Featured Post

Market Failure 6: Behavioural Economics (A mind is a terrible thing to trust)

Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance.

Daniel Kahneman, Thinking Fast and Slow

Most of microeconomics is based on rational choice – people are assumed to act in such a way as to best advance their own preferences. This is in fact one of the few things about microeconomics that people know, and it is the most common criticism of microeconomics. People clearly aren’t rational, so how can you build your elaborate models assuming that they are? What good are the elaborate signals and incentives of the market system if people make the wrong decisions based on them?

There are three broad reasons why the rationality assumption was (and is) so popular, the third of which I will come back to later in the post. The first is that, as I noted in the previous part, mistakes tend to cancel out in large numbers. People randomly screwing up doesn’t jeopardise the market system as a whole. It’s only when people consistently make an error more often than they make the opposite error (people must be biased, not just error-prone) that we have problems.

But biases do exist, so why assume rationality in the presence of them? The principal virtue of rationality as an assumption is that it’s concrete. Rational behaviour has certain observable properties, even if you don’t know what someone’s preferences are (I’ll talk about these later), which means that it’s at least testable. But simply declaring people to be irrational doesn’t give you any guidance as to how they will behave. For irrationality to be tractable you need specific theories of how human behaviour systematically varies from theoretical ideals.

Enter Daniel Kahnemann and Amos Tversky. Psychologists rather than economists, they nonetheless earned their Economics Nobel by providing a clear outline of cognitive biases that make it possible to discuss how people are irrational, rather than simply declaring that they are irrational.

So what do we mean by irrational? At one level it’s pretty straightforward – a decision is irrational if it predictably leads to outcomes that are contrary to your preferences. If there is another decision you could have made that would predictably lead to better outcomes, by your own definition of “better”, then your decision was irrational. The complicated part is that you can’t perceive someone’s preferences directly. So how do you decide whether a decision is irrational? There are two ways you can determine an action to be irrational:

  1. You can comment on the rationality of an action contingent on some specified goal. For example: economists and political scientists will often say that voting is irrational if your goal is to change the outcome of the election since there is effectively no chance of your vote changing the outcome of the election. Note that this type of statement is of limited utility as it is only applicable to people whose goals match your statement. If you have goals aside from changing the outcome of an election, voting might be rational for you.
  2. Alternatively (and more usefully), you can demonstrate that a decision is irrational if no possible set of preferences could support it. This is normally done by looking for inconsistencies in sets of decisions. The textbook example is intransitivity – if a person can be shown to consistently choose A over B, B over C, and C over A, then there is no possible coherent ranking of A, B, and C that could justify that set of choices. Kahenman and Tversky focused on this sort of irrationality in their work.

The biases Kahneman and Tversky outlined form the core of behavioural economics, the branch of economics that considers irrational behaviour. Some of the more important biases include:

  • Anchoring Bias – a tendency to evaluate an option by comparing it to irrelevant contextual information. If you ask people to say how much they will pay for something, you will get different answers if you give them a range of options from $0 to $100+ than if you give them a range of options from $0 to $1000+.
  • Hyperbolic Discounting – an inconsistency of time preferences that leads people to be less willing to tolerate delays that happen in the near future versus ones that happen in the more distant future. People should find a day’s delay to receiving a payment to be equally bad (if you express badness as a percentage reduction in value) if the delay is from 0 days to 1 or 365 days to 366, but in practice people find the more immediate delay worse.
  • Framing Effects – People make inconsistent choices, depending on how the choice is presented. Offer people a choice between risking deaths or certain deaths, they are more inclined to taking risks. Offer them the same choice framed as choosing between a chance of saving lives or a certainty of saving lives, and people are more inclined to choose certainty.
  • Improper Probabilistic Reasoning – Whole books have been written about this one. Needless to say, regular people who haven’t had statistical training are utterly useless at dealing with probabilities. Not that trained statisticians are good in any absolute sense, just less useless.

Behavioral economics is the newest branch of market failure economics, so it’s policy prescriptions are still in development. The leading school of thought when it comes to policy solutions is called choice architecture (or nudging) and was popularized by Richard Thaler and Cass Sunstein in their book Nudge. The premise behind nudging is that if subtle features of how choices are presented change what we choose, then why not structure choices so as to more closely produce the decisions someone would make if they weren’t plagued by all these biases. Note that nudging is not compulsion – an example from Nudge is a school cafeteria putting the salads at eye level, and having the desserts at the bottom of the cabinet, where they are harder to see. If you really want a dessert, then it’s still for sale. It’s just less likely to present itself as an option if you haven’t already decided to buy one. Another example is making retirement savings programmes opt-out, rather than opt-in. Now you have to make a deliberate decision not to save for your retirement rather than a deliberate decision to save.

Like a lot of economic terminology, the meaning of nudge can start to slip if you’re not careful. Nudges do not involve reducing consumer choices but merely changing the salience of different options. As soon as you start forbidding some choices or even making them more expensive you have moved beyond nudging. I believe that keeping different kinds of intervention conceptually separate is worth a little pedantry – if someone tries to dress up traditional regulations or taxes as “nudging” I recommend you stop and clarify terms. So many internet arguments are fuelled by conflicts in each interlocutor’s definitions.

There are also dangers with nudging that are less semantic. Earlier in the post I outlined two of three reasons why rational choice is popular in economics. The third is that it takes the agency of the public seriously. The danger with making policy to correct irrational decisions is that you can’t observe people’s preferences directly. The cognitive biases I mentioned above were found in lab conditions with all the noise of the real world filtered out. In the real world, figuring out whether a specific decision is irrational (as distinct from being the rational product of preferences that are very different to yours) is much more difficult.

Eliezer Yudkowsky noted that learning about cognitive biases can make it really easy to find flaws in other people reasoning, thereby paradoxically making it harder to realize when you’ve made a mistake. Doing this in a debate makes you obnoxious but doing it as a policy maker can turn you into a tyrant. If your nudge doesn’t work, it is very easy to conclude that more force is called for – the nudge becomes a shove. And if people object to your attempt to ‘help’ them, you can easily rationalize away their objections by listing all of the cognitive biases they are probably suffering from. This is a danger even if you rely on stated preference as a guide (for example, concluding that since a lot of people who say they want to quit smoking fail to quit, they need a nudge in the right direction) since stated preference is not especially credible. People say all sorts of things because they think it will make them look good or simply because they think they should. This is why economists take people’s choices so seriously – there are serious risks involved in neglecting people’s revealed preferences.

I am not suggesting throwing the baby out with the bath water – cognitive biases are real, no matter how convenient it might be if they weren’t. But you should proceed with caution – not every strange decision is irrational, and if the public doesn’t respond to your nudging you should resist the urge to switch to compulsion. If people aren’t responding to the nudging, their choice might be less irrational then you originally supposed.

Caution will also be the order of the day in the next part where I will talk about the limitations of government as an institution and why everything I’ve discussed so far is more complicated in practice.


Staff Writer
Home Page 

James is a government policy analyst, and lives in Wellington, New Zealand. His interests including wargaming, computer gaming (especially RPGs and strategy games), Dungeons & Dragons and scepticism. No part of any of his posts or comments should be construed as the position of any part of the New Zealand government, or indeed any agency he may be associated with.

Please do be so kind as to share this post.
TwitterFacebookRedditEmailPrintFriendlyMore options

112 thoughts on “Market Failure 6: Behavioural Economics (A mind is a terrible thing to trust)

  1. One of the difficulties here is with the ever receding nature of the meaning of words dealing with subjectivity. Case in point is “preferences”. Describing cognitive biases as “biases” suggests that our preferences are irrational if they do not compensate for the biases. However, we could conceptualize these biases as heuristic devices that average out our mistakes at the front end of decision making.

    This seems overall to be a useful approach to solve the black boxes of ourselves and our environments since here we are with all this stuff around us.

    Science and logic have greatly extended human access to logically processed information, cybernetics if you will, and so the small scale errors are more clearly visible. Science and logic also enable technical development that magnifies the extent of both individual and collective errors.

    Then we must reconsider the word “errors” as imprecise at least – error existing in what moral/ethical frame? for example. The arbiter of this question is a product of subjectivity that partly relies on biases for its existence.

    Report

    • Was hoping someone else would ask: What impact would reconsideration of the sort you are recommending have on the economic analysis? Or are you just proposing an alternative, philosophically more robust way of saying essentially the same thing – i.e., regarding error correction.

      Report

      • The place where I think it matters is James’ third reason why rational choice is popular in economics – “it takes the agency of the public seriously.”

        Big Data ie cybernetics can be used to find current associations of individual inputs/outputs. This information can then be used to nudge, or more ambitiously design, economic situations that do not rely on an assumption of the robust agency of humans to discern the causal paths of decision making. Individuals can be taken as black boxes whose internal workings are irrelevant. What is important is the dynamic, evolving associations of input, (an individual’s trackable behavior) with output (structuring the sell).

        That is, robust human agency is then a folk psychology (heuristic) artifact that works well enough in a lower information environment, but is surpassed in a higher information environment.

        As James notes, Nudging begins to undermine the libertarian project the more robust it gets. Indeed there is widespread concern from just about all political persuasions about how ho information environments undermine the idea of robust human agency.

        It seems to me the practice of economics has largely abandoned the actual use of human agency even as it continues to use its rhetoric. I wonder if that’s gonna cause some problems down the road.

        Report

        • Big Data ie cybernetics can be used to find current associations of individual inputs/outputs. This information can then be used to nudge, or more ambitiously design, economic situations that do not rely on an assumption of the robust agency of humans to discern the causal paths of decision making.

          I very much doubt that would work. There are thing you need to know to engage in central planning that no amount of Big Data can tell you about (and Big Data in general is overrated).

          Report

          • My wording was perhaps a bit sloppy, and conflated a possible future with the present. The current state of BD is not strong enough for “central planning”. I didn’t mean to speak directly to that possibility.

            OTOH, the future will involve a huge increase in machine sensors collecting data on any activity of any entity on earth that seems economically relevant.

            However, I am interested in your response to my general point on the limited viability of a robust human agency as the basis for economic analysis. Or, put another way, could you expand on why you mentioned it in you post?

            Report

            • Or, put another way, could you expand on why you mentioned it in you post?

              One mistake I sometimes see people making when it comes to formulation policy is to assume away diversity of preferences. It is disturbingly common to have people implicitly assume that is they wouldn’t do something then it isn’t rational for anyone to do it. For example, deciding that people who smoke or drink or do drugs are making the “wrong choice” and need to be prevented from doing so for their own good.

              The whole point of using allocative efficiency as a policy goal is that it is inclusive of people’s individual preferences, and the advantage of assuming rationality as a general case is that it treats people as capable of making their own choices instead of treating every decision you don’t approve of as a problem to be solved.

              Report

  2. The difficulty I have with conversation of “rationality” in this context is that it seems to reduce humans to emotionless robots.

    Regarding the A>B>C>A paradox, this isn’t necessarily the result of irrationality. Rather, it can be the application of different preferences in different contexts.

    I believe inarguably that White Manna in Hackensack, NJ makes a better burger than the McDonalds across the street. I won’t argue this objectively; rather, my personal preference is for the former. But sometimes I don’t want a “better burger”… I want a Big Mac. White Manna does not make a Big Mac. A Big Mac is, technically, a hamburger. But it is a specific type of hamburger that fills a particular niche in the hamburger eating world that no other burger — regardless of the strength of preference for it — can fill.

    Similarly, as I discussed on another of these posts, sometimes I’ll go to the corner store near work and pay an extra buck for an item rather than the cheaper store 6 blocks away. Sometimes, that dollar is SO WORTH the added convenience. But on other days, it isn’t. On other days, I *need* that little dose of sunshine and fresh air and movement. So, how much is that $1 worth to me? How much is a 12 block round trip walk worth to me? The answer is: it depends. But at any given time, I might offer an answer that you could immediately call irrational based on observed behavior.

    I’m not sure how this all fits into the broader argument here and it certainly isn’t meant to refute anything. Only that I bristle when economists describe people or choices as irrational based on a really unnuanced, black-and-white analysis.

    Report

    • I don’t care what you say, someone choosing to forgo critical medication or food to keep their car is irrational.
      Intelligent business decisions are often made by finding irrationality and exploiting the everliving fuck out of it.

      Report

      • If the choice ultimately gets forced, I don’t see anyone ultimately choosing the car over food. Searing hunger, right here, right now, is just too unpleasant. But short of that situation, it’s really just a matter of how much sacrifice short of all the food you might want that you are willing to make to retain your car. The thing is, finding food isn’t all that hard, and it’s pretty hard to get a person to where they do still have a car, but have nothing else they could sacrifice to get food – and can’t find any other way to get food, either, like charity. There’s always something at hand to trade for some food.

        Like medication, or the ability to buy it (as you suggest). So let’s take medication. It’s really not necessarily irrational at all to forego meds. The danger of forgoing medication is largely perceived as the risk of a shorter life. But there are amenities in life that people become so attached to as to make the prospect of having more life, but having it without those things, less attractive than having less life, but having those things. At least from afar, when not directly considering the immediate reality of a shorter life. For some people, having a car might be one of those things. For others, certain deices, or etc.

        It’s an extremely exacting idea of rationality to hold that rationality requires never accepting risk to maximum longevity or health in exchange for experiences one knows brings done pleasure in the short-term. It may be that eventual regret proves to a person that, with the benefit of all the relevant information, certain choices were the wrong choices from their perspective and set of preferences. But that doesn’t mean that they were irrational when they were made, because the person who made them didn’t have all that information – namely, they didn’t know exactly what the experience of the result of not taking a prescribed medication would feel like, or they didn’t know exactly how they would feel at a later moment when they came to truly internalize that it’ve very likely they are going to die imminently, months or years before they might have had they made different choices earlier. I’m not saying some of those earlier choices couldn’t possibly have been irrational, but this informational gap produced by not being able to truly experience the downsides of less prudent choices raises a lot of questions about how irrational it can be to take the pleasures you can find while you know they are pleasurable. There are always still other risks, not related to the choices in question, that could come out on the downside in a big way that could mean you don;t get the benefit of the more prudent choices you’re considering in the show term.

        It’s extremely hard to calculate rationality where these short-term/long-term sacrifice-for-later-benefot propositions are concerned. At the very least where such calculations are concerned, we should say that restricting what we allow is rational to only that which is maximally prudent is too strict a definition of rationality. There can be rationality in a choice to gather ye rosebuds (or cheeseburgers) while ye may. It all depends.

        Report

    • 1) While culture in general tends to think of reason and emotion as opposing forces, that’s certainly not the way economists see it. Our emotions give us our preferences – no statement of pure logic can ever say X is better or worse than Y. Rationality is about having your emotion and your reason work together, not one dominating the other.

      2) Your examples show how complicated this stuff can be in the real world. In a lab you can control for the sorts of confounding factors you raise, but the real world is much messier. For example, I wouldn’t describe your preferences as intransitive or time inconsistent. The first case is a preference for variety – You don’t want to eat the same thing, or even the same hamburger all the time. The second case is more about your circumstances – on any given day, how tired or pressed for time are you? How pleasant is a walk going to be today? There is nothing irrational about doing different things in different circumstances.

