not necessarily things that are important.

Gross domestic product is a rough measure of annual production of a country. Production matters in the grand scheme of things because it means more food, health, education, life expectancy, leisure, environmental concern, and so on. But, there are ways our measure of production does not always track with those things in short spaces of time. Take a gander at this graph of U.S. gross domestic product per person over time (adjusted for inflation):

Circled, notice a spike in the GDP per person during World War II.

If we take an increase in GDP per person to mean an increase in standard of living, we should expect that life was prosperous and comfortable during WWII. Is that consistent with what we know about that time?

Well… not exactly. Spending and production were exceptionally high, but because the production was of guns and tanks rather than food and books, standard of living was  low.

“Ration cake” that is actually quite tasty from the 1940’s omits goods that were rationed and difficult to acquire: milk, eggs, and butter. (This particular variant does include sugar which is a cheat since that would have been also rationed. More authentic recipes use raisins for some of the sweetening. But I love you and would not do that to you, my dear reader. We don’t have to live like refugees.)


Ration Cake

This is just one example, but the key to using aggregates wisely is to think about why they are changing before we claim victory or defeat.

What College Ranking Systems Can Learn from Yelp

Why is St. Elmo’s Steakhouse (25th best steakhouse in the U.S., according to a Daily Meal ranking) ranked below a Cuban sandwich shop on Indianapolis’ Yelp?

In the U.S. News ranking of colleges, the criteria are, “graduation and retention rates,” “undergraduate academic reputation,” “faculty resources,” “student selectivity,” “financial resources,” and “alumni giving rate.” Conspicuously absent from the criteria? Tuition price.

College rankings are of what is best*, not what is the best value. But the surest way to make a bad decision is only to look at the benefits of an option, rather than the benefits weighed against the costs. It sounds great to improve cars to reduce the deaths from car accidents, but if it costs a million dollars per saved life and we can save several lives per million dollars spent on something else, then it would be a poor use of resources to improve those cars.

Fortunately, when students are deciding on colleges, price is a significant factor in many students’ decisions.

The problem with a ranking system that does not directly include cost is that colleges care about improving their rankings because potential students consider rankings, so it would be sensible for colleges to they take actions that raise their scores. My concern is that those actions might lead to higher costs without improving the learning experience.

To the first question: a Cuban sandwich shop can beat a top steakhouse on Yelp because ratings consider the quality of the food and experience relative to the price. That is to say, the bang for the buck.

What would it look like to rank colleges on a value basis? I don’t know. U.S. News has an attempt at such a ranking, and perhaps I will explain my concerns with that ranking’s metrics in a future post.


*Allowing, of course, that the criteria may be not be a good reflection of what makes a college “the best.”

Keep Breaking Those Windows

As I prepare to speak on a Bastiat panel at the Association of Private Enterprise Educators conference next week, I am recalling the many reasons why Bastiat is one of my favorite economists. I wrote the following tribute to Bastiat earlier this semester:

One of my greatest influences is Frederic Bastiat, because his writing possesses clarity and perceptiveness that have continued to win minds for freedom since he first began writing. Though he contributed little original theory or research to the study of economics, he has been a strong voice for limited government and sound economic policy. He had a remarkable proclivity for illustrating fallacies by telling colorful tales. His wit stripped away the facades that statist positions try to hide behind, and the movement for freedom is stronger for it. Bastiat is a model of dedication to freedom in many ways.

Even though he did not develop new economic theories, he was a great communicator of the importance of property rights, individual liberty, and justice. His work illustrates that an individual does not need to be as brilliant as Alchian or Hayek to make a lasting contribution towards a freer society.

His passion for the work of liberty is a remarkable example for modern liberty-lovers. He encountered hindrance after hindrance in his political work, but by dogged determination and tireless effort, he and his colleagues were able to stop the encroachment of protective tariffs. As Bastiat wrote to an acquaintance,

“For my part, I will join the combat at whatever level I am placed, for apart from the fact that I put our noble cause a thousand times higher than our little individual ideas, I have learned from Mr. Cobden… that individual self-sacrifice is the soul and cement of any voluntary association” (The Man and The Statesman).

Edit 3/25/17: I wrote above that Bastiat did not develop new theories, but that is not true. Embarrassingly, I did not realize until a year after writing this piece that Bastiat’s “unseen” costs are the missed benefits of a choice that was not made because another choice was made instead. Sound familiar? Bastiat may have been the first to write about opportunity costs, now one of the first and most important concepts learned in economics. So I suppose my quest for a liberty hero of ordinary intellect continues.

Soapboxing On The Deplorable State of American Education…


An “exciting” and nerdy display at my local library.

