Sunday, August 19, 2007

Butt Cam Differentiates Retail Service

A defining characteristic of Monopolistic Competition is product differentiation. However, since 80% of the US economy is service, we really should call it service differentiation.

Retailers work hard at differentiating their service. They do this to keep a step ahead of the competition and lure additional customers into their stores. One clothing retailer in Scottsdale has taken a unique approach.

Stationed outside the dressing rooms at Hub Clothing at Scottsdale Fashion Square, a video camera points toward the customer's posterior and displays the rear view on a flat-screen TV.

At Hub, where most jeans fall between $135 and $250 but go as high as $900, the Butt Cam underscores that the test of a great pair is how they look from behind.

Apparently the store owner thinks this is great innovation in retailing.

Hub co-owner Tom Simon created the Butt Cam after watching customers twist in front of mirrors. He applied for a patent after research showed no others like it.

This whole topic is just begging for puns, however, as an instructor, I'll leave those as an "exercise for the reader."


Canceling the Marginal Section

Enrollments are down at the Maricopa Community Colleges and as a result, a number of sections have been cancelled. So how does a college determine how many sections to cancel?

The way economists answer that question is to do some marginal cost analysis. Since decisions are made at the margin, it is the best way to predict behavior.

To make a rational choice you compare marginal cost to marginal benefit. If the marginal benefit is greater than the marginal cost, you are better engaging in the activity so you do it. If the marginal cost is greater than the marginal benefit, you would be worse off, so you don't. So let's look at the marginal cost and marginal benefit of offering one more (or one less) section.

The marginal section is taught by adjunct faculty. At Mesa Community College there are about 900 adjuncts and just over 300 residential faculty. About 60% of sections are taught by adjuncts. The salary for an adjunct is $766 per load hour. A load hour and a credit hour are the same for most classes, labs being the exception. For a 3 credit hour course like ECN 212, Principles of Microeconomics, the adjunct salary is $2,298. In addition, there are some incremental overhead costs - payroll taxes, classroom HVAC, copies, secretarial support, IT support... Those things add up so lets call the incremental cost of a section $3,000 to $3,500.

The marginal benefit to the college of an additional section is the additional revenue it generates. That comes from three sources, tuition, district funding, and state funding. Tuition is $65 per credit hour, or $195 for a 3 hour class. Using tuition only, a class needs 12 students to cover adjunct faculty salary (12 x $195 = $2,340). It needs 15 students to cover salary plus $700 in incremental overhead (15 x $195 = $2,925).

Now you’ll argue that I’ve left out the incremental funding from the district, which is true. But is there really any incremental funding available? Most of the district’s revenue comes from property taxes. Those are independent of enrollment. It is what it is. If one college gets more by having more sections with smaller class sizes, then another college gets less. They will react by doing exactly what the other college did. Since the total size of the pie doesn’t get bigger (just because enrollment did) district funding per student has to fall. Hence, in the long run, there is no incremental funding per student available from the district. (This is called a zero sum game.)

Now you can make exactly the same argument about the state subsidy. You just have to do it at the district level rather than the college level. (This is left as an exercise for the reader.)

So how does a college determine which sections to cancel? Based on the marginal cost analysis, the college is making a rational choice when it cancels sections with less than 15 students.

(Please note that I am not privy to any business deliberations made by any of the colleges. I do not know their specific costs beyond the publicly available information. I do not know if the colleges are actually using marginal analysis to make their decisions. However, as an economist, I do know that marginal analysis accurately predicts behavior.)

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Monday, August 13, 2007

Cigarette demand and Taxes

Two of the propositions on the ballot last fall raised cigarette taxes. The state tax went from $1.18 per pack to $2. This was passed along to consumers and they responded as predicted (by economists) with a reduction in the quantity of cigarettes demanded.

State officials say it's too early to tell whether the recent state tax hike and the new statewide smoking ban have curbed per capita smoking rates in Arizona. But tax officials say sales were down 23 percent in May and 15 percent in June from a year earlier. And a Web-based survey by the University of Arizona and Northern Arizona University found that 84 percent of smokers considered quitting after the tax hike and 28 percent quit for a day or more.

Another interesting, but entirely predictable impact was the significant increase in cigarette tax stamp sales prior to the new tax rate going into effect. The graph isn't availble in the on-line edition of the paper, but it shows a huge increase in October, November and December, with a corresponding decrease in the first quarter of this year. This is a classic example of an expected price increase (tax increase) triggering an increase in demand.

The price elasticity of demand is also interesting. The demand for cigarettes has long been thought to be inelastic. However, if you raise the price high enough, eventually you get into the elastic region of the demand curve. The 82 cent increase represents about a 20% increase in the price of a pack of cigarettes. If volumes stay down by a similar amount, we're getting to the point on the demand curve where we transition from an inelastic demand to an elastic demand.

That means further tax increases would likely result in revenue decreases. There are hints of other problems.

Industry groups predict increased black-market sales and thefts. They also warn that tax increases can backfire. If smoking declines, programs that depend on tax revenue could lose money.

As I like to point out, just because something is illegal doesn't mean there still isn't a market for it. It just raises the opportunity cost.