You’ve Decided to Buy Twitter, So Who Are You Going to Call?  Investment Banks, of Course

Elon Musk. (Photo from the Associated Press.)

That’s what Elon Musk did in April 2022.  In early April, Musk purchased about 9% of Twitter’s shares.  On April 25, he became the owner of Twitter by buying the roughly 90% remaining shares for $54.20 per share. The total he paid for these remaining shares came to $44 billion. Following his often unorthodox style, Musk announced his plans in a tweet on Twitter. Where did he get the money to fund such a large purchase? 

According to Forbes magazine, in March 2022, Musk was by far the richest person in the world with total wealth of about $270 billion—nearly $100 billion more than Amazon founder Jeff Bezos, who is the second-richest person.  While it appears that Musk could afford to buy Twitter without having to borrow any money,  Bloomberg estimated that in April 2022 Musk had only $3 billion in cash. Much of his wealth was in Tesla stock or his ownership shares in SpaceX and the Boring Company, both of which are private companies that, therefore, don’t have publicly traded stock. Musk was reluctant to fund all of his offer for Twitter by selling Tesla stock or finding investors willing to buy into SpaceX and Boring.

Musk turned to investment banks to help him raise the necessary funds. Investment banks, such as Goldman Sachs, differ from commercial banks in that they don’t accept deposits, and they rarely lend directly to households. Instead, investment banks have traditionally concentrated on providing advice to firms issuing stocks and bonds or to firms (and billionaires!) who are looking for ways to finance mergers or acquisitions.  A syndicate of investment banks, including Morgan Stanley (which served as Musk’s lead adviser), Bank of America, Barclays, and what an article in the Wall Street Journal described as “nearly every global blue-chip investment bank aside from the two [Goldman Sachs and JP Morgan Chase] advising Twitter,” put together the following financing package. Initially, Musk wanted to raise $46.5 billion in financing—more than in the end he needed. Of that amount, Musk would provide $21 billion and the investment banks would provide loans for the remaining $25.5 billion. As collateral for the loans, Musk pledged $60 billion of his Tesla stock. 

Musk’s financing was a combination of equity—the $21 billion in cash—and debt—the $25.5 billion in loans from investment banks. To fund his equity investment, he was considering selling some of his stock in Tesla but hoped to attract other equity investors who would put up cash in exchange for part ownership of Twitter. According to press reports, Apollo Global Management, a private equity firm was considering becoming an equity investor. (As we saw in Chapter 9, Section 9.2, private equity firms raise equity capital to invest in other firms.)  Musk’s purchase is called a leveraged buyout (LBO) because (1) he relied  on borrowing for a substantial part of his purchase of Twitter and  (2) he intended to take the company private—the company would no longer have publicly traded stock.

Why would Musk want to buy Twitter? He shared the view of some industry analysts that Twitter’s management had failed to take advantage of opportunities to increase the firm’s profit. The actions of Musk and the investment banks were part of the market for corporate control. As we discuss in Microeconomics, Chapter 8, Section 8.1 (Macroeconomics, Chapter 6, Section 6.1), in large corporations there is often a separation of ownership from control. Although the shareholders legally own the firm, the firm’s top management controls the firm’s day-to-day operations. The result can be a principal-agent problem with the management of a large firm failing to act in the best interests of the firm’s shareholders. The existence of a market for corporate control in which outsiders buy stakes in firms that appear to be poorly managed can make firms more efficient by overcoming these moral hazard problems.

             But Musk had another reason for buying Twitter. As he stated in an interview, “Having a public platform that is maximally trusted and broadly inclusive is extremely important to the future of civilization.”  It was unclear whether this and similar statements meant that  after gaining control of Twitter he might take actions that won’t necessarily increase the firm’s profitability. 

            Elon Musk’s purchase of Twitter is a high profile example of the role that investment banks can play in determining control of large corporations. 

Sources: Kurt Wagner, “Elon Musk Lands Deal to Take Twitter Private for $44 Billion,”, April 25, 2022; Cara Lombardo and Liz Hoffman, “How Elon Musk Won Twitter,” Wall Street Journal, April 25, 2022; Michele F. Davis, “Elon Musk Vets Potential Equity Partners for Twitter Bid,”, April 21, 2022; Sabrina Escobar, “Elon Musk Isn’t Twitter’s Only Problem. It Faces a Number of Short-Term Headwinds,”, April 21, 2022; Cara Lombardo and Liz Hoffman, “Elon Musk Says He Has $46.5 Billion in Funding for Twitter Bid,” Wall Street Journal, April 21, 2022; Andrew Ross Sorkin, Jason Karaian, Vivian Giang, Stephen Gandel, Lauren Hirsch, Ephrat Livni, and Anna Schaverien, “Elon Musk Wants All of Twitter,” New York Times, April 14, 2022; Rob Copeland, Rebecca Elliott, and Cara Lombardo, “Elon Musk Makes $43 Billion Bid for Twitter, Says ‘Civilization’ At Stake,” Wall Street Journal, April 14, 2022; “The World’s Real-Time Billionaires,”, April 24, 2022; Musk’s tweet announcing his offer to buy Twitter can be found here.

Inflation, Supply Chain Disruptions, and the Peculiar Process of Purchasing a Car

Photo from the Wall Street Journal.

Inflation as measured by the percentage change in the consumer price index (CPI) from the same month in the previous year was 7.9 percent in February 2022, the highest rate since January 1982—near the end of the Great Inflation that began in the late 1960s. The following figure shows inflation in the new motor vehicle component of the CPI.  The 12.4 percent increase in new car prices was the largest since April 1975.

