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Friday, December 01, 2006

Microeconomics Quiz of the Week

From the Wall Street Journal's ProfessorJournal.com:
The article reports possible Congressional action to limit the high prices of high-demand popular toys. "As the holidays approach, a crisis has gripped America. Stores are running out of toys. Shoppers are waiting in lines for hours, sometimes days, to get items like the Play Station 3. Worse, the 10th-anniversary edition of the Tickle Me Elmo doll is almost nowhere to be found. In many communities, this "must buy" Christmas item for toddlers can only be purchased at a high price -- or it cannot be purchased at all. The going rate for Elmo has risen from $39.95 to $100, while PS3s are now selling for up to $3,000 on eBay. Who's to blame for wrecking Christmas? The price-gougers, that's who.... Incoming House Commerce Committee chairman John Dingell called a press conference today, at which he announced that he would ask the Federal Trade Commission to investigate illegal price fixing by Fisher-Price." The issue is whether toy and game manufacturers promoted toys and limited supply so as to charge high prices. The defense of the toy industry against charges of price gauging: We didn't expect the surge in demand and therefore did not ramp up production. Rep. Nancy Pelosi is calling for a windfall profits tax, and Sen. Hillary Clinton is calling for a government takeover of the toy industry.

QUESTIONS:
1.) Define price gouging. Is marketing toys and then selling a small number at high prices a form of price gouging?

2.) Is Tickle Me Elmo a monopolistic product? How do economists determine whether the market for a particular product is monopolistic?

3.) Should it be illegal for Fisher Price to market the Elmo doll so that the
market for the toy is monopolistic?

4.) Should the federal government tax the profits of monopoly products?

5.) Should the federal government take over the toy industry?

As for defining price gouging, I have had the following running bet with my students for more than a decade: 10 points (out of 100) if you can find a specific definition of price gouging in a economics textbook. To date, I haven't had to pay off.

Second, Sony isn't selling Playstation 3's on e-bay. If Sony had raised the price of a Playstation 3 to $3,000 off the shelf, perhaps there would be more reasons to be concerned about "fairness" and the government representatives might have a reason to fire up an investigation. Rather, Sony didn't set the price high enough to discourage the secondary market. However, it would be politically difficult for Sony to set the price at $3,000 - which is one reason they don't do that.

Moreover, the e-bay secondary market is a form of income redistribution, which those who are complaining typically favor. However, the Playstation 3 form or income redistribution is based on who can/wants to sit in line overnight rather than who has the sympathy of the government. Is the government's reaction to a secondary market for toys really the reaction of a redistribution monopolist facing competition (however minor)? That is interesting.

As for the toy companies, they likely know more about the potential demand for certain products than the government or the individual consumer. However, they cannot know - for sure - exactly which of any number of toys will be the big hit of the season. The toy manufacturers cannot afford to make a very large number of units for all toys - this would lead to the toy manufacturers having a large amount of wasted effort tied up in toys nobody wants. The causation does not run from manufacturer making millions of units of Toy X and Toy Y and consumers then responding by purchasing all of Toy X and Toy Y simply because millions of units were made. Rather, consumers reveal their preference for Toy X over Toy Y and only then does the toy manufacturer know where to dedicate its scarce resources. Unfortunately, this might happen in the very short period between Thanksgiving and Christmas, which might make it difficult for everyone to get a version of Toy X in time for present opening.

Finally, I missed the news cycle in which Hillary Clinton expressed her desire for the government to take over the toy industry. How bland and/or inoperable would toys be if the government designed them? Is our society so desperate for stuffed animals that we are susceptible to political slogans like "An Elmo under every tree"?

However, if she'll trade the toy industry for her desire to "take over" the health care industry, maybe we should listen.

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