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Two internet book vendors, Amazon and Bookdepository, have different pricing schemes: usually books are cheaper at Amazon, but Bookdepository does not charge shipping and handling fees. When you live abroad, shipping is relatively expensive, and therefore the difference is usually significant (in favor of Bookdepository). But there is one more issue that makes things a little more intricate: tax. Merchandise is taxed, shipping fees are not. In Israel, if you import goods that cost more than $50, you have to pay a 16.5% tax. Therefore, if one buy books that cost at Bookdepository more than $50 and at Amazon less than $50, then for buying at Bookdepository one needs to pay tax (and not shipping and handling fees), whereas for buying at Amazon one needs to pay shipping and handling fees (and not tax).

The decision problem that the buyer faces is clear. However, this brings up the following pricing scheme: the vendor can ask the buyer to choose whether he wants to pay for shipping and handling, in which case the price of the merchandise is lower, or he/she prefers not to pay the shipping and handling fees, but then the merchandise is more expensive. The total amount that the vendor receives is the same; the total amount that the buyer pays is different. In fact, the buyer may be willing to increase the total amount he/she pays to the vendor, if the price of the goods falls below the maximal amount that is free of tax.

One may wonder how often it happens that the books you desire cost less than $50 at Amazon and more than $50 at Bookdepository. By Murphy’s law, this will happen the next time you make an order. It happened to me in my last order of books.

Ok, not exactly the French Revolution, but they did turn down $6 billion from Google. I can’t help but wonder why. Perhaps my wonder is explained by the Shavian observation about those who can and those who can’t.

Groupon was not the first group buying site. Mobshop, funded, by amongst others, Paul Allen, folded in 2001 (or reincarnated as something else). What is it about Groupon that will ensure its path to glory will lead to other than the grave? I’m tempted to shout Santayana! Stantayana! I won’t, though.

Lets start with Groupon’s offers to users. Pay $x to get a coupon worth $2x from a merchant. If a certain number, say Q, of users sign on, then the coupon is issued, otherwise not. If the target Q is reached, the coupon is issued, the user pays $x, Groupon keeps $0.5x and sends, in installments, $0.5x to the merchant. Notice, by holding back the payment to the merchant, Groupon is able to ensure, to some extent, that the merchant comes through on their promise to discount by $2x.

Now switch to merchants. Why go through Groupon to offer a coupon? There are other outlets, including the traditional ones of coupons in the newspaper, flyers and those sent via the mail. More importantly, why discount in the first place? Let us count the whys (not mutually exclusive but, I hope, exhaustive):

  1. Price discrimination.
  2. To encourage trial, so as to convert to regular business. In effect, advertising.
  3. To attract business during slack periods.
  4. Move inventory that is old or obsolete.
  5.  Incremental volume; coupon may induce an existing buyer to increase the volume they purchase or buy other items they don’t normally buy.
  6. Experiment to determine the demand curve.

Reason (6) may have some merit, but the pool of customers who use the coupon are not an unbiased sample of potential customers. The coupon will attract a disproportionate number of the price conscious (adverse selection!). So, I will focus on reasons (1-5). A common feature of reasons (1-5) is the desire to cut price selectively rather than across the board. Hence, a coupon is effective as a means of selective price cutting as long as those prepared to full price (full payers) are less likely to track and use the coupons. Thus, the important question: what is it about Groupon that allows it to distinguish more effectively between full payers and non-full payers?

Traditional methods (newspapers and bulk mail) impose a slight cost on users with finding the coupon that (potentially) discourages those who would pay full price from coupon hunting. In contrast, Groupon makes it easier to find the coupon by alerting you to the presence of the coupon. On the flip side, to many alerts and sorting through them raises the cost of finding the coupon.

Perhaps Groupon generates higher redemption rates, so that coupons can be sent to fewer people? A merchant can adjust for that by paying different amounts to carry coupons via different channels. For example, suppose channel A generates one redemption for every 10 coupons sent out, while channel B generates one redemption for every 100 coupons sent out. Assuming no adverse selection issues between the two channels, simply pay B a tenth of what one pays A.

No coupon scheme can perfectly screen between the full payer and non-full payer. In some cases the merchant can control for it by limiting when (requiring a reservation) and by whom (new customers) the coupon can be used. So, there will be some mixing. To much mixing, and the coupon becomes an across the board price cut. Groupon’s quantity threshold allows the merchant to limit the downside of mixing. For example, one could assume, in the worst case that only customers who would buy at full price use the coupon. Then compute, for the offered discount, the incremental volume needed to break-even. This break-even volume would be the quantity threshold needed for the offer to go into effect (an aside: it follows that merchants who complain that participating in a Groupon offering lost profits, implies they haven’t done their arithmetic).Traditional coupon delivery methods do not have this capability. However, Groupon clones, can easily replicate this.

