It ain’t what you say, it’s the way that you say it

(featured image credit: Ron Cogswell CC BY)

Can we communicate and not manipulate?

I first encountered behavioural science many decades ago – long before I discovered Kahneman, Thaler, Ariely and co. Moreover, it was not even in an academic paper, but in a book by a humourist named Samuel Clemens, better known under his nom-de-plume of Mark Twain.

In The Adventures of Tom Sawyer, he describes how the main character, having been caught playing truant, is told he must whitewash his aunt’s fence the next Saturday as punishment. He has not long been doing so, when one of his mates, Ben, approaches, taunting Tom for having to work while he can go swimming. Tom, however, takes no notice and proceeds to give all his attention to the fence, closely inspecting the result and adding a touch here and there. Ben keeps on mocking, but Tom points out that whitewashing a fence is a special thing, not something you get the chance to do every day.

Before long, the other boy asks whether he can do a bit of whitewashing, but Tom will have none of it. His aunt is very particular and expects top quality work, definitely not something anyone could do. Eventually Ben offers his apple if he can whitewash just a small bit of the fence, and Tom relents. Soon others arrive – “they came to jeer, but remained to whitewash”. With every one, Tom plays a variant of the same trick: presenting the chore as a huge, special privilege, and by mid-afternoon, the fence is looking like new, and he has accumulated untold wealth. That is expert-level framing.

Now, the amusing side of the story aside, one could question the ethics of the loveable rogue kid’s actions. He may technically not be misrepresenting the situation, and simply allow his unwitting subcontractors to form an inaccurate picture without correcting them, but entirely kosher it isn’t.

Everybody’s framing

Yet not all framing is suspect in this way. We frame things whenever we open our mouth, or put pen to paper or finger to keyboard. Pretty much every choice we can make, every situation we can find ourselves in, has positive and negative features. But we rarely exhaustively consider all of them – we tend to focus on a self-serving subset, on either side.

Say, for some reason, you will move to another country, and you need to discuss with your significant other where you will live. The city is busy round the clock, with traffic noise and exhaust fumes… and has everything, from work and shops to leisure opportunities, all within easy reach without even needing to drive. The countryside has peace and quiet all round, footpaths through fields and woodlands and along rivers and lakes… and all but the most basic amenities at least a five-mile drive, plus a 90-minute commute to work. The suburbs offer the best of both worlds… or the worst.

forgotten house

Superb tranquillity, or the middle of nowhere? (image: Henry Hemming CC BY)

If you have a preference for one option, but you know your partner has another one, how will you present your suggestion? Will you do it straight – like an economist: on the one hand this, and on the other hand that? Or will you be tempted to emphasize the positive aspects of your choice that you know your other half would appreciate?

You could say that deliberately concealing information that might lead to the rejection of your preference would be manipulative. But most people do know that cities tend to be hectic, and that the countryside is generally remote. Does that make framing your preferred choice in the best possible light, and downplaying (or not specifically mentioning) the downsides permissible advocacy, or plain dishonesty? The dividing line is not all that clear.

Often there is not even a hint of concealment, and it is really just a matter of perspective – like the proverbial glass that is half full or half empty, or like the father saying (a bit unoriginally) that he is not losing a daughter, but gaining a son on the occasion of her wedding. Rory Sutherland, advertising man and possessor of extensive behavioural insight, refers to clever framing by a pilot, when announcing to the passengers that the plane will not be parked at an air bridge and that they will need to be bussed to the terminal. (This is generally greatly appreciated by travellers.) “I have bad news and good news”, the pilot says. “The bad news is that we haven’t been able to get an air bridge, but the good news is that the bus will take you straight to passport control, so you won’t have far to walk.” And, with two heavy bags to carry, Rory suddenly felt grateful for the bus transfer, along with, no doubt, most of his fellow passengers – the pilot was a genius.

No malice

There is nothing remotely malicious in the framing of any of these situations. Even so, especially when numbers are involved, we seem not to be so comfortable with some instances of framing.

half full

Half full, half empty? (image: Manu Schwendener)

Imagine your consultant tells you that you need to undergo an operation. You ask about the risks involved and she tells you that it has 95% chance of success – or alternatively that 5 out of every 100 operations fail. Will you feel equally relaxed about going ahead in both situations? If not (which will be the case for many people), which would be the right way of putting it, and why?

When we see shops discounting their wares, we may be suspicious (and perhaps not without reason) about the original price. A so-called Recommended Retail Price may well be a fictitious amount that nobody ever pays. A discount based on that reference may well be completely bogus. But what if it is genuine, and a product that was indeed sold for, say, £49.99 for several months, is now offered at £30 – is that fair? An entirely legitimate alternative framing would be the reverse: the real price for the product is actually £30, and it has been sold at a huge mark-up all this time. How can we tell whether that is not actually the case?

Perhaps we are happy to accept the conventional framing, as it fits the plausible narrative that end-of-season stock must be discounted to make sure it sells. But strictly speaking, there is no reason why that would be the only valid interpretation.

