Market Power

Musings by an academic economist on the power of markets and the power over markets.

Friday, October 29, 2004

More Stuff on Faculty Politics

This quick blurb presents a deflating commentary on political discourse within some universities.


Pharmaceutical R&D

Monday used to be Share Day in my 4-year old's room at day care. Each child could bring a toy to share with his/her friends. Inevitably, some toys would get misplaced or broken. One parent complained about this and, consequently, Share Day is no more.

This is similar to the situation with the pain medicine Vioxx. Researchers were examining the effectiveness of Vioxx in preventing the recurrence of colorectal polyps. Compared to patients taking a placebo, patients taking Vioxx had a higher incidence of heart attack, stroke, and other cardiovascular nasties. You can find more information on this here. As a result, Merck pulled Vioxx worldwide.

This paper by Henry Grabowski at Duke provides some interesting numbers on pharmaceutical R&D. Here are a few that jumped out when I read the paper. Pharmaceutical patents in the US last for 20 years these days, but pharmaceutical companies apply for the patents well before the drug hits the market. In the US, patents can be restored for a few years. As a result, drugs that make it to the marketplace have an average of 12 years of patent life left. Grabowski refers to this as the "effective patent life." It is during this time that the company can use its market power to recoup its R&D investment and opportunity cost of this cash. Here is a quantification of this investment:

"We"Joe DiMasi, Ron Hansen, and Henry Grabowski - link here" found that the representative product" in the late 1990's " incurred out of pocket costs of over $400 million."

This does not include the opportunity cost of investing that money. Assuming a real interest rate of 11%, they estimate that the total cost of bringing a drug to market is over $800 million.

But the vast majority of compounds never make it to market:

"Typically, fewer than 1% of the compounds examined in the pre-clinical trials make it into human testing. Only 20% of the compounds entering clinical trials survive the development process and gain FDA approval."

Substitutes are another matter. Once the patent expires, competitors can develop substitutes - generics. Grabowski estimates that it only takes "a few years and costs one to two million dollars" to bring a generic to market. He also mentions that the probability of success in this case is high.

So, 0.2% of all the newly-developed compounds make it to market. The out of pocket and opportunity costs of these compounds is around $800 million, on average. The company then has 12 years of effective patent life (plus a little more time while the substitutes are being developed and approved) left in which to recoup these costs and to recoup a portion of the costs of developing the ultimately failed compounds.


This does not account for the risk that a new drug on the market will be found to have some nasty side effect that will cause the company to (voluntarily or involuntarily) pull the product from the market. Accounting for this risk would lower the time during which a company could recoup its costs before generics begin chipping away at its market power.

This also does not account for other patented drugs that compete with the drug in question. For example, Vioxx was a competitor to Celebrex. This limits the ability of a pharmaceutical company to recoup its costs.

I understand why Merck pulled Vioxx off the shelf. Call me an idealist, but it's too bad that patients no longer have a choice of whether to use Vioxx. I imagine that some would have been willing to continue using Vioxx and willingly take the risks.

Like Share Day, this won’t be able to happen.

Kudos to the folks at Marginal Revolution for the link to the Grabowski paper.


My Favorite IPA

I am a beer snob. I call myself a homebrewer although I haven't brewed since helping two friends brew a stout over two years ago.

The India Pale Ale style of beer was originally brewed in colonial England for British troops in India. Someone figured out that by upping the alcohol content and upping the use of hops, the beer would be preserved during the trip.

My favorite beer, not just my favorite IPA, is an India Pale Ale made by Avery Brewery in Boulder, Co. It is light and very refreshing, and it has an excellent hoppy aftertaste, as any IPA should. Unfortunately, I can't get it in the Mankato area.

If you can get it and you like IPA's, I think you'll like this beer.


Thursday, October 28, 2004

What's Missing?

Baseball... Football... Basketball

What's missing from this list? Tony Kornheiser has the answer in this column.

If you have a couple of seconds, there's an unscientific poll midway down TK's column. How do the overall results strike you?