So, from my armchair, I cannot tell whether Groupon can distinguish full payers from non-full payers any better than traditional coupon outlets. The merchant is probably in a better position to do this and should be doing so. Thus, why prefer Groupon to any one of its clones. Perhaps its the large installed base of eyeballs? Ok, but what is their cost of switching from Groupon to a clone or going to an aggregator of coupon sites?

According to Herodotus, there is a race of men located

……..beyond the Pillars of Hercules, which the Carthaginians are wont to visit, where they no sooner arrive but forthwith they unlade their wares, and, having disposed them after an orderly fashion along the beach, leave them, and, returning aboard their ships, raise a great smoke. The natives, when they see the smoke, come down to the shore, and, laying out to view so much gold as they think the worth of the wares, withdraw to a distance. The Carthaginians upon this come ashore and look. If they think the gold enough, they take it and go their way; but if it does not seem to them sufficient, they go aboard ship once more, and wait patiently. Then the others approach and add to their gold, till the Carthaginians are content. Neither party deals unfairly by the other: for they themselves never touch the gold till it comes up to the worth of their goods, nor do the natives ever carry off the goods till the gold is taken away.

Trade, if Herodotus is to be believed, takes place with neither sight nor sound of the other. Hence, the term silent trade or dumb barter. Ibn Battuta, the 14th century explorer, relates that on the Volga River he was told of a land of darkness, forty days journey hence where those

who go there do not know whom they are trading with or whether they be jinn or men, for they never see anyone.

An Italian prelate, Paulus Jovius, reports silent trade was common among the Lapps, writing

They bargain with simple faith with absent and unknown men.

Taking these and other accounts at face value raise at least three questions:

1) If the accounts are to be believed and trade is anonymous, why doesn’t one or the other party `defect’ and steal the goods offered by the other?
2) If trade was mutually profitable and longstanding wouldn’t this be an inducement to communication?
3) How do the parties decide the location of the `trading post’ in the absence of communication?

I cannot see an obvious answer to at least two of these questions, and for this reason would expect that any account of silent trade be greted with skepticism. Indeed, some historians argue that the silent trade described by Herodotus and others may be a myth (see for example de Moraes Farias, but his focus is on Africa). If so, why are such tales passed on uncritically? Amazingly, there are instances of merchants sinking princely sums in schemes to participate in such trades based on these tales. The most famous of these are the attempts by Europeans to participate in the silent trade of Wangarra.

Setting aside the veracity of these accounts, one can still ask inquire an institution such as silent trade is even plausible. A starting point, perhaps, might be Kandori (RES 1992) and Ellison (RES 1994). We have an infinitely repeated game where, in each period, players from two communities are randomly and anonymously matched to play the prisoner’s dilemma (PD). Each player observes only the actions played in his own match and nothing more. Interestingly, cooperation can be sustained through community enforcement. If a player is matched with a rival who defects, he punishes all future rivals by switching to defection forever. In this way, information that someone has defected spreads until there is a complete breakdown in trade (how to do this for games other than the PD is discussed in Deb & Gonzalez-Diaz).  Indeed, at least one historical account reports a complete cessation in trade for three years in response to a `defection’. So, it appears the first of the questions I listed above may have an answer. The second question, I have not the wit to answer. The third invites an analogy to coordination games. The historical accounts suggest that river banks are a popular choice because they operated as a natural border between different communities. However, river banks are not the only focal points.

Click on this. Add Video

For those who prefer to read rather than listen (understandable given the way voice rendered is in XTRANORMAL) here is the script.

W: Hi Professor Smith.

S: Ah, Wickham. Thought you were in deepest Africa dispensing economic wisdom to the natives.

W: Yurt in Outer Mongolia actually.

S: So the bloom is off the development rose?

W: Yup. Realized that all that first year micro was going to waste. Reading Freakonomics on the flight over would have sufficed.

S: Now what?

W: Well, I was thinking of theory.

S: Good. What did you have in mind?

W: Behavioral?

S: Interesting.Why?

W: Its the hot the thing. The newspapers talk about it all the time. Obama’s administration is using it. Laibson! Thaler! Rabin.

