Economics usable in an epidemic

   Due to the Novel Coronavirus, numerous aspects in life are affected. Though the nature of the current epidemic is a health issue, various economic issues appear, such as the shortage of important materials like mask, hand-sanitizer, bleach, etc. There is no lack of discussion about these issues in the society although it is doubtful if all these discourses make economic sense. To assess if arguments are economically sensible, we need to be aware of what economics concepts are used, and if they are properly used. In my view, the key point involved is the functions of market and the failure of market.
   Back to the shortage problem, one mostly wanted material is mask. Some suggested that it should be legally considered to be a "reserved commodities" (like rice), which implies that the supply, pricing and distribution of it should be regulated. Does this idea make economic sense? Perhaps you already have an answer in mind. Let me, however, share with you another idea first.
   I read newspaper and find an analysis made by an economist. I think the analysis makes sense and so share with you here. The point made by this economist is: wearing mask involves externality. In economics, externality refers to some effects, positive or negative, generated from someone on others but the effects are not paid for, unlike what happens for market exchanges. Wearing mask protects the wearer. But it also protects others -- the wearer may also sneeze. If the sneeze-makers have worn the masks, they will not infect others and so protect others too. But others have not paid the wearers for their wearing masks. So, this is a positive externality generated by the wearer.
   Normally, economists think that the thing that brings about positive externality is not sufficiently provided: as the supplier of the good thing is not rewarded by all those who benefit from the external effect, they are not financially encouraged to take account of all beneficiaries' values derived from the effect. That's why the supply should be insufficient. That's why the above economist suggests subsidizing mask provision.
   In principle, I think this economist is right. Positive externality justifies subsidy because the supply is insufficient and subsidy normally increases supply. Furthermore, it at least appears to be a better idea than regulating the suppliers in the time of shortage. Regulation may be of two types: regulating the price and regulating the operation of the business. If price is regulated (to be lower than the free-market level), high-school economics students can already tell the consequences: quantity supplied is lower than, and quantity demanded is higher than, the equilibrium level. There will be shortage. If originally the market is in balance, price regulation creates shortage. If originally the market is already in shortage (why is this possible? think about it), price regulation exacerbates the shortage.
   Meanwhile, regulation of operation effectively makes suppliers more difficult to do the business. Hence, it is likely to reduce supply (though quality of the good may be improved). For readers knowing some basic concepts, the reduction can be reflected as a leftward shift in the supply curve. In contrast, subsidy makes suppliers do the business at a lower cost. It is likely to increase the supply. The supply curve will shift to the right. This is exactly what is needed in a time of epidemic.
   Nonetheless, all these suggestions, subsidy or regulation, may not work in the short term. Prices of masks have increased substantially and the financial incentive for supplier is strong enough. The supply is still insufficient because production (or sourcing) takes time while existing capacity to produce cannot be immediately expanded. For what subsidy can help, it is only for long term: subsidy may encourage more suppliers enter the market and increases the long-term supply. In fact, if long term is considered, even regulation may not be so nonsensical. The regulation, as proposed by some people, may require a sufficient stock to be built up by the major distributors (like what rice distributors do). Of course, whether price regulation is a good idea or not is another matter.
   But the current problem is exactly about short term. In the short term, if supply is fixed and is insufficient, what can we do? Not much. The only thing that may be done would seem to be distribution. Someone may accumulate too many masks while someone have no any reserves. If the "surplus" is given to someone who lack it,  in principle there could be a mutual gain. But the big problem is that, given the uncertain length of the epidemic, no one thinks that they have "surplus".
   Even so, there may still be a scope for trade: someone do have accumulated too many in the sense that the safety margin is too high while someone's safety margin is too low. In principle, there can be a better distribution than what it is. The fact that someone donate part of their own masks reflect that they think that their safety margin is high enough. Therefore, donation and, with some middlemen, re-distributing the masks to the needy people is a way to achieve a better distribution. But another problem appears: who are the truly needy. Those who have too few are the truly needy. But the re-distributor cannot easily know who they are. This is the so-called "asymmetric information" problem: someone know less than other people. In the present case, the donors or re-distributors know less than the donation receivers regarding the latter's personal stock of masks.
   In economics, asymmetric information is big topic but it is generally not taught in high school. This may also be of a good reason because the topic is complicated. The idea is not too difficult to understand but the theory is often mathematically complicated. More important, the solutions to asymmetric information is not straightforward. In the case of mask donation, perhaps we don't have a perfect solution. Perhaps donors and re-distributors can only use some traits that are imperfectly related to truly needy, such as being old or being poor, for their re-distributing job. The elderly and the poor may generally have fewer masks than other citizens but that is not definitely right. The elderly may be a rich person and may have had many masks already. We don't know. But at least we can more easily tell who is old than who has accumulated many masks. Hence, we oft for this imperfect solution. For asymmetric information problem, often we have to accept some imperfect solutions.
   To summarize a bit, epidemic reveals many problems involved in market operation. If market is perfect in every aspect, we don't have shortage and suboptimal distribution. But market may fail sometimes, due to externality and asymmetric information, etc. The solutions of them should be carefully considered. Some proposals may backfire. Some are imperfect but better than none.

