Wednesday, July 27, 2011

production of capital goods

The whole philosophy of macroeconomics since Keynes more or less invented it has been to aggregate variables like "consumption" and "investment" and ignore differences between different kinds of consumption, as well as structural details about what specific goods are used to produce what other specific goods. The approach has its uses, and macroeconomists have shed some useful light on the workings of the economy this way, but even on what one would think of as a macro basis it seems likely that some details will make differences in some circumstances. One of the big changes over the past generation or two that might be important is the changing nature of the production of capital goods.

Forty years ago, "capital" meant heavy machinery — factory equipment, earth movers, that sort of thing. People who produced capital goods were to a large extent machinists and factory workers. Today a lot of "capital" is software. Software is "nonrival", meaning that producing software for 1,000,000 customers is not largely more expensive than producing the same software for 10 customers; it is also the case that a lot of software production builds on previous versions of similar software. "Fixed investment" has been supporting the recovery to a greater extent than in previous recoveries, but in 2011 that means more software and fewer tools than it would have 30 years ago.

Institutional capital, which I'm largely leaving out, may also be more important now than it was 40 years ago; more of the labor force consists of people for whom an important part of their value to their current employer is detailed knowledge of coworkers, workplace culture, and procedures than I think was the case forty years ago. This is especially true in the production of modern forms of capital as compared to production of older forms of capital; engineers and computer programmers working on projects too big for any one of them to complete alone are harder to replace with other experienced employees with the same generic training than is the case for machinists. (This is not an absolute truth, but is broadly the case; certainly any sizable company will benefit from employees who know the idiosyncrasies of that company, or even of its particular workplaces. I believe it to be more true, in general, of engineering kinds of work than of machining or factory work.) Related human capital is also likely to be more important for more modern forms of capital than for older forms.

Confident answers are not in the purview of this blog, but it seems reasonably likely to me that this contains a partial explanation for the slow recovery of employment after recessions that has been increasingly witnessed over the past 25 years. When demand shows its first signs of renewal firms may turn first toward replacing their capital, whose prices are more likely to drop than are wages; the producers of capital themselves need not hire a lot of new workers nor raise the prices of their products a great deal until demand is quite substantial, and (especially in times of uncertainty) may be slow to increase employment too quickly because of the investment this would require in institutional capital as well.

Friday, July 15, 2011

price changes

I'm interested in markets, and one of the complicated things about markets is that they involve people. Netflix has gotten itself some flack recently for revamping its price structure, breaking apart (as I understand it) for sale separately (and without a joint discount) two services that were previously bundled, such that the total price of the original package, for those wishing to replicate it, has gone from $10 per month to $16 per month. One of the comments I saw was "this is too big a price change to implement all at once"; if we take this complaint at face value, it might have created less of a stir if they had offered a $3.50 discount on the bundle for a period of time. This is similar to something I heard at the annual meeting of my cooperative apartment; we're being hit with some big expenses in a year or two, so the board decided to increase our monthly maintenance payments this past year so that the increase next year won't be one big jump.

I'm curious as to what kinds of price changes strike people as "unfair" and what kinds don't. Stock prices change quite frequently, but the buyers and sellers are very dispersed and anonymous; I think people have less of an emotional "fairness" response to stock price moves than to other kinds. Gold, at least as traded on financial markets, is similar; so, though, is oil. Most people purchase their oil distillates, though, from recognizable brands, and even though they're usually mercenary about it themselves — most people, choosing between Exxon and BP, will go with whichever is cheaper on the given day — seem to object to higher prices than they're used to. This is likely also a function of the fact that people build their habits around consuming oil distillates at a constant rate, and don't like responding to prices; demand elasticity of gasoline, especially in the short run, is very low (which is precisely why the price is sometimes so volatile).

If the shop on the corner raises its prices, my understanding is that people tend to regard this more favorably if the retailer's costs have recently gone up than if it's simply an attempt to ration rising demand in the face of potential shortages. (It's worth noting in this context, though, that part of Netflix's decision seems to have been related to costs.)

And, as suggested at the beginning, it may be that increases of a certain size produce a certain amount of sympathy, especially in the face of rising costs, but that there are certain breakpoints where the customer would respond less viscerally if the change were phased in. What interests me in particular here is to what extent it's an abrupt change in expectations rather than an abrupt change in prices that creates the angst. If Netflix had announced this change 18 months ago, would it have produced as much complaint then as it is now, or as much complaint now as it is, or would it have spread it out or even reduced it? If the old rates had been (credibly) portrayed, as soon as the bundled items were being sold together, as a special, trial offer, would the new price structure have been more readily accepted? (If you give away an item for free for two months, any increase in price will exceed 60%, but would presumably be more accepted; there would be an expectation that this was a limited-time offer.) I note in this context that O'Hare airport some years back raised its parking rates by announcing, at the beginning of the holiday season, that it was offering "special holiday rates" that equalled the rates in October; they actually raised the rates at the beginning of January by allowing the "special rates" to expire.

Another anecdote: about ten years ago, I was a regular in a sandwich shop, and recognized as such; they increased the price of a sandwich by 10 cents at one point, but comped me a free sandwich when they made the change. I imagine them imagining me thinking, "They're nice people and they like me, so I understand that they have to raise their prices once in a while."

I'm not offering grand theories, but my speculative observations are that upset increases when
  • demand for the good is inelastic
  • price increases result from cost increases, rather than shortages
  • price increases are "big"
  • price increases are unexpected
  • markets are less anonymous.

Wednesday, July 6, 2011

informational complementarities of production

I've had recent occasion to discover that there are certain brands of baby-good manufacturers that produce a number of different items for babies — my wife could tell you the names of some of the brands. These different items often seem to have relatively little in common other than being small consumer-grade manufactured items; it's not clear where a single company would have a production efficiency in producing this set of goods and why e.g. Black and Decker couldn't just as logically produce a stroller. (Perhaps there's some valuable cross-product knowledge about the range of shapes and sizes of babies bodies.) What seems, based only on anecdotal evidence and my own speculation, to drive this more is the reputational complementarity; it would, in fact, not surprise me to learn that the items are produced by third parties and rebranded. A new mother who studies up on products and develops a sense that a brand of one product is good can transfer that impression to other products under the same brand name.