Financial and Economic Literacy: Implications for a Fed policy rule

FINRA and a multitude of other online sources allow members of the public to test their financial literacy. Sadly, the results of these online quizzes showcase a lack of knowledge on basic financial matters by the public at-large. On FINRA’s version, the national average score is solely 2.88 correct answers out of the following 5 questions:

• Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, how much would you have? (Answer choices are simply: “More than $102”, “Exactly $102”, “Less than $102”, and “Don’t Know”)
• Imagine that the interest rate on your savings account is 1 percent a year and inflation is 2 percent a year. After one year, would the money in the account buy more than it does today, exactly the same or less than today?
• If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
• True or false: A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage but the total interest over the life of the loan will be less.
• True or false: Buying a single company's stock usually provides a safer return than a stock mutual fund.

On the National Financial Educators Council’s version, the average score for participants aged 15-18 years old is only 60.08%. These disappointing results serve as exhibit for a need for improved financial and economic literacy among members of the general public.

Most fields of science face challenges when it comes to communication and engagement with the general public. While this is perhaps most pressing for some fields of the natural sciences—for example, those scientists communicating climate change science—it also applies to topics in the social sciences, and in particular to those that guide policy.

A lack of financial and economic literacy does not only jeopardize the individual financial health of households, but also the health of the economy at-large. Be it a chronic lack of saving (a recent Google Consumer Survey found that 62% of American households have less than $1,000 in their savings accounts, and that 21% don’t even have savings accounts) or its implications regarding economic growth and the effectiveness of monetary policy, the ability of economic policymakers to effectively craft policy is hampered by the public’s misunderstanding—or simply lack of understanding—of the policies or the issues underlying them.

Indeed, many—both on and off the political spheres—call for strict audits of the Fed, and for this central bank to follow a policy rule, by which some formula would dictate the effective Fed Funds rate (as opposed to it being voted on by members of the FOMC). As any testimony by Chair Yellen would attest, the Fed faces much pressure to follow this rule, but such a process would severely hamper the Fed’s ability to take extraordinary action during times of crisis, or even of expansion.

After all, when the time comes to set policy, the Fed must be able to weigh different moving pieces and dynamic factors of the economy as they arise and evolve. A formula, no matter how robust or well of a fit to past data it may be, would never be able to deal as effectively with policy-setting—at least for the moment—as the power of human brains trained in Economics.

After all, many point out that well-known “rules” (such as the Taylor rule) would have likely implied negative interest rates during the financial crisis and ensuing recession of 2008-2009. Yet, at the moment, a negative interest rate is not part of the Fed’s arsenal for setting policy. As such, tying the Fed to only follow the prescriptions of such a rule would have implied a policy less responsive to the gravity of the situation (as the Fed Funds rate would have likely been set at the floor of 25 basis points, but without the option for quantitative easing as rolled out further in the crisis, or for forward guidance, two powerful tools employed by the Fed in this recovery).

Moreover, rules would have to follow data as observed historically and regressed with different econometric models, and be at the least informed by economic theory. Yet, even now we face a time where we see a tightening labor market, but persistently low inflation (a phenomenon many have referenced to call for patience from the Fed in raising rates). A model would thus likely respond inadequately to such moving forces—as traditionally and theoretically, an expansion implies lowering unemployment and increasing inflation. The Fed must be able to adapt to the future and to extraordinary circumstances, such as the ones we observe today. A rule would instead limit the Fed’s ability and flexibility in responding to crises.

Lastly, the Fed must be able to gently guide policy, while a rule might instead lead to abrupt changes, or lag the economy. By definition, a rule/ formula must be data-dependent and driven by what’s been historically observed. As such, a rule is almost exclusively backward-looking, so that policy changes may be mistimed, too strong or weak depending on the situation, or fail to adjust for future expectations.

All in all, rules and formulas—like algorithms in general—help simplify processes. But monetary policy should inherently not be simple, and should not follow a cookie-cutter process, as the economy is not itself a predictable mechanism. While more transparency from central banks is always welcome, the truth is that a rule would not benefit anyone in the economy, as policy would likely remain above the level of financial and economic literacy currently observed (thus, no one’s thirst for complete transparency would really be satisfied), a rule might be as or more error-prone than human policymakers (given the limitations in observing all the data and weighing the different factors appropriately, according to purely historical relationships and not evolving phenomena), the models used to determine the rule would likely face as much if not more criticism than the current human policymakers, and a rule might imply a limiting of the effectiveness of monetary policy (making our economy dangerously more policy neutral), as it allows agents in the economy to absorb information more quickly and expect changes in policy before they actually happen, as prescribed by the rule.