With peak and off-peak pricing for transportation or holidays, however, many people are not inclined to accept the operators’ framing. This piece was inspired by a tweet from my friend Greg Davies, accusing the Scottish railway company Scotrail of “Sludge framing” in response to a passenger complaint – i.e. of nudging in bad faith. Here is the original (which, going by the likes and retweets, has struck a chord):

scotrailtweet

The customer sees a “price hike” at peak times, the operator sees it as a discount at quiet times. Is one more right than the other? The same economic logic as with end-of-season sales applies: without a discount, there would be no sales, and no revenue. But is the passenger wrong? Who can tell…

No such confusion in a joke shared by my friend David Perrott, earlier this week:

prayer joke

Even in the absence of any deliberate concealment of misrepresentation, it is almost impossible to communicate without any implied framing one way or another.

How you say it really does matter.

 

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Posted in Behavioural economics, Cognitive biases and fallacies, Ethics, Morality, Psychology | Tagged | Leave a comment

(Spending) money makes us happy

(featured image credit: Boris Kasimov CC BY)

Maybe our preoccupation with earning money is a bit misguided – and for more than one reason

Imagine receiving a bonus of, say, £2,400. Not an insignificant amount – it is close to the median disposable monthly household income in the UK. Imagine how it is being transferred into your bank account, checking your balance and seeing that it has indeed gone up by that amount. Now imagine spending that same amount. You can choose to blow it all in one go on a bathtub full of champagne, or in small chunks – maybe some clothes or gadgets, a nice meal out, some overdue repairs on your house or your car. Which of the two imagined situations makes you happier?

Two recent papers suggest that, for most people, it is consumption rather than income that predicts well-being. Thomas Carver and Arthur Grimes, two economists at Motu, a New Zealand economic and public policy research institute, come to this conclusion in a paper using their country’s General Social Survey data. Independently, Gordon Brown and John Gathergood, psychologists at Warwick University and Nottingham University, used longitudinal US household survey data. They too found that changes in life satisfaction are associated with changes in consumption, not income.

“No shit, Sherlock”, you may think, or at least wonder, “so what?”

Sure, more attention tends to go to income than to consumption in the most prominent economic statistics and commentary: we hear about wage inflation and savings rates, about median household income, or about income and wealth inequality. We don’t hear quite as much about household consumption or about inequality in how we spend money.

Not all expenditure is created equal

Now, arguably income is tantamount to our potential to consume, and so it can be implicitly seen as a proxy for consumption. As it is easier to measure, it might make sense to study the link between income and happiness, while quietly assuming that what is really being investigated underneath is the link between consumption and happiness.

But for that to really hold, consumption would need to rise with income, and that is not the case. At the bottom of the income scale, people typically spend more than they earn (and the difference is made up with support and benefits they receive). As people earn more, however, they save an increasing proportion of their income. Some of this goes to building up a buffer for a rainy day, providing security for unforeseen circumstances, which undoubtedly contributes to overall wellbeing. But we do consume proportionately less and less as our income rises

Of course, we don’t get the same enjoyment out of spending money on toilet paper or utilities as on holidays or meals out. Gordon and Gathergood’s analysis draws a clear distinction across the diverse categories of expenditure. They find a significant difference between conspicuous consumption (relatively luxury goods and services that are highly visible by others, and that signal status and economic power), and non-conspicuous consumption (the stuff nobody sees). It’s the former that really makes us happy.

Conspicuous consumption is often paid for by credit cards. Many people pay their bill at the end of the month, but quite a few don’t – credit card debt in the UK stood at nearly £2,700 (€3.100, $3,500) per household at the end of 2018. That costs money (at typical interest rates something like £800 per year) – and this interest, really, is the money we’re prepared to spend on consuming itself.

creditcards

Spending to be able to spend

Enter the taxman

The fact that people are prepared to pay in order to consume has not escaped the taxman either. Many countries operate a tiered sales tax or Value Added Tax (VAT) that is higher for goods that fall into the conspicuous consumption category. This is easy money: people are typically less price sensitive when it concerns luxury items, so adding a bit of extra tax is not going to affect sales much. Kaching go the government coffers.

Some economists even advocate shifting the tax burden on citizens entirely from income to expenditure. Robert Frank, among the most prominent ones, favours of a progressive consumption tax, which works much like the more common progressive income tax. Instead of paying a higher percentage of the top slice of our salary in income tax, we would pay a higher consumption tax the more we spend.

Prof. Frank’s main motive is social in nature. He sees income inequality as a distraction: what really matters is consumption inequality. The way the rich spend their money – on bigger houses, on flashier cars, on more expensive holidays, clothes, and so on – trickles down and affects the consumption of the less wealthy. They too want a bigger house etc, and their expenditure becomes ever more driven by social pressure to ensure their consumption is adequate according to the perception of their peers. This leads to an infernal spiral, in which people who can ill afford it eventually find themselves in financial trouble – not because of income inequality, but because of inequality in consumption.

Some evidence for this hypothesis, or at least for the negative externality of rich people and their conspicuous consumption, can be found in a study by Rainer Winkelmann, an economist at the University of Zurich. Prof. Winkelmann found that people feel less satisfied with their income if they see too many luxury cars in their neighbourhood. In municipalities with twice the number of Porsches and Ferraris per capita as the national average, the reduction in satisfaction with income is equivalent to a drop of 5% in that income.

