Skip to content

To LSAT, Or Not to LSAT?

To LSAT, Or Not to LSAT? published on No Comments on To LSAT, Or Not to LSAT?

An article in today’s WSJ Online reports that a growing number of law schools in the US are planning to forego the LSAT (Law School Admission Test) as their required entrance examination and to begin accepting the GRE (Graduate Record Examinations) that most (general) graduate schools accept for entry into MS and PhD programs.

Proponents argue that it will broaden the applicant pool for law schools to consider individuals who may not want–for whatever reason–to take the LSAT and the GRE as they weigh grad school options. Opponents argue it will dilute the quality and preparation of students for the rigors of law school. Well that, an cut revenues from test fees if you’re the Law School Admission Council that administers the test. Can both (or all) sides be right?

Yes, they can.

Admission to graduate school (or any academic program really) suffers from a hidden information problem. Applicants have a better idea of their ability to succeed in grad school than do admissions committees. They also have an incentive to over-represent their abilities. (They also may actually over-estimate their abilities, if you follow the behavioral economics literature, but we don’t even need that for the story to be interesting.) Likewise, admissions committees have a better idea of how rigorous their program is and what it takes to succeed than do prospective students. And they don’t want to waste time on students who are not likely to be successful in their program.

In economics we refer to this as an ‘adverse selection’ problem. It results anytime there is an information asymmetry between potential trading partners in which one party has better information than the other, and may have an incentive to hide that information (because the truth would hurt their prospects in the trade).

There are (basically) two solutions for dealing with this adverse selection information problem. First, the information-disadvantaged party (in our case, the admissions committee) can use any number of screening devices to reduce the information asymmetry and sort out the good prospects from the bad prospects. That’s exactly the purpose the LSAT (or the GRE) serves. It reveals something about the applicant’s reasoning ability (especially the LSAT) or general knowledge base (more so the GRE). So the question is, are the attributes the LSAT and the GRE screen for sufficiently similar that relying on either one would be a good screen? Obviously, some law schools–and some very good ones–appear to believe that’s the case. Or they at least believe it’s likely enough to give it a shot. Since some schools have allowed the GRE as a special case in the past, they may even have evidence to support that conclusion.

The second way of dealing with adverse selection problems is for the party with the information advantage (in our case, the law school applicants) to signal their quality by undertaking some special effort that would only make sense if they were actually good prospects. In other words, choosing to send the signal is a self-selection mechanism that makes the applicant’s information claim more credible.

Here is where critics of the GRE standard are likely correct. If schools only accept the LSAT, applicants have to go out of their way to take this “grueling test” if they want to go to law school. Only students who really want to go to law school and who believe they have the ability are willing to put themselves through that (and pay the explicit costs as well). If schools will accept the LSAT or the GRE, on the other hand, some GRE-takers may apply to law school who wouldn’t have if they had to take the LSAT. Which means, as critics point out, there may be more applicants that aren’t really dedicated to the idea of law school and therefore may be less desirable students.

However, it might also be the case that some prospective students have broader interests, and the GRE has a greater utility for a wider set of possible graduate programs. In a world where college students have limited dollars and time to prep for a graduate admission test, the GRE is the more economical investment. While that might make the signal value of taking the LSAT that might higher, since you really have to want to go to law school to take it, it might also be reasonable to infer that the value of the LSAT signal to admissions committees is not high enough to risk missing out on good potential students who choose to economize on their admission test choice.

So ultimately, it’s not about whether one side (or which) is right about their concern. The real question is how much difference do their concerns actually make in the outcome of law school admissions, and is the difference worth the costs associated with either policy?

Of course, there is yet another possibility–and one the American Bar Association seems to be considering. That is, that neither screening device is valuable enough to require it for admission to law school. At least not enough to make requiring a test part of the accreditation standards for law schools. Apparently the ABA believes the information asymmetry may no longer be so great that the screen/signal adds all that much value after all.

If I were in the market of selling that screening device (or either of them) and the ancillary services that go with it (e.g., test prep courses), I’d be a bit concerned about the future of our business model.

