ECONOMIC PERSPECTIVES ON PLANNED OBSOLESCENCE BY Michael Waldman Johnson Graduate School of Manageme

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ECONOMIC PERSPECTIVES ON PLANNED
OBSOLESCENCEBYMichael WaldmanJohnson
Graduate School of ManagementCornell
UniversityPresentation Prepared forThe
Throwaway Society Origins, Causes, and
Consequencesat Sheffield University
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INTRODUCTION

• Planned Obsolescence is a term started outside of
  the economics literature.
• But clearly the term and associated behaviors
  refer to economic activities.
• Not surprisingly, as the term gained in
  popularity more broadly, economists started to
  pay attention and focus on two related questions.
• Are there settings in which economic theory would
  predict that firms and consumers would behave in
  a fashion consistent with planned obsolescence?
• If the answer is yes, what are the possible
  factors driving the behavior?

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• The first set of classic analyses of this and
  related issues in the 1970s, due to Peter Swan,
  found that planned obsolescence should never
  arise.
• Durability choice is socially optimal.
• No incentive to eliminate secondhand markets
  (such as introducing a new textbook edition to
  kill off the old edition).
• But more recent analyses in the 1980s and later,
  due to Bulow, myself, Hendel, Lizzeri, etc., show
  that there are important settings where planned
  obsolescence or related behaviors arise.
• Time Inconsistency can cause durability choice
  to be inefficiently low.
• Time Inconsistency can cause he rate of new
  product introductions that make old units
  obsolete to be inefficiently high.
• Substitutability between new and used units can
  cause durability choice to be inefficiently low
  and can cause incentive to kill off secondhand
  markets.

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PLAN OF PRESENTATION

• Swans arguments
• Time inconsistency and applications
• Loss of market power
• Durability choice
• New product introductions
• New/Used unit substitutability and applications
• Used price constrains the new price
• Durability choice
• Killing off secondhand markets
• Style changes
• Theoretical overview
• Classic perspectives
• Future research
• Public policy recommendations
• Conclusion

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SWANS ARGUMENTS

• Argument 1 Consider the steady state behavior
  of a monopoly seller of a durable good where
  flow utility is a function of service units
  consumed and service units can be combined across
  different physical units.
• Profit maximization requires the monopolist to
  choose the socially optimal durability level.
• Think of light bulb example.
• Argument 2 With forward looking consumers the
  price of a new durable unit should reflect
  expected prices at which the unit will sell for
  in future periods.
• No reason to inefficiently kill off secondhand
  markets.
• Rate of product introductions will be socially
  optimal.
• No inefficient style changes.

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TIME INCONSISTENCY AND APPLICATIONS

• Basic Argument Swans focus on steady-state
  behavior turns out to be important. If we relax
  this and assume the durable-goods producer sells
  and cannot commit, then time inconsistency
  problem arises.
• Firm has an incentive to move down demand curve
  over time which means lower prices in future
  periods.
• If consumers are forward looking and anticipate
  this, then they are willing to pay less early on.
• Primary Result The reduction in willingness to
  pay in early periods reduces market power/prices
  in early periods and overall firm profitability.

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• Application 1 Durability Choice
• The basic time inconsistency problem reducing
  firm profitability arises from the durability of
  the firms product.
• An increase in durability aggravates the problem
  and reduces the firms market power.
• So in choosing the durability that maximizes its
  own profit it chooses a durability that is below
  the socially optimal level.
• Application 2 New Product Introductions
• A generalized version of the time inconsistency
  problem is that the firm does not have the
  correct incentives concerning later behaviors.
• One such behavior is new product introductions
  that make used units obsolete.
• So in choosing the rate of new product
  introductions that maximizes later profits it
  chooses a rate above the one that maximizes
  overall profitability.
• And possibly above the rate that maximizes social
  welfare.

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NEW/USED UNIT SUBSTITUTABILITY AND APPLICATIONS

• Basic Argument Swans assumption that service
  units from new and used units are perfect
  substitutes and can be aggregated turns out to be
  important. If we relax this (and assume
  commitment to abstract awy from previous issues),
  then seller incentives change in important ways.
• Primary Result Used unit prices or values
  constrain the new-unit price.
• If there is a secondhand market, the new-unit
  price cannot exceed the used-unit price by so
  much that a new-unit buyer prefers to switch.
• If there is not a secondhand market, then
  consumers who own used units are only willing to
  pay the incremental value of a used unit.
• And this can also lower new-unit prices.

