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The Economics of McCormick
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I was saddened to hear about the death of long-time Clemson professor Bobby McCormick this week. Although he doesn’t always get as much attention as some of his contemporaries, McCormick had some great papers and insights that deserve attention. Thus, I thought it might be a fitting tribute to summarize the arguments from three of my favorite papers of his. Hopefully, readers will be inspired to go and seek out some of his work.
Where is the Deregulation?
Sometimes monopolies are created through regulation. It would seem to follow from this point that deregulation would offer great societal benefits since it would increase competition and eliminate the welfare costs of monopoly. Indeed, Gordon Tullock famously argued that the typical inefficiency arguments about monopoly actually underestimated the welfare cost of monopoly because the very prospect of regulation that would produce a monopoly would inspire rent-seeking. The monopoly profits would be dissipated by this rent-seeking and therefore must be included in the welfare cost of monopoly.
Tullock’s argument that the welfare cost of monopoly is larger than people think raises an important question. If the costs are so high, why isn’t there a greater demand for deregulation?
Several arguments have been made to explain why such costly policies persist. One argument is that voters and policymakers are ignorant of economics. A second argument is that of concentrated benefits and diffuse costs. The monopoly firm benefitting from regulation receives all the benefits whereas the costs are spread out among a large number of people. Since the cost to any particular individual is small, no one has an incentive to try to eliminate them.
McCormick and his coauthors, Bill Shughart and Bob Tollison, presented a third alternative. Their argument was as follows. The typical textbook argument is that the welfare cost of monopoly is caused by the fact that the monopoly produces too little output in comparison to a competitive market. Put differently, the monopoly maximizes profit at a price that is above its marginal cost. Therefore, there are potential gains from trade that could be had between the firm and consumers that go unrealized. The foregone gains from trade are a cost. Tullock’s argument is that the welfare cost is even higher due to rent-seeking.
What McCormick, Shughart, and Tollison argued is that if Tullock’s argument is correct, then rent-seeking is a sunk cost. As a result, the cost associated with rent-seeking is never able to be recouped. One shouldn’t expect that there would be much demand for deregulation since the cost-saving from deregulation would only be a fraction of the cost of the regulation itself. In fact, they show that under some circumstances the cost of a political program of deregulation might exceed the benefits of deregulation itself.
They summarize their argument as follows: “it is not that the potential gainers from deregulation are large in number, diffuse, heterogeneous, and face high organizational costs, rather, they do not exist to any degree.”
Crime on the Court
Recently, I discussed the economics of crime and punishment. A natural question to ask in this literature is whether more police means less crime. One might think that the answer to this question is simple. After all, couldn’t one of these causal inference people just look at the period before and after a change in the number of police officers and see whether arrests went up or down?
Well, it is not that simple. For a given level of crime, an increase in the number of policeman is likely to lead to more arrests. However, more arrests for a given amount of crime implies a greater probability that a criminal is caught. All else equal, a higher probability of being caught increases the expected cost of criminal activity and therefore decreases criminal activity. This means there are fewer potential crimes for which people could be arrested. Whether more police leads to more arrests depends on how the change in the supply of police affects detection and deterrence. It is possible that arrests go up. It is possible arrests go down.
There is also the issue of how the number of policeman affects false arrests. If more police mean more false arrests, this is a sign of lower quality policing rather than more crime detection. If more police mean fewer false arrests, then fewer arrests might actually be consistent with better quality policing for a given level of crime.
Most importantly, what all of this discussion demonstrates is that arrests are a poor proxy for what we really care about, which is crime and the quality of law enforcement.
In an attempt to disentangle these effects, McCormick and Tollison turned to college basketball. In 1978, the ACC basketball tournament added a third referee to the court. Prior to that, there were only two referees on the court at one time. The arrest rate can be measured as fouls per game. What they found is that this 50 percent increase in the number of referees (police) reduced the arrest rate (fouls per game) by 34 percent. More importantly, they also provided evidence for why this reduction in the arrest rate occurred. They found that having more referees increased the competency of the team of referees (fewer false arrests) and that it led to cleaner play (fewer incidents of crime).
The Third Law of Demand
Among a certain set of economists, the Alchian-Allen theorem is often referred to as the Third Law of Demand. A simple statement of this idea is as follows. If there are two types of the same good, say high-quality and low-quality, a fixed cost of transportation will tend to shift consumption toward the high-quality type at the product’s destination.
Alchian and Allen used grapes as an example. Suppose that grapes are grown in California. High-quality grapes sell for 50 cents per pound and low-quality grapes sell for 25 cents per pound. The cost of one pound of high-quality grapes in California is two pounds of low-quality grapes. To ship the grapes to New York, it costs 25 cents per pound regardless of the quality. This implies that the price of high-quality grapes in New York is 75 cents and the price of low-quality grapes is 50 cents. Thus, in New York, the cost of one pound of high-quality grapes is 1.5 pounds of low-quality grapes. In other words, the relative price of high-quality grapes in New York is lower than the relative price of high-quality grapes in California. We would therefore expect there to be a shift toward more consumption of high-quality grapes in New York in comparison to California.
This idea has been subject to much debate and a number of people have tried to test the theorem empirically. McCormick and his coauthors came up with a clever way to test the idea. Their clever idea is that the Alchian-Allen theorem should hold regardless of whether the goods were being transported to the consumer or if the consumer was being transported to the good. It follows that the theorem should apply to season tickets to Clemson football games.
McCormick and his coauthors noted that the Alchian-Allen theorem really generates two predictions since it must also be consistent with the First Law of Demand. In particular, what one should find is that people who live the farthest away from Clemson’s football stadium should buy fewer season tickets than people who live close, holding the quality of those tickets constant (the First Law of Demand: price goes up, quantity demanded goes down). At the same time, the travel costs are the same regardless of whether one buys the best tickets or the worst tickets. The relative price of the best tickets will be lower for those who live far away and we should expect people who live farther away to buy the better tickets. In short, the Alchian-Allen theorem states that “travel costs reduce quantity, holding quality constant, and increase quality, holding quantity constant.”
When they examined the data for the 1986 and 1987 Clemson football seasons, they confirmed these predictions. Controlling for the quality of season tickets purchased, the cost of travel reduced the quantity demanded of season tickets. Also, controlling for the number of tickets purchased, the cost of travel increased the quality of the tickets purchased. The Alchian-Allen theorem holds.
I chose these 3 papers of McCormick’s because I think they form a representative sample of how he used economics to think about the world. There are many things out there that seem like puzzles, but those who truly understand price theory see its applications everywhere and are able to come up with clever ways to test the theory. These papers are a testament to McCormick’s ability to apply price theory to the real world and find creative ways of testing the theory. Hopefully, readers will peruse some of his other work as well.
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