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Wednesday, December 27, 2006

More anecdotal evidence that I am right

Those who know me know that I am an open-minded person for the most part. However, I fancy myself as a decent economist and once I have myself convinced of a certain line of reasoning, it can take some work to convince me that I am wrong.

As my father says: "I've only been wrong once, and that's when I thought I was wrong."

Okay, I'm not that bad, but I have been keeping an eye open for instances in which the seemingly no-brainer scalping opportunity seems to fizzle. The more anecdotal evidence I can find, the better I feel about my reasoning.

When it comes to scalping, most people think of Super Bowl tickets or tickets to a Rolling Stone concert as poster-child examples of how sclaping of tickets is wrong. However, these huge events are the exception not the rule, and therefore make for bad examples on which to hang policy changes.

Indeed, economists don't scratch our heads so much at people selling an asset, i.e., a ticket, for a profit. Rather, we scratch our heads about why the ticket price was set too low in the first place.

There is a nice literature investingating the reasons for why ticket prices to sporting and entertainment events are seemingly priced below the "market clearing price." After all, if the event promoter had chosen the "correct" price, there would be no opportunity for a secondary market to be created.

The various reasons for why secondary markets consistently exist include different risk tolerances on the part of event promoters and scalpers, different cost functions, different expectations, different information sets, and different opportunity costs. I like all of them and have no quibble with these explanations.

What has always bugged me about the scalping issue is the politicians and consumer activists who insist that if scalping is banned (by law) that the prices of tickets will decline and the availability of tickets will become more democratic. It sounds good on the surface, but these are exactly the type of statements that economists like to think about. Is it really true that if scalping were banned that window prices would fall.

I spent some time thinking about this problem and came up with an answer that, to economists, is not too surprising (although to others it might seem to be a cop-out): it depends. It depends on how many scalpers there are to what I call true fans and it depends on how likely it is for scalpers to sell their tickets in the secondary market. My theory suggests that if there are not enough ticket scalpers in the market, banning scalpers can actually increase the price of tickets at the window. My contribution to the literature was to allow for a very low residual value of the ticket to the scalper. In other words, if the ticket doesn't sell, the ticket isn't worth much to the scalper.

Because it is not guaranteed, in most cases, that the scalper will sell her ticket, this reduces the willingness to pay for a ticket. This, coupled with the low residual value of the ticket, puts downward pressure on prices when scalpers are allowed to mingle with "true fans" at the ticket window. As event promoters cannot distinguish between the true fan and the scalper, event promoters price tickets lower so that they sell more tickets than if they priced for only the "true fan." However, if scalpers are banned from the market, event promoters can raise prices and price only for the "true fan."

The result is that attendance to the event can go down or stay the same! Couple this with a possible increase in ticket prices and we find the potential that banning scalping might actually increase gate revenues! This might explain why event promoters are often at the vanguard of insisting that secondary markets are bad for consumers and they often explicitly support banning secondary markets. This is what I call the "qui bono" or "who profits" test.

The theory and an empirical application to professional football and baseball ticket prices is forthcoming in the January 2007 issue of Public Choice. Hopefully this will make a nice contribution to the literature and motivate additional empirical research in this area.

But, back to the original reason for this post. I came across this story that suggests the pre-Christmas release of Play Station 3, which was accompanied by a large number of speculators/scalpers buying the units with the anticipation of selling them for hundreds or thousands of dollars in profit on e-bay have found a thin market and are returning the units for a refund:
Eager entrepreneurs trying to make a fast buck on hot demand for the new Sony PlayStation 3 this holiday season have found themselves out of luck.
If individuals can return the units for a full refund, they are only out their time waiting in line for the unit and a bit of interest they could have earned if they had parked their money in a CD or some other investment vehicle.

Unlike tickets to a sporting event, the possibility of scalping a PS3 actually has very little downside. From the retailers' point of view, if they wanted to a) dissuade scalpers from grabbing the units themselves, and b) wanted to dissuade scalpers from returning the units, they could have posted a restocking fee for PS3s returned within five months (or something like that). This would have reduced the expected value of attempting to scalp a PS3 and would have therefore reduced the number of people trying to scalp and would have also reduced the number of people that would be trying to buy on the secondary market.

I like the fact that the scalpers find themselves with PS3s that they are willing to return - this suggests that the residual value of the marginal PS3 is relatively low for the average scalper.

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