The increase in new car prices was being driven partly by increases in aggregate demand resulting from the highly expansionary monetary and fiscal policies enacted in response to the economic disruptions caused by the Covid-19 pandemic, and partly from shortages of semiconductors and some other car components, which reduced the supply of new cars.

As the following figure shows, inflation in used car prices was even greater. With the exception of June and July of 2021, the 41.2 percent increase in used car prices in February 2022 was the largest since the Bureau of Labor Statistics began publishing these data in 1954. 

Because used cars are a substitute of new cars, rising prices of new cars caused an increase in demand for used cars. In addition, the supply of used cars was reduced because car rental firms, such as Enterprise and Hertz, had purchased fewer new cars during the worst of the pandemic and so had fewer used cars to sell to used car dealers. Increased demand and reduced supply resulted in the sharp increase in the price of used cars.

Another factor increasing the prices consumers were paying for cars was a reduction in bargaining—or haggling—over car prices.  Traditionally, most goods and services are sold at a fixed price. For example, some buying a refrigerator usually pays the posted price charged by Best Buy, Lowes, or another retailer. But houses and cars have been an exception, with buyers often negotiating prices that are lower than the seller was asking.

In the case of automobiles, by federal law, the price of a new car has to be posted on the car’s window. The posted price is called the Manufacturer’s Suggested Retail Price (MSRP), often referred to as the sticker price.  Typically, the sticker price represents a ceiling on what a consumer is likely to pay, with many—but not all—buyers negotiating for a lower price. Some people dislike the idea of bargaining over the price of a car, particularly if they get drawn into long negotiations at a car dealership. These buyers are likely to pay the sticker price or something very close to it.

As a result, car dealers have an opportunity to practice price discrimination:  They charge buyers whose demand for cars is more price elastic lower prices and buyers whose demand is less price elastic higher prices. The car dealers are able to separate the two groups on the basis of the buyers willingness to haggle over the price of a car. (We discuss price discrimination in Microeconomics and Economics, Chapter 15, Section 15.5.)  Prior to the Covid-19 pandemic, the ability of car dealers to practice this form of price discrimination had been eroded by the availability of online car buying services, such as Consumer Reports’ “Build & Buy Service,” which allow buyers to compare competing price offers from local car dealers. There aren’t sufficient data to determine whether using an online buying service results in prices as low as those obtained by buyers willing to haggle over price face-to-face with salespeople in dealerships.

In any event, in 2022 most car buyers were faced with a different situation: Rather than serving as a ceiling on the price, the MSRP, had become a floor. That is, many buyers found that given the reduced supply of new cars, they had to pay more than the MSRP. As one buyer quoted in a Wall Street Journal article put it: “The rules have changed so dramatically…. [T]he dealer’s position is ‘This is kind of a take-it-or-leave-it proposition.’” According to the website, in January 2021, only about 3 percent of cars were sold in the United States for prices above MSRP, but in January 2022, 82 percent were.

Car manufacturers are opposed to dealers charging prices higher than the MSRP, fearing that doing so will damage the car’s brand. But car manufacturers don’t own the dealerships that sell their cars. The dealerships are independently owned businesses, a situation that dates back to the beginning of the car industry in the early 1900s. Early automobile manufacturers, such as Henry Ford, couldn’t raise sufficient funds to buy and operate a nationwide network of car dealerships. The manufacturers often even had trouble financing the working capital—or the funds used to finance the daily operations of the firm—to buy components from suppliers, pay workers, and cover the other costs of manufacturing automobiles.

The manufacturers solved both problems by relying on a network of independent dealerships that would be given franchises to be the exclusive sellers of a manufacturer’s brand of cars in a given area. The local businesspeople who owned the dealerships raised funds locally, often from commercial banks. Manufacturers generally paid their suppliers 30 to 90 days after receiving shipments of components, while requiring their dealers to pay a deposit on the cars they ordered and to pay the balance due at the time the cars were delivered to the dealers. One historian of the automobile industry described the process:

The great demand for automobiles and the large profits available for [dealers], in the early days of the industry … enabled the producers to exact substantial advance deposits of cash for all orders and to require cash payment upon delivery of the vehicles ….  The suppliers of parts and materials, on the other hand, extended book-account credit of thirty to ninety days. Thus the automobile producer had a month or more in which to assemble and sell his vehicles before the bills from suppliers became due; and much of his labor costs could be paid from dealers’ deposits.

The franchise system had some drawbacks for car manufacturers, however. A car dealership benefits from the reputation of the manufacturer whose cars it sells, but it has an incentive to free ride on that reputation. That is, if a local dealer can take an action—such as selling cars above the MSRP—that raises its profit, it has an incentive to do so even if the action damages the reputation of Ford, General Motors, or whichever firm’s cars the dealer is selling.  Car manufacturers have long been aware of the problem of car dealers free riding on the manufacturer’s reputation. For instance, in the 1920s, Ford sent so-called road men to inspect Ford dealers to check that they had clean, well-lighted showrooms and competent repair shops in order to make sure the dealerships weren’t damaging Ford’s brand.

As we discuss in Microeconomics and Economics, Chapter 10, Section 10.3, consumers often believe it’s unfair of a firm to raise prices—such as a hardware store raising the prices of shovels after a snowstorm—when the increases aren’t the result of increases in the firm’s costs. Knowing that many consumers have this view, car manufacturers in 2022 wanted their dealers not to sell cars for prices above the MSRP. As an article in the Wall Street Journal put it: “Historically, car companies have said they disapprove of their dealers charging above MSRP, saying it can reflect poorly on the brand and alienate customers.”