      As I said, this is why economists generally reluctant to declare decisions irrational – it is very hard to figure out if someone is making a bad choice.

      Report

      • I remember sitting in on an economics course once and the Professor told a story about his brother wanting a concert ticket but insisting he wouldn’t pay more than $200 for it. His brother got the ticket and was then offered $400 and turned the offer down. The Professor asked if his brother acted rationally. This was a basic econ class and the general response was that he wasn’t because his refusal “cost” him $400, twice what he said he was willing to spend on the ticket.

        This didn’t really make sense to me. Yes, there is a consistency between his stated preference and his choice, but that doesn’t necessarily mean he was acting irrationally; rather, I see it as an indication that his actual preference was different than his stated one. Which can happen for any number of reasons. But, at least according to this prof, the dude made an irrational decision.

        Maybe I’m using the term “rational” differently. In fact, I almost surely am!

        So I guess I’m wondering why make all these efforts to analyze decision making processes that seem infinitely complex?

        Report

        • I don’t think I understand the situation. Is it that Prof’s bro paid $200 for a ticket and was then offered $400 for it and refused? If so, that doesn’t seem like enough info for answering a question about his rationality. Eg, if he bought the ticket to resell it at a higher price and then refused to do so, then he’s possibly acting irrationally. If he bought it to go to the show then he isn’t. I’m not sure how the question makes any sense as presented except as a device to explore the concept of individual rationality in general.

          Report

          • The prof implied that hte brother REALLY wanted to go to the concert but not so much that he’d spend more than $200 on a ticket. He bought it for $200 and then turned down an offer to sell it for $400.

            Report

            • Kazzy,

              I can totally understand that chain of events. Let’s say he simply couldn’t pay more than $200 and still make rent and buy food. If he had more disposable funds he likely would have been willing to pay more. But once he had the tickets his decision matrix was completely different. He’s paid rent and bought food so now the choice is between going to the concert or having $400 more in his pocket. The $200 is a sunk cost and irrelevant.

              Report

        • It does seem irrational that someone would value a concert experience at no more than $200 when they don’t have a ticket yet at more than $400 once they posses the ticket. If it were rational, it would be because the professor’s brother was not accurately stating his preferences.

          Report

          • Diminishing marginal utility could theoretically explain it. If $200 is all he can afford to spare without making huge sacrifices, then that’s all he’s going to pay. But give him the ticket, and now he can afford to pay up to $600, so he’s fine with paying $400.

            Report

            • I agree that something like this could easily explain the apparent discrepancy in the brother’s behavior, but I’m not seeing how it could be characterized directly as diminishing marginal utility — after all, the number of units consumed is the same, not increasing. It’s probably better to say something like “his budget constraint shifted outward and this changed his measured spending preferences”.

              Or, better yet, you could say “economics is a pseudo-science, so don’t bother trying to use it to label other people’s actions ‘irrational'”.

              Report

              • Posit the existence of quanta of pleasure, a unit called the “hedon.” There is an exchange rate between dollars and hedons, although this need not be linear. Various activities either expend or gather one or both of these values. One way to exchange dollars for hedons is to purchase the ability to participate in a hedon-generating activity.

                Attending the concert will generate, say, 1,000 hedons. The ability of some other activity to produce hedons (for this consumer based on subjective taste) is substantially lower, even if the cost of that other activity is lower.

                So if a daily membership in a croquet league costs $10 and produces 100 hedons, it might seem to make sense to sell the ticket for $400, forego the 1,000 hedons that the ticket generates, and use the $400 to buy 40 days’ membership in the croquet league, thus generating 4,000 hedons. That would seem to leave the consumer 3,000 hedons better off for the same net expenditure of $200 dollars. Even if the consumer uses only the profit from the sale of the concert ticket, that’s still 200 games of league croquet, resulting in what looks like 2,000 hedons — double the pleasure of attending a concert.

                But the marginal enjoyment of croquet will diminish over time. The first game of croquet may produce 100 hedons, but the next one 98, the one after that 96, and so on. The curve will probably not be strictly linear, either, but is more likely to become negatively hyperbolic or something resembling it, because of diminishing marginal returns: the fifth game of croquet may well not produce 90 hedons but only 80.

                The cost of $200 for a 1,000-hedon concert ticket starts to look pretty good: 5 hedons to the dollar. And soon enough, the marginal enjoyment of another game of croquet drops below the threshold of 5 hedons to the dollar, well before we even reach the 20th game of croquet. So now the cumulative dollars-to-hedons conversion becomes less efficient with croquet than with would be with the concert. Thus, the concert is a better choice.

                The more sharply curved the diminishing rate of returns on croquet is, the more it makes sense to not sell the concert ticket even at a significant profit.

                Report

                • This is a good explanation of standard diminishing-utility scenarios, but I think the concert ticket example is really about something different.

                  The concept of diminishing marginal utility doesn’t explain the apparent contradiction between the brother’s unwillingness to spend $205 to obtain the concert ticket on the one hand, but on the other hand his willingness to keep the ticket even when a sale is offered for $400. This appears to break the principle of transitivity: The brother prefers $205 to the concert ticket, would presumably prefer $400 over $205, but then would prefer the ticket to $400. Expressed mathematically, the brother’s preferences can be represented as “ticket<$200<$400<ticket", which on its face doesn't make sense. (Looping in , because he might find this explanation a little more clear than the others in this thread.)

                  As @j_r helpfully pointed out, the behavioral economist's archetypal explanation of the concert ticket scenario is "loss aversion", but the concept of anchoring can also a good explanation for the brother's behavior here. When the brother does not have the ticket, his "anchor" when faced with the valuation of the ticket is the situation in which he does not have the ticket. After he obtains the ticket, his anchoring scenario is the one in which he has the ticket. Economists would tend to say that this anchoring behavior is inherently irrational, as on this framing, it violates primary mathematical principles. Liberal economists may even use it as a rationale for overriding expressed consumer preferences, while "choice architects" famously apply countervailing libertarian-ish "nudges" in response.

                  However, there's almost always a way to reframe an apparently-irrational decision as one that seems eminently reasonable. In the concert ticket scenario, the brother could defend his valuations by saying that the fact that he has newly acquired the ticket is not *actually* irrelevant information. When a person newly acquires an item, it changes not only what they have, but who they are. They may start to make other decisions in their lives: they start to think, perhaps even subconsciously, about how fun it would be to go to the concert, or how they're gonna get there, or how they want to lose weight before dancing in public, or what other people would think about their being the type of person to go to the concert, or a million other things. Often, these new thoughts lead to new information that wasn't presented to the actor at the start, which can easily change their individual valuation of the good. Economic analysis typically abstracts from these minutiae, because otherwise the analysis becomes too complicated to perform. But that doesn't mean they're not they're not there, or even that they can have large impacts on the actual subjective utility of the decision being made. To say that it's inherently irrational to change preferences after receiving a gift is to assume that a person is never changed by receiving a gift. But that cannot be true, as people are not inert and unchanged by the circumstances of exchange.

                  In this way, economics can be seen as a kind of attempt at artificial intelligence. It takes individual decisions that are enmeshed in a complicated social matrix and attempts to boil them down to simple rules that can be then be manipulated (and hopefully optimized) by a central source, much like a computer might attempt to model human decision-making and replicate it with a processing unit. (Self-described libertarian economists may chafe at this description, but it's true even for them: Laws regarding property rights work in exactly this way.)

