Econ 101 and the Cost of Cell Phone Plans

My one time colleague (Evan Lawrence-Hurt) posted the following:

In Colombia I was able to purchase an iPhone SIM card for 7 pesos (~$5), got great reception and data that lasted a week with no contract and I could refill it whenever and wherever I wanted. Here in the U.S. I pay Verizon >$100 per month for the same service on a 2 year contract. Discuss.

Since I’m not teaching this semester, I’ve really missed the fun, illustrative graphs that can get at the heart of a question. First, the set of disclaimers. I have no special expertise in the complicated field of cell phones. This is a gross simplification, and probably wrong in a bunch of ways. I did not spend the time to actually look at data points such as regulations, market concentration, comparative consumer buying power, etc.

In the cell phone market, the biggest cost are no doubt fixed. The fixed cost of laying down physical communication lines, building towers, buying/leasing wireless spectrum cost a lot more than the marginal, per-user/megabyte cost, which in small quantities is near zero. Also, irrespective of the regulation regime, it is very difficult to have a very competitive market. Cellular providers are close to what is called a natural monopoly. This means that once fixed cost are covered, the price that is charged is determined mainly by two things: the composition of the demand curve and the ability of the telecom companies to price discriminate.

So, if we 1) assume that the market is similar to a simple monopoly (and ignore price discrimination), 2) realize that because American’s have more disposable income they have a higher willingness to pay, we can draw the simple monopoly set up for each country:

I apologize for the crudeness of these charts and this analysis, but I think it actually gets pretty far. We  start with the two demand curves. The higher disposable income in the US is reflected by the higher demand curve (willing to pay more at any quantity). We then put in the marginal cost curves, which for simplicity I’ve kept low, constant and the same across the two countries. The marginal revenue curve is the extra revenue the monopolist sees by lowering the price and selling another plan. Because the monopolists are not price discriminating in this example, it is a simple downward sloping curve.

A profit maximizing monopolist will sell at the point where MR=MC. While the quantity that this happens at is not very different across the countries (looks to be near 40% in this totally made up example), due to the different in the demand curves the price that reaches the profit maximizing quantity is actually very different.

So what this very simple analysis tells us, is ignoring any differences in regulations, market structure, population density, etc, a lot of the variation in prices could potentially be explained simply by the differences in consumer disposable income across countries.

The Free-Market Case for a Strong Social Safety Net

My time constraints mean this needs to be brief, but I think one of the strongest arguments for a strong social safety net comes directly from free-market economics. Let me explain.

In last night’s snoozer of a presidential foreign policy both candidates argued that they would be better able to project American jobs from foreign competition. Obama in particular pointed to tire tariffs on China as a major success. But these tariffs are an economic disaster that the American consumer is paying for (see http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/10/23/how-obamas-tire-tariffs-have-hurt-consumers/). A very conservative estimate says that each job has cost consumers nearly $100,000 a year.

There is no unified lobby for the American consumer. When we all take small hits, it gets ignored.

Instead of pursuing really bad economic trade policy that cost the American consumer loads of money to save a couple of jobs, we would be much better off pursuing free trade, helping the world specialize and grow. By lowering the cost of job loss, a strong social safety net can free us up to pursue good policies at a cheaper end cost to consumers. There is a true pareto improvement to be had here.

Sadly, this is a case of the all-to-often true: when the political parties agree, they usually are both wrong. George W pursued similar policies in the steal industry, with will documented massive cost to the American consumer and economy.