What Is A Police Officer Worth? Insights of Opportunity Cost

What Is A Police Officer Worth? Insights of Opportunity Cost published on No Comments on What Is A Police Officer Worth? Insights of Opportunity Cost

Zig Ziglar is purported to have said, “Show me your checkbook and your calendar and I will tell you what is most important in your life.”  There is truth in that statement. Economists refer to it as “revealed preferences”; when faced with actual choices and opportunity costs, how you choose reveals what you value most.

Yesterday I had opportunity to visit with a local high school AP Econ class to discuss whatever they wanted about economics and various issues. At some point we got on the topic of the recently rejected “use tax” proposal floated by our city and county governments that I wrote about earlier. A primary argument for the use tax was that our city needs to hire more police officers, and online sales are diverting local sales tax dollars from the city coffers.

This raised the question of what priorities does the City government actually have? After all, the City has two ways of paying for more police officers: raising more revenue (in the form of more taxes) or reallocating its existing revenues from competing uses. If the City truly believed having more police was such an important use of tax dollars, the City could do what many households do: reallocate their budget to their higher priority items, then go back and buy those other things when there’s more income available.

I decided to take a peek at our City’s budget for FY2018. In particular, how much does the City spend to staff an “Office of Cultural Affairs” that basically uses tax dollars to pay city employees to subsidize and promote public art and local artists. Don’t get me wrong–art and cultural attractions are an important element of the quality of life in our community. But rarely do we fret about choosing between a good option and an undesirable option. The nature of economics is having to choose between two goods, and what that choice says about how we evaluate them.

Traffic control box art.

Based on our City’s checkbook (budget), publicly supported art and culture is worth more than having six additional sworn police officers. That’s how many additional sworn police officers could be hired if the City redirected the Cultural Affairs budget to policing. That’s not a judgment of the trade-off–it’s simply the economic facts based on the opportunity cost of the City’s revealed preferences in its resource allocation decision. We could go down the line with any number of other City ‘services’ to draw similar comparisons of opportunity costs.

Would the average citizen agree that public funding for art is worth more than six additional police officers? I don’t know. I’m doubtful. But the citizens have never been asked that question. Instead, the City just continues to seek an increase in taxes to pay for more police so it can have its art and its police, too.

Of course, there’s a political economy angle to this that might be perceived as more cynical (or sinister?). Which is the average citizen more likely to be willing to be taxed for at the margin? More art? Or more police? That strikes me as pretty much a no-brainer. Which likely explains why the City refuses to reallocate the arts funding (or any other expenditures) to pay for the police now and ask taxpayers for more money to resume doing those other (lower-valued) things.

Entry way globe decorations.

Either one of two alternatives would appear to be true: our city government values public art more than it does having another six police officers; or, City officials manipulate the decision options for taxpayers by allocating funding to lower-valued services (making the City less safe?) in order to request tax increases for the foregone higher-valued services that taxpayers are more likely to approve. The latter would seem a form of extortion, so I’m sure it must be the former.

This situation is by no means unique or limited to our fair city. It’s true in yours, too; and at the State and Federal levels as well. Every government entity has decisions in how to allocate its receipts. How those allocations are made speaks to what is truly important to those making the decisions, and to their ability to manipulate voters’ interests at the margin.

“Net Neutrality” Isn’t So Neutral–Nor So Good

“Net Neutrality” Isn’t So Neutral–Nor So Good published on No Comments on “Net Neutrality” Isn’t So Neutral–Nor So Good

The Federal Communications Commission lit up social media by formally announcing plans to roll back regulations imposed by the Obama administration that treat internet service providers (ISPs)–companies such as Comcast, AT&T, Verizon, or my beloved-be-damned Mediacom–like traditional utilities. Part of this roll back includes rules about net neutrality, which forbid ISPs from treating packets of data differently depending on who sent them or what they contain.

