Monday, February 23, 2009

Buick or Toyota? You make the call.

If I am an energy-conservation-minded consumer who can't afford to buy a new car, should I rent a 10-year old Buick ($200/year, 20 miles per gallon) or a 10-year old Toyota ($600/year, 40 mpg)? What does my choice depend upon? Explain. (Hint: How many miles would you have to drive each year for the Toyota to become more cost effective than the Buick?)

Congratulations to Andrew Bolton for being the first to provide a correct answer. This question (with a few modifications) came from Robert Frank's Microeconomics and Behavior text. Frank writes that it depends on how many miles you expect to drive:

The impulse of many conservation-minded consumers is immediately to choose the Toyota because of its better gas mileage. But there are only so many used Toyotas to go around. Suppose there are a total of 1000 Buicks and 1000 Toyotas. If I rent a Toyota instead of a Buick, someone else will have to rent a Buick instead of a Toyota. If my goal is to save energy, I should take the Toyota only if the person who will end up with the extra Buick is someone who drives fewer miles each year than I do.

But how can anyone possibly know whether that would happen? If the rental rates of the two cars are determined in the open market-place, and people generally pick the kind of car that minimizes their total driving expenses, we can say this: My choosing the Toyota will reduce society's energy consumption if and only if the Toyota is cheaper for me than the Buick. To see why, first note that if gasoline costs $2 per gallon, the yearly cost of the Buick is given by Cb = $200 + 2M/20 where M is the number of miles I drive each year. The corresponding cost of the Toyota is Ct = $600 + 2M/40. These two costs will be exactly the same if I happen to drive 8000 miles (set Cb = Ct and solve for M). If I drive more than 8000 miles, the Toyota is cheaper for me; if I drive less, the Buick is cheaper.

But how do I know that the person who rents the Toyota I could have rented won't be someone who drives even less than I do? If everyone follows the rule "drive the cheapest car," this clearly cannot happen at the given rental rates. (If the Buick is cheaper for me, it will also be cheaper for someone who drives fewer miles per year than I do.) But what if half the drivers, including me, drive 4000 miles a year while everyone else drives only 3000? If that were the case, then everyone would find the Buick cheaper at the current rental rates. No one would want to rent a Toyota. Rental companies would then discover that they could boost the prices on their Buicks substantially and still manage to rent them all. By the same token, they would have an incentive to cut the rental rates on their Toyotas, rather than watch them gather dust in their parking lots. In the end, the rental rates of the two cars would adjust so that the Toyotas are cheaper overall for the heavy-mileage drivers, the Buicks cheaper for the light-mileage drivers.

Monday, February 16, 2009

Vending Machine Economics

Tokyo's streets are characterized by a plethora of vending machines--dispensing everything from soft drinks, candy, cigarettes, magazines, personal toiletries, and beer. Unlike other major cities such as New York and London, virtually every downtown street corner seems to have at least one vending machine. Explain why vending machines are so prevalent in Tokyo versus more traditional purveying mechanisms such as newsstands, grocery stores, and liquor stores.

Congratulations to Jenny Kuebel (our first two-time winner this semester) for being the first to provide a reasonable explanation for the prevalence of vending machines in Tokyo. I think Jenny hits the nail on the head when she notes that vending machines take up very little space compared to a standard brick and mortar store. The scarcity of land in downtown Tokyo suggests that rents would be very expensive for such brick and mortar stores.

Monday, February 9, 2009

A Beautiful Equilibrium?

The movie A Beautiful Mind details the life of mathematician John Nash, winner of the 1994 Nobel Prize in economics for his contribution to game theory known as the Nash Equilibrium. Consider the following cola pricing game as described by the matrix below.


Cut Price Maintain Price
Coca-Cola Cut Price 50, 50 100, 40
Maintain Price 40, 100 80, 80

Each firm has two strategies: either maintain the current price of their cola, or to cut price. The numbers inside the matrix represent the profits that each firm earns depending on the strategies chosen by each firm. Thus, if Pepsi maintains its price and Coke cuts price, then Coke will earn $100 and Pepsi will earn $40.

What is the Nash Equilibrium for this game? Explain carefully.

Congratulations to Jake Verdoorn for correctly identifying and describing the only Nash Equilibrium in the game above.

Monday, February 2, 2009

(Famous) Economists?

Can you identify the three economists pictured below?

Here are a few clues to help you out.
  • PhD's from the University of Chicago and the other two from the Ohio State University.
  • Dedicated teachers all...out-of-the class their roles are as a woodworker, poet and a roundtable organizer.
Congratulations to Andrew Bolton for recognizing the three economists above as (left to right) Jack Prince, Wen-yu (Frank) Cheng, and Bert Glaze. You are welcome to learn more about these three pillars of Marietta College by visiting the Business & Economics Department's to see tributes displayed on the walls of the B&E Reading Room, Thomas 123.