Wednesday, March 01, 2006


Via Marginal Revolution

Another "Markets in Everything" post over at MR caught my attention. Here is the post about a governmental corruption case where the representative had a "bribery menu" listing prices for awarding contracts including the statement that every additional one million in contract value would cost $50,000 in how much was needed for the bribe. Alex has this to say:

"What's most disturbing about this is how low the prices were, $50,000 for $1 million in contract value. Now let's remember Econ 101, what makes prices low? That's right, competition. So who was Cunningham competing with?"

Now I'm about as cynical as anyone, but I think Alex isn't giving this his usual thoughtful analysis. First of all, selling contracts is similar to an auction for a unique item and so we would expect the price that it is sold at to be the market clearing price for only one buyer and would thus be higher than if we were trying to maximize profit while fixing a price across multiple buyers. Secondly, Alex is making a similar mistake that people make when they see oil companies posting huge revenue numbers. The absolute dollar amount is not the relevant factor, but rather what is their return on investment? In other words, it doesn't matter if a company makes 100 billion dollars in profit if their return on investment is equal to what they could have gotten from bonds (or whatever investment would be of comparable risk or less than the venture they engaged in) - they still didn't make an economic profit and aren't really doing that well. Similarly, if a company wins a 20 million dollar contract, that says nothing of their margins and what percentage of that is actually profit. Let's say that a company wins a contract and has a 10% profit on it. If it is a one million dollar contract that means that 100,000 of it is profit. But they haven't paid the bribe now it is only $50,000 dollars of profit or 5%...all of a sudden it may not even be clear if they have gotten anything out of the deal (which is what we would expect from our theory of rent-seeking).

Anyway, comments weren't open on the post over at MR so I figured I'd post about it over here...not that Alex is likely to read my blog anytime soon (which I should be greatful for since I'm sure he'd be able to hammer me more frequently than I him, plus I might feel obligated to proof read my posts then).

Catch ya all later.

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