Below is a pdf download of a presentation on consumer behaviour that I did for our Yr12 and Yr 13 students last week. It focuses on the following:
Hedonic Treadmil – Paradox of Choice – Algorithms and Choice – Happy Money – Well-being around the world.
Click here to download. I particularly like these images.
Flicking through the TV channels one evening one found that what was supposed to be a time of relaxation was actually quite tiring. Surely with more choice and freedom to chose what to watch I would be a lot more content. In the age of the Internet, smartphones etc there is a paradoxical effect in that we have access to an endless amount of movies, TV programmess, documentaries, sport etc.
My mind went back to Barry Schwartz’s TED talk “The Paradox of Choice” and what he calls the “official dogma of all western industrial societies” – see below. This is the common belief that by maximising one’s choice, we are maximising their freedom, and therefore their welfare. A clear intuitive example is a medical doctor offering a patient certain treatment options. The patient has choice, but he/she would most likely lack the knowledge and physical state of mind to make the best decision. Obviously, it should be better if the doctor, with all their experience and knowledge, makes the decision, even though it restricts the patient’s choice.
However freedom can do more harm than good in that it paradoxically causes paralysis in decision-making. When people have a lot of freedom, they have to spend time and effort considering the many options and making a decision. Should I watch rugby, cricket, league or ESPNFC on Sky? What about PBS News, CNN or Discovery? Some will say just record the programmes you didn’t watch but what you end up doing is filling your disk so that you can’t record anything else. These rather futile, yet difficult decisions make us indecisive, slow, and permanently pre-occupied in our lives, all thanks to the “problem” of having a bit too much freedom. Growing up in Ireland we had access to BBC1 Match of the Day (two games of highlights from English Football Division 1 – Premier League now) and it was something that you really looked forward to – 10pm on a Saturday night. Here there is limited choice and because of this maybe more satisfaction in that I didn’t have to worry about who or what to watch. In fact the pleasures of anticipation of Match of the Day on Saturday built throughout the week and provided more happiness – research shows that waiting for something – a chocolate – makes it taste better when we get it.
However, there are some more subtle cognitive effects that come with more freedom. First, it is very easy to imagine that there was a better choice than the one that you had chosen – i.e. the opportunity cost can take away your happiness from your current decision. This causes us to regret our own decisions (even if the option we took was the best choice), and this can seriously damage how satisfied we are with something. And with more freedom, comes more capacity to imagine that the grass is greener on the other side.
Finally, in this “choice-full” world of today, people are bound to choose an option that is almost perfect. Schwartz talks about how there only used to be one kind of jeans that you could buy, compared to the many different colours, fabric, fit, and size that you can buy today. He claims that by being able to buy such near-perfect jeans, you have such high expectations for the next pair that you can’t be completely satisfied. He jokes: “the secret to happiness is low expectations.”
Maximizers and Satisficers
With so much choice today we tend to fall into two categories of consumers.
Maximizers are those people that spend all their time exhaustively search for every piece of information about a product in order to make what they believe to be the perfect choice. However it can lead to nagging doubts about their choice and they can become unhappy.
Satisficers are those people that settle with the decision that is good enough and seem to be happier with their decision.
In 1776 Scottish economist Adam Smith talked of the economy as the invisible hand. Here he emphasized the self-regulating nature of the economy as individuals, firms and companies independently seek to maximize their gain which may produce the best outcome for society as a whole. The capitalist systems seems to rely more on the relentless growth of consumer spending and, although it can lead to dramatic improvements in standard of living, it does require people to become resolutely addicted to products/services and be prepared to get into significant debt.
Today, an economy is a much more intricate machine which aims to allocate scarce resources to satisfy the utility of economic agents such as individuals, firms and government. The dominant model for many years has been “Dynamic Stochastic General Equilibrium” (DSGE) and it takes all the characteristics of an individual (this person is typically called the representative agent) which is then cloned and taken to represent the typical person in an economy.
Therefore it assumes that all individuals and firms have identical needs and wants which they pursue with total self-interest and complete knowledge of what they desire. DSGE also takes into account the impact of shocks like oil prices, technological change, interest rates, taxation etc. However a couple of areas that it doesn’t represent accurately is the financial sector and the instability of markets – booms and slumps. A new task will be to include the banking sector into the models as macroeconomists assumed it to be a screen between savers and borrowers rather than profit orientated organisations prepared to take big risks with increased leverage and sub-prime lending. For example as house prices increase banks are willing to lend more money to speculators who bid up the price above what is the fundamental value. The opposite applies if banks become more risk adverse and marginal buyers are forced out of the market causing prices to drop. By representing the financial sector in an economic model you go some way to help solve the major problem with DSGE and other models in that they are useful only if they are not unsettled by external factors like a banking crisis.
Keynes said “If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid!”. To achieve this there needs to be structural reform in the discipline.
An emerging field called agent-based modelling has grabbed the attention of some economists. This is where large amounts of data is collected from individuals who are unique to each other in they have different motives and actions in the market place. The behaviour of these individuals overlap and interact which generate predictions through a messy process but similar to what happens in real life, unlike DSGE and the clean old-fashioned macroeconomic models. Agent-based modeling has also shown promise in other disciplines like Physics and involve real-world problems. The example used by John Lanchester (New York Times magazine) is how Brazil nuts seem to end up towards the top of the mixed-nut package and nut research has since found real-life applications in industries such as pharmaceuticals and manufacturing.
With a better sense of what is influencing behaviour in the economy, economists might become less blinkered by their own theory, and better able to foresee the next crisis. Meanwhile, they would be wise to repeat (daily) the words: “My model is a model, not the model.”
Macroeconomic models need to be adapted to take account of the events of the last 20 years. For so long typical macro model has been DSGE but as yet no model includes the impact of recessions and the eighty-year depressions. Economics failed to predict or prevent the GFC and this was based on conceptual faults which included a refusal to engage with the role of the banking and finance system in the economy.
Dani Rodrik of Harvard University splits economists into two camps: hedgehogs and foxes.
Hedgehogs take a single idea and apply it to every problem they come across.
Foxes have no grand vision but lots of seemingly contradictory views, as they tailor their conclusions to the situation.
Maybe more fox like behaviour is needed.
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.
A 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
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
- 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.
Money 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.
Today 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.