                  Unfortunately for economics, attempts at creating artificial intelligence have foundered on fundamental problems that are pretty intractable. Cognition is embodied in complex systems, and cannot be separated from them. Models can only incompletely represent the real world (as Bertrand Russell learned from Ludwig Wittgenstein), and even slight differences in modeling can lead to vastly different outcomes (as mathematicians like to remind us with chaos theory).

                  Interestingly, these criticisms are not just potshots from the leftie skeptics of economics, but been leveled from economics’ relatively conservative political quarters as well, although with slightly less force. In the 1940s, laissez-faire economists derided Keynesian attempts to systematize and plan the economy, saying that they would never be able to get around the “economic calculation problem“, which claims that central authorities lack sufficient information to appropriate price consumer goods. Keynesian economists temporarily enjoyed a bit more prestige in the 1950s when the nascent field of computer science made it seem like computation power would soon no longer be a constraint on planning, but this excitement died down pretty quickly once it became apparent that the calculation problem seemed a lot more intractable.

                  I side here with the position of the 1940s laissez-faire economists: human activity is too complicated to centrally plan. But I go a step further: Rules of organization, such as property rights, are also a kind of planning, as they assume certain models of human behavior, and thus require predictability of human behavior to have predictably beneficial results. Even in a laissez-faire economy, consumer prices as discovered by free market exchange are still a function of the (inherently complicated) system of property rights in which they operate.

                  Thus it can hopefully be seen that attempts to distinguish between rational and irrational behavior in economics are inextricably theory- and value-laden. Therefore, hard claims (as made from the abstracted vantage of economics) that specific behaviors are irrational, such as the brother’s concert ticket valuations, are at best only pseudo-scientific.

                  Report

                  • If this were an example of bias (it’s not), there’s already a name for it: the endowment effect. The theoretical explanations from behavioral economics are built upon primarily loss aversion or framing/reference bias. It is not an example of anchoring.

                    What’s now, the argument you make for considering behavioral economics a pseudoscience would of course apply to all social science, and most of it more so, since behavioral economics is one of the few largely experimental social sciences.

                    Also, the alternative explanation you give as a criticism of behavioral economics is the sort of explamation behavioral economists might give for deviations from non-behavioral economic models.

                    Report

                    • Chris, you’re writing as if there were no overlap between the various cognitive biases, but I don’t see why that would be true. You may very well be right that the example is not a form of anchoring, but to demonstrate that, you’ll have to make more of an argument than you have here.

                      I’m not a priori opposed to saying the other social sciences are pseudo-sciences as well. But economics still seems distinct from the other social sciences in its insistence on its own “rationality”, and in using that supposed superiority to crowd out competing considerations in public policy debates. So if I seem irritated with economics more than other disciplines, that’s why.

                      I think you’re right that behavioral economists would be tempted to accommodate my above criticism into some behavioral econ framework. But because behavioral econ is more about establishing competing models to the typical rational-actor economics, my criticism that modeling is inherently dubious is not very helpful to the behavioral econ endeavor.

                      Report

                      • Again, your criticism is behavioral economics.

                        And anchoring in pricing involves the initial value influencing subsequent valuations disproportionately. It wouldn’t cause someone to turn down twice the price. You see anchoring in price evaluations when people pay too high a negotiated price because the initial offer (on a car, say) was high, and the negotiation went from there, with subsequent prices lower than the initial offer considered better than they are simply because they are lower than that initial offer. This means that sell prices above the initial price would also be evaluated overly positively by the seller.

                        Report

                        • I’m in over my head in this conversation but that’s not gonna stop me from chiming in (why would it??).

                          In Robert’s initial comment, I took his suggestion of anchoring to have been proposed as a better account than what BB had proposed, not that it was his account of how to determine why the prof’s bro was behaving irrationally. As he made clear (or I thought, anyway) his account of why PBro’s actions weren’t irrational was due to the context under which his preferences are expressed being different and distinct, and under *that* type of context-dependent analysis the presumption the otherwise applicable incoherent transitivity regarding valuation doesn’t make any sense. Hence his rejection of those particular types of restrictions on rationality.

                          Alsotoo, if that’s all wrong then just imagine there’s a question mark at the end of it, since that’s what it effectively is anyway.

                          Report

                        • I think these definitional debates are not very useful. The source of our disagreement seems to be that I’m using a more expansive definition of “anchoring” than you are. The definition I’ve been working from is “when people place too much importance on one aspect of an event, causing an error in accurately predicting the utility of a future outcome”, which seems to be well-accepted. Your definition appears to be a little narrower, which is also a definition some use. That’s fine.

                          I haven’t seen any behavioral economists voice the criticisms I’ve leveled above; I doubt that they’d be willing to saw off the branch they’re standing on, but maybe you could point me toward some? Thanks.

                          Report

                          • You’re perhaps thinking of anchoring in the broader psychological sense, though it’s still not applicable here: it concerns estimating or predicting outcomes based on initial information. The use inbehavioral economics is precisely the one I described. Think of it as a special case of the broader one (which, again, is not applicable).

                            As I said, there’s already a behavioral economical label for treating something as more valuable when I posses it than before I do: the endowment effect. And there is actual research on its causes, so idle speculation is at best unproductive.

                            As I said elsewhere, nothing about the scenario Kazzy raises implies any bias, and in fact even with a lot of missing information, the best inference is that the professor’s brother behaved rationally. But if he really was treating the ticket as more valuable simply because he possessed it, that would be the endowment effect.

                            Report

                  • For what its worth, I do agree that Behavioural Economics needs to be handled with care in a policy context, in fact I noted as much in my original post. It’s very easy to start running around declaring things irrational and then deciding that Something Must be Done.

                    If that’s what you mean by “economics needs to be more humble” then I agree, with the proviso that the problem is really more with the process of policy formation than it is with economics.

                    Report

              • Robert Greer: I agree that something like this could easily explain the apparent discrepancy in the brother’s behavior, but I’m not seeing how it could be characterized directly as diminishing marginal utility — after all, the number of units consumed is the same, not increasing. It’s probably better to say something like “his budget constraint shifted outward and this changed his measured spending preferences”.

                Diminishing marginal utility of wealth, not diminishing marginal utility of concert tickets.

                Report

          • It does seem irrational that someone would value a concert experience at no more than $200 when they don’t have a ticket yet at more than $400 once they posses the ticket.

            Only if money is no object. And in the hypothetical we don’t know if it was or not. The only information we have regarding his subjective value of the concert experience was his failure to sell the ticket for $400 bucks. So he obviously thought it was worth more than that in exchange value. In advance of possessing the ticket, tho, his price determination – which doesn’t reflect his value assessment of the concert experience given that money is an object – was set at $200. Which implies that if he had more money he’da been willing to pay more for the initial purchase, not that he was irrational in not selling it for a higher price.

            Report

            • Thinking about that a bit more, it seems to me that even if money were no object, the fact that he set a price limit and purchased a ticket at that price indicates that he got a really great deal: he got over $400 in (subjective) value for only $200. The only way the scenario entails irrationality, seems to me, would be if a) money were no object, b) he set the price limit at $200, c) failed to get a ticket, and d) believed that the ticket was worth more than $400.

              Report

              • I dunno, James. It certainly seems rational for a person to value a concert experience higher than the amount of money they’re willing to pay for the ticket to have that experience. If not, why would people trade the cash for ticket?

                Report

                • If you can turn around and buy a ticket in an equally good position for $200, it makes no sense to not take the $400, because you would then buy the ticket and make the $200 profit. I highly doubt that’s what happened here, which would mean that the prof’s brother most certainly did not behave irrationally.

                  Again, no one accuses a scalper of being irrational for not accepting $400 for a (legally) sold out ticket that he or she can get $600 for. Unless we just accept that the prof’s brother is an idiot, we have no reason to think that he behaved any more irrationally than the scalper would in rejecting the $400.