If you believe critics of this decision (such as here and here), the Internet is about to fall apart and all the things you love, from cute cat videos to online shopping to the latest streaming series sensation, will no longer be delivered to your desktop or mobile device. Instead, ISPs would control everything you’re allowed to say, do and view on the Internet, and they would thwart all innovation and potential disruptive technologies.

Never mind that the Obama-era regulation wiped out consumer protections that the Federal Trade Commission had developed, leaving Internet consumers in a privacy protection wasteland. And never mind that the regulation traded a vague threat of control by private companies for a very tangible control by government. The reality is that “net neutrality” itself threatens innovation and the development of disruptive technologies.

The concept of net neutrality is nothing new and isn’t unique to the Internet. Consider your local road system. The roads are the “pipes” of the Internet. Packets of data (cars and trucks) use the pipes to go here and there. Different packets carry different kinds of data–semis full of food, semis full of hazardous materials, city buses, and lots of personal vehicles whether with single passengers or multiple. Some of these packets are very big, take up a lot of space, and tend to bog things down in traffic. And especially at peak times of day, when there are thousands of different ‘packets’trying to get here and there, the system gets very congested and everything slooowwsss dddoooowwwwnnnn. Don’t you just hate that?

In order to alleviate congestion, many transportation authorities (the ISPs of the highways) restrict use of certain lanes to certain kinds of vehicles: “No Trucks in the Left Lane”, high-occupancy vehicle (HOV) lanes, and even toll roads that charge different fees for different size vehicles reflecting the different costs they impose on the system.

Why do we allow transportation authorities to discriminate on who gets to drive where and how much they have to pay to use the road? Simple. We understand the congestion problem. We understand that having lots of individual cars with only one passenger contributes more to the congestion than a car (or bus) with many passengers, so we reward  HOVs by giving them a lane with less congestion so they can get to their destination more quickly. We understand that bigger vehicles impose higher costs on the system. We also know they value using the roads more than smaller, especially personal, vehicles, because they typically are carrying products to market that consumers value. Not surprisingly, trucking companies tend to dislike higher toll fees because it increases their cost of business. They’d much rather have other vehicles–and even people who don’t drive on the roads–pay for the infrastructure instead.

Proponents of net neutrality on the Internet–particularly streaming companies like Netflix, Hulu, or Sling–are basically like truck companies. These companies stream huge packets of data, taking up tons of bandwidth. If you have a cap on your data plan, you know how quickly you can reach your limit if you stream a lot of television through one of these services. Likewise, you know how frustrating it is when the pipes are so full of packets of all sorts that you get a lot of buffering or reduced image quality or the interminable little whirling circle that your download is still in progress.

With net neutrality, ISPs cannot charge more for “big trucks” and they can’t set up dedicated lanes for high-value traffic. They’re forced to make everyone stay on the same road, at the same speed, and deal with the congestion. Not only do they have less incentive to invest in the infrastructure since they can’t charge more for it, they also have fewer resources to do it since they can’t collect more money from the higher-value users.

As consumers of the Internet, the problems of net neutrality are less immediately obvious than our experiences with traffic on the highway. However, the nature of the problem is the same. We understand why ‘net neutrality’ on the highway is not the best policy. And the same applies to the Internet.

 

Shifting the (Online) Sales Tax Burden

Shifting the (Online) Sales Tax Burden published on 1 Comment on Shifting the (Online) Sales Tax Burden

Recently a friend (and former student) Tweeted about the politics of regulation (see the Tweet below). Today, the city (and county) where I live is voting on a new “use tax” that would be applied to all “purchases made from out-of-state vendors”. Ostensibly, this is to offset lost sales tax revenue due to online shopping–the bugaboo of many local retailers and governments.

This morning I lectured on the relationship of demand elasticity to the question of who pays for a sales tax. As illustrated in the simple example below, both the consumer and the seller pay portions of the sales tax–provided neither Demand nor Supply are perfectly elastic (flat) or inelastic (vertical). When the supply curve shifts up due to the tax, it reduces how many units consumers buy (Q1 vs Q). Consumer pay more than they would have without the tax (P1 vs P), and sellers receive a lower price (net of the tax) than they would have without the tax (Ps vs P). So both sides bear some of the burden of the sales tax. The question is, which side pays more? It’s a pretty simple exercise to show that the “steeper” curve pays the bigger share just by redrawing the picture with lines of different relative steepness. Try it for yourself using this simple graph as an example.