But the car manufacturers ran into another consequence of the franchise system. Using a franchise system rather than selling cars through manufacturer owned dealerships means that there are thousands of independent car dealers in the United States. The number of dealers makes them an effective lobbying force with state governments. As a result, most states have passed state franchise laws that limit the ability of car manufacturers to control the actions of their dealers and sometimes prohibit car manufacturers from selling cars directly to consumers. Although Tesla has attained the right in some states to sell directly to consumers without using franchised dealers, Ford, General Motors, and other manufacturers still rely exclusively on dealers. The result is that car manufacturers can’t legally set the prices that their dealerships charge. 

Will the situation of most people paying the sticker price—or more—for cars persist after the current supply chain problems are resolved? AutoNation is the largest chain of car dealerships in the United States. Recently, Mike Manley, the firm’s CEO, argued that the substantial discounts from the sticker price that were common before the pandemic are a thing of the past. He argued that car manufacturers were likely to keep production of new cars more closely in balance with consumer demand, reducing the number of cars dealers keep in inventory on their lots: “We will not return to excessively high inventory levels that depress new-vehicle margins.” 

Only time will tell whether the situation facing car buyers in 2022 of having to pay prices above the MSRP will persist. 

Sources: Mike Colias  and Nora Eckert, “A New Brand of Sticker Shock Hits the Car Market,” Wall Street Journal, February 26, 2022; Nora Eckert and Mike Colias, “Ford and GM Warn Dealers to Stop Charging So Much for New Cars,” Wall Street Journal, February 9, 2022; Gabrielle Coppola, “Car Discounts Aren’t Coming Back After Pandemic, AutoNation Says,”, February 9, 2022;; Lawrence H. Seltzer, A Financial History of the American Automobile Industry, Boston: Houghton-Mifflin, 1928; and Federal Reserve Bank of St. Louis.

Will the U.S. Ban on Russian Oil Imports Reduce Russian Oil Revenue?

Photo of Russian oil refinery from the New York Times.

On March 8, 2022, President Joe Biden announced that the United States would no longer allow new shipments of oil from Russia to the United States. Russian oil made up about 8 percent of total U.S. oil imports and about 2 percent of U.S. oil consumption.  European countries, which are much more heavily dependent on oil imports from Russia, announced plans to gradually reduce Russian oil imports.

The point of these policy actions was to reduce the revenues Russia would receive from oil exports as retaliation for Russia’s invasion of Ukraine. Beyond the effect of direct action against Russian oil imports, Russian oil exports were reduced further as a result of other sanctions imposed on the Russian economy by the United States and other countries. These sanctions made it difficult for Russia to access shipping services and the international payments system.

The decline in Russian oil exports reduced the total supply of oil on the international oil market, pushing up the price of the oil. The following figure shows the daily price in dollars per barrel of Brent crude oil, which is the most commonly used benchmark price of oil.

Will the actions taken by the United States and other countries reduce Russian oil revenues? As we discuss in Microeconomics, Chapter 6, Section 6.3, whether a seller’s total revenue will decrease as a result of a decrease in the quantity sold depends on the price elasticity of demand for the seller’s product. If demand is price elastic, the revenue the seller receives will fall. If demand is price inelastic, the revenue the seller receives will rise. 

In this case, Russia’s oil revenue will decline if the percentage increase in the price of oil is less than the percentage decrease in the quantity of oil Russia is selling. The energy information firm Energy Intelligence has estimated that Russian oil exports have declined by about one-third. On the day before the Russian invasion of Ukraine, the price of Brent crude oil was about $99 per barrel. It then rose to $129 per barrel on March 7 before falling to $109 per barrel on March 10.  Based on these values, the price Russia received per barrel of oil increased between 9 and 29 percent or by less than the 33 percent decline in the quantity of oil Russia sold.

Because the percentage decline in quantity was greater than the percentage increase in price, we can conclude that the actions taken by the United States and other countries reduced Russian oil revenue. In fact, the reduction in revenue is probably larger than indicated by the change in the price of Brent crude oil. Media reports indicate that to find buyers Russia is having to discount its oil by more than $10 per barrel from the Brent price.  In addition, the countries of the European Union have pledged to reduce Russian oil imports by two-thirds by the end of 2022 and the United Kingdom has pledged to end them entirely. Although Russia might be able to redirect to other countries some oil it had been exporting to Europe and the United States, it seems likely that Russia’s total oil exports will eventually decline by more than the initial one-third.

Sources: Andrew Restuccia and Josh Mitchell, “Biden Bans Imports of Russian Oil, Natural Gas, Wall Street Journal, March 8, 2022; Stanley Reed, “The Future Turns Dark for Russia’s Oil Industry,” New York Times, March 8, 2022; Collin Eaton, “How Much Oil Does the U.S. Import From Russia and Why Is Biden Banning It?” Wall Street Journal, March 9, 2022; “Russian Oil Exports Fall by One-Third,”, March 2, 2022; and Tsuyoshi Inajima and Serene Cheong, “More Russian Oil Deeply Discounted as Ban Risk Alarms Buyers,”, March 7, 2022. Brent crude oil price data from the Federal Reserve Bank of St. Louis and the Wall Street Journal.

Glenn’s Opinion Column on the Economics of an Increase in Defense Spending

Graphic from the Wall Street Journal.

Glenn published the following opinion column in the Wall Street Journal. Link here and full text below.

NATO Needs More Guns and Less Butter

Russia’s unprovoked invasion of Ukraine has challenged Western assumptions about security, economics and the postwar world order. In Europe and the U.S., public finances have long favored social spending over public goods such as defense. While President Biden doubled down on his proposal to increase social spending during his State of the Union address, Russia’s aggression highlights the shortcomings of this model. Western democracies now face a more uncertain and dangerous world than they did two weeks ago. Navigating it will require significantly higher levels of defense and security spending.