As even some Fed papers have laid out, the Fed can often be a bit of a black box. As such, economists and policy makers face a challenge in increasing the financial and economic literacy of the general public, such that their own policy recommendations and research results are more meaningful, fruitful, and effective. However, a rule to tie the Fed’s policy-making power goes too far in the direction of “increased transparency,” instead limiting the Fed’s ability to carry out its dual mandate. A happy medium between outreach to the public-at-large, simplified policy statements, and increased knowledge of the workings of economic policy would go a long way in bridging the gaps between economists and the laymen affected by the former’s policy actions.

The Fed’s Decision: On the Federal Funds Rate and Optimism

This Wednesday, December 16^th, members of the Federal Open Market Committee are widely expected to raise the Federal Funds rate—and with it, short-term interest rates—for the first time in nearly a decade.  While it is of course simple enough to come to an opinion when the choice seems much clearer—though many still remain skeptical of the appropriateness of a rate hike, and there are of course many risks and uncertainties—I am currently of the opinion that an interest rate increase is the proper course of action at this time.

While there are ongoing and vigorous debates in macroeconomics about the role of policy in the economy—in particular, whether fiscal and monetary policy are effective tools at all in a “policy-neutral” economy—there are several reasons why an announcement by Chair Yellen and the members of the FOMC regarding an increase in the Federal Funds rate is appropriate this Wednesday. I will try to list these reasons here, as well as acknowledge and potentially address some of the main concerns that arise with this potential action.

Why the Fed should raise rates:

• A higher Federal Funds rate is a sort of macroeconomic insurance policy, potentially pressing the brakes on the economy and slowing its momentum (the policy’s premium), but for the sake of more flexibility at a time when a stimulus policy is required (the payout).  Having an interest rate above 25 basis points provides a cushion and some wiggle room for potential further slowdowns.

• Whether we believe or not in the role of psychology and behavior in the strength of the economy, raising interest rates is a signal of confidence from the Fed in the economy, that may spur further confidence in the agents that participate in the economy itself. As learned in any introductory macroeconomics course, inflation (among other economic variables) can often be self-fulfilling. When people expect or believe the economy to be heating up, they may behave in a way that confirms and produces that very expectation.

• Most of the recent concern over the last few weeks has regarded falling commodity prices, which many see as a sign of weakness in the global economy. Coupled with still comparatively weak Eurozone and Chinese economies, many are concerned that we are still in a highly unstable situation. However, the Fed has expressed its belief that this downward pressure on inflation should abate with time. Naturally, there should be a floor to which prices of commodities—such as oil—should fall. When that process ends (at the time of this blog post, a barrel of crude oil is well below $40, as are its futures), there should in fact be an upward pressure on inflation. The performance of commodity prices should be seen as a temporary phenomenon, and one that is considerably supply-driven. As we know, production of crude oil by the United States is near record-highs, and the members of OPEC have not pared down their production targets to lower global supply. As such, falling commodity prices (in particular, oil) could be seen predominantly as a supply-driven phenomenon, which is less concerning in the immediate time span than the demand-driven view (where falling oil prices might signal a weakening in manufacturing, production, etc.).

• While financial stability is under the purview of the Federal Reserve, financial markets should not be the main consideration behind the Fed’s decisions. In fact, many of the notable movements over the last weeks in the prices of several important assets (the EURUSD exchange rate, bond yields, etc.) show that markets have long begun pricing in the effects of a rate hike, and widely expect the Fed to raise rates this Wednesday. Deciding otherwise at this point might be a negative signal on the strength of the economy. While there are of course valid concerns over the level of inflation, the labor markets and growth, the U.S. economy in particular is considerably healthier than it has been in nearly a decade (since the beginning of the recession in 2008 and the first rumblings of crisis in 2007).

