Fixed Costs, Marginal Cost, and Ronald Coase

On January 18, Dean Baker published a blog post on the subject of Medicare. In it he discusses the cost of medicine and the standard economic theory of sunk costs and marginal cost pricing. He writes:

In the vast majority of cases, the drugs in question are not actually expensive to manufacture. The way the drug industry justifies high prices is that they must recover their research costs. While the industry does in fact spend a considerable amount of money on research (although they likely exaggerate this figure), at the point the drug is being administered this is a sunk cost. In other words, the resources devoted to this research have already been used; the economy doesn’t somehow get back the researchers’ time and the capital expended if fewer people take a drug that is developed from their work.

Ordinarily economists treat it as an absolute article of faith that we want all goods and services to sell at their marginal cost without interference from the government, like a trade tariff or quota. However in the case of prescription drugs, economists seem content to ignore the patent monopolies granted to the industry, which allow it to charge prices that are often ten or even a hundred times the free market price. (The hepatitis C drug Sovaldi has a list price in the United States of $84,000. High quality generic versions are available in India for a few hundred dollars per treatment.) In this case, we are effectively looking at a tariff that is not the 10-20 percent that we might see in trade policy, but rather 1,000 percent or even 10,000 percent.

The high fixed costs associated with research and development (R&D) in medicine are "sunk" in the sense that they can't be recovered after they are incurred. Leaving aside the effect of patents on the price of medicine, it is really the case that the price of a pill of Medicine X should be equal to the incremental cost of producing the marginal pill? In other words, should these firms follow marginal cost pricing?

Farmer Hayek at the 2016 Southern Ag Economics Association Meetings

Four of us will either be presenting at the SAEA meetings next week or are authors on papers and posters. Here's a list of titles with links to abstracts and full papers!

Levi Russell

Price Impacts of Brahman Influence in South Texas

Profitability of Beef Cattle Best Management Practices in South Texas


Michael Langemeier

The Challenges of Precision Agriculture: Is Big Data the Answer?

Economic Threshold for Dynamically Optimal Late Blight Management


Gregg Ibendahl

Kansas Farm Profitability Persistence: Do Top Farms Remain Top Farms? (also with Terry Griffin)


Terry Griffin

Defining the Barriers to Telematics for Precision Agriculture: Connectivity Supply and Demand

Value of Internet Connectivity Uptime for Multiple Vehicles Using Automated Section Control

Applying Data Envelopment Analysis Methodology to Site-Specific Precision Agriculture Data

Farmers' willingness to pay for farmland based on machinery and precision technology adoption

GMO Labeling and Market Failure

Three Oklahoma State University ag economists, Eric DeVuyst, Jayson Lusk, and Cheryl DeVuyst, recently published a short fact sheet on GMOs. The whole thing is interesting, but I especially liked #9.

9. Should food companies be required to label foods with GMOs?
     There are several existing voluntarily labeling programs, such as the USDA organic certification, which provides consumers choices on this matter in the marketplace. Thus, the question isn't whether GMOs should be labeled, but rather whether labels should be mandatory.

Though they aren't the same thing, any product that is USDA certified organic is also GMO free. The only reason I can imagine this wouldn't be a satisfactory solution to the problem of GMO labeling would be that a significant number of people want GMO-free products but don't care if they're certified organic.

Whether or not that group exists in large enough numbers determines the need for a mandatory label. If most people who want GMO-free products are content buying certified organic products, there's not much of a profit incentive to create another label or certification scheme specifically for GMOs. In that case, the mandatory label isn't necessary either.

If there are a substantial number of people who want a specific label for GMOs and that label doesn't exist, I would conclude that either 1) there's some "hidden" cost out there preventing the creation of that label (see this podcast or read about the "people could be different" fallacy) or 2) this is a textbook case of market failure.

I'm no expert on labeling (I dabble) but it seems to me that most people who don't want to consume GMOs also prefer organic. What do you think? Is this a textbook market failure? Are there costs we aren't counting? Have I missed something?

Subjectivity of Costs and Benefits or Why Minivans are Cool

On Tuesday I wrote a post on the economics of everyday life. The image below inspired me to write about the economic principles at work in my own life again today.

This image was posted by a friend of mine who is part of a select group of young adults. He and his wife are D.I.N.K.s which stands for "Double Income No Kids." Since he's not a drummer in a Rush tribute band, he has little reason to own one of these fine machines. However, there are obviously good reasons to own a minivan, otherwise no one would.

When I got my first job after grad school, my wife and I bought her a car. She wanted something fairly big since, at the time, our son was a toddler. We needed a family hauler, but she wanted something cool. This is what she got.

Price and Non-Price Allocation - A Personal Story

I've been very busy lately but I want to share a short personal story that illustrates an important economic principle.

Last year our son started speech therapy with a highly-qualified and experienced pediatric speech therapist. She's really good with him and he has made tremendous progress over the last year. She was able to get us in within a couple of weeks of our first contact with her and he's been seeing her nearly every week since.

The speech therapist is paid through our health insurance, so we pay a specialist copay for each visit. After about six months of seeing her twice a week, we started feeling the pinch of what amounted to several hundred dollars per month in copays. Figuring that the school system would provide us with an equally-qualified speech therapist and considering that we already pay taxes to fund the school system, we thought we'd start sending our son to the local grade school for therapy.

It's been four months since we first contacted the school and he still hasn't seen a speech therapist there (he continues to see the other therapist). By contrast, our current therapist saw him in roughly 1/4 the time after our first contact. We've called the school a couple of times just to be sure they haven't forgotten us. They've assured us that we are "on the list" and that this is a typical wait time.

My Confusion on WOTUS and Ag Exemptions

In the past I've been puzzled over the conflicting stories told about WOTUS by the EPA and Farm Bureau. The EPA claims that the rule does not impact normal farming operations but will require permits for many non-day-to-day activities farmers might engage in that would affect a "water of the United States." Farm Bureau makes much stronger claims, indicating that many typical practices will be hindered by bureaucratic red tape.

I've not found any source that nails down precisely what is and is not a "water of the United States." That's more than a little bit unnerving, as the definition of that term is the basis of the regulatory authority. [A previous version of this post indicated that my colleague Tiffany Dowell-Lashmet claimed that the EPA's characterization of the WOTUS rule is more accurate than FB. I've been informed that this is not her view and have deleted the offending portion of the post.]

A recent DTN column entitled "Farming Under Regulatory Fear: California Farmer's Battle Spotlights Growing Fear of Government Overreach" sounds at first like clickbait, but brings to light a case that makes me think Farm Bureau's claims are more accurate than I first believed. The article is ungated for now, but might be behind a paywall in the near future.

Richard Langlois on Dynamic Competition

This is probably the clearest explanation of the differences between the concepts of dynamic and static competition I've ever read. In his written testimony to the British Parliament in December 2015, Richard Langlois explains the differences between these two ways of understanding competition in the context of technological innovation and competition in electronics. While he focuses on electronics, many of the concepts can be applied to agricultural innovation. One especially interesting application to agriculture is the increases in the features seed companies provide to their customers (e.g. crop scouting for a relatively small fee). This testimony would be a very good addition to the reading list of any IO course.

The document is pretty short and is certainly worth reading. Here are a few of my favorite paragraphs: