OFF: consumer economics (was: Hawkwind MP3's)

[M Holmes]

Doug Pearson writes:

> Mike, your economic theory is (nearly) impeccable; unfortunately, the
> theory you present is not reflected in reality.  Let me start with some
> examples ...
>
> Shortly after the CD format was introduced, EMI Japan released a CD version
> of the Beatles' 'Abbey Road', that was withdrawn a couple years before EMI
> reissued the complete Beatles back catalog worldwide.  For those couple of
> years, the Japanese 'Abbey Road' CD changed hands on the secondhand market
> for around $200.  According to your argument, this high secondhand price
> would be reflected in a higher sale price for the reissued 'Abbey Road'.

Nope, that simply shows that for other reasons, the retailers weren't
willing to either release the item in the quantities demanded, or to
charge the price the market would bear for the limited release.

Once again: there are *OTHER* factors in pricing. Secondhand value is
simply one more effect.

> OK, let's say you reject that example on the grounds that only one CD from
> the Beatles' back catalog was on the secondhand market, period, so you
> can't compare it to the other CD's in their back catalog.  Take David
> Bowie's back catalog, originally released on CD by RCA shortly before their
> contract with Bowie expired.  As soon as the contract expired, the CD's
> were deleted, and only available secondhand.  Again, they fetched higher-
> than-average CD prices, although more in the $25-$40 range than the $200
> range.  The most popular titles ('Ziggy Stardust', for instance) commanded
> closer to $40-$50, while less-popular titles (like 'Lodger') would only
> sell for $15-$25.  According to your theory, reissues of the former would
> sell for more than reissues of the latter.  Yet, when Rykodisc revamped the
> Bowie catalog a few years later, all the titles sold for the same price.
> (Now, I'm sure that Bowie *has* subsequently received more royalties from
> sales of 'Ziggy' than sales of 'Lodger', but that's because 'Ziggy' is a
> more popular album that has sold more copies, not because it sold for more
> secondhand when it was out of print.)

It's also a non-perfect market. Secondhand value is *estimated*
conciously or unconciously by buyers of new product. They may not know
how rare a particular product will turn out to be, or indeed how
popular. Thus they may estimate the secondhand value as more or less
"the normal amount plus maybe a little extra because it's Bowie".

> So even though your theory is *logical*, the evidence shows that it is not
> accurate, and for very good reasons ...

Sorry, but the evidence indicates that it's quite accurate. It also
indicates that these aren't perfect information markets and that the
theory won't be predictive in every single case. On *average* though,
bands receive more royalties on new purchases because of a positive
secondhand value than they would if people were shot if they ever sold
secondhand and the value went zero or negative.

> This is true only under the assumption that CD buyers are, indeed, taking
> into account the resale value of a CD when they buy one, whether new or
> used (reasoning flaw #1).

Please show why this is a flaw.

> The reality is, consumers care no more about the
> resale value of CD's than they do the resale value of a restaurant meal or
> a movie ticket or a foreign vacation (all three of which are, of course,
> zero).

Indeed.

> >To the extent
> >that this raises the royalty of the band and to the extent that
> >competition permits retailers to reach towards this price, the royalty
> >to the band increases.
>
> This isn't the way the music business works (reasoning flaw #2).  Royalties
> are not based on retail prices - a band receives the same royalty for
> copies of the same CD title, whether it has a $14 price tag on it or a $16
> price tag.

OK, I thought I'd made it pretty clear that the argument applies only if
the band royalties were a percantage (or vary in some other way with)
the retail price.

> If on a percentage royalty, bands receive a percentage of what
> the *label* (manufacturer) takes in, not what retailers take in (as Andy G
> states in his message).

The argument still applies wherever a higher retail price means a higher
price for the label. Not otherwise.

> >Further than that, I guess you'll have to take it up with the theorists.
> >It makes sense to me, but then I like to read about economics so my
> >mileage might clearly vary.
>
> I don't doubt that these theories hold true for some markets, but they
> don't hold true for secondhand CD's and record label royalty rates.  Like I
> said, the theory is logical and makes sense to me (thanks for the detailed
> explanation, sometimes I'm a bit slow), but the reality is contrary to the
> theory in this case.

