BP Oil Update

In my last post, I made some guesses about the costs the BP oil spill was imposing on the environment and Gulf tourism and fishing. I assumed that BP would be able to cap the leak and clean up would proceed from there. However, that is not the case, and I thought I ought to go back and look at some of my numbers and how they hold up in the face of new potentially higher costs.

My original estimate was $98 billion. So far it has cost BP around $3 billion and they have a total of $7 billion in escrow for future payouts.

President Obama made a speech that BP was going to "pay every dime for the oil spill." If this is true then the $10 billion cost to BP must also be the total cost of all damages. This would mean my estimate of damages done was $88 billion too high.

My conclusion in the previous post was that a tax of $3 per barrel would earn enough to fully pay for this spill. Given that the true costs are likely to be far lower than I estimated, the cost (and thus tax) per barrel of offshore oil would be much lower. Perhaps, somewhere around $1.

Can we afford to spill?

A friend of mine, Harrison, posted this graphic about the BP Deepwater oil spill. The caption reads, "Can we afford to spill any oil?" Um, no I guess not. The graphic shows the damages done by spilling, and I guess how much we need the oil. So, the graphic says, spilling is bad. Ok, sure, but how bad? Bad enough to shut down Obama's proposed offshore drilling? Bad enough to shut down all offshore drilling around the US?

The graphic doesn't have enough information to answer that, so I decided to do some digging, here is what I found:

Based of some numbers I got off a government website, the average amount of oil pumped out of US offshore oil rigs is around 2 billion barrels per year. Suppose that 2010 is peak oil for US offshore rigs and that every year after 2010, the supply dwindles to nothing by 2030. Under these stringent assumptions, that would be 32.6 billion barrels of oil pumped from 2000 to 2030.

There are three main costs that the spill has created, loss of fishing, loss of tourism and damage to wildlife. This website reveals that Louisiana fishing yeilds $2 billion annually. Suppose the spill completely shuts down the LA seafood industry this year and the industry only recovers a little bit each year until after 10 years, it is back to it's $2 billion status.

This EPA website says that the tourism industry for the Gulf Coast is worth $20 billion anually. Suppose the tourism for the Gulf completely shuts down this year and slowly recovers a little each year until 2020 when it get back to $20 billion.

Finally, there was damage to wildlife. This website estimates Exxon-Valdez spill cost $7 billion dollars. So let's assume the same amount of damage from this spill. So in 2010, we lose $7 billion worth of marine life and it takes 20 years to recover fully from the spill.

Using a little present value discounting, the total cost of the the oil spill would be $98 billion.

With that dollar amount in mind, we can find the cost per barrel pumped from offshore oil over the course of 2000 to 2030. So it's $98 billion divided by 32.6 billion barrels which gives us a cost of: $3.02 per barrel.

Spilling really doesn't appear to be much of a cost. Can we afford to spill? No, that's waste, clearly we'd rather not. But does it cost that much? Eh, not really. Should we shut down offshore drilling? No, but we should tax off shore drilling at about $3 per barrel. Why not even make it $4? Even if I undestimated the costs, we'd still be covered*.

*Really love wildlife? Make the cost to wildlife $100 million and the costs per barrel rise to $16. That would still be only about 22% of a $70 barrel of oil.

Cadillac Health Plan Tax

My friend, Justin, posted this radio interview with economist, Jonathon Gruber, on why the Cadillac Health Care Tax is a good idea. Allow me to summarize his points:

1. People with insurance that has a low-deductible (like people who have Cadillac plans) overuse medical treatments. For instance, I get a headache and go get an MRI to find out it's just a headache. I do this because I don't pay for the MRI directly (in general I'd only pay a small fraction.
2. Wages will rise after the Cadillac Tax is passed.

I agree with arugment 1. People do probably overuse health services since they don't pay for them. If people have to pay for them, then they'll use less. This can be good and bad. Let's say that the MRI revealed something and my life is saved at a realatively low cost. Paying for the MRI discourages my use and thus increases costs later.

His whole point is that on net, this will be cheaper for the economy. We save more medical resources by doing less useless medical spending than we lose by having that later spending.

Argument 2 works for me...mostly. Wages and fringe benefits are substitutes for employees. Probably perfect substitutes. If my employer pays an additional dollar of my health insurance, that is one less dollar that they have to pay me in wages.

His argument, is that by taxing Cadillac plans, people switch to cheaper plans which means (under competition) wages rise.

My concern is this: if people switch out of the Cadillac plans into high-deductible plans then the premiums on those high-deductible plans ought to start rising (according to economic logic on substitutes). This will have a downward pressure on the wages of the people who were previously not on the Cadillac plans.

I'm not sure how this all would play out. It seems like it depends on how many people opt to pay the fine for not having insurance.

Economics Of Thanksgiving

My darling wife found this article on the average cost of a meal at Thanksgiving and requested my analysis of the economics of Thanksgiving. Since I hate to deny her anything she wants, here are my thoughts:

As an economist, I wondered why people don't go out to eat on Thanksgiving and instead eat a large meal they prepare at home.

The article quotes a study that finds that a meal for 10 people costs $44.61 or about $4.50 per person which on the face of it seems pretty cheap. A good reason for eating in, as you can't get that quality of a meal at that price from a restaurant.