The steepness of the curve reflects the sensitivity of consumers (on the Demand side) and sellers (on the Supply side) to changes in price. The more sensitive either side is, the more their quantity decision will change when price changes. More sensitivity means ‘flatter’ lines. Less sensitivity means ‘steeper’ lines.

Consider demand for something that’s very important to the consumer, like insulin. Even if the price goes up, insulin-dependent consumers will not reduce their consumption of insulin very much at all–unless the price really goes up a lot. In that case, the Demand line would be very steep.

What affects the steepness of Demand? Lots of things, but one of the biggest is the availability of other goods that provide the same (or very similar) benefits to the consumer. For instance, if you need insulin, you don’t have many alternatives. Orange juice, on the other hand, has several. If the price of orange juice goes up much, I might choose another juice, milk, or just plain water.

What else has substitutes? Stuff sold in local stores that can also be bought online. If I’m willing to wait two days, a large percentage of the things I might buy locally can be delivered right to my doorstep without me having to leave my house. If the price of buying things online is lower than the price of things sold locally, buying online is a really good substitute–if I can exercise a little patience. And if the local sales tax does not apply to my online purchases, that gives online sellers an automatic price advantage over local sellers–as much as 4.5% where I live (and that doesn’t count State sales tax).

So, what does that have to do with who pays the sales tax or Per’s tweet above?

First, demand for local purchases is more price-sensitive because the price of substitute items (from online sellers) is lower. If we impose (and actually enforce) a use tax on online sales, that will make consumers a little less price sensitive in their demand for local stuff, i.e., their Demands for local goods will get steeper. That means the relative tax burden will shift from local sellers to consumers. And this is even before the retailer’s ability to increase prices (or to not lower them as much to compete with online sellers). Little wonder local retailers are more than happy to “level the playing field” with online sellers by imposing the tax. They get to increase prices and pay less of the sales tax themselves; a win-win.

Second, the process giving rise to this proposed tax follows exactly the process Per outlines:

  1. Government imposes a regulation (a sales tax) that makes local retailers less competitive in the market place. There are other forms of taxing municipalities can and do use. Ours chooses to use a sales tax (for lots of things).
  2. Higher sales taxes encourage more people to buy online to avoid the sales tax, which not only reduces local sales, but local government tax revenue. Two problems for the price of one!
  3. Blame “The Market” for the loss of sales and tax revenue. Our City Manager even suggested it is immoral for people to live in the City and use City services while buying stuff online.
  4. Demand new regulations (i.e., the use tax) to “fix” the problem created in Step 1.

So here we are on election day in Boone County, Missouri. The voters that bother to show up will get to decide: who should pay more of the tax burden? Consumers or retailers?

Epilogue
Record low voter turn out (suggesting few people cared–if they were even aware of the special election) and the proposed use taxes failed 49.2-50.8 and 45.3-54.7 in the city and county, respectively. Not surprisingly, those residents for whom brick-and-mortar shopping is even less convenient voted even more to keep the price of the substitute lower.

 

Gambling on Your Kid’s Life

Gambling on Your Kid’s Life published on

My Twitter feed brought me an interesting piece by Christian Britschgi at Reason’s Hit & Run blog. In it, he lambasts this Washington Post op-ed decrying what they portray as the rampant abuse of life insurance policies by individuals who insure children only to then kill them and collect the insurance benefits. WaPo goes on to call for stricter regulations, naturally, to put a stop to this abuse.

Britschgi adeptly points out the self-refuting assertions in the WaPo piece–particularly that in each case cited either a) the victim wasn’t a child (not that adults’ lives don’t count, but it doesn’t comport with the drama of the headline), and/or b) the killer had already committed fraud (i.e., violated existing laws and regulations) in the process of buying the life insurance policy and then didn’t receive the payment because they committed further “fraud” by killing the insured. He also highlights that there’s nothing very ‘rampant’ about this kind of fraudulent behavior.

