A Beautiful Theory Falls to Ugly Data
marginalrevolution.com
marginalrevolution.com
EDIT I still don’t understand it, I think. My read is: someone named Coase theorized that monopolists of durable goods will actually sell their products at marginal cost because of some weird mind game with their customers (the obvious unwritten corollary being that monopolies are fine). This is obviously untrue and we all know plenty of examples (pharma anyone? plenty pills are mega durable). Nevertheless, somehow economists cheered at this theory and called it beautiful, despite how obviously ridiculous it is. But now the authors of this post debunked it with real data to, I hope, nobody’s surprise.
That can’t be it, can it?
Buyers don't just pop up on timestamp zero and remain unchanged. They anticipate price changes, potential new buyers come in, the market is dynamic.
I also don't understand why this only affects monopolies. The same logic should dictate that all products and services fall towards MC?
The authors themselves had the same reaction.
It's similar to physics: you make small simple models, you investigate what they say, you compare to what you get in reality, and then you make adjustments.
The interesting bit is: what kinds of friction or airpressure or shape do you need to add to your pig to recover what parts of reality?
> quite general conditions [under which] the logic goes through.
This seems pretty contradictory. There is no hint at which of the constraints is edited to fit better to reality.
Consider e.g. Steam (digital video games): Prices are discounted over time because of "greed" (=> desire to sell the same product to customers that value it less than the first wave).
Customers do adapt to this, and expect future discounts (sales) at release date already, and defer their purchase accordingly (despite valueing it higher!).
But in reality, customers are not 100% rational, don't have perfect information (on seller strategy), and the product value (to buyers) changes over time too (typically mostly downward), so the base assumptions are difficult to find in reality.
E.g., it is implied that consumers can postpone their purchase longer than the monopolist is willing to realize the profit. Is it the case here?
Or is there actually a game so durable that is not losing its appeal over time?
And is there a game which can be considered a monopoly (as an activity for spending free time)?
All of these points have to be fulfilled, none of them is, i.e., the conjecture simply doesn't apply.
Steam doesn't have actual monopoly. Their position is caused wholly by competition consistently shooting themselves in the foot by either offering inferior product or just annoy the customers
For example let's take EGS:
"We will take lower cut, buy from us!"
"Ok, so that means game will be cheaper right ?"
"Of course not! Just devs get that. Also we lied in marketing and compared our pre-transaction-fees cut to Steam's post transaction fees cut. Also we didn't mention Steam lowers their cut when games sell well, so the difference is far smaller in reality"
"Sigh, I guess I might try it for that reason, how does your service looks like"
"Well it has 1% of the features Steam has and about 20% of the features you actually use in Steam are here"
"...why the hell I'd buy at you?"
"Coz we paid devs of games you like to release exclusively at our platform?"
"How about fuck you I'd just get it on Steam".
About only competitor that tried was GOG but their "no DRMed games at all" motto meant that they just don't have games people wanted.
So, Steam enforces DRM while GOG doesn't? That's an improvement!
Actually no, Steam DRM is entirely opt in and devs don't need to use it at all.
So yeah. I do wait for deals sometimes but it would be silly to say that these two things have the same value in the eye of the consumer.
If that what it means, Steam would not apply, because games were by that definition very much not durable.
It's the same as watching a movie in cinema or following a series or watching it later.
This doesn't just apply to multiplayer games either. There is value in the active community conversation surrounding games like Expedition 33, Elden Ring, Baldur's Gate 3, etc.
> But in reality, customers are not 100% rational
Or they are, and assign higher value to having the product now, rather than in the future.
I can easily see that apply in the case of pharma, where paying $$$ now can be preferable even over getting the product for free a month from now, when you’re dead.
The gist of the conjecture is that if the customers can wait out for price drops and the monopolist wants to sell their thing, then after a few rounds of "he knows that we know that..." the price ends up to be the marginal cost.
Now, real world disagrees with the model, so next steps are to examine why this happens and maybe discover some new economic interaction.
The conjecture requires a theory of time in the form of periods/rounds to reduce price to zero - but wants to ignore time when it comes to information spread and product value.
Pinning a variable to any 1 extreme can be very informative, but when the variable has to both exists to justify the presumption, but also be ignored in the model - you're not going to find an elegant basis for a grand-theory-structure to add corrective terms onto.
Instead, you'll just get a mess of variables from over-fitted data.
If you want to make Game Theory collide with reality, the actual convergence to an equilibrium is only one of many venues where there is a large divide. Other assumptions of these models - from rational behavior to uniform prior assumptions - are equally problematic.