Only upsides?

To fix this kind of problem, you don’t need a high income tax. Let the rich get richer, and leave them alone as long as they leave their money in the bank. But when they come to spend it on a Ferrari or a beach house, whack. The big benefit is that, by avoiding the deadweight loss of income tax, you do not discourage people from earning more (and saving and investing more). By taxing consumption progressively, you actually encourage people to save and invest.

vault

No tax as long as your money is in here! (image: skeeze)

It would not even be particularly hard to implement such a tax in practice. There are only two things you can do with your income: spend it or save it. If citizens report their savings as well as their income, the difference between the increase in savings and their income is how much they consumed, and that is then taxed according to a progressive scale.

If the rates are set such that it is a neutral operation for middle income households with a typical expenditure pattern, the vast majority of the population would be able to continue enjoying their consumption without much encumbrance. The consumption of the very rich could be taxed at whatever rate is necessary to really make a difference on their actual overly conspicuous consumption. If, say, a 50% tax on expenditure above 50 million dollars doesn’t make them consider whether they really need to buy a fifth Porsche, then maybe an 80% or a 150% tax will do it.

Eventually this might mean a shift away from the production of very expensive goods: fewer Bentleys and Lamborghinis. But would that be a bad thing? Those resources could now be deployed into the development and production of less expensive goods aimed at people with more modest spending power, where the demand is higher. Even if that irks the top 0.001%, it will increase the wellbeing of many times more people in the bottom 99.999%.

We do, however, seem to nowhere near the implementation of such a system. How come nobody has tried an approach that appears to be an economic panacea that solves many social and economic problems?

The answer to that question probably belongs in the domain of politics, rather than economics. And that is a different story.

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More indifference

Why strong preferences and opinions are not (always) good for us

My young teenage daughter used to ask me whether I ‘hated’ the male lead singer of the band The Beautiful South every time one of their ditties was played on the radio. It is true, there are some singers whose tones are anything but dulcet to my ears, and Paul Heaton is one of them, along with R.E.M.’s Michael Stipe, The Kooks’ Luke Pritchard, and Florence Welch of the band Florence+The Machine. These are all, no doubt, fine vocalists, and the problem is surely situated entirely in my own auditive system.

But I do, of course, not remotely hate them, not even their voice.  If I really did, hearing a song by these artists would probably make me throw the radio out, or at the very least make me change the station. Instead, I am pretty much indifferent – in an economic sense, that is.

Indifference is one of these words that have a slightly different meaning when they’re used by economists. Imagine you are standing in front of a shop window, looking at a pair of trainers you would like to buy priced at, say, £50. But price-sensitive as you are, you whip out your phone and you check the prices nearby. And what do you know, about two miles away, identical trainers are for sale for £45. Would you make a detour of a good half hour to save a fiver? Probably not. If the other shop was just two doors down, however, my guess is that you’d make the tiny effort to buy them there.

On the curve

Somewhere between two miles away and two doors down is the point where you would be indifferent – you would not have a preference either way. In economics, the varying quantities of two (or more) goods in a bundle that provide the same utility is plotted as a so-called indifference curve. The figure on the left below shows that, for a particular person, a bundle of 4 biscuits and 2 apples, and one of 1 biscuit and 6 apples gives them equal satisfaction. We can do the same for the price of the trainers and the distance walked (on the right). This shows that walking a little less than half a mile for trainers that are £5 cheaper represents the same utility to us as buying them right here at the full price, as would all the other points on the curve – for example, you’d be just as willing to walk two miles if you got a £15 discount..

indifference1

For economists, this curve is infinitely thin. If the trainers were £35.01 in the shop two miles away, you’d definitely stay here. If they were £34.99, you’d definitely walk the two miles. For real people, it is not quite like that though. We don’t normally think in such black-and-white terms, and so there is typically a range across which we would be indifferent. The one day we may be inclined to walk two miles for a pair of trainers even if they’re only £10 cheaper than those right here, and the other day we may buy them right where we are, even though we can get them for £20 less two miles further.

But is this necessarily a sign of indifference? One way to find out is to look back. The day after you bought the more expensive shoes, do you feel regret you didn’t, after all, go the extra distance to get them cheaper? If so, you are not being indifferent. Instead, you just have fluctuating, noisy preferences, with an indifference curve that moves around – one day here, the other day there.

And that is a recipe for frequent disappointment, dissatisfaction and stress. Even though the choices you face are rarely about buying the same item for a different price at different locations, any choice risks putting you in this predicament. You can experience it after the event – yesterday you were sure this T-shirt was really much better than that other one, but today you believe you made the wrong call. And you can experience as indecision while you are making up your mind what to buy: will you have a bacon sandwich for lunch, or a prawn one? Both situations are symptoms of the same problem.

Indifference with good credentials

Conventional decision approaches won’t help you here. If you are so anxious about making the right decision and avoiding subsequent regret, a thorough cost-benefit analysis is the last thing you need. It will promptly give you what is sometimes called analysis paralysis There are umpteen factors you could take into account – how long ago since you had a bacon sandwich? How many calories do they each have? What are you having for dinner this evening? Do they cost the same? Before you know it, lunch time is over and you still won’t have made up your mind.