On-line shopping on the rise?

   On-line shopping has obviously become more popular. First, this is perhaps a long-term trend, supported by technological change and changes in consumer habit. Second, there is a more recent factor: much fewer people would go to shopping malls in recent months due both to the inconvenient transport and uncertainty involved in demonstrations. The latest development is of course quarantine issue due to coronavirus.
   But one thing is clear: On-line shopping is not as popular in Hong Kong as elsewhere. Taobao makes a big profit in mainland China while Amazon does so in America. However, in Hong Kong, famous on-line retailers are still struggling. Why? Some students of mine had indeed tried to investigate this in their general-education project. They had discussed with me and had done some initial researches. Certain factors were identified. First, logistics or goods-transporting is more expensive in Hong Kong than elsewhere. Second, physical distances between homes and shops are closer to each other than elsewhere. Taken together, people may not think on-line shopping is so attractive.
    Yes, the recent events may change these factors somehow. Going out for shopping may no longer be so convenient as before. But it is unclear whether consumers' habit will be changed permanently. For this, we have to look at some fundamental factors and assess if there are some fundamental changes.
   Recently, I have read a newspaper column that analyzes the financial positions of retailers. The major findings include: The profit rate, or profit-to-revenue ratio, of a famous on-line shop is actually much lower than a grocery shop, which mainly sells goods at physical stores. This is a little surprising as many people may believe that rents of physical stores are high in Hong Kong. Avoiding the high rents, on-line retail may be a lower-cost business. But it is not! Why? On one hand, logistics cost is high and indeed not lower than rental cost. On the other hand, on-line marketing requires more advertisements and promotional discounts to attract customers. I am not a business analyst and have no any expertise in the business models of on-line shopping. But I think this analysis is convincing. Nonetheless, this analyst report describes only the existing situation. The question is: will the problem be overcome in some days?
   As an economist, I notice that logistics cost is a variable cost: it increases if more goods are sold and more delivery services are needed. Meanwhile, rents are a fixed cost: no matter how few goods are sold, the rents have to be paid. Of course, the fixed versus variable cost are only a relative distinction. For example, once a truck is bought, it can deliver few or many goods but the cost is the same. So, before its capacity is reached, it is a fixed cost. Beyond the capacity, if the business still expands, you need one more truck, and this is a variable cost to the firm. For another example, the rent of a store is a fixed cost to the store. But a company running many stores will consider renting more stores if its business expands. Then, from this company's viewpoint, rents are variable, at least over a longer period (where leases may be renewed or ended).
   If the concept is relative, then can we tell which cost is (relatively) variable and which cost is (relatively) fixed? I think we can. In my view, logistics cost is more variable than rent. Let us consider the same time span and the same quantity of goods sold. With a physical store, one can sell (or store) more goods in a given time (e.g. a day) than a truck can deliver. Hence, a company does not need to rent another store for a substantial volume of sale but another truck is needed for some business expansion. Furthermore, the salary of the driver and delivery staff may be directly related to goods sold while the rent is often unrelated to sale.
   If we accept that logistics cost is mainly variable while rent is mainly fixed, then there is another surprising point. This is because people often think that on-line shopping involves a high fixed-cost structure so that economies of scale is a key for its success. The point is: on-line shopping involves an expensive electronic system that handles orders, retrievals of goods in warehouses, and automatic assignments of packaging and delivery jobs. However, once the system is installed, it can handles many orders and jobs. Thus, it is mainly fixed cost. Selling more goods does not increase this cost, and so the average cost of sale is decreasing with sale. This is economy of scale. Furthermore, if the sale volume is high, the on-line retailers can bargain for a deeper discount for goods from suppliers, which promote sales. This is also economy of scale. Due to this belief, many on-line retailers are willing to invest and expand. Their hope is that if they can secure enough sale, scale economy will help them achieve low cost and profit eventually.
   Now, there seems to be a fact inconsistent with this belief. If the dominating cost of an on-line shop is logistics cost, and logistics cost is mainly variable, then the overall cost structure of the company does not exhibit significant scale economy. If this is true (I don't know), these Hong Kong on-line shops cannot hope for a brighter future by expanding sale. Struggling for a longer time does not help!
   Of course, these on-line shop owners are not stupid. Perhaps I miss something. Perhaps only at the moment logistics is the major cost component. Perhaps in future volume sale can bring about more discounts on goods, thus generating a bigger scale effect to outweigh the logistics cost. There may be some rationale for them to keep betting on it. Of course, as a consumer, I wish them every success in future.