S: Bit like curve fitting isn’t it?

W: That’s harsh.

S: You’re right. I should guard my toungue. I’m sure it is all very valuable and important. When the behaviorist’s produce an Arrow, I shall read him. Until then, best to let sleeping dogs lie. What else?

W: Ambiguity aversion, unawareness and preference for flexibility. In short decision theory.

S: I see, you’ve been reading your Econometrica. Agreed, its very seductive. Much like social choice in its heyday. And like social choice, a new Sonnenschein will arrive and say, enough with the axioms.

W: But, but, what about Pesendorfer, Dekel, Epstein and so on?

S: Aristocrats of the profession! Always the last to ride the tumbrils. Not a good idea to assume you will enjoy the same fortunes they did.

W: OK then. Existence of equilibria in repeated games with imperfect monitoring?

S: What made you think of that?

W: It’s hard and no one has cracked it. Plus, Horner, Fudenberg, Olszewski, are all good company.

S: You are right. If economic theory had a Manhattan project, this would be it.

W: Thats irony, right?

S: Irony? I don’t think there has been much call for irony in the profession, oh since, Lucas invented rational expectations.

W: Social Networks?

S: Only if you want to end up on the B ark.

W: Pardon.

S: Sorry. Forgot they don’t teach anything anymore in school. The Golgafrincham’s, decided to rid themselves of a third of their population.

W:This is fiction, right?

S: Yes. From the hitch hikers guide to the galaxy. The leaders of the Golgafrinchams announce the planet is about to die and so must be evacuated. A B ark is constructed to hold amongst others management consultants, insurance salesman and telephone sanitary engineers.

W: Ok, then, Global games?

S: Will the refinements literature never die?

W: Professor Smith if you don’t mind me asking. Are you really a theorist?

S: Why do you ask?

W: You seem awfully critical of theory.

S: I see. Yes, I am a theorist. But one just past middle age.

W: Why is age relevant?

S: Just as Salmon go upstream and Vulcan’s undergo Pon Far

W: Pon what?

S: Pon Far! A psychological condition affecting Vulcans. The benefits of a classical education. Look, never mind. All theorists undergo a mid life crisis. Some emerge from it declaring theory is dead. Others, become empirical. Some cynical, treating the whole thing as a game.

W: And you?

S: I say, its time to return to our roots. Back to catallactics.

W: Cat uh what?

S: I see, no Greek either. Pertaining to the exchange of money. Its what economics used to be about before we became an imperial science. Hayek always thought that Economics should have adopted the label catallactics instead

W:I see.

S: Yes, a return to our republican roots as it were. When none was for party and all were for state.

W: Poetry?

S: Macaulay. Anyway, what I’m trying to say is that we’ve been digging around the foundations of the subject so long that we’ve turned into Morlocks.

W: Got that one. H. G. Wells right?

S: Hope for you yet Wickham. Back to the point I want to make. All of this foundational work should, at some point, say something about trade. What’s amazing is the number of questions about markets that we don’t have answers for. Even wrong answers.

W: So, what do you suggest?

S: Off the top of my head? Lets see. Bankruptcy.

W: Bankruptcy?

S: Yes.In the US there are two ways to deal with it. First, is liquidate and apportion the proceeds according to a fixed priority rule. Second, on the assumption that a reorganized firm might be more valuable than in liquidation, reorganize.

W: Does the second mean that a contract can be revised after the fact?

S: Exactly. Why not write the contract to account for the contingency for bankruptcy? Thats an incomplete contract issue. But consider something more concrete. Assuming the firm is in banruptcy, what is the efficient mechanism to decide whether it should be liquidated or reorganized recognizing the claims of the various creditors and shreholders?

W: Why would that be useful?

S: Well, there has been a great deal of criticism of the existing approach arguing it is inefficient. That may well be, but what is efficient? While a number of scholars have written about this question, none has taken the problem head on by defining the environment and determining an efficient mechanism.

W: What else?

S: The design of healthcare exchanges.By their supporters they are touted as a panacea for a variety of ills. But their effectiveness will depend on the details of their design. What can we say? For example, should the kind of insurance contracts offered be limited in some way? Or , look at the exachnages already in place. Some appear to have failed others not. Why? I cannot recall a paper that talks about the design of markets where adverse selection plays an important role.

W: Professor Smith, this seems to smack of applied theory.

S: Don’t be profane Wickham.Its not applied theory. Its high theory applied!

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