                  I’d add that if he could still get the ticket for $200, it’s unlikely anyone would offer him $400 for it, therefore, again, we can be pretty certain that he was not behaving irrationally, because regardless of the subjective value of the ticket, the cash value was almost certainly no longer $200.

                  Report

                  • In case it’s not clear, “irrational” really just means suboptimally, where suboptimality is determined by some idealized model. Of course, heuristics and biases may be “rational” even in this sense in the aggregate, which would be why they developed in the first place, and they may be rational in other senses as well, but behavioral economists might describe them as irrational as a criticism of models with strict, formal, and necessary concepts of rational embedded in them (that is, most non-behavioral economic models), not as a criticism of the people who exhibit the biases. Judging ourselves because we use an initial price to estimate value (anchoring), say, because it is irrational in the above sense would be silly.

                    Report

            • Maybe he just misjudged his preferences.

              As stated, I don’t see any misjudging going on. He expressed his preferences. Prior to obtaining the ticket, he expressed his preference by purchasing a ticket at the limit under which the transaction resulted in positive expected utility: $200. After the purchase, he expressed his preference that the ticket was worth more than $400 in expected utility by refraining from selling it at that price. The only thing we don’t know is whether he had unlimited funds (ie., that his initial decision to limit the purchase price to $200 or less given that his expected value was greater than that was justified or merely capricious). In any event, I don’t know why we’d conclude he’s acting irrationally by not selling the ticket: he got great value in the transaction. By my reconning, he’s up over $200 dollars in (subjective) value.

              But that’s the problem with subjective utility, seems to me. If he’s subjectively rational in putting an upper limit on his purchase price (he is) and if he’s subjectively rational in valuing the ticket at a higher price than what he paid for it (he is) then he’s subjectively rational full stop. Especially given that he actually purchased the ticket at his stipulated price.

              Report

              • If someone is willing to pay no more than $200 for a ticket that suggests they value the concert experience at no more than $200. If they are unwilling to sell a ticket for $400 this suggest they value the concert experience at more than $400. Hence the paradox.

                There are a bunch of things that could dissolve this paradox, but it is a paradox nonetheless.

                Report

                • James K:

                  If someone is willing to pay no more than $200 for a ticket that suggests they value the concert experience at no more than $200. If they are unwilling to sell a ticket for $400 this suggest they value the concert experience at more than $400. Hence the paradox.

                  There are a bunch of things that could dissolve this paradox, but it is a paradox nonetheless.

                  Doesnt that assume all money is of equal value, which isnt?

                  If i can only afford $200 and still pay tge rent money, i won’t spend more than that on a ticket. But if i really want to go, i get less utility from an addition $200 than i do from tge ticket, so wont sell for $400.

                  Report

                  • Brit,

                    I’m no behavioral economist, but here’s how it seems to me…

                    By definition, ProfBro engaged in the transaction because the concert experience’s expected utility was greater than the disutility of parting with $200. By hypothesis, the expected utility of the concert is greater than the expected utility of $400 cash. Supposedly, that’s a paradox – and is perhaps accounted for by attributing irrational behavior to ProfBro – but only by focusing exclusively on ProfBro’s behavior (ie., his actions) in isolation from any other considerations. That is, the bare evidence we have to work with is that ProfBro values the ticket at T1 at no higher than $200 and at T2 no lower then $401.

                    Accounting for the differing valuations seems trivially easy, seems to me. So the question I’m wondering about is this: why think that ProfBro’s valuations need be consistent at T1 and T2 in order to be rational? In other words, why think that such consistency is required for a person to be rational? That condition would only apply in an idealize situation in which people had unlimited cash and time, transaction costs were non-existent, (and so on), but also that ProfBro could, in advance of purchasing the ticket (that is prior to T1) be able to determine the concert experience’s subjective value in exchange dollars once the ticket is purchased.

                    But why think that?

                    Report

                    • You are not accounting for the explicit statement that he wouldn’t pay more than $200 for the ticket. If he had simply purchased it for $200 and not sold for $400 then I’d agree there was no paradox, but if we take that statement seriously then that means he can’t value the concert much more than $200, or his willingness to pay would be higher.

                      Now it could be that ProfBro bought that ticket with his last $200 (but that seems really unlikely), or it could be that the story has been incorrectly conveyed a some point along the line. Perhaps Profbro was only willing to buy the cheapest ticket at $200 because he cared more about going than getting a good seat; in that case his willingness to pay for a basic ticket might have been higher than $400. Or it could be that ProfBro said he would only pay $200 without actually meaning it (this is why we need to be careful of stated preference!), but one of these needs to be going on to avoid an inconsistency.

                      Report

                      • Again, just because I won’t pay more than $200 (perhaps more than that is not in my budget) does not make not accepting $400 irrational. It says nothing about the worth of the ticket after he’s purchased it for $200 (which, if it’s sold out, could be much, much higher), for one. What’s more, even if he can only afford to pay $200, the value of the ticket, particularly when it is no longer available at $200 (or under $400) may be much greater than that. The value I’m willing to spend for something is a result of a complex combination of factors, of which its perceived monetary value is only one.

                        One of the most potent criticisms of market ideology is that it reduces the value of things to their exchange value. This is a pretty good example, I suppose, of people interpreting someone’s behavior from that perspective.

                        Report

                      • but if we take that statement seriously then that means he can’t value the concert much more than $200, or his willingness to pay would be higher.

                        No, he can value the concert much higher. It seems perfectly rational for a person to say, in advance of purchasing a ticket, the following: “If I had one of those tickets I’d only sell it for $1000, but I’ll only spend $200 to get one.”

                        That only means the expected utility of attending the concert is higher than the expected disutility of paying $200 dollars for a ticket to have that experience. According to the logic being employed, in this scenario ProfBro is irrational straight off the bat! ANd the reasoning seems to be that if he values the ticket at $1000 dollars, he’s must be willing to purchase it for $999.99 on pain of irrationality!.

                        But why think that? It seems perfectly rational (subjectively, to be sure, but objectively as well) to say “my upper limit on price is $200 even tho I’ll derive the equivalent of $1000 dollars of enjoyment from the experience.” There could be all sorts of reasons to account for this type of decision process, but (and this is my point) the conclusion that he’s irrational in thinking this way depends on applying a conception of rationality to a person in which their highest purchase price is one $utile-exchanged below their lowest resale price. But why think that that’s a condition on rationality, even in the ideal case? Eg, in practice, no one would purchase a ticket where the marginal gain was only $utile-echanged since that wouldn’t even cover the cost of engaging in the transaction.

                        Even then, abstracting away transaction costs from the calculus, a person will only pay for a (scarce) consumptive good if the expected utility – in exchange dollars – is higher than the price paid. The argument in favor of ProBro’s irrationality seems to imply that he’s only rational if he prices the ticket at effectively zero marginal utility gain. And that’s not only counterintuitive, but (it seems to me) irrational on it’s face.

                        Report

                    • 200 might be the most cash he’s willing to fork over (spending anymore might require him to forgo certain other activities he has planned).

                      So 200 dollar’s isn’t his personal “value” of the concert, it represents the maximum price he can pay, in his overall budget, for the concert. He might value it at 500 or 600 dollars, but be unable to afford it.

                      In which case, getting a 200 dollar ticket is a huge bargain. He gets what he values highly, but can’t afford to pay at the amount he values it.

                      I think the Prof here was assuming an unlimited budget and no competing factors, and decided “ability to pay” and “value” were identical.

