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Subsidies, taxes, and queuing
Today: Some methods that either
hurt or improve efficiency
Today
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More on topics related to efficiency
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Subsidies
Taxes
Queuing and first-come, first-served
policies
A subsidy for renters?
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Recall that last time, we concluded that
rent control had few (if any) winners
and many losers
Suppose that we wanted to find another
way to help I.V. renters
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How about a $500 check per month for
each renter of I.V.?
Think, think, think
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As aspiring economists, we need to
examine whether a subsidy is a good
idea
We must keep in mind
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Subsidy is not a “benefit” in economic
terms, but a transfer
Money for subsidy must be raised from
somewhere
Short-run analysis
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In this case, we will look at the shortrun consequences
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Assume for the near future, nobody can
build new apartments or convert
apartments to condos
Supply is vertical
What happens?
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Initial demand is D
After subsidy is
given, each person
is willing to pay
$500 more than
before, changing
demand to D’
What happens?
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Before the subsidy, price
is P2; quantity is Q1
With subsidy, quantity
demanded at price P2 is
Q2
In short-run, notice new
price for apartments is
P1
This price is $500 higher
than before
What happens?
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All of the subsidy
goes to the
apartment owners
(and we have not
even found money
for the subsidy yet!)
First-come, first-served policy
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This is essentially what happens today
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When a vacancy occurs, the manager
accepts applications
If the rent is at the market-clearing price:
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Each person willing to pay the price should find
an apartment
Each apartment should be rented
First-come, first-served policy
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What if the apartment is not at the
market-clearing price?
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If the
price,
If the
price,
rent is below the market-clearing
long lines develop
rent is above the market-clearing
the apartment will sit unoccupied
The inefficiencies of long lines
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In 1978, airlines adopted a voluntary
approach to overbooked flights
Before this, people were allowed to
board on a first-come, first-served basis
Remember to think like an economist:
Waiting time is a loss to society that
nobody benefits from
The inefficiencies of long lines
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Each person has a value of their time
People on vacation typically have lower values
of time than those traveling for work
Let’s look at a tale of two people for a
concrete example
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Max, who is ready to go on a skiing trip
Jill, who has a business meeting tomorrow in
Denver at Noon
Max, a single guy who likes to
vacation in style
Jill, a busy executive at a local
firm
They book seats on 6:05 am
flight to Denver tomorrow
A tale of two people: Max
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Max has shopped at Vons
for the last 12 years in
order to accumulate enough
miles to book his free flight
He stays in Denver for one
night before embarking on
a two-week ski tour of
Colorado
A tale of two people: Jill
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She receives a call
tonight at 10 pm
She must be in Denver
tomorrow for a Noon
meeting tomorrow, or
else her local firm loses a
$2 million contract
She books an Economy
seat to Denver for $775
Check-in for United flight 6682
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Max and Jill are the last two people to
check-in for the flight
Jill is right behind Max in line
Unfortunately, only one seat is left
Should Jill be bumped?
Efficiency
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As economists, we want to find a way
for the most efficient outcome to occur
As an airline, we want to make ALL of
our customers happy
How do we do this?
Suppose that United cannot
overbook its flight
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Empty seats
Higher ticket prices
Jill becomes desperate to find a way to
Denver
With overbooked flights
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Voluntary system to find a person with
a low value of time
Offer an incentive so that someone is
willing to travel on a later flight
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A First-class seat on the 1:45 pm flight to
Denver
Cost-benefit analysis of
incentive
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Max’s cost of waiting in Santa Barbara
for eight hours is low, since he was just
going to check into his hotel and eat a
nice dinner at a local restaurant
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$10 cost per hour, or $80 total
Jill loses a big contract if she does not
make the flight
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$50,000 total cost
Cost-benefit analysis of
incentive
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Assume that either Max or Jill benefits
the same from a First-class seat
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$200
Max gains $120 by offering to give up
his seat in order for Jill to attend her
business meeting on time
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He instantly volunteers to give up his seat
for Jill
Cost-benefit analysis of
incentive
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Going from a first-come, first-served
policy to a voluntary incentive system
has improved the outcomes of both Max
and Jill
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Max has improved by $120 and is traveling
in style, just the way he wants
Jill is able to make her meeting and save
the contract
Pareto improvements
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When one or more people are made
better off without making anyone else
worse off, these are known as Pareto
improvements
In our previous example, both Max and
Jill were made better off without
making any other passenger worse off
Hypothetical cost-benefit analysis
from United’s point of view
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United Airlines has determined in its
computer system that the probability of
the last First-class ticket being booked
for the later flight is 0.05, at a price of
$1200
The marginal cost of an a First-class
passenger over an Economy passenger
is $50
Cost-benefit analysis from
United’s point of view
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Marginal benefit of booking Jill’s ticket:
$775
Marginal cost of booking Jill’s ticket:
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Possible loss of First-class ticket being
booked on the later flight, $60
Additional First-class cost of Max’s trip, $50
Total, $110
United is better off with this policy, too
In the text
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Demand curve is derived from reservation
price (or highest willingness to pay)
Max’s reservation price is low in this example
Jill’s reservation price is high in this example
People with low reservation prices will
voluntarily accept the airline’s offer if the
individual’s MB of the offer exceeds the MC of
the time lost and inconvenience
What have we learned today?
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A subsidy, like rent control, is not a
good solution for the I.V. rental market
Voluntary incentives can be used to
improve the efficiency of some markets
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Airlines use price discrimination to help
achieve this (More on this in Ch. 10)