• If we view inflation rates as tied (and potentially lagging) interest rates, raising the latter may in fact be a good way for the Fed to address concerns over disinflation and a potential deflationary spiral. Of course, we should not fall into the fallacy of believing that the Fisher equation—or generally the fact that interest rates and inflation rates are highly correlated—implies a causal relationship between these two variables. After all, the omitted variable here is likely that higher inflation rates follow a strong and vigorous economy, which may be accompanied by increasing interest rates as the Fed prevents overheating. But to the extent that prices follow increased costs of capital, and other factors provide a more causal relationship between interest rates and inflation, perhaps a hike in interest rates may help breathe further life into U.S. inflation.

• Wage growth, which has been closely observed as it is tied to and is a strong signal of inflation, should face upward pressure as the labor market tightens further. Concerns over the low labor participation rate are partly addressed by the beginning and continuing retirement of the large generation of baby boomers.

• "Creative destruction”: easy money makes risk-taking easier (the Fed is often blamed for not raising interest rates quickly enough in the years preceding the financial crisis of 2008, as low interest rates encouraged risk-taking in mortgages and other financial products), and allows for the inefficient survival of firms that—in a more competitive environment—would potentially go under. While the closing-down of firms and the subsequent loss of jobs is often not a positive development, if these firms are sluggish and inefficient, they can be a drag on the economy and prevent more innovative, entrepreneurial firms to take their place. Indeed, it can be as problematic to make running a business easy as it is to make it difficult; “creative destruction” entails that it is more optimal for inefficient businesses to not survive. Enabling them to survive means a weaker economy, less innovation, more complacency and deadweight losses on the economy. Less easy money and loans will mean literally “survival of the fittest” firms, which some might argue is how economies should thrive.

• Many have remarked on the abundance of excess reserves in banks. In a world where we perhaps see supply of loans (as opposed to demand) as the main driver of the amount of credit in the economy (meaning, a large determinant of how much loanable funds exist in the market is banks actually being willing to lend out money, which we saw was not the case during and immediately after the financial crisis), then raising rates may actually be an incentive for banks to increase their lending out processes, enabling a smooth flow of credit into the economy that might help counter any negative effects of a rate hike. Indeed, with higher interest rates the supply of loanable funds should increase, allowing us to increase our savings rate and, in the context of the Solow growth model, help propitiate a faster accumulation of capital.

• A slow, gradual tightening of policy should be good for the economy; the brakes need to be applied at some point and it’s better it be done smoothly and with warning (see criticisms of last crisis, how the Fed didn’t raise interest rates in time time). We wouldn’t want to raise rates too quickly, without warning, actually causing trouble for markets and consumers alike. The way the Fed has framed and given extensive forward guidance should ensure that expectations have been primed so as to avoid a major shock to the economy.

Of course, as with any other major policy action, there are significant risks and uncertainties. Perhaps the most cited concern by economists and commentators alike is a potential deflationary spiral, as an increase in interest rates provokes a slowdown in the economy (potentially a recession) and the vicious cycle of continuously falling prices (Japan presents a clear case-study).

To address this issue, it’s important to first gain some perspective. After all, the likely increase in interest rates is only a 25 basis point hike, which would then be followed by a slow, gradual increase that would likely follow the same guidelines the Fed has set with forward guidance.  Because of this new practice, in fact, the economy has absorbed and “priced in” the effect of this hike already. As such, this policy action should not actually be a “literal” shock to the economy.  Considering that many macroeconomic models view a role for unexpected shocks (for example, models like the Phillips curve, and generally rational expectations), the interest rate hike should ideally not have a major negative effect on the economy, as it has already been incorporated into our collective information set. Of course, this brings us tangentially to the topic of policy neutrality. After all, if the economy prices in and adjusts for this change in the first place, is the Fed actually able to provoke any changes in the real economy? That is a debate I’m likely not prepared to address—at least not at this time.

Another concern relates to the politics of the situation—some are concerned (on all sides of the political spectrum) that the Fed might provoke a change in the performance in the economy that will have real implications on the Presidential and Congressional elections next fall. To Democrats, a rate hike has the potential for a recession that would destroy any positive legacy regarding the Obama administration’s role in the recovery, and potentially make it more difficult for the Democratic nominee to win election to the White House (with all the subsequent policy implications that would entail). Republicans, on the other hand, are concerned that a delay in the interest rate hike would be a concerted ploy to aid the party in power by stimulating the economy further.