Wednesday, October 27, 2004

Pharmaceutical Price Controls

Kenneth Todd summarizes some of his research on the effect of pharmaceutical price controls in the Fall 2004 issue of Regulation. It's the second story in this link. Todd and his coauthors of a forthcoming Journal of Law and Economics paper estimate that each 10% reduction in drug prices will lead to a 5.83% decrease in research expenditures on pharmaceuticals. Furthermore, Todd calculates the number of life-years lost in various price control scenarios. For example, a 10% reduction on drug prices through price ceilings would lead to 40.1 million lost life years - 40.1 million fewer years lived by US inhabitants. A 50% reduction leads to an estimated 178.8 million life years lost.

Closer to home, I have high cholesterol and have recently been diagnosed with high blood pressure. My father died of a heart attack when he was 44 and my grandfather (dad's dad) died of a heart attack while in his 50's. Grandpa was overweight but dad was small. Both were heavy smokers. I do not smoke but family history and these conditions make me a walking time bomb.

My doctor has me on Lipitor for my cholesterol and he has prescribed Benicar for my blood pressure. If there were heavy price controls on drug prices back in the 60's - 80's, would any of these drugs have been around? How many substitutes would there have been? What would have been my choices?

Today's price controls on pharmaceuticals will also affect my two sons as they get older. What is moral about giving today's people lower drug prices since my sons will have to pay the price in the future?


Another Thought on Sports Teams and their Facilities

Dennis Coates and Brad Humphreys have written a paper on the purported economic benefits of a new MLB team in D.C. Their argument is not surprising - it won't do anything to the local economy and may end up harming it slightly.

The last paragraph of the paper starts thusly:

"A baseball team in D.C. might produce intangible benefits. Residents might have an enhanced sense of community pride and another opportunity to engage in shared experience of civic expression."

Coates and Humphreys emphatically state that this is no reason for public subsidization.

Such external benefits are sometimes held up as reasons for small subsidies for teams and stadiums. But what if the team is horrible? Is there a lot of civic pride around the Tampa Bay area for the Devil Rays? The Arizona Cardinals are playing competitive football this year, but they are still 2 and 4. Baylor University is a fine university, but the Bear football program is a perennial doormat in the Big 12 and it is the only team in the Big 12 south division to *NOT* beat a Big 12 North foe this year. In contrast, the other 5 Big 12 South division teams have yet to lose a game against a North division team. Is there a lot of civic pride for the football Bears?

Of course, some fans may take masochistic pride in their team's second-class standings. Goats anyone?

Thanks to Skip Sauer's blog for the heads up.


Stadiums and Local Economies

It's almost amazing how well independent economists agree on the economic impact of teams and stadiums/arenas - they don't do much, if anything, to improve employment and wages and may even slightly harm an economy. This flies in the face of what public proponents of public funding for stadiums trumpet.

The explanation given by economists on why there is no net impact is fairly straightforward. Most spending on sports comes from people in the local economy - it's redistributed spending, not new spending. A similar thing happens with big sporting events like Super Bowls and Final Fours. These events draw lots of people to the host economy, but it also scares away other people who otherwise would have come. There's no net impact.

This does not mean teams should not exist. It's an argument against public funding for teams and the places they play in.

Craig Depken at Heavy Lifting has a series of excellent posts on the situation in Arlington regarding the Cowboys desire for public money to build a new stadium there. His posts will appear at the top of his blog until November 2nd.

For the record, Red McCombs, owner of the Minnesota Vikings, has given up lobbying for a new stadium - at least for the time being.

Hmmmm. LA still doesn't have an NFL team although it supported 2 teams for several years. This is the second largest market in the US. The NFL dictates what teams can play where. Can you say "credible threat"? Can you say "Market Power"? Can you say "Minneapolis Lakers"?


Tuesday, October 26, 2004

I Hate These Things

Mankato - North Mankato: A Little Twin Cities, a Lot Minnesota...

A lot of freakin' asian lady beetles!

It's fall here in the northlands which means two things - harvesting and infestation! During the summer months when the tall corn is growing around my area, the little beetles have a place to live. But when the combines come out before Halloween to slit the corns' stalks, the summer home of the beetles are destroyed and they find alternate housing.