Game Theory models are nevertheless very helpful because they require you to actually lay out your assumptions or - when you observe something else - reason about "what else is going on" in any of these areas. As it turns out (as another person has said), it is also immensely helpful when designing mechanism (i.e. games) like a Steam store or an ad auction, which is why tech companies hire quite a few Game Theorists.
Game theorists, like any academic, prefer models with the least number of assumptions and (transitive) dependencies.
My issue is with thinking this presumed fixed point was created with an elegant model (and thus conclude it's relatively interesting to study).
If you deconstruct the model - i.e. look through its full dependency tree to state the assumptions - It's not simple or elegant.
Other assumptions like modeling without irrational behavior are purer in that sense.
EDIT: I now understand “durable” to mean “something that lasts long”, whereas I thought it just meant “non-perishable” (ie not fruit or flowers).
Gotta admit I still don’t understand how the original theory resonated with anyone though. I can’t even come up with an example. What monopolist sells a durable good? Games aren't a monopoly. Most other monopolists sell subscriptions or consumables (eg a train ride).
There is durable good which means that consumers will only buy once (pharma doesn't seem to fit here).
And there is the monopolist. So there shouldn't be any outside options, as the last paragraph claims in the OP.
And the marginal costs seem to be constant. Which is only the case for things like data or software. For most goods, however, one needs to invest in production facilities to increase output for a bigger number of goods. In this case the marginal costs will increase as well and so it would make sense to first sell a lower number of goods for a higher price.
Somehow, it doesn't quite add up for me, but I can't quite put my finger on what it is. It reminds me of the unexpected hanging paradox.
The issue if, of course, that marginal revolution overstates the contribution of a single empirical study here.
Of course everyone is aware that the original model doesn't hold in reality. The contribution of showing this in the ebook market is... not zero, but certainly not the implied "We killed the theory!!!!"
Instead, there are decades of papers poking holes in the Coase model and producing ideas as to why the conjecture doesn't hold. In my mind, these are the more interesting contributions. The authors mention two, but I think far more tangible are time preferences, time horizon limits, pertubations, non-uniform prior assumptions and bounded rationality.
Being a bit more humble, perhaps the lesson is that the difference between the theory and reality highlights externalities that always exist in the real world that make the theoretical model miss a crucial piece of the real world. It's logically correct in some sense, but incomplete.
Paul Krugman: https://www.princeton.edu/~pkrugman/interstellar.pdf
"This paper, then, is a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics."
- Classic HN commentor
Sure, my tone was dismissive but that’s because what I understood the article to mean was clearly, obviously ridiculous and I tried to make that clear.
I also clearly introduced myself as someone not knowing anything about economics, having to google “MC”.
Much like the the people ignored the idiot savants tucked away in medieval monasteries. At some point they become useful, like when the king needs to know what the nature of God is, who It approves and why it’s him and not the other guy.
Now that we've traded our warrior nobility for economic nobility, the neurodivergent and mildly touched ones are tucked away in academia instead. Pleasantly seperated from their subject of study. To figure out the nature of "The Market", and why it is, in theory, as Rational and Self Organizing as a medieval Thomist Universe.
And we are like the medieval peasantry who cannot understand an iota of what they're scribbling in their intimidating books. But we can see they're still fighting over It, just like they fought over resolving the philosophic contradictions of the faith.
It makes one wonder: what shape and mission will They have next? Will it be in explaining the actions of some sentient supercomputer, which both feeds and spanks us? Or which irradiated plants will take us beyond the Seventh Sphere, in theory? More at eight.
If that fails. Coase's argument fails. No?
Anyone writing books (or a "firm in coses math) needs to persist, aka they need to keep things like consumers understanding of their quality and pricing. If they drop prices to nothing they have consumers learn that. Consumers that try to wait forever in an "idle" state make no purchases and are not part of the ecosystem. Only consumer that don't wait forever matter. aka if they are looking at your ebook and don't buy they will rapidly buy a different ebook because they cannot wait for infinite time. aka if you teach your customers to wait they wont actually wait for you, but will simply switch to something else.
This is a control-and-feedback problem. Coase Conjecture fails because it assumes that you can have a system that persists without a governor. The two real world explanations correspond to the two ways you can introduce a governor.
An equilibrium for a given game is - depending on the equilibrium concept (bummer, even more conditions) - is a stable outcome of some sort with usually no claims as to how it would actually be reached.
By that, you can already see that this is not really an actual theory of an empiric situation, but rather a mathematical model of a certain solution structure.
