Tuesday, May 20, 2014

Heaven's Going To Burn Your Eyes

Alex Tabarrok responded to my previous post!  It's pretty wonderful that he took the time to do so.

My impression is that the large bulk of his response was allocated to highlighting the extent and the legitimacy of the non-price realm.  He concluded his entry by saying...
Economists often focus on the virtues of the price system but that should not blind us to the many virtues and many margins on which a free society operates.
Given that the main thrust of his response was to highlight the non-price realm...it seems likely that, by arguing for pricing individual cable channels, I gave the impression of being among the economists who focus too much on prices at the cost of failing to see/appreciate/understand the non-price realm.

It's a really funny dynamic though because my entire blog is dedicated to exploring and explaining how resources are efficiently allocated in the non-price realm.  It's my very favorite topic!  All of my 200+ blog entries have to do with tax choice...which would create a non-price (chip) market in the public sector.  Here are some of my blog entries where I even consider whether or not prices can be eliminated entirely...

But because I am arguing that it would be better if individual channels had prices...it's entirely understandable for Tabarrok to perceive that I'm just another free-market economist who is fixated on prices.  In reality though, as my blog attests, I find the non-price realm to be extremely fascinating.  So I strongly agree with Tabarrok's conclusion and would really love it if he could flesh out his thoughts on the topic.

He did mention the fact that firms are centrally planned...but I'm really not quite sure what relevance this has to the topic of whether cable should be unbundled.  Yes, firms make educated guesses regarding how to allocate the resources that they have...but markets work because consumers are the ultimate judges of how accurate the guesses of the "islands" are.  If an island is wasting too many of its resources...then consumers will stop dollar voting for it.  As a result, the island will sink into the ocean.  Because...dollar votes are the only thing keeping the island afloat.  Hmmm...maybe it's better as a metaphor than as an analogy.  What's a better analogy?

Capitalism and socialism both have firms making educated guesses...the difference is that with capitalism consumers are free to give their positive feedback (money) to the producers who have made the best guesses.  Consumer choice is a fail safe device.  It prevents too many resources from ending up in the wrong hands. We can think of the market as a 3V network...vet/validate/vouch.  Everybody can give everybody else feedback on how well they are using society's limited resources.  

With this in mind...let's take a look at Tabarrok's Sopranos scenario...
In 2002 should HBO have individually priced episodes of the Sopranos and sold them through AOL?  Individual pricing generates value but it also has costs. Tradeoffs are everywhere. And, to the crux of the issue, if a law had been passed in 2002 requiring HBO to sell The Sopranos on an episode by episode basis would that have resulted in better and more programming at lower prices?
In retrospect...with perfect hindsight...we know that the Sopranos was a huge hit.  But when the first episode aired...it was simply HBO's educated guess.  Like every single allocation, it was a gamble.  There was absolutely no guarantee that the show was going to be great or even good.  Uncertainty is the very reason why we need markets.  If somebody has a crystal ball...or they are omniscient...then markets are very undesirable.  If we can know for certain beforehand which endeavors are going to be winners...then it's a massive waste of scarce resources to hedge them on multiple bets.  But the reality is that nobody has a crystal ball...nobody is all-knowing.  Therefore, it's absolutely imperative that consumers have the ultimate say on how well producers are using society's limited resources.

If episodes of the Sopranos had been sold individually...then what would have happened after the first few brave souls purchased the first episode?  With our perfect hindsight...it's reasonable to guess that the 3V network would have kicked in.  More and more consumers would have vetted/vouched/validated how HBO was using society's limited resources.  Cowen would have said, "Hey Tabarrok!  It's really worth it to buy the first episode of the Sopranos!  You really won't regret your decision!"  As more and more people purchased the first episode...HBO would have earned more and more money which would have given it more and more control over how society's limited resources were used.    

Would tightly tying results and rewards together have led to "better and more programming at lower prices"?  Tabarrok thinks that it wouldn't have.  But regarding the "better" part...it seems logical that HBO would want more, rather than less, money per episode.  So given that "better" would mean "more money"...HBO would have the strongest possible incentive to try and make each episode better than the last.  Regarding the "lower prices" part...this largely depends on the amount of competition.  High profits, all things being equal, will result in greater competition.  The higher the price of gold...the more prospectors there will be.  As the supply of successful shows increased...prices would have decreased.  My post on value signals covered this concept in more depth.