                      Report

                    • that would dissolve the paradox

                      James, I think what some of us are saying here is that the bare facts of the story aren’t enough to create a paradox (or determine irrationality) and that it’s only by reducing each transaction to the bare exchange (while keeping all other things equal over time!) that a paradox ostensibly emerges. So the question seems to be this: why think that ProfBro’s rationality requires consistency in valuations over time to the exclusion of contextually relevant factors? (I mean that question seriously btw, since a good answer would clarify the justification for why such a condition is justified as constitutive of rationality.)

                      I’d also add one other worry: you believe ProfBro’s actions are paradoxical yet you’ve refrained (down below) from calling them irrational. I don’t think you can have it both ways on this, since the ostensible paradox results entirely from ProfBro’s subjectively determined valuations of the ticket at two points in time. It’s an if and only if sorta thing, seems to me.

                      Report

                    • Yes if it were ProfBro’s last $200, that would dissolve the paradox, but that really doesn’t seem likely to me.

                      I think you’re viewing this situation as a practical rather than philosophical issue, James. In practice, it’s easy to construct a scenario in which ProfBro is irrational (by including relevant stuff). But the point Brit is making is philosphical, it seems to me, one that applies the generality of the principle being invoked. If there’s a single scenario in which ProfBro’s behavior isn’t irrational, then the the principle upon which his putative irrationality is determined isn’t fully general. So it’s not a necessary condition for rationality, and so on.

                      I think that might be where the communication breakdown is occurring, actually. No one is saying that there’s no context in which ProfBro is irrational, we’re just saying there’re contexts in which he’s rational. ANd if so, then the principle isn’t fully general (and isn’t a condition on rationality without adding in some other stuff).

                      Report

                • James K

                  It’s only a paradox if we include an additional premise: that ProfBro’s $200 cap on purchase price = the value he ascribes to it. I see no reason, given the evidence we have, to think that’s the case.

                  Report

        • I believe where the logic goes astray is in the assumption that pricing mechanisms are the exclusive expression of value.

          Nonetheless, oddities outside of the normal parameters do exist.
          For example, consider the last loaf of bread sitting on the shelf of a market during a food shortage.
          Or the last pack of batteries on the shelf an hour before a hurricane hits.

          Why should these items sell for the same price as the others?
          Why doesn’t each item sold increase, even if ever-so-slightly, the price of the next?

          The common factor is time; more specifically, timeliness.

          Report

        • “The Professor asked if his brother acted rationally. This was a basic econ class and the general response was that he wasn’t because his refusal “cost” him $400, twice what he said he was willing to spend on the ticket.”

          Could he get another ticket for less than $400? If not, then it was entirely rational to not sell it, assuming he still wanted to go to the concert.

          Report

    • The behavioral economists have a name for this type of bias: loss aversion: https://en.wikipedia.org/wiki/Loss_aversion

      People tend to feel greater disutility at losing $200 than they would feel utility at gaining the same amount. It is a bias in the sense that in purely logical terms gaining $200 ought to have the same absolute value as losing $200, but human beings are not wired to maximize logic. We have preferences and emotions and fears and etc.

      Or, better yet, you could say “economics is a pseudo-science, so don’t bother trying to use it to label other people’s actions ‘irrational’”.

      If by this, you mean that economics is a social science, then sure. What exactly do you get by labeling economics as a “psuedo-science?” Economics is not one of the hard sciences. Economists cannot do laboratory experiments; therefore, their results will never have the same level of precision or accuracy as chemists or physicists. It doesn’t mean that economic analysis cannot be useful.

      Report

      • People tend to feel greater disutility at losing $200 than they would feel utility at gaining the same amount.

        Note that there are two ways to interpret this, and only one of them is what is meant by “loss aversion.”

        The most natural way to interpret this is that if you have $100, you lose more utility from losing that $100 and ending up flat broke than you would gain from gaining another $100 and ending up with $200. This is not loss aversion. This follows trivially from the diminishing marginal utility of wealth and has been incorporated into economics for well over a hundred years.

        Loss aversion is the phenomenon where a person who has $100 and gains another $100 is happier than a person who has $300 and loses $100. They both have $200, so in classical economics, where utility is assumed not to be path-dependent, they are assumed to have the same utility.

        Economists cannot do laboratory experiments

        The article you linked to describes laboratory experiments in economics. Here’s more. That said, they are necessarily somewhat limited in scope, so determining exactly what the findings say about the real world is problematic.

        Report

        • Right, and the professor’s example is not really an example of loss aversion, at least given the info we have. If the tickets are sold out, for example, it’s possible that they’re worth a lot more than $400, and selling them at that price would be irrational. No one says a scalper who pays $200 and then refuses any offer less than $600 is irrational if she can get at least $600.

          Report

          • Postulating some degree of competence on the part of the professor, I think it’s reasonable to assume that his brother actually went to the concert. “My brother said he wouldn’t be willing to pay more than $200 for a ticket but then passed up an offer to sell it for $400…so that he could sell it for $600” isn’t a terribly interesting story.

            Report

            • No, but that’s not really my point. It’s still not irrational to pay $200, not sell the ticket for $400, and go to the concert of the once $200 ticket is now worth more than $400. This isn’t even behavioral economics we’re talking about, without more information at least.

              Report

              • I am not sure where the term “irrational” came up in this. Something doesn’t have to be irrational for it to be a cognitive bias. People tend to be more averse to losing something that they already have than they are to not gaining something of equal value.

                All loss aversion says is that the absolute value of -$200 is greater than +$200. There is no need to attach a value judgment to this.

                Report

                • It comes from the OP, as well as from much of the discussion of behavioral economics in economics, and in comments it was the primary source of the objections to the ideas discussed in the OP.

                  Report

                  • Unfortunately, it is a loaded term and has a specific meaning within economics that is close, but not the same, to the meaning that it has in general usage. I’m not sure what to do about that except to not spend to much time thinking about the term and instead focus on whether the application of either classical economics or behavioral economics has something interesting to say about social phenomena.

                    In this case, I think that loss aversion is a real thing that can be demonstrated in people’s choices, so I agree with the general tenor of the OP.

                    Report

              • Chris,

                Seems to me like there’s something paradoxical about the way the “BrofBro’s irrational” reasoning goes. On the one hand, ProfBro is irrational because he valued the object on resale at a dollar exchange value than he did during the purchase transaction. But the only way that wouldn’t be the case is if he purchased the object at the highest price under which he’d resell it once it was possessed. But if that were the case, he’d never buy the ticket since there’d be no utility gain by engaging in the transaction.

                On the other hand, a voluntary transaction is rationally engaged in because it results in a net increase in utility, that is, the object exchanged for dollars is valued more than the dollars themselves. So here’s the paradox:

                ProfBro is rational only if his upper-limit purchase price = his lowest limit resale.
                Profbro is rational only if he sets a purchase price below his resale price.

                Now, I don’t know if that’s right, but it’s how the logic appears to go to me. And clearly, to me at least, the first one is bunkadiddle. But that seems to be the basis for ascribing irrationality to ProfBro. And if that were the operative definition of rationality, then no one would ever engage in any rational transactions whatsoever because they don’t result in positive utility.

                Report

              • I agree, the more I think about this, the more convinced I am that we simply do not have enough information to make a determination here. This is the difference between studying rational behaviour in lab conditions versus in the real world.

                Report

  3. Re: Hyperbolic Discounting.

    Does this take into account that people are more likely to know their immediate expenses rather than their distant expenses?

    Lots of people live paycheck to paycheck and this is true across all income levels for a variety of reasons. Perhaps people get more hyperbolic about 0 to 1 on a paycheck delay because they know it means the difference between getting a payment in on time or getting interest rates. Or making the rent, etc.?