Of course, this concern should be easy (and highly critical) to assuage, as independence from political pressures is an incredibly important factor in the credibility of central banks and—in turn—the effectiveness of their policy actions and their ability to actually have an impact on the real economy. I think it should be clear enough that the Fed’s role is not to hamper or abet the political campaign of any one candidate or political party, and (while it might be necessary to do so) addressing these concerns directly might go too far in the way of granting validity to those who already criticize the Fed for lack of political independence. Validating these concerns is to accept that they are founded and pressing—which we would all like to think they are not.

Lastly, many are concerned about the dynamics of the Fed raising interest rates and, in turn, strengthening the value of the dollar, while the European Central Bank simultaneously continues and expands its own program of monetary stimulus that might further strengthen the USD. This, of course, plays into the recessionary fears, as a significantly strengthened dollar would reduce American exports, increase imports, and in turn, lower growth and GDP. However, this can also be seen as a positive for American consumers and for foreign investment, as the higher interest rates provoke a larger inflow of capital looking to invest in the United States.

I would like to end by once again providing some perspective, and perhaps some caveats. The action the members of the FOMC may take on Wednesday represents a long, careful deliberation process years in the making, and one that in the end may represent a comparatively small increase (likely 25 basis points) in the Federal Funds rate. Like with every policy action, there are risks and concerns. At some point, however, we must lift off. Now is looking better than it has in a while for it to happen.

This financial crisis and Great Recession has done a lot in the way of provoking a sense of pessimism and lack of confidence in the American and global economy. The repercussions of this crisis were indeed painful, far-reaching, and long-lasting, so any hesitation or skepticism at this time from both professional economists and laymen is understandable. Moreover, some may be concerned that the Fed is rushing into an action by simply trying to follow the psychological “clock” of moving early, before the end of the year is out. The turn of the calendar page could be seen as yet another failure—another year in which the economy has not fully and entirely recovered.

Yet, the economy has weathered both the original crisis and many other, smaller panics over the last years, and particularly over the last few months and weeks in the financial markets. I am confident in our policymakers, and optimistic that forward guidance should imply that with rational expectations, markets and consumers have absorbed all relevant rate hike information. Unemployment should not rise (especially given the strength in the labor market anyway), weak companies might be replaced by stronger and more innovative firms, and prices should follow the rise in interest rates as people ask for and obtain higher wages.

We can certainly expect some turbulence, but an increase in interest rates also represents a return to normalcy. In her testimony to Congress recently, Janet Yellen stated: “In closing, the economy has come a long way toward the FOMC's objectives of maximum employment and price stability. When the Committee begins to normalize the stance of policy, doing so will be a testament, also, to how far our economy has come in recovering from the effects of the financial crisis and the Great Recession. In that sense, it is a day that I expect we all are looking forward to.” Indeed, psychologically, Wednesday will be a day when we can all finally say: we made it.

After this entire discussion, the most important thing is that an interest rate hike perhaps means the return to one of the factors that’s been missing and, personally, I think is critical to the strength and performance of an economy: optimism. It is optimism that makes us move forward, take [healthy] risks, and progress. It is time for us to be optimistic about the economy once again, and Wednesday will hopefully be just a smooth and careful first baby step.

Polling and Measuring Economic Data

Anyone following electoral politics for the last couple of years will likely admit: opinion polling has definitely trended both less accurate and precise. As this article from The New York Times outlines, there are several factors underlying the decline in accuracy in public polling of election races. For the apolitical or those unconcerned with elections, this may not be a problem. But when it comes to economics, this may be a problem that should concern us all.

It is often easy to overlook data and its sources, and take the information we obtain for granted. Yet, behind the numbers on unemployment, growth and GDP, inflation, and other macro and micro variables, are strict methodologies that attempt to measure data as accurately and precisely as possible. These methodologies are of course oriented to ensure large random samples when necessary, and generally to avoid bias and ensure consistency in the variables that organizations and government agencies report on a regular basis. Some of these methods—such as seasonal adjustments—are more familiar than others. But the problem is that, if standard and tested methods are failing when it comes to measuring political sentiment, those economic variables that take in the public’s answers and opinions may be inaccurate as well.