So they come to my house! I can't sit and eat a meal or play with my kids without being buzz-bombed by what seems like dozens of these bugs. Since I've started writing this piece, I've had one fly onto my monitor and one has decided to hang out under one of my speakers. I counted 8 of them hanging out on my ceiling in my sitting room last night.

There's even one that's been hanging on the wall by my office door for the past week or so. I haven't squished his buggy-butt yet cuz he hasn't bothered me much.

According to this article, the USDA started releasing them. Thanks a pantload, Chet!

In any case, I wish they'd go away.


Revenue sharing in sports part deux

I described in an earlier post how the NFL and MLB share locally-generated revenues. Teams share a constant proportion of their local revenues. In MLB, teams share 34% of their "net local revenues" - gross revenues minus actual stadium expenses. The shared revenue goes into a central pool which is then divided equally among clubs.

Suppose we have a two team league and team 1 generates $200 million of net revenue and team 2 generates $100 million of net revenue. Under this plan, team 1 shares $68 million while team 2 shares $34 million. The $102 is divided equally between the two teams giving each team $51 million. The net effect is a transfer of $17 million from team 1 to team 2.

As I mentioned in the arlier post, there is a fear that this shared revenue will just be pocketed by the teams and not spent on players. Not only will this lower overall player payrolls, it may not alter competitive balance. So there is a stipulation in the MLB Collective Bargaining Agreement stating that receiving clubs should spend their receipts on players. If not, they will have to answer to the commissioner.

What's he gonna do? Spank them? Take away their Tonka trucks (an action that really annoys my 4 and 2 year-old sons)?

In any case, asuming the threat is credible, the commissioner's office takes on the responsibility of monitoring team spending on players. I'm betting that the commissioner's office has better things to do with their resources.

I've wondered about ways to restructure revenue sharing systems to reward net revenue receiving teams with a little extra if their teams "perform better", however we want to define it. This would impose an opportunity cost on these teams if they choose to pocket the cash. This could provide an incentive to these teams to spend shared revenues on acquiring more talent.

This, of course, doesn't tell us whether competitive balance is socially desirable.


Bank on it - Lower Fees and More Choice

I found the following blurb in the October 9th issue of The Economist. It's from the "The World This Week" section on page 9.

Credit where it is due

"As if American consumers needed greater access to credit-card debt, the Supreme Court upheld a ruling that Visa and MasterCard violated antitrust rules by banning banks that issue their cards from also offering rival cards. American Express, in partnership with MBNA, immediately annonced plans to launch competing cards."

So the Visa and MasterCard rules allowed them to earn economic profits which are now going to be eaten away by competitors, just as we'd expect when barriers to entry are knocked down.

I was perplexed by the first part of the first sentence... it seems the writer of this piece thinks this may not be a good thing. But it is a good thing. I expect that there will be lower fees paid by banks to credit card companies. This should then be passed on to the customer in terms of lower fees. It also gives consumers a wider variety of choices when it comes to plastic - not from the issuing banks but by the credit card companies themselves.

Question: Why did banks allowed Visa and MasterCard to limit their ability to offer the rival cards in the first place?


Homogeneity Everywhere

In this article , Ruth Wisse mentions that "all groups tend to a measure of homogeneity." Yup. I played in a heavy metal band in 1984 and 1985 in Sioux City (yes, Sioux City), Iowa. Near the end of our run one of our drummers (we had two guys who switched between drums and vocals) befriended one of the local punk rockers. One of the punk's things to do then was to make fun of the so-called preppies, the kids who wore the alligator shirts with the collars up (which is back in style and looks as silly now as it did back then). He derided them for spending time and money trying to make themselves look good.

But the punks spent just as much money on clothes - possibly more since they were dressed in leather coats - and spent just as much time trying to make themselves look bad as the preppies spent trying to make themselves look good.

Me? I'm a t-shirt and jeans kinda guy.


Conformity in American Universities

There was this interesting article in today's online version of the Wall Street Journal about the political leanings of academics. The author, Ruth Wisse, a professor at Harvard Univeristy, writes about her reaction to donation figures made to Bush and Kerry last spring. Not surprisingly, Kerry's campaign fared much better:

The reporter's "inquiry was prompted by the disparity he'd discovered in donations by Harvard faculty of about $150,000 for Kerry to about $8,000 for Bush."

