Shark Tank Markups

Mark Cuban, Daymond John, Kevin O'Leary, Barbara Corcoran and Robert Herjavec are judges on “Shark Tank." Credit Richard Cartwright/ABC

For an economist, one of the most educational and entertaining shows on TV these days is Shark Tank, which lies squarely in the intersection between venture capital and reality TV. The judges, called "sharks” are shown as choosing whether or not to invest their own money in ventures on the spot as entrepreneurs make their pitch during the taping of the show. There are also some follow-up segments about how ventures one or more of the sharks invested in previously have been doing.  

It is well worth hearing the incisive questions and opinions given by the sharks. Among the inevitable questions are “How much do you sell it for?” and “How much does it cost to make and deliver?” or in the case of a service “How much does it cost you to do it?” The intriguing thing to me about that is being able to get a measure of the actual markup ratio

Actual Markup Ratio = Price/Marginal Cost

for a wide variety of goods and services. I think a great undergraduate economics thesis could be written by watching all of the episodes of Shark Tank, compiling all the data on price and marginal cost and then analyzing the determinants of the markup ratio (such as sector and how different the product is from competing products–something that could be coded up systematically from the televised discussion in the show).

Once price has had a chance to adjust optimally, the markup ratio should equal the target markup ratio

Target Markup Ratio = Price/Marginal Revenue = ε / (ε - 1)

where ε is the price elasticity of demand seen by the firm. The price elasticity of demand seen by a typical firm (or a typical firm’s target markup ratio) is a key parameter for macroeconomics as well as for industrial organization. For example, the value of ε tells how close things are to perfect competition. and ε is important for optimal monetary policy, as you can see in my discussion of Michael Woodford and Vasco Curdia’s paper at a conference at the Bank of Japan. Macroeconomists typically assume a value of 1.1 for the markup ratio, which implies ε = 11. To me, that seems too low a markup ratio and correspondingly, too high a firm-level price elasticity of demand. In any case, the value of typical markup ratios is a central issue that should be disputed in the light of as many different types of relevant information as we can get hold of.

Sometimes the sharks also ask about marketing costs. It is important to recognize that marketing costs (for example, “customer acquisition costs”) should not be included in marginal cost. They are a different animal. When price is above marginal cost, then there is a reward to marketing that pushes out the demand curve the firm faces. If a firm is optimizing, then it should be true that 

Marginal Cost to Make and Deliver + Marginal Marketing Cost of Raising Demand by 1 Unit at the Going Price = Price

So if one (in my view mistakenly) includes marginal marketing cost as part of “marginal cost” then the markup ratio should always look like 1 for an optimizing firm. This obscures the key forces arising from a markup of price over the marginal cost of making and delivering a product. 

Avik Roy: A Conservative Case for Universal Coverage →

Avik argues that Switzerland and Singapore may provide a good model for conservative health care reform. 

“Too many people spend too much time trying to perfect something before they actually do it. Instead of waiting for perfection, run with what you’ve got, and fix it along the way.”

— Paul Arden (via creativesomething)

Kim Schoenholtz and Stephen Cechetti: Has Paper Money Outlived Its Purpose?

Link to Kim Schoenholtz’s and Stephen Cechetti’s post “Has paper money outlived its purpose?”

This is a nice article that speaks favorably of my proposal for enabling negative interest rates. In the end, they come down in favor of keeping paper money.

I wish Kim and Stephen had made it clearer that my proposal in “How Subordinating Paper Currency to Electronic Money Can End Recessions and End Inflation” involves keeping paper money in a subordinate role that retains the positive aspects of paper money they mention. Indeed, during periods of time in which negative interest rates haven’t been necessary for a while, the monetary system I propose would look very much like the current system. That makes it very different from proposals to abolish paper money entirely.

John Cochrane: Larry Summers' Martin Feldstein Speech →

I love this post by John Cochrane.  

John Stuart Mill: People Should Be Allowed to Govern Their Own Lives Because They Care More and Know More about Themselves Than Anyone Else Does

Image source: “Self-knowledge, A Path to Happiness” by Karem-Barrett

Even if the self is an illusion, what we call the self reflects a fundamental fact about the aggregate of all human consciousness: informational links are much thicker within a human being than between human beings. Even a Utilitarian social planner who has no doctrinal attachment to Libertarianism should take advantage of those dense informational links within a human being by allowing each person to make decisions about his or her own life.

John Stuart Mill makes that case in On Liberty, Chapter IV, “Of the Limits to the Authority of Society over the Individual” paragraph 4:

But neither one person, nor any number of persons, is warranted in saying to another human creature of ripe years, that he shall not do with his life for his own benefit what he chooses to do with it. He is the person most interested in his own well-being: the interest which any other person, except in cases of strong personal attachment, can have in it, is trifling, compared with that which he himself has; the interest which society has in him individually (except as to his conduct to others) is fractional, and altogether indirect: while, with respect to his own feelings and circumstances, the most ordinary man or woman has means of knowledge immeasurably surpassing those that can be possessed by any one else. The interference of society to overrule his judgment and purposes in what only regards himself, must be grounded on general presumptions; which may be altogether wrong, and even if right, are as likely as not to be misapplied to individual cases, by persons no better acquainted with the circumstances of such cases than those are who look at them merely from without. In this department, therefore, of human affairs, Individuality has its proper field of action.