If you were to write this paper today as an economist and your goal was to claim that is actually, really holds in reality, then you'd not only have to produce the theory but you'd also have to build some sort of empirical model that you can estimate with somewhat plausible identification conditions and structure, or be able to show it in a (pseudo-)experiment setup that is believable enough. Suffice to say that there are very few such claims made on reality in modern microeconomics (that is to say, Game Theory by and large)
As it turns out, these sort of mathematical models have quite a bit of value in a normative setup, say if you go and design a market or an auction. Less so as a theory to explain all of reality.
I think in Coase's time, it was easier to write a 6 page paper from your bathtub and claim something about the world. Wasn't there an xkcd comic like this?
The full set of constraints (monopoly, durability, constant MC, timelessness) can hardly ever be fulfilled. So it is not falsifiable by empirical data.
But nobody has questioned the logic conjecture itself here, even the article doesn't try. It seems pretty plausible, doesn't it?
In practice a lot of reader will just be looking for a hit for their dark academia vampire romantasy addiction. The book is essentially read once, and the buyer is perfectly fine with a different title. It's durable in the same way that a newspaper is, and the publisher has a monopoly in the same way that a used car salesman has a monopoly on the car with VIN f6d45280.
Similarly, the reader's perceived value isn't constant. A newly-released "part 1 of 7" of an unknown author (who knows if it'll ever even get a part 2) is less interesting than the debut novel of a well-established author. Likewise, demand can significantly increase due to the release of a spinoff TV series, or significantly decrease when the author is disgraced in some scandal.
There's only a true monopoly on things like college books, and there the demand has basically zero elasticity: either accept paying $200 for the book now, or fail your $2000 course. And those aren't exactly durable either!
Also books without copyright are obviously cheaper beyond pricing than those with copyright. There is a rights holder there somewhere making a cut.
That reads absolutely like a wishful thinking of people that desperately want you to believe that monopolies have any saving grace.
The best strategy is to delay the sale as much as possible, if your potential customers get more affluent on average (more than safe return on capital). Keep price high and steady, gradually capturing more and more customers at this price. The only thing that could force you to lower prices would be looming effective competition (which means you are about to lose your monopolist status) or your customer base shrinking due to general increase in poverty.
Similarly, the marginal cost of a new release has to include all of the creative production of it to that point. Authoring and editing. Not just the marginal cost of replication of a completed work.
That is, the marginal cost of a new release is creating the new release's content! Which is very very different from the marginal cost of just making a copy of it months later.
If you look at real world examples like wheelbarrows (something like 80% of all wheelbarrows sold in the US come from one company) - sure they use a bunch of tricks to charge more for some customers - but the cheapest, basic wheelbarrow is being sold for something close to marginal cost.
Nearly every brand of wheelbarrow you see at hardware stores is just a white-labelled Ames product. (With the exception of Gorilla Cart and a few niche players).
There are a limited number of iPhones....?
Do either of those examples shed light on where Coase went wrong that agree or disagree with the authors?
Generally, the assumption is that everybody in the market is aware of what's going on, and can adjust their spending accordingly.
Unless you mean discounted future cashflows of purchases, but that would imply by charging a low enough price all future purchases would move to the present.
I'd consider the case of laundry machines. People buy them every so often and then don't need a new one for awhile. Since they didn't buy them all at the same time in the past, one should not expect they will buy them all at once in the future. It seems profit maximizing to behave like traditional monopoly theory, to keep the price high. Is there an economic pressure that would push a monopolist's prices down?
I mean, with any theoretical modeling, you have to assume that the market actually fits the theory's requirements, right? From what I can gather just reading about it, the market the Coase conjecture model requires is one with a fixed set of consumers, a homogeneous durable good, and a monopolistic seller. But the real ebook market has a constant influx of new consumers, substitute content, complex contract structures, and, crucially, promotional events and coupons.
So in the end, I think we have to understand it as something that only holds under very specific conditions, not something that maps neatly onto real world cases.
That said, I'm curious. If you were to model the ebook market in general, what would the high impact variables be, and which ones would have relatively little influence?
But what I don't get is, are there even that many markets where the Coase conjecture actually holds? I'm not so sure.
I mean, you take reality and you turn it into a theoretical model. So my question is, are there really that many markets out there that fit the Coase conjecture in the first place? Sometimes when I read stuff about economics, it feels like people slice up the variable modeling to only look at what they want to see, and only in the regions they want to see, and then they claim it's universal. Of course, counterexamples keep popping up. And that's why it always feels so shaky.