That's an 18.75 to 1 ratio with 94.9% of contributions at that time going to the Kerry campaign.

The author's comments about the pressure for graduate students and non-tenured faculty to at least appear to conform is particularly disheartening:

"A junior professor told me that when she began teaching at Harvard she resigned from several organizations that would have betrayed her conservative leanings. She hadn't wanted to give colleagues an easy excuse for voting her down when she came up for tenure; but now that the prospect of tenure was before her, she didn't know whether she wanted to stay on in such a repressive community. "

This wouldn't be so concerning if there were some balance of political leanings between universities even if there isn't much balance within each university. That way bright young minds, be they students or faculty, that don't conform at one institution can more easily find a better match with another institution. They can then become part of the conversation that universities are supposed to foster.

But I have a strong hunch that faculty at colleges and universities throughout the US lean far to the left. This tilts the overall academic discourse in that direction as well.


Monday, October 25, 2004

Revenue Sharing in Sports

Revenue sharing is used in sports as a way to improve competitive balance. It is felt that teams with larger revenue streams are able to afford more talent over the long run. According to the sports economics literature, if teams maximize their own respective profits, then more talent will drift to the teams for which talent generates the highest revenue at the margin - the high revenue teams. Revenue sharing, it is generally felt, would lower the marginal value of talent and therefore keep talent from going to the high revenue teams.

In the NFL and MLB, each team shares the same proportion of its ticket revenues regardless of how much revenue each team generates. In the NFL, 40 cents of each dollar brought in through ticket sales goes to revenue sharing while in MLB, 34 cents of each dollar brought in through ticket sales goes to revenue sharing. Ignore how this money is divied up among teams and focus on what the systems do to the marginal value of talent.

With this type of revenue sharing, the value of talent at the margin decreases for every team by the same proportion. It is argued that profit maximizing teams will not alter the amount of talent that they will try to acquire - but that talent will bring less in pay for the players. In other words, relative talent is unchanged leaving no change in competitive balance.

There are two things of interest here: 1. why does each team share the same proportion? 2. where is the incentive for revenue-receiving teams to spend some of their shared revenue?

MLB has recognized that there may be a need for an incentive to entice receiving teams to spend some of their shared revenues. The most recent collective bargaining agreement signed by baseball players and owners states that "each club shall use its revenue-sharing receipts... in an effort to improve its performance on the field." "... the Commissioner", Bud Selig, " may impose penalties on any club that violates this obligation." These quotes are from page 106 of the 2003-2006 Major League Baseball Collective Bargaining Agreement.

Might there be a better way?


Sunday, October 24, 2004

Drugs and Professional Sports

One doesn't often hear about illicit drug use in professional sports these days. Leagues have rules against illicit drug use and there are other economic pressures felt by athletes to stay away from marijuana, cocaine, and such.

Before the beginning of the current NFL season, Onterrio Smith was set to become an important part of the Minnesota Vikings offense. The second-year man out of Oregon ran for 579 yards on 107 carries in his rookie season and looked to improve on that output in 2004.

But Smith failed a drug test before the 2004 season when he tested positive for marijuana. He was suspended 4 games and will lose approximately $70,000 in forfeited pay. But the long-term cost could be much higher. In Smith's absence, rookie back Mewelde Moore has emerged as a solid bperformer, rushing for 92 yards against Houston and 109 yards against New Orleans. Mr. Smith may find it difficult to find much time to play for the Vikings if Moore stays productive and healthy. Moreover, given his past problems, other teams may shy away from signing him in the future.

Performance-enhancing drug use is another thing. Since athletic success depends on the absolute performance of the athlete as well as his/her performance relative to others in the league, there will be pressures to enhance individual performance, including enhancement through steroid use. In part because of the positional externalities associated with these drugs, leagues have rules aginst the use of these drugs as well. If caught, the player faces fines and suspensions.

