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Cash is a rational birthday present but inappropriate

February 23, 2017 Leave a comment

Here is a clip from Seinfeld that I use when teaching Behavioural Economics. It seems rational that Jerry gives Elaine $182 for her birthday but it really is inappropriate. Cash replaces social norms by market norms and ruins the feelings usually evoked by a typical non-cash birthday gift. The deadweight loss of giving is the loss of efficiency that occurs when the value of the gift to the recipient is less than the cost of the gift to the giver. In this case, economists argue that cash would be a more efficient gift.

Options for taking on Trump – the Japanese Model.

February 7, 2017 Leave a comment

trump-abeA colleague alerted me to a Terrie Lloyd a New Zealand businessman in Japan who writes a weekly newsletter. With the election of Donald Trump his recent writing looked at bullies and ways in which you deal with them. Shinzo Abe, the Japanese prime minister, has been proactive in getting to know Trump and his team and how the two countries can work together.

Research on bullies

Lloyd suggests that there are generally three ways to deal with a bully.

Run – UK seem to be taking this option
Fight – Chinese will do this
Suffer and appease – Japan, having a bullying culture already, will go for appeasement

Abe will be meeting with Trump on 10th February for a second time in as many months and will want to convince him that Japan is one of the good guys and if he has to pick on someone in the area he should pick on China. For this to work Abe also needs to feed Trump’s ego publicly

Lloyd looks at the work of Dacher Keltner who has written about appeasement and related
human emotion and social practice. He looks at two general classes of appeasement.

1) reactive – the person provides appropriate responses after incidents and these responses are usually public displays of embarrassment and shame.
2) anticipatory appeasement where a person is proactive and engages in certain strategies to avoid conflict. Polite modesty and shyness are also considered anticipatory appeasement.

Japanese Model for dealing with bullies

With Japan taking the latter option, Keltner is suggesting that Abe must appease Trump with gifts of value and that they are seen publicly to assist Trumps power and reputation. Last month the Japanese gave access to US car manufacturers but will that be enough to keep Trump happy? At the meeting on 10th February Abe will propose a package that could generate 700,000 U.S. jobs and help create a $450-billion market. It includes the building of infrastructure projects such as high-speed trains in the northeastern United States, and the states of Texas and California, and renovating subway and train cars. It also includes cooperation in global infrastructure investment, joint development of robots and artificial intelligence, and cooperation in cybersecurity and space exploration, among others.

Toyota the car manufacturer has also been taking the appeasement option after the Trump administration criticised their building of a second car assembly plant in Mexico and also threatened to impose a 20% tariff on Japanese automobile and auto parts makers with plants in Mexico. Toyota quickly announced it would invest $10 billion in its U.S. operations over the next five years.

Abe has definitely been massaging the ego of Trump not only being the first international leader to visit Washington after his election but also telling Trump that he “hopes the United States will become a greater country through (your) leadership,” adding Japan wants to “fulfill our role as your ally.” It will be interesting to see what happens after their meeting on Friday 10th February.

Sources: Terrie Lloyd,  The Japan Times

Motivating workers with emotion – Dan Ariely interview on PBS

January 22, 2017 Leave a comment

Below is a recent clip from Paul Solman of PBS who interviewed Behavioural Economist Dan Ariely. Ariely states that behaviour is driven by emotion not rewards like money; the ability to help other people, feel that we’re useful, feel that we’re getting better or living up to our potential are much stronger motivators than cash. The interview discusses an experiment that he at a computer chip production line in Israel. Workers who made their chip quota got either

  • $30
  • Voucher for pizza to take home to the family
  • A“well-done” text from the boss.

In the actual experiment, workers who made the quota and received the $30 and those that got a pizza voucher and the group that got a compliment were all more productive than workers who received nothing.

But, on the second day, when the workers who got the $30 were not paid a bonus, regardless of how many chips they turned out, their productivity actually dropped below those who got nothing.

In total, by giving people $30 bonus, Intel lost almost 5 percent of productivity. That’s a lot. Now, think about it. You give money because you think this would increase motivation. It actually decreases motivation.