The underlying problem is in how important you think your choice is. The more you feel that your eventual choice really, really matters, the closer you are to the teenager for whom emotions tend only to occur in a totally saturated condition: no such thing as mild dislike, only profound hate.

The kind of indifference that can help us avoid the emotional distress of having to make the right choice, or facing regret for making the wrong choice has pretty good credentials. It is rooted in equanimity, an attitude that also has a prominent place in Stoicism and Buddhism. Yes, the bacon sandwich could give you just a little more pleasure than the prawn one, but does it really matter that much? You could have saved £10 on the trainers by going out of your way, but is the money worth that much, especially considering you got home half an hour earlier?

indifferent

“I used to be indifferent, but now I am easy either way.” (image: mangostar via Freepik)

There is even a (behavioural) economics concept that captures the spirit: satisficing, a term coined by the great economist and polymath Herbert Simon more than 60 years ago. It is a fusion of satisfying and sufficing – alluding to the act of being happy with an alternative that is good enough, instead of seeking out the optimum (which is termed maximizing). It’s almost like being a bit more meh – not in a bored way, but in an “it’s fine either way” sense.

Choosing between alternatives can be hard, because there are so many different facets that seem to matter. For some of those, one of the alternatives wins out, for others the other one (and it gets much worse if you have more than two options). Figuring out which ones truly matter can be hard too. But what is easy, is to imagine all but one of the options away – imagine there was no choice. Would you be happy with the remaining one? If not – discard it, there’ll be a better one among the ones you’ve ignored just now. But if you would be quite content with it, go for it and move on. It is good enough, and you have just satisficed yourself.

Being more indifferent brings another advantage. Sometimes the problem of choice is not about figuring out what we really want, but choosing between our preference and that of another person – our spouse or partner, or a friend, say. They want to have a Thai takeaway, and we prefer Chinese. You got it: imagine the Chinese is closed – would you be satisficed by Thai food? Bravo, you have made indifference work for you.

Indifference is being happy enough with several alternatives, and that can make you happier overall.

(I would have said I hope that this post doesn’t leave you indifferent, but actually, it’s fine either way.)

 

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Money talks (but do we understand what it says?)

(featured image credit: Olivier Mabelly CC BY)

What the flood of financial support for the rebuilding of the Notre Dame (and the reactions to it) tells us about ourselves

Fires at famous landmarks understandably get a great deal of attention. But the dramatic images of the blaze at the Parisian Notre Dame cathedral seem to have touched many people in ways that other such disasters do not normally do. The only reported casualty was one of the 500 firefighters who was injured, so it was not the human toll, but the material damage to the building that was the reason for the extraordinary emotional reactions. This was evidenced by the speed with which money was being raised to finance the restoration of the stricken church. But this raised some questions too. How come?

While fire was still raging, some of France’s richest families were already pledging hundreds of millions of euros. It was hard not to notice how incongruent it all looked in a city that has, for many months, seen people in yellow vests calling for lower fuel prices and higher wages for the millions of citizens struggling to make ends meet. An old building catches fire, and within two days more than a billion euros (£860 million, $1.2 billion) is donated to fix it.

Something seems wrong with the priorities of these rich folk. They could have donated that money instead to the poor of France – hell, they could have given money to both and it would still not make a dent in their fortune. But they appear to care more about a pile of stones than about the wellbeing of their destitute compatriots. Come to think of it, what about the president who has pretty much been turning a blind eye to the protesters’ demands, but who was quick to put the resources of the state behind the rebuilding of the Notre Dame? Where do his priorities lie?

Priorities measured by money

If we can see the priorities of rich people in how they spend their money, then we should be able to draw a similar conclusion about society’s priorities, by the way in which local, regional or national authorities spend their money. In the UK, for example, public expenditure in 2017-18 on education was about £90 billion, while nearly £150 billion was spent on healthcare, and about £40 billion on defence. Does that mean that education is more than twice as important as defence, and healthcare 1.6 times as important as education? Of course not.

If it doesn’t make sense to derive the relative importance of a sector by the amount of money that is spent on it, does the allocation of expenditure tell us something else? We should at least expect the resources to be spent wisely, that is, not spend it on something relatively unimportant when there is still something more important that requires more money. For example, should the country be spending £40 billion on bombs and aircraft carriers, while there are people who need to go to food banks to feed their children?

bandstand

Trading a bandstand for a police car? (image via Twitter)

Even that is tricky. Say by some stroke of luck the government finds another £25,000 to spend. It could hire another primary school teacher with it, or an extra nurse, or it could raise unemployment benefit for 460,000 people out of work by £1.50 per month. Which of these options represents the best value for money? That is almost impossible to determine.

And we are not even talking about less critical expenditure like the upkeep of parks and amenities, or street lighting. At what point do you decide to fund the replacement of a police car with 150,000 miles on the clock instead of the restoration of the clapped-out bandstand?

Hard criticism

All this shows that criticizing how authorities spend money is harder than we may have thought. It’s easy to protest that more money needs to go to the National Health Service, or to free school meals for all children, but it’s less so to say where the money will need to be taken away.