This poses an interesting question - are the implicit penalties different for illicit drug use vs. performance-enhancing drug use? Consider two players who play the same position on a team. Assume player 1 uses steroids but not cocaine. Player 2 uses cocaine but not steroids. The league rules are the same for the two drugs (i.e. they face the same chances of being caught and the same penalties if caught).

Player 1's use of steroids could improve his performance while player 2's use of cocaine would not help and could hurt his performance. All else equal, we'd expect that player 1 would be able to command more playing time than 2 and would be compensated at a higher rate. In this regard, there is a difference between the implicit penalties. Since illicit drugs don't enhance performance, the implicit penalties are higher for the use of these drugs and we would expect fewer instances of their use.

Indeed, one could argue that the same competitive pressures that lead some athletes to use steroids can steer athletes away from illicit drug use.


Comparative Advantage or Production Possbilities

It has been several years since I taught the production possibilities frontier (PPF) in my Principles of Economics classes. In its place, I teach the concept of comparative advantage.

When teaching the PPF, the professor can show students how choices between goods are choices between how productive inputs are used. It is also used to develop the idea of opportunity cost - producing additional units of one good necessitates taking resources from another good. Society, therefore, loses some of that other good. It can also be used to talk about the concept of increasing opportunity costs. While these are important topics, I have found I can make most of the same arguments by teaching Ricardo's concept of comparative individuals trade with one another.

In a simple two-person two-good economy, a person has a comparative advantage in the production of a good if he/she has to sacrifice the least to obtain it (i.e. has the lowest opportunity cost). For example although I can brew beer fairly well, Schell's Brewery in New Ulm, Mn. can produce it at lower cost (it costs me about $40-$50 to purchase the materials to brew 44 12-ounce bottles of Octoberfest plus several hours of cooking, cleaning, and bottling plus several weeks of waiting). On the other hand, I can go to the local liquor store and get 2 cases for $56 + 9% sales tax and have a beer with dinner that night.

In short, Schell's has a comparative advantage in beer production. They should since they have economies of scale!

Alternatively, Schell's could train their employees about economics and other general business education courses. But this means taking resources out of beer production and putting them into teaching. Instead, Schell's hires people educated outside the factory and focuses on beer production. This provides income for teachers (like me) who then go out and buy beer from someone, like Schell's, who have lower costs of beer production. This enables teachers to acquire more stuff with their given resources. This gives them a higher standard of living.

Basicaly, according to the principle of comparative advantage, we trade with others because they do some things at a lower cost than we do and trading improves our standard of living. That's the mainstream view in economics and those are the main points I try to make when teaching comparative advantage.

I realize that Schell's decision not to teach general business education classes to their employees is more involved than in my simple case. We don't live in a two-person two-good economy. Additionally, since general business education courses are just that - generally applicable - the students could take what they learn in those classes and put it to use in other businesses - the skills are easily transferable and may even be harmful to Schell's.

The sorts of things learned from studying the PPF that I don't get to while teaching comparative advantage, namely increasing opportunity costs, are things that I find I can teach elsewhere in Macro and Micro. For example, I can talk about diminishing returns and increasing marginal costs in macro when discussing a country's production function. Moreove, since international trade is often such a hot topic (outsourcing anyone?), I find I can expose students to the mainstream economics position of the benefits of international trade.

That's why I don't teach the PPF anymore.


My wife turns 36 today.

Today is my wife Shirley's 36th birthday. The former Shirley Janel Goetsch was born on October 24th, 1968 to William and Darlene Goetsch of rural Cresco, Iowa. The valedictorian of her high school class, she graduated in 1987 from Crestwood High School in Cresco, Iowa and studied pre-pharmacy at Morningside College in Sioux City, Iowa from 1987 - 1989. She transferred to Creighton University and earned a Doctorate of Pharmacy - Magna Cum Laude - in 1993.

We met at Morningside in 1987, began dating in early 1988, and got married in May of 1989. We've been married for 15.5 years and have two big boys, Alex (4) and Jared (2).

One of our former professors at Morningside, Jan Hodge, used to refer to her as my "better three-quarters." The older I get, the more I realize he was right. I do not deserve her and she does not deserve me. Both of those are meant as compliments to her.

Happy birthday, Shirley.