John talks not just about an individual knowing more about his or her own situation but also about how the individual cares more about him or herself than others do. Letting people make decisions about their own lives does a lot to take care of bringing the the strongest preferences into social choice.

But in addition to simply making sure that all strong preferences are well represented in social choice, letting each individual make decisions about his or her own life makes sense also because each person also typically has a knowledge advantage not only with regard to circumstances, but also with regard to his or her own preferences. Without a great deal of tricky inference, one of the most difficult things for someone else to know about me without me telling them, is what I want and how much I want it. One of the most basic jobs of any adult is to carefully figure out what he or she wants. It is difficult for anyone else to do that for the individual, though software designers for websites like Amazon, Netflix, Pandora etc. are trying hard to be able to predict what someone will like.

Emily Silberstein: Who Repays Microloans? →

Emily Silberstein’s is Head of Asia at Entrepreneurial Finance Lab, which helps lenders use psychological tests to gauge credit risk. In the article linked above, she reports these non-obvious results about characteristics that are predictive of loan repayment:

1. Honest people are more likely to pay loans, but not if they are super-honest. Emily speculates that super-honest people may be slow to detect the dishonesty of others they deal with.
2. Optimism is positively correlated with loan repayment for young people, but negatively correlated with loan repayment for older people.
3. People who feel they have control over their own lives are more likely to repay loans. People who feel that outside forces control their lives are less likely to repay loans.
4. However, cultural difference in the way people answer the questions used to assess this should be taken into account.

Reihan Salam: Miles Kimball’s Quixotic but Interesting Tax Proposal

Link to Reihan Salam’s National Review essay "Miles Kimball’s Quixotic but Interesting Tax Proposal"

I was pleased to belatedly run across Reihan Salam’s discussion of my proposal to provide key public goods with a minimum of tax distortion by expanding the non-profit sector rather than expanding government. In Reihan’s article, “Miles Kimball’s Quixotic but Interesting Tax Proposal,” Reihan says it might not curtail growth in government spending, but then continued:

What Kimball’s proposal does do, however, is address the normative demands made by egalitarians for higher taxes on the affluent (the notion of paying your fair share) while not directly addressing this structural dynamic. This is arguably a feature of Kimball’s proposal and not a bug, as it undermines the most potent case for higher taxes (the rich should bear more of the burden of making the investments we need to help vulnerable people flourish) without effectively rewarding public sector inefficiency. 

Unfortunately, as Kimball would surely acknowledge, this proposal is wildly unrealistic, in no small part because it would drive a shift in resources from the public sector to civil society organizations that will embrace a wide variety of business models, not all of which will be incumbent-friendly. And over time, one assumes that incumbents will work to stymie empowering innovations in this space that prove threatening. That doesn’t change the fact that Kimball’s proposal is extremely interesting. 

Here is a Twitter discussion I had with Reihan about this, without realizing he had written a whole article. 

The Book of Uncommon Prayer

image source

The Book of Uncommon Prayer is a collection of prayers for non-supernaturalists. I plan to keep this updated, and to add a section of shorter mantras.

“The Litany Against Fear” was written by Frank Herbert, the rest by me. The title of each prayer below also serves as a link to the original post that has commentary on each prayer.    

Daily Devotional for the Not-Yet

In this moment, as in all the moments I have, may the image of the God or Gods Who May Be burn brightly in my heart.

Let faith give me a felt assurance that what must be done to bring the Day of Awakening and the Day of Fulfilment closer can be done in a spirit of joy and contentment.

Let the gathering powers of heaven be at my left hand and my right. Let there be many heroes and saints to blaze the trail in front of me. Let the younger generations who will follow discern the truth and wield it to strengthen good and weaken evil. Let the grandeur of the Universe above inspire noble thoughts that lead to noble plans and noble deeds. Let the Earth beneath be a remembrance of the wisdom of our ancestors and of others who have died before us. And may the light within be an ocean of conscious and unconscious being to sustain me and those who are with me through all the trials we must go through. 

In this moment, I am. And I am grateful that I am. May others be, now and for all time.

An Agnostic Prayer for Strength

May I be strong and steadfast, 

calm and collected, 

as I set out to serve 

the God or Gods who may be.  

An Agnostic Prayer for Awareness

May I be subtly aware of everything going on around me

So that I may better champion the God or Gods Who May Be.

An Agnostic Invocation

May this gathering uplift our hearts, enlighten our minds, and inspire our endeavors to bring us closer to, and glorify, the God or Gods Who May Be.

• Gratitude: (We are thankful …)

• Hopes: (We hope …)

• Concerns (We are concerned …)

• Worries (We are worried about …)

• Thoughts (We are thinking of …)

• Addition wishes (May …)

• etc., in no particular order

And may we understand more fully the mystery of the humanity we all share, and act as one family to bring this Earth nearer to Heaven. Amen.