 

Functions of Money – the easier it is to buy things the more you spend

January 10, 2017 Leave a comment

Yap Money.jpgpewter.jpgMoney has taken various forms over the ages – whether it be tokens on a tree made of pewter (soft metal which comes from Malaysia) to the stone currency from the island of Yap in Micronesia. There was a problem with the stone currency in that one of the essential characteristics of money is portability and a 5 meter high stone with a hole in it doesn’t fit the bill let alone the wallet. Money that comes in small coins and notes became a much more efficient medium of exchange and facilitates more transactions but it still gives you a sense that you are spending it as your wallet becomes lighter and less bulky.

 

creditcardsToday the vast majority of transactions are done without cash and there is a tendency not to feel the cost of the transaction, by physically taking money out of your wallet, when paying by credit card. This ease of payment encourages us to spend more. Research has shown that credit cards make people spend 12-18% more, on average, than they would using cash. But lets go further, you  can now wave your card over the credit card terminal with no need for a security pin number or a signature. In fact a smartphone is able to carryout a similar transaction which further erodes the sense of parting with money. I recently received an updated airpoints card from a national airline which enables you to accumulate points that can be redeemed for flights. However reading the letter I was interested to see that the card was also offering me $10,000 credit limit. Credit was also offered from a petrol station and a supermarket card – the means of a deferred payment is a popular function.

For the AS level course remember the following:

The Functions of Money 

There are 4 traditional functions of money.

1. Medium of exchange. 

This is very important in a specialised economy as barter would be very inefficient. It also makes possible a great extension of the principle of specialisation.

The desirable qualities of money are as follows:-

  • Acceptable: Must be sure somebody will accept your money for goods & services
  • Scarce: Should be, if there’s too much, then no one would value it, hence gold was always good money.
  • Portable: Convenient to carry around
  • Divisible: Can be divide up into different denominations
  • Durable: Money (physical) that can last

 2. Unit of Account

A unit of account is a way of placing a specific value on economic goods and services. Thus, as a unit of account, the monetary unit is used to measure the value of goods and services relative to other goods and services. It thus enables individuals to compare, easily, the relative value of goods and services.  A firm uses money prices to calculate profits and losses: and a typical household budgets its regular expenses daily using money prices as its unit of account.

3. Store of Value. 

Once a commodity becomes universally acceptable in exchange for goods and services, it is possible to store wealth by holding a stock of this commodity. It is a great convenience to hold wealth in the form of  money. Consider the problems holding wealth in the form of wheat. It may deteriorate, it is costly to store, must be insured, and there will be significant  handling costs in accumulating and distributing it.

4. Standard of Value/Standard of Deferred Payment.

An important function of money in the modern world, where so much business is conducted on the basis of credit, is to serve as a means of deferred payment. When goods are supplied on credit, the buyer has immediate use of them but does not have to make an immediate payment. The goods can be paid for three, or perhaps six, months after delivery.

 

Categories: Behavioural Economics, Debt Tags:

Pâté and Dog Food – can people tell the difference?

December 4, 2016 Leave a comment

I came across a very amusing academic paper entitled ‘Can People Distinguish Pâté from Dog Food?’ from Michael Cameron’s blog Sex, Drugs and Economics. It was published in the journal ‘American Association of Wine Economists’.

Considering the similarity of its ingredients, canned dog food could be a suitable and inexpensive substitute for pâté or processed blended meat products such as Spam or liverwurst. However, the social stigma associated with the human consumption of pet food makes an unbiased comparison challenging. To prevent bias, Newman’s Own dog food was prepared with a food processor to have the texture and appearance of a liver mousse.

After fully disclosing the aim of the experiment – to evaluate the taste of dog food -18 subjects volunteered. Subjects were college-educated male and female adults between the ages of 20 and 40.

The five sample dishes, A – E, were presented to subjects with a bowl of crackers (“Table Water Crackers,” Carr’s of Carlisle, UK). The identity of the samples, unknown to the researcher, was as follows.

  • A: Duck liver mousse.
  • B: Spam.
  • C: Dog food.
  • D: Pork liver pâté.
  • E: Liverwurst.

Subjects were asked to rank the “tastiness” of the samples relative to each other on scale of 1 (best) to 5 (worst). They were instructed to taste all of the spreads, in any order and as many times as necessary, in order to make a sound judgment. After the rankings were recorded on data sheets, subjects guessed which of the five samples they believed was the dog food.

Ranking order

dog-food-1 The dog food was ranked the lowest by 13 of the subjects whilst the duck liver mousse was rated the best of the five samples by 10 subjects. Between these extremes, the majority of subjects ranked spam, Pork liver pâté, and liverwurst in the range of 2nd to 4th place. However if you consider which of the samples they believed was dog food the results were very different.