 One of the greatest challenges to liberty is the decline of personal responsibility and the accompanying desire for “protection” from harm, hunger, unemployment, and so forth. A society that fosters citizens that can take care of themselves but are also willing to help neighbors who are in need will develop the fabric of social cooperation that makes a nation stable and healthy. In this way, no one imposes on anyone else and all charity is given from genuine concern for the other’s well-being. A major contributing factor to the erosion of personal responsibility seems to be a mediocre public education system that leaves students with no conception of the importance of integrity and hard work. Alternative schools, such as private schools and homeschools are making great strides towards changing the schooling culture, but as long as the federal government has a vice grip on America’s educational system, we will continue to see lower standards. Returning America’s school systems to local control is the best way to improve the educational system and grow a generation of individuals who know what it means to be a good individual and a good neighbor. If bureaucracy is slashed, parents will have more influence and teachers will be more accountable. Continued growth of competition from private and charter schools will keep public schools accountable, but without a substantial reforms of the American public school system, we will be left with students who are not equal to the blessings of liberty and do not know its value.

James M. Buchanan: One of The Greats

Nobel Laureate James M. Buchanan passed away today at the age of 93. He founded the field of public choice economics, and his writings have had a greater impact on me than any other economist I have read. This summer I heard stories about him from people who knew him, and apparently he didn’t always observe the rules of order in Liberty Fund conference discussions. When you win a Nobel Prize, I’m sure people will give you a little leeway too. I made this poster for Econlib to commemorate the passing of this giant of 20th century economics.

Buchanan Obit

A Sticky Misunderstanding

Critics of free markets often claim that one of the major shortcomings of an unrestricted market is that companies “extort” large profits, to the detriment of consumers. Underlying this claim is the assumption that companies should not be making profits; that a no profit situation would be more desirable. Perhaps the “Perfect Competition” model of a market contributes to this fallacy, because in this ideal state companies don’t make economic* profits. In this model, the price of a good equals the cost of producing the good, including opportunity cost-the profits forgone by not pursuing the next best use of resources. So a firm can make an accounting profit (bringing in more money than you pay out, and what is generally meant by the term “profits”) and still have no economic profits. The critical part of this picture is the opportunity cost, because it cannot be calculated and it is the difference between accounting and economic profits.

Labor and material costs are easy to measure, but by selling tables, a firm forfeits the chance to make dressers, or ships, or thousands of other things. How costly is that sacrifice? Only the decision maker of the firm can guess for himself what the forgone benefits could be. The extra compensation for making tables (beyond the obvious costs) is an inducement for a company to make tables instead of one of the other possibilities. If there were no profits, a company could not know how best to use their resources. These profits are signals to alert people that there is more need for one good than another. When lawn flamingos become more highly desired, the price rises. This economic profit opportunity attracts more companies to provide that good. Therefore, some compensation above cost of production is a reward for a firm “closing the gap” between what people want and what producers are making.

So here is the catch: The opportunity cost of making one thing over another can’t be calculated, and it is different for each firm. The Perfect Competition model glosses over this complexity and simply bundles a place-holding “opportunity cost” with the other costs. This model assumes no economic profitsbecause any money firms make beyond costs is reimbursement for forgone opportunities.  (This can be assumed because if there was a better use of a company’s resources, they would be pursuing that action instead.)

Non-economists can easily assume that “no economic profits”= no profits (in the general understanding of the term). Those who say that profits are higher than necessary (Occupiers, among others), don’t realize that economic profits only exist for very short periods because if the money to be made is one industry is so much higher than in another, firms will move to that industry. Prices will fall, and profits will eventually even out between industries. (In theory.) But the weird thing is, even if we accept the idea that accounting profits are not a big deal and economic profits are the real profits, we miss the point that economic profits drive innovation. Yes, it is true that businesses that make economic profits are raking in the moolah. But they earn that extra moolah by meeting the needs of customers.

*Key: Accounting profits: The money left over after all expenses are paid; general understanding of the term “profits”.

Economic profits: Accounting profits minus opportunity cost (the potential gains you give up by taking one course of action rather than another). Because we can only guess what we are giving up, and because it does not fit into a tidy equation, opportunity cost is too often ignored. *sigh* Theoretically, economic profits won’t last long, because they are a signal that it is more advantageous to make one item over another. So more companies will shift to making the higher valued item, and the price will fall until the economic profit is gone.

A special thank-you to Dr. Ivan Pongracic, Mises Chair of Hillsdale College’s Economics Department and my Industrial Organization professor, for inspiring this post and generously proofreading the draft.