But change will be difficult, and the magnitude of what needs to be done is sobering. The U.S. currently spends 3.2% of gross domestic product on defense—roughly half of Cold War spending levels relative to GDP. An increase in spending of even 1% of GDP would amount to about $210 billion. That’s about 5% of the total federal spending level using a 2019 pre-Covid baseline. While Covid spending was large, it was transitory. Defense outlays would be much longer-lasting, an insurance premium or transaction cost for dealing with a more dangerous world.

The U.S. is not alone. Germany’s announcement of €100 billion in additional defense spending this year represents an increase of just over 0.25% of GDP, leaving Berlin still under the 2% commitment agreed to by North Atlantic Treaty Organization allies. Increasing Europe’s defense spending merely to the agreed-on level would require significant outlays. Such spending increases would occur against the backdrop of elevated public debt relative to GDP, brought on in part by heightened borrowing during the Covid pandemic and the earlier global financial crisis. High levels of public debt make it unlikely that countries will want to pay to increase their defense spending with new borrowing.

Paying for higher levels of defense spending will force most governments either to raise taxes or cut spending. Tax increases raise risks to growth. The larger non-U.S. NATO economies are already taxed to the hilt. Tax revenue relative to the size of the economy in France (45%), Germany (38%), Canada (34%) and the U.K. (32%) doesn’t leave much room to tax more without depressing economic activity. The U.S. has a lower tax share of GDP—about 17.5% at the federal level and 25.5% in total—but its patchwork quilt of income and payroll taxes makes tax increases more costly by distorting household and business decisions about consumption and investment.

A significant tax increase in the U.S. would need to be accompanied by fundamental tax reform, dialing back income taxes (as with the 2017 reduction in corporate tax rates) and increasing reliance on consumption taxes. A broad-based consumption tax could be implemented by imposing a tax at the business level on revenue minus purchases from other firms (a “subtraction method” value-added tax). Alternatively, the tax system could impose a broad-based wage and business cash-flow tax, with a progressive wage surtax on high earners. These consumption-tax alternatives would be efficient and equitable in a revenue-neutral tax reform. And they are crucial in avoiding decreases in savings, investment and entrepreneurship that accompany a tax increase.

Since the 1960s, spending on Social Security, Medicare and Medicaid has come to dominate the federal budget. Outlays for these programs have almost doubled since then as a share of GDP to 10.2% today, and the Congressional Budget Office projects they will consume about another 5% of GDP annually by 2040. Spending offsets to accommodate higher defense spending would surely require slowing the growth in social-insurance spending. As with tax increases, there are trade-offs. It is possible to slow the growth of this spending while preserving access to such support for lower-income Americans. Accomplishing that will require focusing net taxpayer subsidies on lower-income Americans, along with undertaking market-oriented health reforms. Such changes require serious attention.

The U.S. and its NATO allies will face a challenging set of economic trade-offs and political realities in achieving higher defense spending. The challenge will be exacerbated by additional private investment needs in a more dangerous world of investment risks, skepticism about globalization, and cybersecurity threats. 

In the U.S., the failure of the 2010 Simpson-Bowles Commission’s proposed spending and tax reforms to spark a serious discussion is a warning sign. So, too, is the antipathy of Democratic and Republican officials alike toward creating the fiscal space necessary to accommodate greater defense spending. Such challenges don’t cause threats to vanish. They require leadership—now.

Fanatics: The Unlikely Unicorn

Image from website.

unicorn is a startup, or newly formed firm, that has yet to begin selling stock publicly and has a value of $1 billion or more. (We discuss the difference between private firms and public firms in Economics and Microeconomics, Chapter 8, chapter opener and Section 8.2, and in Macroeconomics, Chapter 6, chapter opener and Section 6.2.) Usually, when we think of unicorns, we think of tech firms. That assumption is largely borne out by the following list of the 10 highest-valued U.S.-based startups, as compiled by

SpaceX$100.3 B
Stripe$95 B
Epic Games$42 B
Instacart$39 B
Databricks$38 B
Fanatics$27 B
Chime$25 B
Miro$17.5 B
Ripple$15 B
Plaid$13.4 B

Nine of the ten firms are technology firms, with six being financial technology—fintech—firms. (We discuss fintech firms in the Apply the Concept, “Help for Young Borrowers: Fintech or Ceilings on Interest Rates,” which appears in Macroeconomics, Chapter 14, Section 14.3, and Economics, Chapter 24, Section 24.3.) The one non-tech firm on the list is Fanatics, whose main products are sports merchandise and sports trading cards.  Because a unicorn doesn’t issue publicly traded stock, the firm’s valuation is determined by how much an investor pays for a percentage of the firm. In Fanatics’s case, the valuation was based on a $1.5 billion investment in the firm made in early March 2022 by a group of investors, including Fidelity, the large mutual find firm; Blackrock, the largest hedge fund in the world; and Michael Dell, the founder of the computer company.

These investors were expecting that Fanatics would earn an economic profit. But, as we discuss in Chapter 14, Section 14.1 and Chapter 15, Section 15.2, a firm will find its economic profit competed away unless other firms that might compete against it face barriers to entry. Although Fanatics CEO Michael Rubin has plans for the firm to expand into other areas, including sports betting, the firm’s core businesses of sports merchandise and trading cards would appear to have low barriers to entry. There are already many firms selling sportswear and there are many firms selling trading cards. The investment required to establish another firm to sell those products is low. So, we would expect competition in the sports merchandise and trading card markets to eliminate economic profit.