    I think there are a lot of disconnects between the way economists see the world and the way non-economists see the world. These can mainly be described by psychology. The example I remember from a class is that economists think people are nuts for taking a dollar today rather than two dollars a year from now. The issue for me here is that the amount given in the hypothetical is too low to have real meaning to most people.* Maybe people’s answers would change if you said 100,000 today or 200,000 in a year. The experiment also does not calculate that people might say “100,000 today means paying off all my debt!!” Yet it seems that economists often ignore these practicalities when making their experiments.

    *One thing that institutional investors get to do is make really long term bets. Most people don’t have this luxury. I think this is why a lot of VC bets and valuations seem nutty to many people. Investors are clearly playing a long game for Amazon, Uber, and company. Other businesses need to make money right away or soon enough or close. IIRC restaurants and bars need to be profitable right away or they tend to close.

    Report

    • Any idiot who starts a business that needs to be profitable right away should pack his bags and stop being a businessman.

      I do know people who run restaurants… you generally give at least 6 months of net losses, sometimes up to a year. You plan a budget, and you say, “I can take at least X Months with my cushion.”

      If a business was going to be profitable in the first minute, everyone under the sun would start it. (That’s what happened with the Kaleidoscope craze, by the way.)

      Even the most profitable companies have time horizons before making a profit. “I’ll double your money in 18 months” is about the sweetest investment pitch I’ve heard (the owner pocketed the other eight times original investment). Betcha can’t name the company though… (here’s a hint: it’s directly responsible for nearly a third of advances in 3D printing technology)

      Report

      • On a barely related note, I’m always a little disturbed to see that opening a restaurant seems to be the default “new business” for a lot of would be entrepreneurs who want to strike out on their own. On paper, it seems like one of the worst possible businesses to open. Low margins, lots of inventory management with inventory that spoils, high regulatory burden, nontrivial startup costs for a restaurant grade kitchen and dining space, usually requires adding employees to the payroll right off the bat (instead of after some time to grow), etc. Having something like that be your first business venture seems like a pretty risky move.

        Report

        • I’ve seen worse business plans. (Such as one that was actually intended to be part of Shadowrun… ) Or the idea that had clear legal issues (and was sold to the military as a sideline because of the legal issues)… but that one made money.

          People get into restaurants because they don’t understand business, by and large. It’s apparently not too terribly difficult to make a profit while having a business collapse around your ears [sell your customers data, hmm?]

          Report

    • I think another reason for disconnection between economists and non-economists is terminology. Non-economists (like me, especially before I started listening to the economists here and at Positive Liberty/One Best Way) tend to hear the word “economic” and think “monetary” or “financial.” Therefore, a decision was ipso facto “irrational” when it coudn’t result in the decision maker getting some financial benefit.

      Report

    • The experiment also does not calculate that people might say “100,000 today means paying off all my debt!!” Yet it seems that economists often ignore these practicalities when making their experiments.

      With this example, it sounds like you’re just objecting to the word “irrational” being used to describe people who are bad at making financial decisions. Unless your debt is to a loan shark who will murder your family or you owe enough money to a payday lender that it will cost you $100K this year to ignore him, paying off all of your debt early is a really dumb answer to that offer.

      Report

      • With this example, it sounds like you’re just objecting to the word “irrational” being used to describe people who are bad at making financial decisions. Unless your debt is to a loan shark who will murder your family or you owe enough money to a payday lender that it will cost you $100K this year to ignore him, paying off all of your debt early is a really dumb answer to that offer

        You’re missing several factors: The stress of debt. The liklihood of additional debt, emergency, or other factor overwhelming your ability to pay in two years. If you’re hand-to-mouth, clearing all your debts NOW might be worth not getting an extra 100k.

        What’s the value of no longer worrying that the car will break and you’ll not be able to pay your rent and get evicted?

        A lot of what’s going on in ‘irrational’ decisions are people making intuitive price decisions on intangible things like “peace of mind”. 100k now versus 200k a year from now? Depends on what the state of my finances is, the amount of stress I’m under, how fragile I feel my debt structure is, etc….but I’m not tossing 100k away (I do realize I’d have 100k less if I took the ‘now’ offer). I’m trying to decide “now” versus “then” is worth 100k, based on a whole host of internal and external factors.

        Report

    • Lots of people live paycheck to paycheck and this is true across all income levels for a variety of reasons. Perhaps people get more hyperbolic about 0 to 1 on a paycheck delay because they know it means the difference between getting a payment in on time or getting interest rates. Or making the rent, etc.?

      The problem is that effect appears in both directions. It’s not just that people strongly prefer receiving money relative to a short delay (as opposed to the same delay further into the future), they also strongly prefer to buy now rather than in a day’s time.

      Report

    • I think there are a lot of disconnects between the way economists see the world and the way non-economists see the world.

      Isn’t this the case for just about every profession? You lawyers speak a completely different language and if I were to start complaining about the unnecessary verbiage in contracts, you might explain to me why all those words and phrases and clauses need to be there and in a particular combination for the contract to do what it is supposed to do.

      An auto mechanic has a fundamentally different view a car than does its owner. A cardiovascular surgeon has a fundamentally different view of the human heart than does the hear’s owner. This is how specialization works. It requires a certain level of detachment.

      The check to all of this is to remember that economists are not here to tell you what you ought to do with your money. They are there to help you make an informed decision about the myriad of possible outcomes of all the things that you might do with your money. And even that is an almost impossible task.

      Report

  4. Hperbolic Discounting: I certainly know that I get pissed when my direct deposit salary is delayed because of a holiday even though its never been an emergency so far.

    Report

  5. Maribou recently had a conversation with me about the couch set in the basement. My dad bought this couch/loveseat/ottoman combination back in the mid/late 70’s and my mom got them re-upholstered in the early 90’s. When I moved out and got my own place in the mid-oughts, I inherited them.

    After a decade of being abused in the basement, it was decided that we should look into getting the furniture reupholstered ourselves, make the fabric fuzzy and new again, make the stuffing fluffy, and otherwise turn our set into a new combo.

    Getting all the stuff reupholstered would cost $2200. (We quickly agreed that this was not the solution we wanted.)

    Compare to going to American Furniture Warehouse and wandering around and seeing complete sets for less than a grand. Single pieces in the low-hundreds.

    Throw out the old stuff. Buy new stuff. Cheap.
    Fix up the old stuff. Make it like new with the help of a tradesman. Expensive.

    There are all kinds of incentives out there.
    If you want people to make better choices, they’re definitely going to need better incentives for the good option.

    Report

      • If the only thing you care about is the comfort level of the chair, throw out the old one (it’s too shabby to give to Goodwill) and buy a new one for cheap. For *CHEAP*. (You wouldn’t believe the deals in the “last one!” section of the furniture store.)

        If you start doing all this bullshit “but what about the morality/ethics of seat procurement?”, suddenly you’re exploring all sorts of weird stuff.

        There is no confusion. At the end of the day, it’s just a question of “exactly how comfortable do you want the chair to be?” and different kinds of padding have different pricetags.

        Report

        • Yeah, but that’s not really what the reupholstery industry markets itself as.

          The process of reupholstery is actually dirt cheap. It’s fabric and staple (or, if you prefer, tacks). It’s also incredibly easy. So if what you want is a comfy couch and you’re happy to keep your current one, you can spend a few hours and do it yourself for less than a Benjamin.

          It’s precisely because it’s so cheap and easy that the reupholstery industry’s market isn’t selling comfy couches. It’s selling an artisan skill, as well as knowledge about things such as how to handle expensive, delicate, and/or antique items without damaging them or greatly diminishing their value. If you have an inexpensive and non-valuable piece of furniture, you’re not their market.