Which sample is dog food?

dog-food-2 Although subjects disliked the taste of dog food compared to the other meat products they were no better than random at identifying dog food among the five samples. The two sets of results seem to be paradoxical as 13 of the subjects identified dog food as the worst in terms of taste but did not guess that sample C was dog food – only 3 out of 18 identified dog food. It seems that the subjects do not enjoy eating dog food but are not able to distinguish its flavour from other meat products that are intended for human consumption.

You can read the full paper below:

Can People Distinguish Pâté from Dog Food?

Categories: Behavioural Economics

Sharemarket investors and the endowment effect

September 17, 2016 Leave a comment

I cover the endowment effect as part of the Behavioural Economics course that I teach. The example that I use was aired on the PBS TV channel and was an experiment at the University of Chicago where students are told to work out how much they would be prepared to pay for a travel mug – they offered an average price of US$6 per mug. Then some of the students were given the same mug for nothing and an hour later, asked how much they’d be willing to sell it for. In rational economics, the price should be exactly the same but when asked they now wanted US$9 for the mug. The emotional pleasure of owning something for just an hour pushed the price up by 50 percent. It’s an unexpected outcome, suggesting we are unaware of the emotions that drive this behaviour.

Endowment effect in the Indian stockmarket

Recent research (Endowment effects in the field: Evidence from IPO lotteries in India Santosh Anagol, Vimal Balasubramaniam, Tarun Ramadorai – 2016) use a real life experiment in the Indian stockmarket to study the endowment effect. It focuses on the floatation of new companies on the Indian stockmarket referred to as initial public offerings (IPOs). When the Indian IPO’s are oversubscribed issuers use a lottery to ensure that winners received a fixed number of shares of the IPO stock whilst the losers in the lottery receive zero shares.

  • Winning investors are allocated shares on the floatation of the company
  • Losing investors can buy only after the issue of the IPO’s start trading.

The researchers tracked the behaviour of 1.5 million winners and losers in the lottery following the random endowment of the stock in lotteries in 54 IPOs occurring between 2007 and 2012. What they are tracking is the propensity of winners and losers to hold IPO stock following random allocation. The randomisation ensures that winners and losers are (based on forecasts) identical in terms of their information sets, beliefs, and preferences. Moreover, they have equal opportunities to trade once the stock is listed in the market. If endowment effects do not exist in this setting, holdings of the randomly allocated stock amongst winners and losers should converge rapidly over time.

Findings

endowment-effect

The authors also find that the estimated endowment effect has little relationship with listing gains on the first day – the average IPO increase in price is 52% suggesting among other things that these effects are not driven by a wealth effect accruing to lottery winners. However, after 12 months the IPO price falls by 54% so you would expect lottery winners to off load their shares after the first day’s trading and for the losers to buy stock which is much cheaper.

Another finding is that when IPO returns are substantially greater than a winner’s previously experienced returns they are more likely to sell the IPO stock, and losers are more likely to buy the stock. That is to say, the endowment effect reduces considerably when past personally experienced returns are taken into account, suggesting that experience-based learning plays an important role in individual decision-making.

Inertia effect?

The Economist has suggested that the inertia effect could be present as investors are too busy to make time to buy or sell shares once they have been successful or unsuccessful with the lottery issue. However the authors shows that the endowment effect is still present when they study investors who make more than 20 other stockmarket trades in the month of the IPO floatation. The research also looked at those experienced investors who have taken part in 30 IPOs and found there was still a significant endowment effect with winners being four times more likely than losers to hold shares at the end of the first month of trading.

Winning the lottery seems to make investors more likely to hold onto shares regardless of profit or loss.

The Birkin Handbag – is it a Veblen Good?

August 22, 2016 Leave a comment

Conspicuous consumption was introduced by economist and sociologist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status.

Economists and sociologists often cite the 1980’s as a time of extreme conspicuous consumption. The yuppie materialised as the key agent of conspicuous consumption in the US. Yuppies didn’t need to purchase BMWs or Mercedes’ cars for example; they did so in order to show off their wealth. This period had its origins in the 1930’s with Austrian economists Ludwig von Mises and Fredrick von Hayek – the latter being the author of “The Road to Serfdom”, in which he said that social spending rather than private consumption would lead inevitably to tyranny. Margaret Thatcher (UK Prime Minister 1979-1990) and Ronald Reagan (US President 1981-1989) believed in this ideology and cut taxes and privatised the commanding heights in a move to a free market environment.