The key to Fanatics success is that it is selling differentiated products in those markets. Its differentiation is based on a key resource that competitors lack access to: The right to produce sportswear with the emblems of professional sports teams and the right to produce trading cards that show images of professional athletes. Fanatics has contracts with the National Football League (NFL), Major League Baseball (MLB), the National Hockey League (NHL), the National Basketball Association (NBA), and Major League Soccer (MLS)—the five most important professional sports leagues in North America—to produce jerseys, caps, and other sportswear that uses the copyrighted brands of the leagues’ teams. (In some cases, as with the NBA, Fanatics shares the right with another firm.)

Similarly, Fanatics has the exclusive right to produce trading cards bearing the images of NFL, NBA, and MLB players. In January 2022, Fanatics bought Topps, the firm that for decades had held the right to produce MLB trading cards. 

Fanatics has paid high prices to these sports leagues and their players to gain the rights to sell branded merchandise and cards. Some business analysts questioned whether Fanatics will be able to sell the merchandise and cards for prices high enough to earn an economic profit on its investments. Fanatics CEO Rubin is counting on an increase in the popularity of trading cards and the increased interest in sports caused by more states legalizing sports gambling. 

That Fanatics has found a place on the list of the most valuable startups that is otherwise dominated by tech firms indicates that many investors agree with Rubin’s business strategy.

Sources:  “The Complete List of Unicorn Companies,”; Miriam Gottfried and Andrew Beaton, “Fanatics Raises $1.5 Billion at $27 Billion Valuation,” Wall Street Journal, March 2, 2022; Tom Baysinger, “Fanatics Scores $27 Billion Valuation,” March 2, 2022; Lauren Hirsch, “Fanatics Is Buying Mitchell & Ness, a Fellow Sports Merchandiser,” New York Times, February 18, 2022; and Kendall Baker, “Fanatics Bets Big on Trading Card Boom,”, January 5, 2022.


On Tuesday, March 1, Glenn and Tony will record a podcast on the economic consequences of the Russian invasion of Ukraine. The recording will be posted to this blog and also available through iTunes.

Some useful links

General information on developments (political and military, as well as economic):

Updates on the website of the Financial Times (note that the FT has dropped its paywall to allow non-subscribers to read this content). This article on the possible effects on the global economy is particularly worth reading.

The Twitter feed of Max Seddon, the FT’s Moscow bureau chief, is here.

The website of the New York Times has an extensive series of updates focused on military and political developments (subscription may be required).

Streaming updates on the website of the Wall Street Journal (subscription may be required).

A Twitter feed that provides timely updates on the military situation.

An article in the New Yorker discussing Russian President Vladimir Putin’s claims about the historical relationship between Russia and Ukraine.

A pessimistic blog post by a retired U.S. Army Colonel on whether the U.S. military is equipped to fight a war in Europe.

Discussions focused on economics:

As background, the following figure from the Our World in Data site shows the growth in real GDP per capita for several countries. The underlying data were compiled by the World Bank and are measured in constant international dollars, which means that they are corrected for inflation and for variations across countries in the purchasing power of the domestic currency.

In 2020, Russian GDP per capita was less than half that of U.S. GDP per capita although about 50 percent greater than GDP per capita in China. GDP per capita in Lithuania, part of the Soviet Union until 1991, and Poland, part of the Soviet bloc until 1989, are significantly higher than in Russia. These two countries have become integrated into the European economy and have grown more rapidly than has Russia, which continues to rely heavy on exports of oil, natural gas, and other commodities. Ukraine is not as well integrated into the European economy as are Poland and Lithuania and Ukraine experienced little economic growth since attaining independence in 1991. In fact, Ukraine’s real GDP per capita was lower in 2020 than it had been in 1991.

Here is a transcript of President Joe Biden’s speech imposing sanctions on Russia.

Informative Full Stack Economics blog post by Alan Cole explaining the likely reasons why U.S. and European sanctions on Russia excluded energy. Useful explanation of the role of correspondent banking in international trade.

An article in the Economist discussing sanctions (subscription may be required).

An article in the New York Times discussing the SWIFT (Society for Worldwide Interbank Financial Telecommunications) service, which is based in Belgium, and is a key component of the international financial system. Some policymakers have proposed cutting Russia off from SWIFT. The article discusses why some countries have been opposed to taking that step (subscription may be required).

An opinion column by Justin Fox on examines in what sense the United States is energy independent and the economic reasons that the U.S. still imports some oil from Russia (subscription may be required).

Blog post by economic writer Noah Smith on the possible effects of the invasion on the post-World War II international economic system.

Would Cutting the Federal Excise Tax on Gasoline Lower the Price that Consumers Pay?

Photo from

The federal government levies an excise tax of 18.4 cents per gallon of gasoline. (An excise tax is a tax that a government imposes on a particular product. In addition to the tax on gasoline, the federal government imposes excise taxes on tobacco, alcohol, airline tickets, and a few other products.) In February 2022, inflation was running at the highest level in several decades. The average retail price of gasoline across the country had risen to $3.50 per gallon from $2.60 per gallon a year earlier. The following figure shows fluctuations in the retail price of gasoline since January 2000. 

Policymakers were looking for ways to lessen the effects of inflation on consumers. An article in the Wall Street Journalreported that several Democratic members of the U.S. Senate, including Mark Kelly of Arizona, Maggie Hassan of New Hampshire, and Raphael Warnock of Georgia proposed that the federal excise tax on gasoline be suspended for the remainder of 2022. The sponsors of the proposal believed that cutting the tax would reduce the price of gasoline that consumers pay at the pump. Other members of the Senate weren’t so sure, with one quoted as saying that cutting the tax was “not going to change anything” and another arguing that oil companies would receive most of the benefit of the tax cut.

