The price of diamonds

The diamond market is really strange. The wholesale market is dominated by a single firm that basically acts like a monopolist, as it is able to control supplies with large stockpiles (and even get a bailout from the government) and thus sets the prices at will. The resale market is heavily self-regulated to limit the supply from others than the dominant firm (just try to resell your diamond and get more than half what you paid for it...). Thus, if you would want to study price setting in this market, you would want to look at it from the angle of a monopolist trying to maximizing its profit and extracting as much as possible from demand.

Nicolas Vaillant and François-Charles Wolff do none of it. They just apply a hedonic regression and blindly regress selling prices on diamond characteristics. It is interesting that they find that there are some important non-linearities at round carat sizes, but is to be expected given the marketing by the diamond industry. But what quickly put me off in this paper is that the authors do not seem to understand some basics of economics. Here is a quote from the first paragraph:

In 2003, world demand for rough diamonds (US$9.5 billion) was significantly above the diamond supply (US$8.2 billion), so that the excess demand had to be satisfied from producers’ existing stockpiles.

First, by definition, supply includes stockpiles. How one would measure supply by ignoring the stock is a mystery to me. And how could one quantify supply and demand separately like this? In addition, it is not like there is rationing going on, which would justify higher demand than supply, as I cannot imagine that a monopolistic supplier set prices below equilibrium. After this opening paragraph, I cannot trust anything in the paper.

PS: And I just realized this is the second time I criticize a paper by these two authors...

Milk quota markets are not efficient

Many countries have some sort of rationing system in place for their dairy industry, because apparently farmers have a tendency to produce too much milk and depress its price, in the end getting less, I guess because the price elasticity of demand is high. This rationing is typically done through a quota system, and these quotas are sometimes tradable. This last point is important as it makes it possible for the allocation to be efficient: the most efficient producers should indeed acquire more quotas, which they buy from the least productive farmers.

Rebecca Elskamp and Getu Hailu tell us this is not at all what is happening in Ontario, Canada. Elskamp and Hailu identify quota net buyers and sellers and they try to match them with various characteristics. As the milk sale price is uniform, it must have to do with production and costs. The latter do not seem to matter at all. Scale does, though. Thus, if you are a farmer who happens to have an empty barn, you buy quotas whether your costs are high or not. But if you are a very inefficient farmer with high costs, you do not think of selling your entire quota and live from it. Strange.

Should we see more university mergers?

When should universities merge? The recent examples I have witnessed were due to economic hardship, where one college could simply not meet ends and was taken over by another one. There is also a new trend in France to merge universities that had previously been split apart, as part of the eternal higher education reform in this country. Many universities grew so large that they were split along sciences lines (natural, engineering, social sciences, humanities), only to realize that French universities were then really hurting in international rankings. But none of this follows any reasoning about what is best from a social point of view.

Marisa Hidalgo-Hidalgo and Guadalupe Valera try to get to this by using a bit of theory, comparing a university monopoly to a duopoly. A monopoly can bargain better for lower wages and better faculty, and it can create synergies. But a duopoly encourages better competition for excellence. The overall results is that the more heterogeneous universities are, the easier a merger will turn a societal benefit. The current merger craze in France is thus appropriate, but for a different reason.

Yet the model does not allow to take into account some very important aspects of education. Think for example about the diversity of classes than can be offered in a larger institution. And that includes the French mergers, as now there is a potential for students to take classes outside of their field and thus emulate something like a liberal arts education. After all a big drawback of European and especially French education is the excessively specialized education, leading to a workforce lacking flexibility.

American colleges could also benefit from mergers. Think about all these tiny colleges that can barely offer a halfway complete curriculum for the most popular majors. These micro-colleges are expensive for students and pay actually very little to faculty who have to teach extremely varied classes and struggle to do tat well. There is definitely scope for taking advantage of some economies of scale here. But merging large, complete universities, like what the authors have in mind, is definitely less advantageous. Imagine if Columbia University and New York University were to merge. There would be little to gain in a programmatic sense, and I do not think there would much pressure on faculty wages. After all, the market for good faculty is national, if not international.

Complicated auctions are more proftable

There was a time where auction theory limited itself to studying very simple auction, where the subtleties were whether the first or second price should be paid (or the first less an increment). Now, auction theory looks at much more complex mechanisms, for example where bidders may or may not reveal their bids, or whether they are bidding, or where bidding comes with a fix price. Not all these mechanisms try to obtain a surplus maximizing outcome. Some maximize the profits of the seller, sometimes by confusing or even misleading the seller. The most extreme example are penny auctions, about which I posted before (I, II).

Andrea Gallice discusses a variation of the Dutch auction where the current winning bid price remains hidden but can be observed against a fee. This so-called price reveal auction has an additional twist: paying that fee makes the winning bid fall by a predetermined amount. An auction so complex must be designed to maximize someone's surplus. It is the seller. And his profits are even higher if he manages to keep the number of bidders secret. This is not unlike penny auctions, where the profits come from the fees, not the winning bid.

OK, this maximizes profits, but I do not think this maximizes overall well-being. Obfuscation is not likely to be beneficial, and I am quite surprised the author does not address this. Until convinced of the contrary, I am going to assume that such obfuscation is detrimental for society and should be outlawed. And with rules so complex, it would not surprise me that bidders would have a hard time behaving rationally.

The evil of patents

The litigation saga between Apple and Samsung over minute and obvious details of their respective phones makes good entertainment but has little economic value. In fact, it highlights all that is wrong with the current state of the patent system. Sadly, textbooks still teach how temporary monopolies are beneficial for innovation, yet evidence is now overwhelming that they hurt the production of innovation, the use of innovation and well-being in general. I have blogged a few times about some cases and discussed some research in this regard.

Michele Boldrin and David Levine have written a nice summary on where we stand on the usefulness of patents. They have written a very good book about the topic a few years ago (buy it or download it for free, the authors are consistent with their message). The new working paper provides a shorter breviary with the main arguments for and (mostly) against patents, with a few updates from the literature and case studies. The major point is that despite a huge increase in the number of newly granted patents, there is no evidence of increases in R&D expenditures or total factor productivity. In fact, there is a growing consensus that technological progress is slowing down and we should get used to slower growth in the economy. Patent law and practice is at least partly responsible for this.

Shopping hours competition

Firms not only compete with prices, but also with product characteristics. In the retail market, an important characteristic is the opening times. In some areas, for example in much of Europe, shopping times are regulated, the motivation being to give retail workers somewhat "normal" working hours. In some countries, for example the United States, there is much less regulation, and shops have extensive if not around-the-clock hours to satisfy King Customer.

Miguel Flores, who must have won the award for the shortest paper title, studies whether regulation is welfare enhancing when incumbent retailers can prevent entry of competitors by strategically choosing opening times. This essentially comes down to a model of competition through product differentiation. The standard result that regulation is bad when there is little diversity (regulation cannot promote differentiation) and good when there is a lot of it still holds here. The subtlety of the paper is to consider a situation where the incumbent chooses hours of operation, the competitor chooses to enter and its hours, and then they compete on hours. It is thus a two-dimensional space with entry deterrence on one.