These articles reminded me of a conversation in one of my classes just a few weeks ago–and one I posted on four years ago here. Namely, the idea that life insurance is basically a bet that the insured person is going to die in the next year–and that when you lose the bet (i.e., the person doesn’t die), you pay up again for the next year.

This is a rather disturbing perspective for (apparently only an overwhelming majority of, but not all) parents who consider taking out life insurance policies on their children.  After all, how many parents would admit to gambling on the prospect that their kid will die in the next year? And yet, that is exactly what they do when they buy that insurance policy. (Yes, I know; there are other reasons to insure children, as I discussed in that earlier post…but the point remains.)

In Vegas, bets don’t get paid if the bettor is found to rig the game. Counting cards, loading die, rigging jackpot machines, etc. And the house has a strong incentive to monitor betting behavior to weed out cheaters. As the Reason blog shows, the same is true for life insurance companies.

Economics and the Millennial Marriage Drought

Economics and the Millennial Marriage Drought published on

“Why aren’t Millennials getting married? Despite the popularity of dating apps like Tinder, Grindr, and OKCupid, Millennials are not pairing off.”

That’s the opening line of an interesting post by Olivia Gonzalez and Erikagrace Davies over at LearnLiberty.org. It’s an important question. And an important observation.

They go on to suggest that a significant reason for the drop in marriage rates among millennials is due to lower real incomes relative to prior generations, combined with the need to be more mobile in today’s society and the difficulty that creates for young, dual-income couples. They suggest that the gig economy may create more non-traditional income opportunities that make it easier for such couples to work and, thereby, afford to get married.

I’d propose an alternate hypothesis–though one still rooted in economics–and it’s based on the opening lines themselves. The popularity of dating apps like Tinder, Grindr and OKCupid do more than just increase the ease of finding one’s true love. They highlight the great diversity of potential mates–not even just locally, but around the globe. What’s more, such apps and other social media make it easier to access–and assess–that much more diverse population of potential mates.

So what’s economic about that? Option theory.

An option is the right, but not the obligation, to take some action. Think of the decision to marry as an option. Dating allows someone to do more than just sow their wild oats. It allows them to consider different potential mates to find the “best one” for them, however one might define “best”.  But when one exercises the option to marry, the option to continue looking for a better mate is killed (at least in a society still dominated by norms of monogamy). In other words, there is an opportunity cost to getting married in the form of the foregone opportunity to find someone even better.

That means the opportunity cost of getting married is higher when there is a greater diversity of potential mates in the world. To use the language of option theory, the value of the “option” to marry is higher when there is a greater variance in the value (or quality) of potential mates. But once one executes the option and gets married, that value is lost.

This is really nothing new. According to the US Census Bureau, the rate of marriage among young adults has been declining for decades (as shown in the nearby graph from FiveThirtyEight)–well before social media and well before the economic constraints Gonzalez and Davies describe, but in line with the increased education and labor force participation of women. This provided women more economic independence, which allowed women to retain the option to marry longer–not needing to “cash it in” at a discount in return for economic security. Similarly, men encountered a more heterogeneous population of potential mates with a higher variance in potential quality. Throw in changing norms on same-sex partners and marriage over the past few decades, and the pool of potential partners is even more diverse.

Social media has not only amplified that fact, but has made it easier to consider and explore the greater variety of potential partners–making it that much easier to draw a sample from the population distribution. That means one can keep looking at relatively low cost, which increases the probability of drawing someone from the “best” end of the distribution. That makes the option all the more valuable–and the opportunity cost of executing the option that much higher.

Marriage is a complex issue, as reflected in this Pew Research Center report. (Staying married is even more complex.) I’m not suggesting an option framework fully captures the motivation and explanation for the “millennial marriage drought”, but understanding that perspective sheds more light onto what otherwise might be oversimplified as a simple budget-constraint argument that fails to account for the value created in the uncertainty of the process.