Most economic variables are measured very consistently over time—such as unemployment, by interviewing a set number of households over a time period—and generally, since economic surveys try to capture facts on the economic situation as opposed to opinions, there should in theory be less of a concern than there is in political polling.

However, many other variables cited frequently both by the media and practicing economists—such as consumer confidence, indices of job creation, etc.—rely on the opinion of those polled (which may not be a random sample or not reflect a consistent sample across time) to less clearly defined questions (i.e. questions such as “is your company hiring?” “is the economy headed in a good direction?” “rate the strength of the economy” that might have much less objective criteria or set of answers). Moreover, the methodology to ask these questions often does not rely on the sophisticated methods used to measure other economic variables, such as the Current Population Survey.

As such, the use of these measures to gauge the strength of the economy, potentially define economic or public policy, or sway the outcomes of elections, can be highly problematic. While Economics is a rigorous science, and policy-making an intense study of all the factors in play, how we measure the economy has always been a topic of discussion, and one that we should continue to examine carefully—particularly regarding the sources and, in turn, the accuracy and precision of our measures. From the criticism of economists—including Nobel Prize laureate Joseph Stiglitz—regarding GDP and our measures of welfare, to the surprising lack of accuracy in political opinion polling running up to electoral events, how we measure the data around us should be as important (if not more) as the applications we find for that data. After all, without ascertaining the reliability of the data itself, all inferences obtained from that data should be moot points.

Public Funding of Football Stadiums

In recent months, various National Football League franchises (primarily the San Diego Chargers and the St. Louis Rams) have threatened their respective home cities with a move to another locale remarkably without such a sports team: Los Angeles. With the expressed motive of receiving public funding for new or enhanced football stadiums, these teams and their supporters invariably cite many an economic argument for why public funding for these pieces of infrastructure should be approved. Befittingly, back in 2001, the St. Louis Fed already published a summary of the economics behind public funding of stadiums, available here: https://www.stlouisfed.org/Publications/Regional-Economist/April-2001/Should-Cities-Pay-for-Sports-Facilities.

Of course, among the arguments included are the fact that most revenues from these upgrades or new stadiums stays with the owners of the franchises themselves, since these franchises usually sign contracts giving them full benefit over naming rights, concessions, ticket sales, etc. In particular, the oft-cited argument that these stadiums will benefit their home cities through increased tourism, spending in the stadium and businesses surrounding stadiums, and multipliers that amplify the effect of these revenue increases, is usually a misrepresentation.

After all, it doesn’t require an individual with advanced training in Economics to consider the issue of opportunity costs. After all, by investing public money in these stadiums, cities are not only suffering the direct costs of funding, but also forgoing the benefits of other—often much more lucrative—alternatives. In particular, many economists point out that the quoted increases in revenues are often not materialized, as new stadiums do not inherently cause new tourists to visit these cities that already housed these sports teams. Moreover, considering the spending of both citizens and tourists as mostly fixed budget constraints, the construction of a new stadium for an already-existing football team may potentially increase revenues for the franchise owners, but only at the expense of other businesses these people would have spent their money in otherwise. Thus, in short, most economic benefits—when they even exist—of new or upgraded stadiums are nullified (and often overpowered) by the costs to the cities that house them. And most critically, when they do exist, they often stay at the hands of those individuals who own the franchises, rarely seeping back into the economy that helped fund them. In short, public funding of new stadiums—in particular when used as a threat against moving to another city—represents almost entirely public costs and private benefits. The marginal benefits of other alternatives at the same marginal costs to the cities that would house these stadiums should make the refusal of these projects a no-brainer.

Of course, this question spans more than economic arguments and assumptions. After all, these sports teams possess loyal and committed fan bases that very much fight for their team’s permanence in their cities. Their loyalty and commitment is not something I can argue against, but from an economic and financial perspective, using their and their fellow taxpayers’ money to fund teams that hold these cities hostage for funds they can easily raise on their own, and that will have few returns on taxpayers, is not a sound decision. Research in behavioral economics likely would provide some intuition behind these fans’ willingness to support these projects.