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• Application 1 Durability Choice
• Consider a case where durability choice is the
  choice of the speed with which product quality
  falls over time.
• Then the firm will choose durability below the
  socially optimal level because this allows the
  firm to increase the new-unit price.
• Application 2 Killing Off Secondhand Markets
• By making used units unavailable for consumption
  or eliminating the ability to trade used units,
  the firm loosens the new/used unit price
  constraint.
• This, in turn, allows the firm to increase the
  new-unit price.
• Textbooks is a classic example.
• Application 3 Style Changes
• Style changes are a way to directly reduce
  substitutability between new and used units.
• This again loosens the new/used unit price
  constraint and allows the firm to increase the
  new-unit price.

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THEORETICAL OVERVIEW

• The modern literature on durable goods provides
  two theoretical mechanisms that can lead to
  planned obsolescence type results.
• Time Inconsistency
• New/Used Unit Substitutability
• But I think the latter is more important.
• Firms have an incentive to avoid the former since
  it reduces the firms overall profitability.
• Further, the literature identifies various
  feasible ways firms can achieve this such as
  leasing/renting and long-term contracts.
• In other words, if the focus is on why durable
  goods have short lifetimes, the new/used unit
  substitutability argument is likely more
  important.

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CLASSIC PERSPECTIVES

• The previous slides focused on various ways that
  modern durable goods theory can explain overly
  short lifetimes of products.
• But there are other more classic perspectives
  that can also explain the phenomenon.
• Classic perspectives.
• Production is associated with negative
  externalities and, since consumers and firms are
  not taxed to reflect these externalities,
  production is too high and product lifetimes too
  short.
• Disposal is priced below cost which leads to
  product lifetimes that are too short.
• Disposal is priced at its direct monetary cost
  but do not reflect negative externalities
  associated with disposal. This again leads to
  product lifetimes that are too short.

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FUTURE RESEARCH

• Empirical Evidence
• The durable goods theories discussed are
  relatively new and except for the textbook market
  there has not been a lot of empirical
  investigation.
• My interpretation of the evidence from the
  textbook market is that it supports the new
  theories, but not all the authors agree with this
  interpretation.
• So it is important to investigate/measure how
  large the effects discussed in these theoretical
  papers are in real world markets.
• Also, my sense is that there has not been much
  empirical work investigating/measuring the
  effects I discussed under classic perspectives.
  So further empirical research there is also
  important.

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• Further Theory
• Much of the research has assumed a monopoly
  producer, so there is a need for further research
  to see how well results generalize to oligopoly
  settings.
• My discussion of style changes was based on my
  intuitive understanding of how the new/used unit
  substitutability argument would apply to the
  topic of style changes, but there is need for a
  formal analysis.
• Related to the next issue I will discuss, most of
  the papers do not include much analysis of
  interventions that could be used to avoid the
  inefficiencies. Especially if empirical work
  were to find these inefficiencies to be large,
  theoretical work along these lines would be
  important.

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PUBLIC POLICY RECOMMENDATIONS

• Taxes should reflect full costs including
  negative externalities of production and
  disposal.
• To the extent the modern arguments I have
  discussed are important, maybe even have taxes be
  above the full costs including negative
  externalities of production and disposal.
• Government subsidies for upgrade production and
  recycling might also be a way to reduce these
  inefficiencies.
• To the extent that problems arise due to style
  change argument and preferences people have for
  newness, campaigns focused on changing
  preferences might be worthwhile. But I am a bit
  skeptical about the effectiveness of such
  campaigns.

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CONCLUSION

• Modern theories of durable goods production
  suggest various market forces can lead to
  inefficiently short product lifetimes.
• Time Inconsistency
• New/Used Product Substitutability
• This outcome could also be due to standard
  classic arguments.
• Production taxes not reflecting negative
  externalities.
• Disposal priced below direct costs or disposal
  prices not reflecting negative externalities.
• Further research needed to investigate/measure
  how important these inefficiencies are.
• Taxes, subsidies, and campaigns to influence
  preferences would seem to be the possible
  interventions.