Some members of Congress were opposed to suspending the gasoline tax because the revenue raised from the tax is placed in the highway trust fund, which helps to pay for federal contributions to highway building and repair and for mass transit. In that sense, the gasoline tax follows the benefits-received principle, under which people who receive benefits from a government program—in this case, highway maintenance—should help pay for the program. (We discuss the principles for evaluating taxes in Microeconomics, Chapter 17, Section 17.2 and in Economics, Chapter 17, Section 17.2) Other members of Congress were opposed to suspending the tax because they believe that the tax helps to reduce the quantity of gasoline consumed, thereby helping to slow climate change. 

Focusing just on the question of the effect of suspending the tax on the retail price of gasoline, what can we conclude? The question is one of tax incidence, which looks at the actual division of the burden of a tax between buyers and sellers in a market. In other words, tax incidence looks beyond the fact that gasoline stations collect the tax and send the revenue to federal government to the issue of who actually pays the tax. As we note in Chapter 17, Section 17.3:

When the demand for a product is less elastic than supply, consumers pay the majority of the tax on the product. When the demand for a product is more elastic than supply, firms pay the majority of the tax on the product. 

Consumers would receive all of the tax cut—that is, the retail price of gasoline would fall by 18.4 cents—only in the polar case where the demand for gasoline were perfectly price inelastic. Similarly, consumers would receive none of the tax cut and the price of gasoline would remain unchanged—so oil companies would receive all of the tax cut—only in the polar case where the demand for gasoline is perfectly price inelastic. (It’s a worthwhile exercise to show these two cases using demand and supply graphs.)

In the real world, we would expect to be somewhere in between these two cases, with consumers receiving some of the benefit of suspending the tax and producers receiving the remainder of the benefit. The short-run price elasticity of demand for gasoline is quite small; according to one estimate it is only −.06.  The short-run price elasticity of supply of gasoline is likely to be somewhat larger than that in absolute value, which means that we would expect that consumers would receive the majority of the tax cut. (Note that we would expect the long-run price elasticities of demand and supply to both be larger for reasons we discuss in Chapter 6, Section 6.2 and 6.6.) In other words, the retail price of gasoline would fall, holding all other factors constant, but not by the full tax cut of 18.4 cents.

Joseph Doyle of MIT and Krislert Samphantharak of the University of California, San Diego studied the effect of suspension in the state excise tax on gasoline in Indiana and Illinois in 2000. In that year, Indiana suspended collecting its gasoline excise tax for 120 days and Illinois suspended its tax for 184 days. The authors estimate that consumers received about 70 percent of the tax cut in the form of lower gasoline prices. If we apply that estimate to the federal gasoline tax, then suspending the tax would lower the price of gasoline by about 12.9 cents per gallon, holding all other factors that affect the price of gasoline constant. As the above figure shows, the retail price of gasoline frequently fluctuates up and down by more than 12.9 cents, even over fairly brief periods of time. In that sense, the effect on the gasoline market of suspending the federal excise tax on gasoline would be relatively small.  

Sources: Andrew Duehren and Richard Rubin, “Some Lawmakers Want to Halt Gas Tax Amid High Inflation. Others See a Gimmick,” Wall Street Journal, February 16, 2022; Tony Romm and Jeff Stein, “White House, Congressional Democrats Eye Pause of Federal Gas Tax as Prices Remain High, Election Looms,” Washington Post, February 15, 2022; Joseph J. Doyle, Jr., Krislert Samphantharak, “$2.00 Gas! Studying the Effects of a Gas Tax Moratorium,” Journal of Public Economics, Vol. 92, No.s 3-4, April 2008, pp. 869-884; and Federal Reserve Bank of St. Louis.

Are Economic Profits a Sign of Market Power?

Cecilia Rouse, chair of the Council of Economic Advisers. Photo from the Washington Post.

An article in the Washington Post discussed a debate among President Biden’s economic advisers. The debate was over “over whether the White House should blame corporate consolidation and monopoly power for price hikes.” Some members of the National Economic Council supported the view that the increase in inflation that began in the spring of 2021 was the result of a decline in competition in the U.S. economy.

Some Democratic members of Congress have also supported this view. For instance, Massachusetts Senator Elizabeth Warren argued on Twitter that: “One clear explanation for higher inflation? Giant corporations are exploiting their market power to further raise prices. And corporate executives are bragging about their higher profits.” Or, as Vermont Senator Bernie Sanders put it: “The problem is not inflation. The problem is corporate greed, collusion & profiteering.”

But according to the article, Cecilia Rouse, chair of the President’s Council of Economic Advisers (CEA), and other members of the CEA are skeptical that a lack of competition are the main reason for the increase in inflation, arguing that very expansionary monetary and fiscal policies, along with disruptions to supply chains, have been more important.

In an earlier blog post (found here), we noted that a large majority of more than 40 well-known academic economists surveyed by the Booth School of Business at the University of Chicago disagreed with the statement: “A significant factor behind today’s higher US inflation is dominant corporations in uncompetitive markets taking advantage of their market power to raise prices in order to increase their profit margins.”

One difficulty with the argument that the sharp increase in inflation since mid-2021 was due to corporate greed is that there is no particular reason to believe that corporations suddenly became more greedy than they had been when inflation was much lower. If inflation were mainly due to corporate greed, then greed must fluctuate over time, just as inflation does. Economic writer and blogger Noah Smith poked fun at this idea in the following graph

It’s worth noting that “greed” is one way of characterizing the self-interested behavior that underlies the assumption that firms maximize profits and individual maximize utility. (We discuss profit maximization in Microeconomics, Chapter 12, Section 12.2, and utility maximization in Chapter 10, Section 10.1.) When economists discuss self-interested behavior, they are not making a normative statement that it’s good for people to be self-interested. Instead, they are making a positive statement that economic models that assume that businesses maximize profit and consumers maximize utility have been successful in analyzing and predicting the behavior of businesses and households. 