Lastly, a major problem is that new stadiums are an unsound investment for cities that already house these teams. Yet, for cities currently without a team, the introduction of a football team might actually provide large economic benefits (depending however, on the profile of the city in question—after all, would more tourists visit LA because of a football team? One might assume the economic impact of a sports team is largest for cities without an established tourist base already. Thus, there would be decreasing marginal increase in tourists as city and established tourist base size increase. This consideration might in turn extend to an interesting game theory question: even if San Diego or St. Louis understood that returns to public investment in these stadiums would not be sufficient, because LA would benefit from such a move and would likely offer money for it, San Diego and St Louis effectively have to bid beyond what they would be willing to, just to beat LA. Cities, invariably, lose in the end. This begs the question: if the NFL can essentially operate as a legal cartel, and the member teams can use their influence to extort their home cities, why don’t cities cooperate between themselves to call the NFL teams’ bluffs, and cooperate so this kind of issue just won’t happen?

The Economics [101] (and Beyond) of Commencement Tickets

Every year, as Winter becomes Spring and the prospect of graduation looms ever closer, many Columbia undergraduates' social media accounts are inundated with requests for (and offers of) extra Commencement tickets. With a maximum of four Commencement tickets per undergraduate student allowed, most Seniors find themselves in the predicament of having too many people to invite and—you guessed it—too few tickets with which to guarantee those guests entrance to the ceremony. Yet, because the number of tickets requested by each student is not tied to the number of people she plans on inviting or who let alone plan on attending the ceremony, there’s always a sizable amount of extra Commencement tickets floating around in the “secondary” market (and an even larger amount of people desperate to find them). This is where the controversy begins. Setting aside that “trading” Commencement tickets is nominally prohibited by the administration, many claim that actually monetizing this trade is unfair and unethical. I will try to explore some of the arguments and to break down the primary issues behind this debate.

Because this debate involves the exchange of a particular good, it is simple to investigate with one of the most basic economic models of them all: a simple supply and demand model. Operating under the assumption that nobody is necessarily against the mere act of exchanging these tickets, the debate is then over the price: should trading these tickets be free, or should “suppliers” be allowed to charge a price for them? The argument of those against this practice can be summarized by the setting of a price ceiling of $0 on this Commencement ticket market (meaning, if you’re supplying tickets in this secondary market, it must be done so for free). After all, Seniors are not themselves charged to obtain their tickets, so the “cost” to the “supplier” is literally $0; why should she sell them at what is essentially an infinite markup over her zero marginal cost?

An essential feature of this market is that we can assume demand is quite inelastic (students are willing to pay a high price to have that relative or friend be at graduation), and supply is perfectly inelastic. Whether we consider a market for both “primary” and “secondary” Commencement tickets combined or we just look at the “extra” tickets floating around campus, the supply of total tickets is fixed by the administration, and the supply of extra tickets can also be assumed to be fixed. After all, it’s a decently safe assumption to make that no one will un-invite Grandma because they’re being offered a high price for Grandma’s ticket. Thus, we can assume the supply of extra tickets is fixed, since the number of people for each student that can and will come to graduation is very unlikely to depend on the price that student can get from giving that ticket away.

Thus, looking only at the market for extra Commencement tickets, it is simple to see that because of the inelasticity of supply, a $0 price ceiling in this market represents simply a redistribution of surplus, not addition of surplus or a deadweight loss. The argument is thus about the breakdown of that surplus, the question becoming: Should the entire surplus of this market be Consumer Surplus (marked in green above)? Or should “producers” of these tickets also obtain some surplus for the “service” they’re providing (making Consumer Surplus the orange portion, and Producer Surplus the yellow square below it)? To some, the answer to this question boils down to how we view the “service” these suppliers are providing. After all, their cost to providing this service is, once again, $0. Moreover, it seems morally wrong to profit off of the emotional: should suppliers make money just because they know having relatives at Commencement is particularly important and meaningful to those demanding these tickets? Let’s explore further, since this simple supply-and-demand framework gives us more intuition.

We can see from this framework that “consumer” surplus approaches infinity the more inelastic the demand. Thus, having Grandma there at Commencement is, like the famed MasterCard ad campaign, “priceless”. In turn, will people really care about paying the 20, 30, 40 dollars of the “free” market if the marginal utility of getting that ticket far surpasses the cost? Will they mind giving up a small fraction of that incredibly large utility to those who made that extra ticket possible? To opponents of people selling tickets, the answer to the previous questions is no: after all, for some, having Grandma there is indeed a “priceless” moment, but “priceless” is literally impossible. The danger of this kind of market is that it threatens to “price out” those consumers who just can’t pay the extra price. It becomes then an inequality problem: should those who are willing and able to pay an “unlimited” price (or are able and willing to increase the price of the ticket in an “unofficial” auction) get the ticket above those who have just as much (sometimes even more) need for the ticket, but can’t pay for it?