An Agnostic Grace

May the works that we do, sustained by this food, bring us closer to, and glorify, the God or Gods Who May Be.

• Gratitude: (We are thankful …)

• Hopes: (We hope …)

• Concerns (We are concerned …)

• Worries (We are worried about …)

• Thoughts (We are thinking of …)

• Addition wishes (May …)

• etc., in no particular order

And we remember Jesus Christ, symbol of all that is good in humankind, and thereby clue to the God or Gods Who May Be. Amen.  

An Agnostic Prayer for Awareness

May I be subtly aware of everything going on around me so that I may better champion the God or Gods Who May Be.

The Litany Against Fear (from Frank Herbert's Dune)

I must not fear.

Fear is the mind-killer.

Fear is the little-death that brings total obliteration.

I will face my fear.

I will permit it to pass over me and through me.

And when it has gone past I will turn the inner eye to see its path.

Where the fear has gone there will be nothing.

Only I will remain.

Anat Admati Makes Time's 2014 List of 100 Most Influential People →

This is a link to Rana Foroohar’s piece about Anat Admati in Time.

Anat is one of my heroes for her dogged advocacy in favor of the high equity requirements that will give us a stable financial system.  

Allison Ross: Many Don't Carry Much Cash Any More →

As you can see from the link above, for most people, it might not be that big a deal if paper currency were demoted, as I advocate in my column “How Subordinating Paper Money to Electronic Money Can End Recessions and End Inflation." For those who actually use paper currency a lot, the system I advocate would help them financially because it would lead to lower inflation, and therefore a lower implicit tax on paper currency. And of course, other than those who use it for illegal purposes, those who use paper currency for a large share of their transactions are more likely to be borrowers than lenders, so they would benefit in the short run from the low interest rates possible when the safest interest rates are negative. And in the long run, they would benefit along with everyone else from a more stable economy.   

Q&A on Electronic Money and International Finance

Question: I can’t resolve a question I have about breaking the ZLB with electronic money, and it’s driving me nuts.

I re-read a couple of your posts that mention a kind of ‘first-mover’ advantage in breaking the zero lower bound: not only does a first-mover get the usual stimulus from lowering the interest rate, but the fact that it is the only country in the world that can offer such a low interest rate is likely to boost demand further.

I’m struggling with the effect on the supply of loanable funds within the first-moving country. Essentially, as the central bank lowers the interest rate, and economy-wide interest rates fall, won’t some investors begin to look abroad for better risk-reward alternatives? I know that it’s not costless or riskless to transfer to a different currency, but it seems that the central bank’s effectiveness in unilaterally changing interest rates would be hampered by the existence of outside options: either some interest rates will remain high or some agents will begin to 'cash out,’ if you’ll pardon the pun, and move their money abroad. 

I hope it’s clear what I’m trying to ask. Would you help me figure out what I’m missing?

Answer: Great question. I am using logic from Mankiw’s textbook treatment of international finance, which I lay out in my post “International Finance: A Primer.”

Basically, when people start investing abroad because rates of return are higher abroad, that is a capital outflow, and that is why exports go up. Capital outflows put domestic currency in the hands of those abroad. They don’t really want it, so exchange rates adjust until that currency (whether physical or virtual) makes its way back to its home country to buy exports. “Moving money abroad” is a stimulus to exports, because goods follow money.  

The only way an outside option would cause trouble is if firms starting setting prices and wages in a foreign currency. It is crucial that sticky prices and/or wages (or at least most of them) be set in terms of the electronic dollar (or whatever the domestic electronic currency unit is called). 

In my electronic money seminar, I make the point that, when they occur, negative interest rates on paper currency are not meant to disadvantage paper currency. What those negative interest rates on paper currency do is make it so there is nowhere to hide from the negative interest rates except by spending the money. You can send your own funds abroad, but then the person who took your dollars in exchange for their own currency now can’t hide from the negative interest rates except by spending the dollars. In that situation, by sending dollars abroad, you haven’t eliminated the hot potato of dollars earning a negative interest rate from the world, you have only made it someone else’s problem. The only escape from those negative interest rates is to spend the money, so someone–you or someone further down the chain–will be driven to spend it.  

Follow-up Question: Ok. In other words, this kind of behavior (bailing on the domestic currency) will just lead the exchange rate to adjust until some form of interest rate parity is achieved again. Is that the right?

Answer: No. There might continue to be an interest rate difference. But the international flow of funds to the higher interest rate stimulates exports through its effect on the exchange rate.

Paul Krugman: That 80s Show →

Here is the key passage, but the whole thing is eminently worth reading:

What actually happened in the 80s, however, was that central banks — most famously the Fed, but also the Thatcherite Bank of England and others — drastically tightened monetary policy to bring inflation down. And inflation did indeed come down — eventually. But along the way there were deep recessions and soaring unemployment, which went on much longer than you could justify with any plausible story about the monetary shock being unanticipated.

This was very much a vindication of more or less Keynesian views about the economy, and the 80s were in fact marked by the New Keynesian comeback.