Subsidies and queuing Today: Some methods that either hurt or improve efficiency.
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Transcript of Subsidies and queuing Today: Some methods that either hurt or improve efficiency.
Today
More on topics related to the Efficiency Principle Subsidies Queuing and first-come, first-served
policies
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.?
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
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
What happens? Initial demand is
D After subsidy is
given, each person is willing to pay $500 more than before, changing demand to D’
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
What happens? All of the subsidy
goes to the apartment owners (and we have not even found money for the subsidy yet!)
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
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
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
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
The inefficiencies of long lines
Let’s 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
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
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
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?
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?
Suppose that United cannot overbook its flight
Empty seats Higher ticket prices Jill becomes desperate to find a
way to Denver
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 9:30 am
Cost-benefit analysis of incentives
Max’s 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
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
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
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
Hypothetical cost-benefit analysis from United’s 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
Cost-benefit analysis from United’s point of view Marginal benefit of booking Jill’s ticket:
$775 Marginal cost of booking Jill’s ticket:
Possible loss of First-class ticket being booked on the later flight, $60
Additional First-class cost of Max’s trip, $50
Total, $110 United is better off with this policy, too
Conclusion of Jill/Max example
People with low reservation prices will voluntarily accept the airline’s offer if the individual’s MB of the offer exceeds the MC of the time lost and inconvenience Max has a low reservation price, due
to his flexibility