Tuesday, August 18, 2009

The Value of Life

Ask most people how much they value their life and they will inevitably say "an infinite amount." That's what my girlfriend told me the other day (generated from a conversation I've forgotten the origins of). "This cannot possibly be true," I said. "You take risks."

Mathematically, here's how it works. The expected cost of any activity under uncertainty is the likelihood of the event times the cost if the event occurred. A fifty percent chance of losing $200 means that the expected cost is $100. For any activity there is a probability you will die, or lose that life you value at an infinite amount. Thus, it's an infinite cost no matter what you multiply it by, no matter how risky the activity is. Since you have to do something to stay alive, you should always choose the least risky activity, no matter how much you might value the alternative because of the costs of that activity are infinite.

That people value their life only because they value what they can do with it doesn't change the math. In life, there are always options. You can watch TV or skydive: both are valuable to you and while the former might be more fun after 8 hours of TV a day, it is still too costly. But people still skydive.

They also show their finite value of their own life in other ways. People speed, jaywalk, ignore check engine lights, confront rude people (who might kill them out of anger), forget to check smoke detectors, travel to foreign countries, and eat unhealthy food. When we change our estimations of how dangerous (or safe) an activity is, we change our behavior. But if we valued our life infinitely, that shouldn't change anything (as the costs would come out the same regardless of the probability of death). Clearly, the costs to risking your life are lower than you might think.

Wednesday, August 12, 2009

Milk, Cheese, and the Myth of Retail Collusion

This week's Economist told the story of falling wholesale milk prices which are bringing EU farmers to call for lower milk production quotas. Some farmers blame supermarkets for the lower prices, noting that they sell milk at about the same price but buy it from farmers at a significantly reduced price.

Falling consumer demand (especially given the recession) isn't the explanation EU farmers give, and it certainly doesn't seem to explain the inconsistency at the supermarket. But the Economist linked them, though they didn't say how. The short version is: it's all about the cheese.

Cheese demand has fallen a lot, especially within the EU. Unlike milk, people buy a lot less cheese when their incomes fall. But cheese is made from milk and in the wholesale market, all cheese is milk (since cheese-makers are buying it to turn into cheese). In other words, grocers who want milk for milk compete with cheese-makers who want milk for cheese. But people want less cheese so there's less demand for wholesale milk.

Just as more cheese-makers bid up the price of milk (and a growing China bids up the price for gas down the street), fewer cheese-makers means there's downward pressure on prices. Grocers, then, are getting their milk on the cheap. But the market for milk-at-the-store changed very little. So we see grocers getting cheap milk, selling it at about the same price, and it's all thanks to consumer demand, not colluding grocers.

Sunday, August 02, 2009

Collusion and Commons

I hope my micro students can answer the following:
How is collusion between firms like a tragedy of the commons? In answering this question, make sure to define tragedy of the commons, reference positive and negative externalities, and summarize the incentives of individual firms.