What about our own expenditure? On a smaller scale, we see pretty much the same challenge. The average British household spends about a third of its income on housing – rent or mortgage, insurance, repairs, utilities and so on, about 15% on transportation, some 10% on food and 6% on eating and drinking out. But it would be meaningless to claim that a roof over our head is three times as important as food on our plate. And can we really conclude that the last, marginal pound spent on alcohol and tobacco (2.2% of our budget) provides us with more utility than the last pound devoted to education (1.5%)?

If we are critical of how the very rich, or indeed the state, spend money on (other) people, how well are we ourselves doing? The average British household spends about £3 (€3.5, $3.9) per week on charitable donations – just over 0.5% of their budget. Not particularly generous – and is that a fair amount? We spend about the same on cinema tickets, almost three times as much on alcoholic drinks, and eight times as much on clothes and shoes. We know we cannot say this means booze is three times more important than charity, but is the last pound in each category well spent?

wine

Shouldn’t we gift a malaria net instead? (image: Steve Buissininne/Pixabay)

Let’s take an example. Malaria is a deadly disease that kills a child every 45 seconds, according to Unicef. Malaria netting that protects nine families costs £19, so just over a pound per week would safeguard 27 families each year. That is the equivalent of a pint of beer per week. Where is that pound best spent? What does the way we spend our money say about our values?

When other people’s money talks, we are quick to hear what it tells us about their priorities. But when we listen to what our money says, we may find it tells us very much the same about ours. Does that mean we should give up everything that is pleasurable until we have contributed enough to save every last life on the planet? Of course not.

Wondering, every time we drink a glass of wine or go to the cinema, whether that money would not be better spent on a malaria net is unlikely to make us happier. The pursuit of happiness is a profound human aspiration, and we are entitled to make the choices that help us in this pursuit – whether it is drinking a glass of wine while there are people dying of malaria, or funding the rebuilding of the Notre Dame while many Parisian citizens get their family meals from food banks.

Our choices are open to challenge, of course – but before we undertake to challenge the choices of others, we should challenge our own.

Posted in Behavioural economics, Economics, Morality, politics, Psychology, Society | Tagged | Leave a comment

A fair price for everyone

(featured image credit: Timothy Takemoto CC BY)

Fairness is an important feature in our society. But is a fair price a fixed price, which is the same for everyone?

For billions of years, life on this planet has been subject to the iron law of the zero sum. Any resource that was appropriated by one organism was automatically unavailable for any other one. Win-lose was the name of pretty much every game – what you won, I lost and vice versa – until our distant ancestors discovered trading, and with it the ‘win-win’ concept. But there is something that complicates matters.

At the heart of every transaction are two key variables: willingness to pay (WTP), and willingness to accept (WTA). If you have something I would like, and the maximum I am prepared to give you in return (my WTP) is greater than the minimum you will take for it (your WTA), we can do business. The difference between my WTP and your WTA is the economic surplus, a measure of the wealth that is being created by the transaction. It doesn’t matter exactly how it is shared: together we are better off after the transaction than before. This is almost miraculous – it is the closest to a true perpetuum mobile humanity has got so far.

Determining our WTP seems simple enough. In mainstream economics, it should reflect the perceived value to us, the worth we attach to what we aspire to buy. Even if we do not perform a full cost-benefit analysis every time, we typically operate a kind of internal benchmark that tells us what would be a reasonable price. We should therefore be able to establish our WTP independently, without referring to anyone else.

But often that perceived value is not the only thing we consider. We also want a fair price. And to ensure that is the case we do need information about others – other buyers, and indeed the seller.

Why are they paying less than we do?

Imagine you had run out of milk and you popped over to the corner shop. By coincidence, your neighbour is just behind you with exactly the same problem. You pay for your milk (your WTP is greater than the shopkeeper’s WTA, so it seems a fair price). But as you put away the change, you notice that your neighbour is charged 20% less than you – for the same pint of milk. All of a sudden, the price you happily paid a minute ago no longer looks so fair.

Milk

Identical milk, identical price, that’s fair (image: Zeyus media CC BY)

This is the kind of issue that Robert Frank, an economist at Cornell University, takes great interest in. His book, The Economic Naturalist, has an entire chapter devoted to situations where different buyers pay different prices for the same thing, and he has recently been tweeting on the same subject.

Is it fair that some people pay less than we do? Unfairness is, ultimately, in the eye of the beholder, but there can be sound economic reasons why sellers would want to sell their wares at different prices to different people.

We all have different limits to what we are willing to pay for say, an airline seat or a pair of shoes, and that causes sellers headaches. If they fix a high price (= their WTA), they will make a handsome margin on each item sold, but only customers with an even higher WTP will buy.  So they risk being left with unsold stock shoes or seats, and with a total income insufficient to cover all their costs.  If they fix the price low enough, there will be enough buyers to purchase all the stock, but now the margin on each item is much lower. So the total income may, again, not be enough to cover their costs. There is no guarantee that there is a fixed price in the middle that will produce enough revenue to offset the cost, but even if there is, there will be unsold seats and shoes – and that is inefficient.

