Subsidies and queuing

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Subsidies and queuing

• Today Some methods that either hurt or improve
  efficiency

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Previously

• We expanded from supply and demand theory
• Elasticity
• Price controls
• Efficiency

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Today

• More on topics related to the Efficiency
  Principle
  
• Subsidies
• Queuing and first-come, first-served policies

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A subsidy for renters?

• Recall that last time, we concluded that rent
  control had few (if any) winners and many losers
  
• Suppose that we wanted to find another way to
  help I.V. renters
  
• How about a 500 check per month for each renter
  of I.V.?

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Think, think, think

• As aspiring economists, we need to examine
  whether a subsidy is a good idea
  
• We must keep in mind
• Subsidy is not a benefit in economic terms, but
  a transfer
  
• Money for subsidy must be raised from somewhere

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Short-run analysis

• In this case, we will look at the short-run
  consequences
  
• Assume for the near future, nobody can build new
  apartments or convert apartments to condos
  
• Supply is vertical

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What happens?

• Initial demand is D
• After subsidy is given, each person is willing to
  pay 500 more than before, changing demand to D

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What happens?

• Before the subsidy, price is P2 quantity is Q1
• With subsidy, quantity demanded at price P2 is
  Q2
  
• In short-run, notice new price for apartments is
  P1
  
• This price is 500 higher than before

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What happens?

• All of the subsidy goes to the apartment owners
  (and we have not even found money for the subsidy
  yet!)

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First-come, first-served policy

• This is essentially what happens today
• When a vacancy occurs, the manager accepts
  applications
  
• If the rent is at the market-clearing price
• Each person willing to pay the price should find
  an apartment
  
• Each apartment should be rented

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First-come, first-served policy

• What if the apartment is not at the
  market-clearing price?
  
• If the rent is below the market-clearing price,
  long lines develop
  
• If the rent is above the market-clearing price,
  the apartment will sit unoccupied

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The inefficiencies of long lines An example

• In 1978, airlines adopted a voluntary approach to
  overbooked flights
  
• Before this, people were allowed to board on a
  first-come, first-served basis
  
• Even Southwest Airlines now lets you buy Business
  Select, which includes boarding priority
  
• Remember to think like an economist Waiting
  time is a loss to society that nobody benefits
  from

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The inefficiencies of long lines

• Each person has a value of her/his time
• People on vacation typically have lower values of
  time than those traveling for work
  
• However, people on vacation can often arrive for
  their flight before business travelers

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The inefficiencies of long lines

• Lets look at a tale of two people for a concrete
  example
  
• Max, who is ready to go on a skiing trip
• Jill, who has a business meeting tomorrow in
  Denver at Noon

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Max, a single guy who likes to vacation in style
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Jill, a busy executive at a local firm
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They book seats on 6 am flight to Denver tomorrow
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A tale of two people Max

• Max has shopped at Vons for the last 12 years in
  order to accumulate enough miles to book his free
  flight
  
• He stays in Denver for one night before embarking
  on a two-week ski tour of Colorado

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A tale of two people Jill

• She receives a call tonight at 10 pm
• She must be in Denver tomorrow for a Noon meeting
  tomorrow, or else her local firm loses a 2
  million contract
  
• She books an Economy seat to Denver for 775

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Check-in for United flight 6682

• Max and Jill are the last two people to check-in
  for the flight
  
• Jill is right behind Max in line
• Unfortunately, only one seat is left
• Should Jill be bumped?

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The efficiency principle

• As economists, we want to find a way for the most
  efficient outcome to occur
  
• As an airline, we want to make ALL of our
  customers happy
  
• How do we do this?

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Suppose that United cannot overbook its flight

• Empty seats
• Higher ticket prices
• Jill becomes desperate to find a way to Denver

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With overbooked flights

• Voluntary system to find a person with a low
  value of time
  
• Offer an incentive so that someone is willing to
  travel on a different flight
  
• Fly through San Francisco, get a first class seat
  from SFO to DEN, arrive at Noon instead of 930 am

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Cost-benefit analysis of incentives

• Maxs value of time is low, since he was just
  going to check into his hotel and eat a nice
  dinner at a local restaurant
  
• 10 cost per hour, or 25 total
• Jill loses a big contract if she does not make
  the flight
  
• 50,000 total cost

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Cost-benefit analysis of incentives

• Assume that either Max or Jill benefits the same
  from a First-class seat
  
• 200
• Max gains 175 by offering to give up his seat in
  order for Jill to attend her business meeting on
  time
  
• He instantly volunteers to give up his seat for
  Jill

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Cost-benefit analysis of incentives

• Going from a first-come, first-served policy to a
  voluntary incentive system has improved the
  outcomes of both Max and Jill
  
• Max has improved by 175 and is traveling in
  style, just the way he wants
  
• Jill is able to make her meeting and save the
  contract

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Pareto improvements

• When one or more people are made better off
  without making anyone else worse off, these are
  known as Pareto improvements
  
• In our previous example, both Max and Jill were
  made better off without making any other
  passenger worse off

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Hypothetical cost-benefit analysis from Uniteds
point of view

• United Airlines has determined in its computer
  system that the probability of the last
  First-class ticket being booked for the SFO-DEN
  flight is 0.05, at a price of 1200
• The marginal cost of an a First-class passenger
  over an Economy passenger is 50

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Cost-benefit analysis from Uniteds point of view

• Marginal benefit of booking Jills ticket 775
• Marginal cost of booking Jills ticket
• Possible loss of First-class ticket being booked
  on the later flight, 60
  
• Additional First-class cost of Maxs trip, 50
• Total, 110
• United is better off with this policy, too

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Conclusion of Jill/Max example

• People with low reservation prices will
  voluntarily accept the airlines offer if the
  individuals MB of the offer exceeds the MC of
  the time lost and inconvenience
• Max has a low reservation price, due to his
  flexibility

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What have we learned today?

• A subsidy, like rent control, is not a good
  solution for the I.V. rental market
  
• Voluntary incentives can be used to improve the
  efficiency of some markets
  
• Airlines also use price discrimination to improve
  efficiency (More on this in Ch. 8)