          But if all you want in a newer looking comfy couch on a budget, that is totally an option.

          Report

          • The marketing for upholstery never really made it into my orbit.

            I was more thinking of how, when I was a kid, it was expensive to buy new and cheap to reupholster.

            Now it’s expensive to reupholster and cheap to buy new.

            Probably because “new”, today, is made overseas by people making pennies and reupholstery, if you can’t/won’t do it yourself, is made by an American here in town who reupholsters professionally.

            Report

      • This seems like more of a case of confusing different markets as one, not poor incentives.

        External to the individual there are two markets: the New Furniture market and the Reuse Recycle Reupholstery market. Internal to the individual, tho, they are both part of the same Furniture Upgrade market, and the choice between them comes down to a single cost/benefit calculus. Perhaps what you’re getting at isn’t so much that Jaybird’s confusing two markets as that the choices an individual faces often include apparently irreconcilable value assignments along two different measures, ones which can’t be “rationally” (by one meaning of the word) compared. But at the end of the day, a choice IS made between paying more to Reuse Recycle or paying less for New, yeah? And that’s the “rational” choice for each person given their own calculus.

        Report

    • A question (and I’m not admonishing you for either choice, but this is what I’m thinking) is about the quality of production. Is the cheap new furniture of the same quality as the reupholstered set? Is it equally durable, comfortable, well-made? Is the structure solid wood in good condition, or is it particleboard that shouldn’t get wet? If you stand on the back to hang a picture, does it creak and groan and flex or is it solid? Does the new stuff look like it will still be around for you to sit on in 2056?

      Of course, if you’re going to get into that discussion, then you also have to go over to the part of the furniture store where the $2200 sofa sets are and look at the quality of *those*.

      Report

      • Well, before we did anything, we talked and said “okay, we’ll send them pictures, talk about what we want, then get a quote. If they say $800 to do everything, we jump at the chance and walk away on the sunny side of the street. If they say $1200, we sit down and we have a Very Important Conversation. If they say $1600, we go to American Furniture Warehouse and start pricing couches and then start having Very Important Conversations.”

        We nodded and said “This is a good plan.”

        We got the quote back and it was $2200.

        Will the couch last 40 years the way that its predecessor did? (Or 20, if you start the timer on the second upholstery?)

        Probably not.

        Will it last 10? That depends mostly on the cats.

        Will it last 5? Almost certainly.

        And that’s without getting into the whole “Maribou hated the old couch with the hate of 1000 suns and she loves the new couch that feels like it was made just for her because it has perfect armrests and perfect cushions and a leg rest that is just *PERFECT* for sitting with a laptop or a book” issue.

        Report

  6. Hyperbolic Discounting – an inconsistency of time preferences that leads people to be less willing to tolerate delays that happen in the near future versus ones that happen in the more distant future. People should find a day’s delay to receiving a payment to be equally bad (if you express badness as a percentage reduction in value) if the delay is from 0 days to 1 or 365 days to 366, but in practice people find the more immediate delay worse.

    This is one of the key factors in negotiating B2B deals. One of the simplest and best pieces of advice I received mid-career was this: He who has the deadline loses [the negotiation]. Success in my field doesn’t come from “hardnosed” or “golden-tounged” negotiations, it comes from the manipulation of time and people. What’s tricky is that the “people” part of the equation is 75% of the time the people on my own team. Corporate quarterly deadlines have squandered more needless (irrational) $$ than any other single factor I’ve ever witnessed. Misaligned time horizons have ruined the careers of many professional Account Executives… and usually the misalignment isn’t with the customer, but with management of the corporation you represent.

    Sorry, probably tangential to your pure Economics theory… but supporting anecdata nonetheless.

    Report

    • The quarterly nature of financial reporting for public companies has caused more insane behavior than I care to think about in companies I worked for. I’ve had managers gladly spend tens of thousands of dollars to book $100K in revenue on Friday instead of spending $0 to book it on the following Tuesday because it was the end of the quarter.

      They always gave me a dirty look when I referred to getting revenue into this quarter as “robbing next quarter of revenue.”

      Report

      • Precisely, I’ve been know to say that the sun will rise tomorrow on another quota.

        Its a market within a market. The market for my goods is driven partly by what we would expect in terms of external market forces (competition, price, quality, etc.) and partly by internal metrics… the market of MBO’s. The internal market is, by design, very time sensitive… but the external market operates on a different time horizon. Managing the Time contingencies is what we do for fun and profit. I give my customers a bigger incentive to work towards an “off” time than the last minute end of quarter. It is worth much more to me to be ahead of the curve, and I know that I can throw their chief negotiator off their game by not caring about the quarter’s end (because their business also has a deadline to start the project). But, that’s a luxury only experience can buy.

        Report

  7. This post really resonated for me as an attorney who frequently guides litigants through complex decisions made with necessarily incomplete information, uncertainty, and risk. All of the listed behaviors are things I’ve identified explicitly in my clients, and sometimes myself, over time.

    For someone like me, who is trained and experienced in appreciating things like…

    1) what we don’t and can’t know about a given situation despite our best efforts to investigate, like how an as-yet undeposed third-party witness will answer a question we haven’t yet thought of when posed by opposing counsel; and
    2) how third parties uninvested in a conflict situation (e.g., jurors) will evaluate both the facts and the disputants, more importantly on an emotional than an intellectual level; and
    3) the consequences an unfavorable resolution of particular disputed issue, such as the other side’s attorney’s fee bill in a loser-pays scenario;

    …the headstrong willingness to simply gamble and couch a decision to litigate rather than opt for the certainty of settling because there is simply no other way of looking at the facts than one’s own side will necessarily prevail, appears to be the very height of foolishness. It is very often my job to advise my clients that indeed, other people might see things differently than them, and that very bad things might flow as a consequence. And it’s exceedingly difficult to attach numerical probabilities to those potential outcomes, more so when we take into account that there are always unknown unknowns.

    This doesn’t even begin to address the fact that I, too, may suffer from cognitive bias. That I, too, may have a preference for settling and risk avoidance in situations like this, a preference which may not necessarily be based in the sort of rationality that economists talk about.

    I suppose this is why, once you get past the easy parts, practicing law is an art rather than a science.

    Report

    • All very true. I thought a bit about the recent treaty with Iran where critics are absolutely positively super sure we could have gotten so much more. Why? Well we just could have gotten more. Negations always involve ambiguity and uncertainty about what the other sides bright lines are. People are usually terrible at understanding the actual motives people opposed to them especially when they don’t like them.

      Report

  8. I have direct experience with applied behavioral economics. There’s a classic experiment that demonstrates that merely holding an object will cause a person to value it more and be willing to pay more for it.

    One of my former gigs was selling cars (actually twice, for a Hyundai dealership and later Toyota). One of the key things stressed in sales meetings was to get the potential customer into the car for a test drive. Your success rate in closing the deal was much higher, even if they seemed ready to negotiate without that step or if they had already driven the car previously. It seems that driving the car imbues a sense of ownership such that walking away psychologically feels like a loss and loss eversion is a powerful motivator.

    Report

  9. Proposition: There is no such thing as irrational behavior. There *is* behavior that follows from incomplete understanding, incomplete information, or preferences that we do not share, but the behavior is still rational based on the person’s preferences and information as they exist at the time.

    It might seem irrational to weigh 0-to-1 days’ delay more heavily than 365-to-366, but “zero-to-one” can be restated as “get money now versus get money later”, whereas 365-to-366 is “wait a year to get money, versus wait a year plus a day to get money”.

    Report

Comments are closed.