This is where some on the opposite side of the argument (those who believe that yes, people should be allowed to sell these tickets) come in and say: We can’t assume that sellers are all wealthy, greedy capitalists; some may very well need the money. In that case, don’t they deserve a bit of the created value from the transaction? Don’t sellers deserve some of that surplus from their “service” of introducing the tickets to the market (that normally, if they didn’t request, wouldn’t be introduced anyway?) In some views, yes.

We can think of sellers as opening the market even more and actually increasing the total supply of tickets available. Thus, in that case, suppliers are providing a very valuable service to the market, and as such should be compensated for the value they are providing.

If we view Supply_original as the supply of tickets requested if everyone actually invited the number that they knew was coming up to the maximum of 4, then Supply_actual is larger thanks to the people who request four tickets (knowing they only actually need less than that) and either sell or give them away in the “secondary market”. In that sense, these “sellers” may be benefitting the market as a whole (as can be seen by the addition of the extra surplus, marked in green). Especially if we assume that potential sellers need some incentive to provide these tickets (i.e. assume those with extra tickets care absolutely nothing about those in need of extra tickets, so if they’re forced to give them out for free, they just won’t go through the trouble of getting extra tickets, communicating with someone and making those available to that “buyer"), then allowing a price above $0 is enough incentive to get those tickets out into the market and provide that extra surplus. More importantly, this assumption would of course make our supply curve quite different, since in assuming that suppliers need an incentive to supply extra tickets, now we’d be no longer facing a perfectly inelastic supply curve. With a supply curve that is no longer completely vertical, it is not difficult to see that the more elastic the supply curve (especially close to price=$0), the more gravely does a $0 price ceiling reduce the quantity supplied in the market and the greater the deadweight loss; allowing the “free” market to function may then create much more value in the scenario where the market faces an elastic supply curve (in short, where suppliers are unmoved by altruism and will only supply tickets for monetary compensation). But of course, this is still a difficult assumption to make; essentially, we’d be assuming that doing good for others is not enough incentive to be nice.

The answer thus boils down to what we believe is fair compensation for the service and the surplus these suppliers are creating. To opponents of selling tickets, the answer is: charity, generosity, and the good feeling from being nice should be enough. In fact, to these opponents, selling tickets is unethical and a rigging of the system in favor of the privileged. To supporters, suppliers themselves may deserve (and at times, need) money for their service. The validity of these arguments in turn depends on where you stand when it comes to:

• the fact that the marginal cost of supplying extra tickets is $0

• whether or not incentives are actually required to supply a product whose total cost is $0 (in short, are people nice, or are they opportunistic?)

• the ability of suppliers to earn money (if they need it) through means other than selling these tickets

•  What is fair compensation given the reality that many deserving graduates are unable to pay a price for a ticket that the supplier essentially got for free? 

While these are primarily philosophical questions, some solutions come to mind immediately.

Firstly, the administration could improve the ticket request system with incentives for honesty (people don’t request more than they really need with looks to sell), allowing those who need extra tickets to request extra ones (from the extra tickets other people didn’t request) in a second stage of the distribution process. Thus, make ticket distribution a multi-step process where admins can gauge need and distribute accordingly, handing those extra tickets out for free. This of course comes at the cost of increased complexity, and thought must be given to the kind of incentives necessary to incentivize honesty when requesting tickets.

Secondly, and this is less of a solution and more an acceptance of the complexity of the problem, perhaps we should consider ticket exchange transactions on a case-by-case basis: some people requested more tickets than they need. Is it bad for them to sell them at more than $0? The prevalent view is that no; this prices people out of the market, only benefits the privileged few who can pay for it, etc. But we have to consider the side of the sellers who may need that money. The prevalent view indeed makes a prototypical image of the “seller” as a greedy capitalist with billions in a bank account looking to profit out of emotions. Yet, we have to accept that for some people, the tickets may be a legitimate and necessary way to make money.