I'm willing to entertain the possibility that you're right, but I'd need
more evidence than a couple of examples. How about some thought
experiments: let's say that the resale value of CD's were negative, say
either you got charged ten times what you paid or you got shot. Do you
think that prices would remain the same for new CD's?

> >> If anything, it seems to me
> >> that a healthy secondhand market would *detract* from a band's income,
> >> since a band's fans have a finite amount of funds to spend on the band's
> >> releases.
> >
> >People only have a finite amount of funds to spend on anything. What
> >retailers and advertisers try to do is change their preferences as to
> >what they'll spend those funds on. Sure, someone might buy two
> >secondhand CD's instead of a new one, and the band might have gained
> >more from the new sale. However someone who might not pay full price
> >might buy secondhand and thus raise the price of the new sale for the
> >next guy.
>
> Huh?  This doesn't sit well with basic economic theory.  If someone has
> bought secondhand CD's in lieu of new ones, that's an indication of
> *decreased supply* of secondhand CD's (theoretically leading to higher
> prices for those), but there's no change to either supply or demand of new
> CD's (if anything, the demand for new CD's is decreased, which is supposed
> to lead to lower, not higher, prices).

I didn't express myself clearly enough. Someone buying secondhand CD's
would raise the *new* price a little.

> >> Just as you describe "basic piracy", secondhand sales do not
> >> help a band economically "unless it serves to bring new buyers into the
> >> process"
> >
> >I disagree with this on the basis of the above argument.
>
> And I've pointed two significant flaws in the above argument (and cited
> examples that run counter to it) ...

I've given the reasons that the examples are counter ones and pointing
out flaws doesn't mean much without the evidence or reasoning to show
that they are flaws.

> >I've no argument with that. Nobody however is suggesting that consumers
> >are irrational either.
>
> It depends on what you mean by "irrational".  If by that, you mean, "acting
> in a random, unpredictable, and unquantifiable manner that cannot be
> understood", I agree with you completely; there certainly are reasons to
> consumers' behavior (it's just that I believe that reasoning is better
> understood by the science of behavioral psychology than by the science of
> economics).  However, if you mean, "acting contrary to their own economic
> best interests", I'd strongly disagree!  One only needs to look at consumer
> debt levels (credit card balances) in the USA to see that many (most?)
> consumers do not act in their best economic self-interest.

Economists would claim that consumers act only in ways that they
*perceive* to be in their best interests. As you point out, the
prevalence of credit bubbles and other manias in history indicate that
even whole societies can for a time have their perception considerably
at odds with reality. For my money (heh) the Austrian school of
economics has it taped on why this is so (essentially the theory of
money illusion under artificially lowered interest rates). Certainly I
am convinced that it's more than coincidence that these things almost
always occur during periods of falling interest rates and manipulation
of interest rates.

> >When consumers behave other than theory predicts
> >then that means to most economists that there are some interesting
> >factors that the theory is missing.

We're in utter agreement here.

> Yes, exactly.  In this case, what's missing is an accurate explanation of
> consumer behavior, which I believe is best explained in mostly non-economic
> terms.

I believe that there are no non-economic terms to pretty much everything.

> >The trick about economics is that it's about people's *real* preferences
> >rather than what they might claim to an opinion pollster or do in a vote
> >that costs them nothing because they'll get it back again at the next
> >election.
>
> Right.  The catch is that real peoples' real economic preferences are
> mostly based on non-economic reasons (buying a vaccum cleaner because your
> carpet's dirty isn't an economic reason

Of course it is! You have a scenario where you can see two choices
(economics is about choices and only choices): keep the carpet dirty and
live with it, or spend X on getting the tools to clean the carpet and
forego the possibility of spending X on beer, CD's or saving up for a
rocketship. That's pure economics.

> buying a Barry White CD because
> you think it will get your next date "in the mood" isn't an economic
> reason).

Two choices: sex tonight but put up with Barry White or no sex but you
have the cash to buy Tim Blake's new CD. Pure economics again. Basically
it's the question of how much sex is worth to you. If you imagine that's
not an economic question then a quick chat with anyone who's worked in
the sex business will quickly reeducate you.