Corporate profits increased from $1.95 trillion in the first quarter of 2021 to $2.40 trillion in third quarter of 2021 (the most recent quarter for which data are available). Using another measure of profit, during the same period, corporate profits increased from about 16 percent of value added by nonfinancial corporate businesses to about 18 percent. (Value added measures the market value a firm adds to a product. We discuss calculating value added in Macroeconomics, Chapter 8, Section 8.1.)

There have been mergers in some industries that may have contributed to an increase in profits—the Biden Administration has singled out mergers in the meatpacking industry as having led to higher beef and chicken prices. At this point, though, it’s not possible to gauge the extent to which mergers have been responsible for higher prices, even in the meatpacking industry.   

An increase in profit is not by itself an indication that firms have increased their market power. We would expect that even in a perfectly competitive industry, an increase in demand will lead in the short run to an increase in the economic profit earned by firms in the industry. But in the long run we expect economic profit to be competed away either by existing firms expanding their production or by new firms entering the industry.

In Chapter 12, we use Figure 12.8 to illustrate the effects of entry in the market for cage-free eggs. Panel (a) shows the market for cage-free eggs, made up of all the egg sellers and egg buyers. Panel (b) shows the situation facing one farmer producing cage-free eggs. (Note the very different scales of the horizontal axes in the two panels.) At $3 per dozen eggs, the typical egg farmer is earning an economic profit, shown by the green rectangle in panel (b). That economic profit attracts new entrants to the market—perhaps, in this case, egg farmers who convert to using cage-free methods. The result of entry is a movement down the demand curve to a new equilibrium price of $2 per dozen. At that price, the typical egg farmer is no longer earning an economic profit.

A few last observations:

  1. The recent increase in profits may also be short-lived if it reflects a temporary increase in demand for some durable goods, such as furniture and appliances, raising their prices and increasing the profits of firms that produce them. The increase in spending on goods, and reduced spending on services, appears to have resulted from:  (1) Households having additional funds to spend as a result of the payments they received from fiscal policy actions in 2020 and early 2021, and (2) a reluctance of households to spend on some services, such as restaurant meals and movie theater tickets, due to the effects of the Covid-19 pandemic.
  2. The increase in profits in some industries may also be due to a reduction in supply in those industries having forced up prices. For instance, a shortage of semiconductors has reduced the supply of automobiles, raising car prices and the profits of automobile manufacturers. Over time, supply in these industries should increase, bringing down both prices and profits.
  3. If some changes in consumer demand persist over time, we would expect that the  economic profits firms are earning in the affected industries will attract the entry of new firms—a process we illustrated above. In early 2022, this process is far from complete because it takes time for new firms to enter an industry.

Source:  Jeff Stein, “White House economists push back against pressure to blame corporations for inflation,” Washington Post, February 17, 2022; Mike Dorning, “Biden Launches Plan to Fight Meatpacker Giants on Inflation,”, January 3, 2022; and U.S. Bureau of Economic

Price Leadership in the Beer Market

InBev’s St. Louis production line for Stell Artois beer. Photo from the Wall Street Journal

Firms in an oligopoly can increase their profits by agreeing with other firms in the industry on what prices to charge. Explicit price fixing violates the antitrust laws and can subject the firms involved to fines of up to $100 million and executives at the firms to fines of up to $1 million and prison terms of up to 10 years. Despite these penalties, the rewards to avoiding price competition are often so great that firms look for ways to implicitly collude—that is, to arrange ways to coordinate their prices without violating the law by explicitly agreeing on the prices to charge. (We discuss the antitrust laws in Microeconomics and Economics, Chapter 15, Section 15.6.) 

One way for firms to implicitly collude is through price leadership. With price leadership, one firm in the industry takes the lead in announcing a price change that other firms in the industry then match. (We briefly discuss price leadership in Microeconomics and Economics, Chapter 14, Section 14.2.)

In their classic industrial organization textbook, F.M. Scherer of Harvard’s Kennedy School and David Ross of Bryn Mawr College summarize the legal status of price leadership, given court opinions from antitrust cases: “[P]rice leadership is not apt to be found contrary to the antitrust laws unless the leader attempts to coerce other producers into following its lead, or unless there is evidence of an agreement among members of the industry to use the leadership device as the basis of a price-fixing scheme.” As the Federal Trade Commission notes on its website: “A uniform, simultaneous price change could be the result of price fixing, but it could also be the result of independent business responses to the same market conditions.”

Scherer and Ross describe price leadership in a number of oligopolistic industries during the twentieth century, including cigarettes, steel, automobiles, breakfast cereals, turbogenerators, and gasoline.

Recently, Nathan Miller of Georgetown University, Gloria Sheu of the Federal Reserve, and Matthew Weinberg of Ohio State University published an article in the American Economic Review analyzing price leadership in the beer industry. They focus on the period from 2001 to 2011, although they believe that conditions in the beer industry are similar today. From 2001 to 2007, three large U.S.-based firms—Anheuser-Busch, SABMiller, and Molson Coors—accounted for about two-thirds of beer sales in the United States. Two importers—Heineken and Grupo Modelo—accounted for about 14 percent of sales.  In 2008, SABMiller and Molson Coors combined to form MillerCoors and InBev—which had a small market share—bought Anheuser Busch. In 2011, MillerCoors and InBev together accounted for 63 percent of beer sales.

