Mind Your Decisions

Markets Aren’t Perfectly Competitive: The Game Theory of Why a Smoking Ban Might Make Sense

Every Tuesday is a Game Theory article at Mind Your Decisions.

This article will arm you with a powerful critique. In no time you’ll be second-guessing how fiscal conservatives talk about economics.

Here’s one of the most common criticisms of a new law:

“My opponent supports law X. While I agree with the spirit of law X, I do not think the government should get involved. If change is really better for us, the free-market economy will make it happen.”

It sounds like good logic. It appeals to people versed in introductory economics. The subtext is that perfect competition always creates better outcomes than regulation. Sorry to burst their bubble, but this is simply not true.

Perfect competition doesn’t always exist. Imperfect competition is commonly seen and allows for strategic behavior (negotiating job offers, pro sports, health care, elections, the used car market…I can go on and on). In these cases, competition might lead to a sub-optimal outcome. For instance see my article about on how price matching guarantees can help businesses avoid price wars.

Don’t blindly think markets will solve problems; always consider the possibility of strategic interaction.

I’ll illustrate the phenomenon through two examples: restaurant leftovers, and the Illinois smoking ban.

Dining out, taking home

Restaurant meals are so large that I often have leftovers. The first inefficiency is the box size. Restaurants usually use the same boxes for an entire entrée as for the leftover portion. This means I use a box that’s too large. If I ate half my meal, I’m using a box that’s twice as large as needed.

But the story gets worse. Because the boxes are big, they usually won’t fit conveniently in my refrigerator. I have to transfer the food to another container. So here’s the recap: I get a box twice as large as needed, take my food home, transfer the food to my own container, and proceed to throw away the leftover box. The box only serves as a way to transport food from the restaurant to my home. This has happened three times in the last month.

I’m sure the restaurant is not happy about this situation. The leftover box costs them money and they would rather not unnecessarily create waste. If customers ate all of their food, or just brought their own containers, it would be easier for restaurants to manage.

Now, there are many solutions to this inefficiency. The simplest is that I anticipate leftovers and bring my own container. I wouldn’t waste food or material, and the restaurant wouldn’t have to pay for boxes.

But I’m lazy and forgetful. This past week I was in a rush and didn’t bring my own container. It’s because my failure carried no individual penalty—I just asked for a leftover box. I would only have to live with the guilt of being wasteful, which is pretty easy to get over.

Is there a way to fix the system?

I’ve seen some restaurants go as far as charge customers for packing leftovers. Needless to say, this is not well received. Customers find it appalling especially because other places don’t have this policy.

The system is clearly broken—the market for restaurant leftovers is failing. There is simply not a natural market for take-out boxes. Restaurants who try to create a market individually look unpopular. Customers have little reason to take action. It’s a big coordination game. And that’s where government action could help.

Imagine there was a law along the following lines: restaurants must charge customers a 25 cents tax for take-out boxes. It would be an environmental law to offset the cost of waste.

If this law existed, a lot more customers like me would remember to bring their own containers. And just as important, restaurants could charge without feeling their competitors could undercut them. It wouldn’t be a popular bill, and I’m not sure it would ever pass. But it’s a fun thought experiment.

Don’t blow smoke in my face

Illinois went smoke-free in 2008. That means no smoking in indoor workplaces or public places, including bars, clubs and casinos. Smokers are annoyed and some are coping by switching to chewing tobacco. Non-smokers are generally pleased at the refreshingly clean atmosphere of nightlife.

Do I think it is a good law? My gut reaction is yes, but the truth is that I don’t know. The cost/benefit analysis is complicated. It could save the state money by improving public health, but it could also cost the state money if businesses like casinos lose revenue. I have not read enough, and the economics are not simple.

People who think they understand the economics really anger me. Many opponents of the law believe the government is wrong to limit choice. They think business should decide and let the free market take its course. Here’s an example of that logic (original pdf):

Aimone said that the public could settle the issue by deciding whether or not to frequent a place that allowed smoking.

“It’s a personal choice not to come in,” he said. “If enough people came in for the bar to pay the bills, the place would stay open. It’s basically economics.”

Oh, this pseudo-economic argument is appealing. Heck, I’ve even uttered it many times when I have a shallower economic understanding.

The claim is analogous to this one: if smoke-free bars were a valued service, wouldn’t competition create a market?

As the restaurant example tells you: no, this is not necessarily true.

Bars are susceptible to local competition. If one bar alone tried to ban smoking, it would be excluding customers and probably losing revenue, like the restaurant that tries to charge for containers.

Non-smoking customers face a coordination problem too in trying to frequent non-smoking bars. If you were in a group of ten people, and just one person really wanted to smoke, but the rest of you did not care as much, you would probably end up going to the smoking bar. It’s not a simple cost-benefit analysis—there is strategic behavior and coordination involved.

My friend was witness to these incentives. Several years ago, his downtown city had exactly one non-smoking bar. Even though it was a clean and great place, it was never as packed as the smoking places. That’s not to say its smoke free policy was the only problem, but it wasn’t helping the bar’s traffic. The bar couldn’t sustain business and shut down.

The smoking ban is a way to coordinate. I have often heard that some bars and restaurants did want to go non-smoking long before the law. It’s a personal concern: bartenders and managers had to breathe in smoke for their long shifts. But they could never coordinate with enough bars to change to non-smoking without the risk of losing customers. Using this logic, you can see that it’s even possible that all bars could desire non-smoking but they could not cooperate. It’s possible that government is needed to limit options and improve the overall social outcome.

In short

Don’t let politicians justify inaction with bad economics. There may be other perfectly good reasons not to get the government involved—bureaucracy, not wanting higher taxes, etc.

But if you see something broken, do not assume that competition will fix it. As I argued in two examples, even if everyone wants a new outcome, it might not happen without a law. Don’t let misinterpreted economics get in the way of better results.