Jumping high for low prices

A more efficient approach is to sell at a higher price to people with a higher WTP, and at a lower one to people with a lower WTP. But then sellers must prevent the high-WTP customers from buying at the lower prices. Frank calls this hurdle pricing – the customer must jump a metaphorical hurdle to benefit from the low price. For airline seats, it may mean that you need to stay a weekend (which is not suitable for many business travellers), or that you need to wait until the last minute, and risk not flying if the flight is full; for shoes it may mean that you need to sit tight until the end of the season when the remaining stock is sold at sale prices – if a pair is left in your size.

Such hurdles can take strange shapes. Frank relates an anecdote in which he had reserved a hotel room a few weeks ahead of time for $200. As he checks in, he spots a sign inviting people to “ask about our special rates”. So he does, and the clerk tells him he can have the room for $150. Is this the lowest hurdle imaginable – just ask, and get 25% off? Why doesn’t everyone do so?

This is where we see how economics and psychology are really quite closely related. Who is most likely to ask about the best rates? Price sensitive patrons, who probably would not take the room at the standard $200 rate, but who might well do so at $150. It is better to have some such guests paying the lower rate, than to have no guests at all – a full hotel is more efficient than a partially empty one. Well-off patrons are not so price sensitive, and might not want to signal that they care about a discount, so they are much less likely to enquire. Business travellers, who can claim back their expenses, even less so – there is nothing in it for them. And curious economist with a high WTP like Frank are rare, so that is not a big worry.

Another remarkable vignette in the book is that of white goods retailers hammering dents in their cookers and fridges. Appliances with cosmetic damage, but otherwise in perfect condition, are often sold at mark-down prices – but why would they be deliberately damaged? It’s the hurdle again: make sure well-heeled customer pay the full price. They will prefer an unblemished item, while those with a lower WTP won’t be too bothered by a little dent or scratch.

Where economic sense and sense of fairness part ways

All of this makes good economic sense. Sellers can get the buyers with a high WTP to cover the bulk of the fixed cost or the product development cost, and make the same product available at a lower cost to people with a lower WTP. As long as there are enough hurdles to jump, few people will consider it unfair (although some might raise their eyebrows at the deliberately damaging of products).

vending

Prices expressed in °C? <image: Bun Oshita CC BY>

But consumers have little interest in economic efficiency if it comes at the expense of fairness – as they perceive it. About 20 years ago, Coca-Cola was planning to install vending machines that sensed the outside temperature, and raise the price of an ice-cold drink when it was hotter. The outrage was predictable. Such unfairness! A company taking advantage of thirsty people on hot days, to boost their profit!

Was it really such an unfair idea? The standard economic rationale often used to justify differential pricing is that the drinks will go to the people who get the most utility out of them, as they are prepared to pay the higher price. But Frank gives us a much more compelling reason. Demand for cold drinks is much higher on hot days – maybe twice as much. To meet that demand, the supplier either needs to install a larger, more expensive machine to hold enough stock for these peak times, or must replenish it more frequently. This represents extra cost, and ironically the fairest way of covering it is by charging those people who are the cause of it: the drinkers on the warmest days. (Note the parallel with congestion pricing on the roads.)

That is not how consumers see it, though. Coke’s plan was shelved, and its then CEO did not survive for long. Robert Frank concludes his Twitter thread, seemingly a little wistfully, by pointing out that it is a mistake to celebrate Coke’s decision to abandon the idea under consumer pressure. Instead, he appeals to economists to explain more clearly why differential pricing of this kind is no more unfair than the differential pricing between one steak and two steaks.

Until then, companies will need to recover the excess cost in another way – in this case, by charging more on ordinary days to absorb the extra cost on hot days. The fairness of this is imaginary, but the price we all pay for it is very real.

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Time is (not quite) money

featured image credit: Jon Vonica

The relationship between the two scarce resources that dominate our life is more complex than it may look at first sight

When Benjamin Franklin published his essay, Advice to a Young Tradesman, Written by an Old One in 1748, he probably did not foresee how popular one particular fragment of one of its constituent sentences would become. Nearly 30 years before Adam Smith’s The Wealth of Nations came out, Franklin explained to his hypothetical reader the fundamental economic concept of opportunity cost. The expense of a half day’s leisure includes the money not earned during that time: “(Remember that) time is money.” There is, however, more to this simple equation than meets the eye.

Both money and time are scarce resources. That means that every pound, euro or dollar (substitute your favourite currency unit) we spend on one thing, we cannot spend on something else. Every minute we are performing one particular activity, we cannot devote to another one. But we can swap one for the other, and that makes Ben Franklin’s observation that time is money so profound.

When we work for our income, we are selling our time in return for money. Even if we do not get paid by the hour, it always costs us time to do whatever it is that others are prepared to compensate us for. Conversely, we also pay other people to do work for us – whether it is a plumber fixing a leaky tap, or the neighbours’ kid mowing our lawn. And we buy dishwashers, microwave ovens and other devices that save us time – that too represents a substitution of one for the other.