ABI has acted as the price leader, announcing prices in the late summer that MillerCoors typically matches. ABI’s Bud Light had the largest market share among beers in the United States in 2011, well ahead of Coors Light, which had the second largest share. They find that industry profits were 17 percent above the competitive level in 2007—just before the Miller-Coors merger—and 22 percent above the competitive level in 2010—after the merger. The U.S. Department of Justice (DOJ) had decided not to contest the Miller-Coors merger because “cost savings in distribution likely would offset any loss of competition.” As it turned out, the cost savings occurred but their value was smaller than the losses in consumer surplus resulting from reduced competition.

The authors estimate that, compared with the competitive outcome, the reduction in consumer surplus in the beer market due to price leadership equaled 154 of the increase in producer surplus before the Miller-Coors merger and 170 percent after it. Figure 15.5 from Chapter 15 of Microeconomics (reproduced below) illustrates why the loss of consumer surplus is larger than the increase in producer surplus: The increase in price and decline in quantity compared with the competitive level results in a deadweight loss that reduces the total economic surplus in the market. (Note that the figure is comparing the situation when a market is monopoly with the situation when the market is perfectly competitive. For simplicity, we are assuming that price leadership in an oligopolistic industry, such as beer, results in the monopoly outcome. But note that whenever collusive behavior, like price leadership, occurs in an industry, we would expect an increase in deadweight loss that will make the gains to firms larger than the losses to consumers.)

Sources: Federal Trade Commission, “Price Fixing,”; U.S. Department of Justice, Antitrust Division, “Price Fixing, Bid Rigging, and Market Allocation Schemes: What They Are and What to Look for,”; Nathan H. Miller, Gloria Sheu, and Matthew C. Weinberg, “Oligopolistic Price Leadership and Mergers: The United States Beer Industry,” American Economic Review, Vol. 111, No. 10, pp. 3123-3159; and F.M Scherer and David Ross, Industrial Market Structure and Economic Performance, Third edition, Boston: Houghton Mifflin, 1990.

Microsoft Buys Activision

Photo from the Wall Street Journal

When a firm decides to expand, it has two main choices: 1) Grow internally, or 2) grow by purchasing (or merging with) another. When Microsoft decided to increase its ability to produce and distribute video games, it chose to grow by acquiring Activision Blizzard, maker of Call of Duty and World of Warcraft among other games. Microsoft’s main objective in buying Activision was to increase the number of games it would have available on its Game Pass cloud-based game streaming service.

Traditionally, people have played video games like Call of Duty on video game consoles like Microsoft’s Xbox or Sony’s PlayStation. This arrangement is similar to how at one time many people watched movies on DVD or Blu-ray players. Today, more people stream movies by subscribing to streaming services like Netflix, Amazon Prime, or Disney+. With these cloud-based movie streaming services, people watch movies on their computers, tablets, or smartphones without having to download them.

With Game Pass, Microsoft is trying to bring the streaming model to video games. If successful, gameplayers would no longer need a video game console, being able to instead play the game on any internet-connected device, including a smartphone.  So far, cloud-based gaming has been growing fairly slowly because games contain much more data than do movies, which makes it more difficult to adapt them to streaming. Microsoft hopes that after successfully converting Activision’s popular games to streaming, it will give a boost to its Game Pass service. 

Microsoft also indicated that it acquired Activision to help it expand its ability to offer products in the “metaverse,” which is a so far not fully developed version of the internet in which people can interact using augmented reality or virtual reality. Most industry observers believe that given that at this point few metaverse services and products are available, the contribution of Activision to the expansion of Game Pass was likely Microsoft’s main motivation in acquiring the company.

Microsoft’s acquisition of Activision would appear to benefit consumers because it would allow them to stream Activision’s games. Prior to being acquired, Activision apparently had no plans to launch its own game streaming service. In that sense, the acquisition brought together a firm with a popular product (video games) and a firm that had a better way of distributing the product (Game Pass). Still, some industry observers wondered whether the acquisition might lead to an antitrust investigation by either the Antitrust Division of the U.S. Department of Justice or the Federal Trade Commission. (We discuss antitrust policy in Economics and Microeconomics, Chapter 15, Section 15.6.)

Antitrust investigations are most common when two firms in the same industry merge because that type of horizontal merger raises the possibility that the new, larger firm may have greater market power, which would increase its ability to raise prices.  Microsoft’s acquisition of Activision is an example of a vertical merger, or a merger between firms at different stages of the production of a good or service. Activision’s game content would be combined with Microsoft’s Game Pass system of distributing games.

The federal government doesn’t typically challenge vertical mergers because they rarely impose a burden on consumers, as horizontal mergers may. But officials in the Biden Administration have promised stricter scrutiny of mergers involving large tech firms, like Microsoft. In response to the possibility of antitrust action against its acquisition of Activision, Microsoft argued that it wouldn’t “be withdrawing games from existing platforms, and our strategy is player-centric—gamers should be able to play the games they want where they want. We believe this acquisition will only increase competition, but it is ultimately up to regulators to decide.” 

Sources:  Kellen Browning, “It’s Not Complicated. Microsoft Wants Activision for Its Games,” New York Times, January 19, 2022; Cara Lombardo, Kirsten Grind, and Aaron Tilley, “Microsoft to Buy Activision Blizzard in All-Cash Deal Valued at $75 Billion,” Wall Street Journal, January 18, 2022; Sarah E. Needleman, Wall Street Journal, January 20, 2022; and Stefania Palma, James Fontanella-Khan, Javier Espinoza, and Richard Waters, “’Too Big to Be Ignored’: Microsoft-Activision Deal Tests Regulators,”, January 22, 2022.