So in short, selling the tickets isn’t inherently wrong; it’s the free market and there’s clearly a demand for them for which, for many people, the marginal benefit of getting a ticket (I get to see Grandma at Commencement) is more than the monetary cost of getting Grandma a seat. The real unfairness comes when, let’s say, we have one person announcing a ticket, and two people reply: one honestly can’t pay and asks if the “seller” would be generous to give it away for free, while the other suggests she’s willing to pay a $20 price for it. The ticket goes to the $20 buyer. Does one of these buyers ultimately “deserve" it more than the other? This is a question a simple model like this really can’t answer very well. A utilitarian view perhaps considering the total social benefit might ask: Who gains the most utility from getting this ticket, and thus contributes the most to our collective Commencement surplus? If one is looking to invite a sibling, but the other a third-cousin five times removed from Latvia, many might agree that perhaps the one inviting the sibling should get it. In that sense though, since we can’t presume to know everybody’s story or reasons for buying or selling a ticket, it’s really too difficult to impose market-wide restrictions in the form of a price ceiling (after all, this “secondary” market is already, in essence, a black market) or to systematically monitor the fairness of transactions. In that situation, like in many other scenarios, education may actually be the best response, and the third possible solution (already, in fact, being exercised by many):

• Campaign so that nobody sells his or her tickets. If every single supplier gives them out for free, we all win: nobody gets priced out, and there’s no sense of unfairness or a rigging of the system by the most privileged. Now, in this “always free” scenario, what about the people who might need the money? Many might say they have other recourses to turn to: after all, there’s hundreds of ways to make money while only one way to get Commencement tickets. Surely then, a person looking to make money out of ticket sales (even if they really need the money) can have other options to make that money, whereas the person looking to invite Grandma to Commencement only has one. But, if this is still a concern, maybe sellers could be compelled to “tip” their seller for their services if the seller really needs the money (after establishing this on a case-by-case basis between buyer and sellers individually). Of course, the distinction between this and flat-out selling the ticket is very, very small (then, instead of the seller setting prices, the onus is on the “buyer” to suggest themselves as a “generous tipper”, which brings us back to our original problem).

Another consideration is the “war on drugs” example: if we assume that, removing all possible monetary incentives some suppliers will “exit” the market, if we limit the supply of “priced” tickets (in this case, by forcing them all to be handed out for free, or forcing everyone to request exactly the amount they need), then we could hurt some consumers: there’ll always be someone to profit from hiking the prices even further because making them free has now severely limited the number of tickets available. Whereas before Mary could get one for $20, now that everyone’s giving them out for free, everyone she turns to has already given his or hers away… except for Josh, who’s now in the position to ask a desperate Mary for $60 instead.

In that sense, then, this question is really a difficult one to answer, not least importantly because it has a very strong emotional undertone. We all want to see all our loved ones’ faces there on Commencement day to celebrate our triumphs. Should some benefit from their extra tickets and the needs of others to sell in a “secondary market”? Is the system rigged to help the wealthy more than those who may not afford the price of the ticket in that secondary market? Is it necessarily a "bad thing” that some are able to pay for the tickets while others are not? Do the wealthy, after all, deserve to get an extra ticket more or less than those without the resources to buy one? Most importantly, are there any new systems that we could think up to address this issue and ensure that everyone gets to see as many of their loved ones as possible come Commencement Day, without having to dish out extra money to someone who didn’t have to incur any costs in acquiring that “product” themselves? These questions are a great overview of the kinds of normative questions Economics oftentimes can’t find an absolute answer to. They’re also an interesting example of the kinds of economic and social issues us graduates will be facing (and for many of us, have had to face already) as we head out into the real world: What’s “fair”? Does our system unfairly benefit some over others? Should access to a product or service be determined by one’s ability to pay? Do some deserve access to a product more than other people? Does the “free (in this case, secondary) market” produce optimal outcomes for those who participate in it? And how can the government (in this case, the administration) step in to produce closer-to-optimal results? I wish I had the answers, but hopefully, this simple framework anyone could see in just the first month of Econ 101 has shed some light on both the superficial and the underlying issues behind the buying and selling of Commencement tickets.

I leave you with my final questions: can we put a price on everything? And even if we can, does that still mean we should always have the license to charge it?