Let me hedge my bets by sharing what others have said on the topic...
The increase of demand, besides, though in the beginning it may sometimes raise the price of goods, never fails to lower it in the run. It encourages production, and thereby increases the competition of the producers, who, in order to undersell one another, have recourse to new divisions of labour and new improvements of art which might never otherwise have been thought of. The miserable effects of which the company complained were the cheapness of consumption and the encouragement given to production, precisely the two effects which it is the great business of political œconomy to promote. - Adam Smith, Wealth of Nations
Loss of personal wealth is a powerful dissuader, while profits are a powerful persuader to pay heed to other people’s preference. - Armen A. Alchian, Private Property and the Relative Cost of Tenure
The effectiveness of this trial-and-error method is analogous to the theory of biological evolution by natural selection, where economic actors are guided by profit-loss signals and “survival” is determined through market selection. Entrepreneurs who satisfy consumers’ demands at the lowest cost and highest quality earn positive profits, which signal socially desirable actions that allocate resources to their highest-valued uses. Entrepreneurs who do not do so, on the other hand, suffer monetary losses and are eventually eliminated via market selection (Alchian 1950). - Peter J. Boettke and Kyle W. O’Donnell, The Failed Appropriation of F. A. Hayek by Formalist Economics
Second, where residual claimancy and control rights are closely aligned, market competition provides a decentralized and relatively incorruptible disciplining mechanism that punishes the inept and rewards high performers.  Markets are a way of increasing what biologists call selective pressure: they have the effect of reducing the variance of performance and hence (under suitable conditions) increasing average performance. - Samuel Bowles, Microeconomics: Behavior, Institutions, and Evolution
The producer whose product turns out to have the combination of features that are closest to what the consumers really want may be no wiser than his competitors.  Yet he can grow rich while his competitors who guessed wrong go bankrupt.  But the larger result is that society as a whole gets more benefit from its limited resources by having them directed toward where those resources produce the kind of output that millions of people want, instead of producing things that they don't want. - Thomas Sowell, Basic Economics 4th Ed: A Common Sense Guide to the Economy
Unbundling cable would subject channels/shows to far greater selective pressure.  Given that carrot-wielding consumers would be the source of the selective pressure...how is it possible for unbundling cable not to greatly improve welfare?  Production mistakes...errors...inaccurate guesses would be identified sooner rather than later.  To steal Boettke's analogy...the market is really great at pulling weeds.  But if cable bundles 100s of channels together...and each channel is a bundle of shows...and each show is a bundle of episodes...then how can we ensure that the weeds are quickly pulled and the wonderful is well watered?  

When I cut the cord...I didn't just get rid of the weeds...I got rid of the entire garden.  Dendrobiums and dandelions alike were trashed.  It's really not a very precise feedback mechanism when there's no choice but to throw the baby out with the bath water.

This analogy is pretty good...
The management of a socialist community would be in a position like that of a ship captain who had to cross the ocean with the stars shrouded by a fog and without the aid of a compass or other equipment of nautical orientation. - Ludwig von Mises, Omnipotent Government
If cable fails to go in the right direction...then consumers should certainly have the option to abandon ship.  But what if a channel or a show fails to go in the right direction?  If it improves welfare to prevent consumers from exiting from channels and shows...then why doesn't it also improve welfare to prevent consumers from exiting from cable?

It kinda gives the impression that there's some concern that consumers are going to exit from something because it's too wonderful.  This probably is going to count as one of those instances where discretion is the greater part of valor...but a few months ago I started reading 50 Shades of Grey on my gf's Kindle.  Half way through I had to stop reading it.  Why?  Because it was too good.   It was so good that I had to put it down.

Should Kindle users be charged per page read?  Doing so would really cut into Thomas Piketty's profits.  Facilitating exit really isn't in the interests of producers.  I suppose that's the bottom line.  

But I am liking this whole "tai hao, shou bu liao" idea...something is just so wonderful that you just can't stand it.

Bob is in hell when he spots his old friend Dave.  Bob says to him, "woah, never thought I'd see you here!"  Dave replies, "Yeah, I couldn't take heaven anymore...it was just too wonderful."

If Tabarrok doesn't reply to this blog entry then whatever shall I think?  Of course I'm going to think that he exited from our debate because my words were so wonderful that they were burning his eyes...

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