Economists, and by no means the least among them, have long had an interest in time and how we use it. Gary Becker’s classic 1966 paper, A theory of the allocation of time, considers the implied cost in non-work activities, and how this enables an economic treatment of the household.  In 1930 John Maynard Keynes, in an essay entitled Economics possibilities for our grandchildren, famously predicted that we would by now be working a fifteen-hour week. It doesn’t take much verifying to show that this is way off the current norm. What does that tell us of the time is money equivalence?

Money and time in the balance

In a recent episode of the (highly recommended) Econtalk podcast, host Russ Roberts speaks with economist Daniel Hamermesh on his recent book, Spending Time, the most valuable resource. He opens with the question why it is that, now that we are living longer, and are more productive and richer than ever, we also feel more pressed for time than ever? A key reason, Hamermesh says, is precisely that we are richer, while the days haven’t got longer. We have much more money, but barely more time. And time becomes relatively more precious, the richer we are, because it takes time to spend money. What’s more, we can spend our time in many more ways if we have more money, and that enlarged choice makes it feel even scarcer.

We could of course pay people to do more for us. But much of the activities that eat up our time we cannot really contract out. It’s hard to imagine how we could engage someone to lay the table or to put the rubbish out, let alone to sleep or go to the theatre for us. It’s hard to buy much more time than we do.

oecdhoursworked

Time or money? (source: OECD – click for enlarged version)

Perhaps we could decide to work less, and earn less money. This would redress the balance on both sides: we’d reduce the opportunity to spend by being less rich, and we’d increase our leisure time. This is where we find large differences between countries. Averages can hide all sorts of detail, especially since figures include part-time and seasonal work, but they do give us a general idea. The OECD chart above shows the data for 2017 (or most recent if not available).

With 1,356 hours per year, the average German worker is the closest to Keynes prediction, but it is still more than twice as much. He or she does have 158 hours more leisure time than the equivalent in France or the UK, 190 hours more than the Belgian, and a whopping 424 hours more than the American worker. That corresponds to, respectively, around 3 hours, 4 hours and 8 hours per week.

Much of this difference is explained by the number of paid holidays people take. While the legal minimum is 20 days, German workers have an average of 30 days’ paid leave (plus 10 public holidays). In the US there is no legal obligation for employers to grant staff any paid holidays. Many organizations do offer 10-20 days’ paid leave, but more than half of employees do not take up their full annual entitlement. Why do we still work so much?

The situation in the US is quite intriguing. One might speculate that, if holidays are a valued perk, employers would be able to use this as a differentiator in the labour market: offer more vacation and get the best staff. But if so many people don’t even take the holidays they do get, that seems not to be the case. Besides, the discrepancy with Western Europe is a recent phenomenon, says Hamermesh – 40 years ago there was no difference.

Reversing the equation

We can ask ourselves how come the US does not mandate a minimum number of paid holidays. But more telling is the fact that, in Europe, people tend to stick to the available number of paid days off. Taking unpaid leave is not something people do, despite the common complaints about so-called ‘work-life’ balance.

Revealed preference theory (our behaviour is an indicator of our preference) suggests that people value money more highly than time – otherwise we’d all be working 15 hours per week, as Keynes thought. But that assumes that people reason about how much time they will devote to working – and they don’t, by and large. Legal arrangements and social conformity mean we generally do pretty much what others do. We simply do not deliberately consider whether we would prefer an extra day of leisure, or the pay of an extra day work, and we do not consciously make that trade-off.

Time for a cuppa

More time for a cuppa – what is it worth to us? (photo: Dominic Hargreaves)

Perhaps, if Russ Roberts is right and we feel busier than ever, we should reverse Franklin’s dictum: money is time. This swaps the emphasis, and reflects much better that time is the scarcer resource of the two, the one that most constrains how we live our lives. Having 25% less money, for example, seems like a massive drop, but is the life of someone who actually has 25% less money than we have right now that different from ours? Not really. Now picture having 25% less time, and you’ll see what I mean.

More importantly, it implies that time is the more important of the two, and that we have it in our power to acquire more of it, by giving up money. Time to spend on things we enjoy, time to spend with our loved ones. “Money is time” tells us that we have that choice.

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Unthinkable

Be careful when you label a possibility ahead of you as unimaginable: your imagination may well be tested to destruction

Have you ever attempted to log on to a website you rarely use, only to find that the password you entered is not accepted? And if so, did you try the same password again, only with more vigour the second time (and perhaps even a third time)? I have.

The more we believe something to be true – even something as trivial as what a password is– the more we reject signs that we are wrong. We not only hang on to our conviction, we also go on to express it more forcefully. Hitting the keys harder is not going to make any difference – of course we know that. And yet we feel as it will somehow make the password be recognized after all, because we just cannot imagine that it might be wrong.

The persistent premier

I have been thinking about this kind of weird persistence as I watch British prime minister Theresa May. She has doggedly been trying to get the Brexit Withdrawal Agreement (WA) she negotiated with the European Union approved by parliament, for over three months now. The plan was that it would be endorsed on 11 December 2018, well ahead of Brexit day, 29 March 2019. But after seven ministers (including the Brexit secretary himself) resigned from the government because they opposed the WA, she deferred the vote, fearing that she would be “defeated by a significant margin”. That fear was well justified. On 15 January 2019, the House of Commons voted against the agreement by 432 votes to 202. Even given the government’s wafer-thin majority – with the support of the 10 Northern-Irish Democratic Unionist Party MPs, it can only count on 326 seats of the 650 in the House – this was a truly historic defeat, the scale of which had not been seen for over 100 years.