So-called Veblen goods (also as know as snob value goods) reverse the normal logic of economics in that the higher the price the more demand for the product – see graph below

VeblenOver the last three decades conspicuous consumption has accelerated at a phenomenal level in the industrial world. Self-gratification could no longer be delayed and an ever-increasing variety of branded products became firmly ingrained within our individuality. The myth that the more we have the happier we become is self-perpetuating: the more we consume, the less able we are to tackle the myth.

The Economist 1843 bi-monthly magazine had a very good article on Hermès’s Birkin handbag (named after Jane Birkin, an Anglo-French actress who spilled the contents of a overfull straw bag in front of Jean-Louis Dumas, Hermès’s chief executive) and how it has become one of the world’s most expensive – prices start at $7,000; in June Christie’s Hong Kong sold a matte Himalayan crocodile-skin Birkin with a ten-carat diamond-studded white-gold clasp and lock for $300,168. The rationale for its expense is that it is hand crafted and can take up to 18 hours to complete although the production cost is estimated to be around $800.

Birkin Bag

One would think that this would be a Veblen Good – a good in which the higher the price the more demanded. However there are a couple of ways that the Birkin handbag is not.

1. The bag is not all that conspicuous as although most people can identify Gucci, Louis Vuitton or Chanel, a Birkin is not so easy to find. In fact it is an inconspicuous but expensive bag. This theory was explained in the article “Signalling status with luxury goods: the role of brand prominence” from the Journal of Marketing (2010). It divided the high income earners into two groups;

Parvenus – who want to associate themselves with other high income groups and distinguish themselves from those who do not have material wealth.

Patricians –  who want to signal to other people in their high income bracket and not to the masses. They are of the belief that more expensive luxury goods aimed at them will have less obvious branding than cheaper products made by the same company. This was achieved with smaller logos for more expensive items and larger ones for cheaper goods which are aimed at the masses. People who cannot afford the luxury items will buy the big logo items (louder products) and this is where the counterfeiters have a field day.

2. Normally producers of Veblen goods should raise the price till the point where the demand curve starts to follow it normal shape – downward sloping from left to right. However with Birkin they maintain its exclusivity not by raising the price but by limiting the supply. Unlike other Veblen goods you just can’t walk into a shop and buy a Birkin bag – you have to place an order and wait for it to arrive. But you would wonder why they don’t sell more and make more money? It is a supply constraint – limited availability of high-quality skins and craftspeople to make them – it takes two years training. Hermès suggests, Birkins are mined, not simply made.

Commercial Reasons to limit supply of Birkins

Rationing by supply rather than price does make good commercial sense for the following reasons:

1. It gives Hermès a buffer as if demand drops, sales will not.

2. It creates excess demand for the bags, which overflows into demand for other Hermès products – wallets, belts, beach towels etc.

3. Profitability in the short run would reduce its exclusiveness as the main buyers of the bags would eventually be those concerned with social climbing. Therefore the rich may lose interest in the bags and so will those that aspire to be like them.

However I not sure Hermès actually want you to buy their amazingly expensive bag.

Should we stop consumption?

Geoffrey Miller is his book – Spent: Sex, Evolution, and Consumer Behaviour – examines conspicuous consumption in order to rectify marketing’s poor understanding of human spending behaviour and consumerist culture. His thesis is that marketing influences people—particularly the young—that the most effectual means to show that status is through consumption choices, rather than conveying such traits as intelligence and personality through more natural means of communication, such as simple conversation. He argues that marketers still tend to use naive models of human nature that are uninformed by advances in evolutionary psychology and behavioural ecology. As a result, marketers “still believe that premium products are bought to display wealth, status, and taste, and they miss the deeper mental traits that people are actually wired to display—traits such as kindness, intelligence, and creativity.

The recent recession has sent out a few mixed messages. Firstly there has been the reduction in consumption as people’s credit lines have dried up but there are those that believe that you should spend more to maintain growth and employment in the economy. With household budgets being very tight smarter consumption rather than less consumption has been advocated by Geoffrey Miller. He refers to this as more ethical consumption where the production of produce does not involve the abuse of natural resources or the exploitation of people or animals.

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