 

 

Calling a Cost a Cost: NY Anti-Free Speech Edition

Calling a Cost a Cost: NY Anti-Free Speech Edition published on

Seems the State of New York is going to the Supreme Court for another of its protectionist regulatory policies. Yesterday the US Supreme Court granted a petition to hear the case of Expressions Hair Design v. Schneiderman. As the WSJ explains, at issue is whether New York’s regulations concerning credit-versus-cash retail prices constitute a First Amendment speech violation.

The problem stems from the fact that the State of New York has attempted to have its cake and eat it to by ignoring economic rcredit-card-1520400_1280ealism and prohibiting retailers from calling a cost a cost. The State prohibits retailers from charging customers a fee for using a credit card, but allows retailers to give customers a discount if they use cash. A group of hair salons, led by Expressions Hair Design, sued the state for infringing on its right of free commercial speech. The salons won their initial case, which was reversed on appeal. Now SCOTUS will have an opportunity to weigh in.

The Cost of Using Credit
From an economic perspective, the issue is fairly simple. Credit card companies charge vendors a fee every time a consumer pays with plastic. How much depends on the credit card company, whether the transaction is run as debit or credit, and the amount of the transaction. But typically, the fee is around 2-4% of the amount of the purchase. This reduces the amount of revenue retailers receive when the customer uses plastic. Put another way, when customers choose to use plastic, it raises the retailer’s cost of doing business for that sale.

In a free economy, retailers could choose one of three options: 1) force the credit card user to pay the additional transaction fee, which raises the price at the point of sale, 2) charge the same price for all buyers, implicitly charging cash users more for the product to subsidize the costs of the plastic users, or 3) pass the transaction fee savings on to cash users by giving them a discount. The only economic difference between 1 and 3 is what the sticker price is relative to the price actually paid. In #1, credit card users pay more than the sticker price; in #3, cash users pay less than the sticker price. In #1, the credit card fee is made explicit by adding it on just for those consumers who use plastic. In #3, the sticker price includes (i.e., hides) the cost of using a credit card and by default is the price everyone pays unless they are aware of the cash discount. In either case (1 or 3), the retailer is price discriminating between cash and plastic users. Or the retailer could simply post two sets of prices, one for credit and one for cash, which would then beg the question of “why the difference?” And that is where the NY regulations become a problem.

The NY regulation prohibits retailers from choosing #1 but allows them to choose #3. In other words, the regulation allows retailers to price discriminate, but only if they present it as a discount for cash users rather than a surcharge for credit card users. In short, NY allows the exact same price discrimination between two sets of consumers, but restricts the speech of retailers in how they are allowed to describe that price difference. As Expressions Hair Design argues in their complaint, this places a burden on the business in how it is allowed to explain or justify what is otherwise a perfectly legal two-price pricing system since the regulations make it illegal for employees to explain that the difference between the cash price and the credit price is due to the cost of the credit transaction. It would be like passing a law prohibiting a restaurant from explaining the cost of its steaks went up relative to its pork chops because the price of beef rose.

Framing matters
Why would the State of New York prohibit credit card surcharges but not prohibit cash discounts? Consumers respond to price signals, so how those signals are presented matters. If consumers are charged an extra fee for using their credit card, it makes the cost (price) of using the credit card very obvious to the consumer and she is more likely to change her behavior by using cash instead. This would be bad for the banks that make a significant amount of money on credit card swipe fees. Not surprisingly, banks support laws prohibiting explicit credit card surcharges. However, as noted in #2 above, charging cash and plastic users the same forces cash users to subsidize the purchases of plastic users, which also tends to penalize lower income persons relative to wealthier shoppers. So allowing retailers the opportunity to provide cash discounts is socially superior to not allowing differential pricing. However, the NY’s prohibition on calling a cost a cost and explaining the price difference for what it is, is not only an infringement on speech, but unjustifiable as anything other than an attempt to mislead consumers and protect credit card issuers.

Primary Sidebar