However, the study doesn't take into account the value of people's time. One recipe site recommends beginning your preparations at 10:45 am in order to eat at 5:30 pm. There are at least 2 hours of breaks in their cooking schedule but also, we need to add the time spent shopping for the specific Thanksgiving foods and clean up, which I'll estimate at 1 hour and 1 hour respectively. The total time for Thanksgiving cooking: 5 hours and 45 minutes.

Here are where some assumptions are going to be important. The less people enjoy cooking, the higher their time cost is going to be. Typically, the assumption is that people value their time at their wage rate (that being the opportunity cost). Below are some assumptions of people's value of time and their effect on the per person cost of the meal.



According to the Bureau of Labor Statistics, the average production worker earns just under $19 per hour. Earning $50,000 per year leads to an hourly wage of $25 per hour (working 40 hours a week, 50 weeks per year).

My guess is that to buy a comparable meal from a restaurant you'd have to pay at least $20 plus tip. These estimates seem to indicate that people who earn more $40 per hour (salary of $80,000 per year) would be made worse off by having to stay home and cook their own meals!

This clearly isn't the whole picture. People value time with the family and the special taste of their family recipes. Thanksgiving isn't inefficient for the rich because they enjoy the family time too. However, if Lincoln had added a second and a third Thanksgiving in March and July and I bet you'd see more people eating out.

Illegal Music

Here’s the headline and subtitle of an article about British music priracy:
“Illegal downloaders 'spend the most on music', says poll
Crackdown on music piracy could further harm ailing industry”

The author of this article is making a critical error. She assumes that the correlation between amount of money spent on music and downloading is causal when based on this study, it is just correlation. Consider two people: Al, a music-lover, has a high willingness to pay for music and Bill, who is indifferent to music, and has a low willingness to pay.

If there is no possibility that they could download music illegally, Al would still spend more on music than Bill. If all music was free on the internet and could be downloaded without fear of punishment, Al would again consume more music than Bill.

Since the legal music competes with illegal music, the price of one affects the demand for the other. An increase in the price of legal music may drive Al to download more illegally. In fact, since Al can get music illegally, it makes him less willing to pay for the legal music.

The effect would be the same for Bill. Low music expenditures would be correlated to low illegal downloads because that person doesn’t like music! This correlation does not imply that shutting down music piracy would be bad for the music industry. Shutting down piracy would drive Al and Bill back to legal music downloads (since the price of illegal music would become infinite). This would be good for record companies.

When the author claims that a crackdown could harm the music industry, she is assuming that legal music and illegal music are complements. That perhaps if you can hear it an album first, you’re more likely to pony up money for it.

My point is that the study doesn’t tell you whether legal and illegal music are substitutes or complements. You’d need a study that looks at how changes in the price of legal music affect the amount of illegal music downloads or a study that looked at how restricted access to illegal music affects legal music purchases.

Based on what the recording industry says, I’d bet they are substitutes. It’s their profits that are being impacted, so I’d give them the benefits of the doubt on this one. If illegal music is really a complement, they wouldn’t be so avid to shut it down, they'd be running free music stations themselves.

An Unintended Consequence to the Baucus Bill

Greg Mankiw posted this his comments on a study by the Congressional Budget Office of the Baucus Health Care Reform Bill.

The bill aims to give households a subsidy for the purchase of health care. To limit costs, the amount of the subsidy phases out for richer families. What is implicit in this phase out is that it works as a 20% tax on income.

A family of four that earns $23,000 per year gets a subsidy of $15,000 while a family of four that earns $92,000 per year gets no subsidy.

Let's say that the low-earning family has a chance to earn $1,000 more dollars per year by working more. Their subsidy would fall by $210.

If you think about total income as money from work and from the subsidy, they originally earn $38,000. After working more, the family earns $38,790.

Increasing earnings by $1,000 per year would require 3 more hours of work per week earning $7 per hour. However, the additional 140 hours a year that this person works doesn't increase their income by $1,000 (it only goes up by $790). So they really only earn $5.56 per hour!

The family implicitly earns less than the minimum wage and so those 3 hours a week of work may not be worked at all. This bill creates an incentive to stay in poverty.

It goes further than just an incentive to work less. As the CBO states:

Higher tax rates also reduce people’s incentive to raise their income in other ways,such as working harder in the hope of winning raises; accepting new positions or responsibilities with higher compensation; or investing in their future earning capacity through education, training, or other means....

There is no easy fix to health care. There are no free lunches.

Schools in the News

I don't like public schools. In spite of mixed evidence, I get the feeling that they aren't as effective as we hope. So when I read this article on Obama's speech to schoolkids, I was looking for how the government was going to screw things up more in an effort to fix it.

What I found, however, was this quote:

"The president's speeches tend to be [about] what's wrong with the country and
what can we do to fix it," said Bill Hogsett, a parent from Dallas, Texas. "I
believe this is the greatest country on Earth, and I try to teach that to my
children. ... I don't want them hearing that there's a fundamental flaw with the
country and the kids need to go forward to fix it.

"What?!?

This disturbing idea is apparently called American Exceptionalism and I think it is discussed best in this Autotune the News clip:


Exceptional Fast Food and Exceptional Dance Moves. God Bless America.