May unhinkable

Brexit deferred? Unthinkable, but true (foto via youtube)

Yet, just like the person who cannot believing that the password they just keyed in is wrong hammers the exact same sequence into the keyboard a second time, she tried again. And again, the agreement – with nominal and insignificant changes – was voted down in the second ‘meaningful vote’ on 12 March, this time by 391 votes to 242. Undeterred, she put it to a third vote on 29 March (the original Brexit day), promising to step down if the agreement got approved. Even that commitment was not enough: it was once more defeated, by 344 votes to 286. A government source said, without irony, “We are at least going in the right direction.” And there is now serious talk about trying for a fourth time to get it passed.

What is behind this remarkable succession of failed attempts? It has the hallmarks of someone pursuing a course of action in the belief that the alternatives are unthinkable. For Mrs May, the alternatives are revocation of Article 50 (cancelling Brexit), a long delay (which would involve holding European elections), and leaving the EU without a deal. All are unacceptable, and hence unimaginable for her.

But she is not alone in parliament with that kind of conviction. To the extreme Brexiteers, the so-called backstop to avoid a hard border between Northern Ireland and the republic, incorporated in the WA, is unthinkable. It would commit the UK to maintaining Northern Ireland in the Customs Union and operating much of the rules of the Single Market in the province, until the EU agreed it was no longer necessary. On the other side, a majority of MPs decided that the “no deal” scenario, whereby the UK would leave without any agreement in place, is unthinkable – it was rejected by 400 votes to 160.

Stages of unthinkability

When we use the word unthinkable, it is often a linguistic hyperbole, an exaggeration to underscore the strength of our opinion or our belief. It is similar to wanting to avoid an undesirable outcome “at all costs”, or saying we’d “do anything” to prevent it from happening. Ands long as it is just hyperbole, or as long as there is no chance that we would actually have to take steps and literally ‘do anything’, that’s fine – strong words are part of our vocabulary.

But if we mean it, and treat courses of action or outcomes as genuinely unthinkable, reality may end up calling our bluff, and expose us as unable, unprepared, or unwilling to ‘do anything’. How does that happen?

We can look at it as different stages. In the first one, deliberately calling something we don’t want to happen ‘unthinkable’ gives us permission to envisage only a future in which it does not figure at all. The unthinkable simply won’t happen, so why then should we worry about it?

In the next stage, doubt might begin to creep in, but we can engage in what is known as motivated reasoning. We come up with reasons why the unthinkable won’t happen, or ways in which it will be averted or prevented from happening. For example, if we believe it is unthinkable that rising sea levels as a result of climate change will submerge cities like London, New York, or Shanghai, we can dismiss the science that predicts it as speculation, or we can put our faith in the resourcefulness and the human ingenuity of government and civil engineers, who will come up with a solution.

submerged

As long as it is unthinkable, we’re fine

Returning to the Brexit situation in the British parliament, we can see how this second stage plays out there. Perhaps prime minister May calculated that with her deal being the only one on the table, the hard Brexiteers may not like it, but they may be even more frightened of the prospect that Brexit is softened or even halted that they will approve it. Likewise, the proponents of a softer Brexit and the recalcitrant Remainers will prefer this deal over the prospect of a no-deal exit. Her tactics since December would certainly seem to support this analysis.

The hard-line Europhobes, however, believe that Theresa May will ultimately have to stand by the 2017 Conservative party election manifesto and deliver Brexit, without a backstop and if need be without a deal. On the other side, MPs trust that Mrs May will act in the interest of the nation, and not let a cliff edge, hard Brexit happen.

In the third stage, the reality of the unthinkable begins to dawn. Preventing the unthinkable requires taking action. The backstop is unthinkable, but so is no Brexit – so we could now see some MPs, who had previously forcefully attacked the withdrawal agreement, voting in favour. We could see Mrs May, to whom not leaving on 29 March had been unthinkable before, going to the EU and asking for an extension.

In the last stage, the bluff is finally called: how unthinkable is ‘unthinkable’ really? We’ve seen MPs reject the ‘no deal’ option by a huge majority of 240. But they will now need to decide what it does find thinkable. Against the wire, there is no time to restart negotiations with the EU to come up with an alternative deal to the current WA, and the stark reality is that only two other unthinkables remain: a long extension, or revocation of the whole Article 50 process.

The Brexit process has been costly so far: it has consumed inordinate amounts of parliamentary time, and large amounts of money have been spent by businesses and the government preparing for it. But it provides us with a salutary tale of how not to handle the unthinkable.

It is not sufficient to consider what we do not want as unthinkable. We have to say what is thinkable instead. We have to know how the thinkable alternative will be realized. And above all, we need to understand what sacrifices we will need to make to end up with the thinkable option instead of the unthinkable. It hardly bears thinking about.

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