> Most people don't buy CD's because they're an investment (the
> economic reason), they buy them because they want to hear the music (the
> behavioral psychology reason).

Choices again. Either would be an economic reason just as paying for a
restaurant ticket because they play the album there would be.

> >When people have to pass over the magic chits in the knowledge
> >that they'll never get them back to spend on the other option, there's
> >no room to lie. What they buy reveals what they actually want and what
> >precisely they're prepared to sacrifice as an option to get it.
>
> Yes and no ... consumer purchases are definitely a good indicator of what
> people "really want", but the prevalence of consumer credit does give "room
> to lie" in that it allows consumers to spend more than they actually
> have,

A good point. However, while they think there's a chance that they'll
have to pay the money back then they're still evincing what economists
call "revealed preference". However it is more interesting where credit
is concerned. For example there has been some interesting discussion of
stockmarket behaviour in recent years (basically the bubble and crash).
It seems that when people are playing with "house money" (I.E money
they've gained in the bubble) they're more willing to take risks with
it. Once they lose their profit in the crash and start playing with
their own savings again, they become much more conservative. This has
been advanced as a reason for "capitulation" during crashes (basically
about halfway down the slide there's a time of huge drops and investors
leaving the market). It seems that since most people came in during the
mid-90's, we're approaching that point now (a big mystery of this crash
has been why there's been no period of capitulation yet). After that
comes investor shunning of the bubble markets and the final slide to the
bottom.

This also shows in the housing bubbles.  During periods of falling
interest rates buyers seem to price based on monthly interest repayments
rather than consider that the actual price is all money that they'll
have to pay back along with interest.  So where this is prevalent, where
rates halve, prices double.  This is money illusion and the downside is
pretty obvious the minute anyone stops to consider that interest rates
must not only ultimately return to the norm, but once
disinflatio/deflation are over, they'll inevitably rise above it if fiat
money (made up money not backed by commodities stored at the bank) still
exists at that point.

> therefore, in effect, casting more votes than they have.

Again, we're in 100% agreement. We're living in the largest credit
bubble there's ever been anywhere in history and future history books
will write of a society gone mad in ways that exceed even the Dutch
Tulip Bubble where people paid a house and twelve acres
for one tulip bulb.

> >In that
> >people lie routinely about damn nnear everything else, I think we should
> >look at the poor economists' crystal balls as half full, and
> >impressively so, rather than half empty.
>
> I'd concur that economic predictions tend to be about as accurate as
> weather forcasts (both are sciences in which not all of the relavent
> variables are yet fully understood or even known ... just like behavioral
> psychology), which are frequently correct.  But attempting to use economic
> theory to make claims counter to reality does not inspire my confidence in
> academic economists (somehow, I have a feeling that if California's
> legislators had applied the same rigorous challenge to the economic claims
> made by energy companies' lobbyists a few years ago that I'm applying to
> yours, the state wouldn't have gotten itself into the deregulatory mess
> that it did).

The problems were that these weren't anything like the free markets the
authorities wanted to pretend them to be. If you dislike free markets
and people press for deregulaton then it's a reasonable political
strategy to deregulate with rules that will force failure. Your astute
politician can then step in, reregulate to save the day and bask in the
adoration of the public while blaming the "free markets" that never
existed anyway. Add in what looks like the biggest financial fraud
conspiracy in three generations (Insul was the last of this size before
Enron in the west) and you have a pretty heady mix. Expecting any free
market model to work under these circumstances is like trying to shovel
hot coals with an ice lolly.

> The economic theories that (accurately) apply to the sale of
> milk are not the same as those that apply to the sale of used/new CD's, or
> houses, or automobiles, or sporting event tickets - they're all similar in
> some ways, but radically different in others.

You're right. For some reason milk markets seem to be completely rigged
damn near everywhere. The record companies would give their eye teeth
for those kind of markets and Hawkwind would probably be earning
set-aside money due to te surplus of Hawkwind CD's.

> Damn!  Fascinating discussion.  Too bad we didn't get to go over all this
> on friday over pints.  That would be much more fun than typing ...

Yeah. It wasn't the best venue but I was pretty desperate for anyone to
get it organised by that point. Next trip we'll organise it between
ourselves and tell the peevers where we're going....

FoFP