Economics in your thoughts

Economic thinking is not just about objective costs and benefits – it is also about your very thoughts

You’re driving along a road in town, and in the distance you can see a pedestrian crossing, protected by traffic lights. A figure with a pushchair is approaching it and proceeds to press the button. By the time you reach the lights, they have turned to red and you need to stop. The pedestrian is an older man, who smiles at you as he crosses, pushing a small child sleeping peacefully in the pram. The light turns green again and you drive on.

A very common scene, and one which – like so often happens in traffic – conceals economic activity. Road space is a scarce resource, which cannot be used simultaneously by different road users without causing unwelcome collisions. And allocation of scarce resources is a matter of economics.

Rules (like the obligation to stop for a red light) and mechanisms (like the push button at the crossing) make that possible in a relatively smooth manner. But when two users compete for the same resource, the benefit of the use to one of them often represents a cost to the other. In this case, the man with the child, in gaining exclusive access to the crossing, imposes a cost on you: you have to wait until the light turns green.

How big is this cost? You could estimate it by assuming a particular hourly rate (for example, what you are paid at work), and working out how much time you lose by having to wait for the light. Or you could ask yourself, how much would I be prepared to pay to ensure the light doesn’t change to read until after I’ve driven past, so my journey is not interrupted? This is a conventional economics way of looking at it. Perhaps you don’t take a single-transaction look: tomorrow you may be the pedestrian, benefiting from the ability to interrupt the flow of traffic, and imposing a cost on drivers. What is a cost today, is a benefit tomorrow – the swings and roundabouts of traffic facilitate efficient interactions, and even things out over time.

All in the mind

There is, of course, more to it. Let’s riff some more on this thought experiment. Imagine the guy pressed the button while you were still 200 metres away, but then judged it was safe to cross at once despite the pedestrian light still being red. By the time you reached the lights, he would be on the other side of the road, continuing his walk, while you would be waiting for a red light – for no obvious good reason. Would your experience be entirely the same? Or would you be somewhat annoyed at the pointlessness of your wait? What if the person had pressed the button but then changed their mind afterwards – perhaps they remembered they still had an errand to do on the same side of the road? Here too, you’d be stopped but there would be nobody benefiting from the transaction. Frustrating, isn’t it?

redtrafficlight

Not all red traffic lights are created equal (image: Matthias Ripp CC BY)

Or picture this, it’s not an older guy pressing the button, but two young kids who see you coming, wait until your stopped for the lights, and then laugh at you and run away – without crossing the road. They’re definitely deriving some benefit from having stopped you, but perhaps not in a way that you approve of.

None of this should make any difference to someone devoid of emotions – or something. Autonomous vehicles would be programmed to stop for red lights, without getting worked up if there is nobody actually making use of the green pedestrian light. In fact, you yourself may not even be that bothered if you need to stop for a red traffic light at a junction operating on a fixed cycle, and there is no traffic in the intersecting road. That’s just how traffic lights work.

But at the pedestrian crossing, being forced to stop may well feel very different in each of these situations. And that is all in your thoughts.

Two kinds of utility

A little while ago I got involved in an interesting exchange with Moshe Hoffman, an economist at Harvard. It started off with this intriguing question*:

moshetweet

We do indeed seem to derive more pleasure from finding money in the road than from receiving our salary into our bank account. That may be explained, at least in part, by the fact that we feel we have worked for or pay, so there’s a clear quid pro quo in this exchange. Finding money is different – there’s a benefit without a corresponding cost. It is rarer too, so the surprise adds to the joy.

This suggests that perhaps there are two components at play here. On the one hand, there is the aspect of pure economic utility, for example the gain of $10 – whether as part of our salary, or by finding it. On the other, there is the effect that the event of obtaining the money produces. In one case, it’s pretty meh, we’ve worked for our boss and in return we get some money. In the other, there is specific pleasure at finding money. Every economic transaction in which goods or services are traded or bartered, but also any human interaction, or indeed a simple event like finding money, could thus have both a strict economic utility (material cost and/or benefit), and a hedonic utility (pleasure and/or pain).

Moshe speaks of ‘pleasure points’ to express the latter utility. These are reminiscent of the hedons and dolors, the units of pleasure and pain in the hedonic calculus proposed more than 200 years ago by the utilitarian philosopher Jeremy Bentham. Economic and hedonic utility are not necessarily related. We can easily imagine events which do not materially affect our wealth, but which provide us with great joy: a smile from a stranger, a compliment from a colleague, a kiss from a lover. But while, say, the monthly child benefit payment increases our spending power, it’s unlikely to produce much specific pleasure.

lunch

Price: $10 – or could it really be free? (image: Asbjørn Sørensen Poulsen CC BY)

Yet the curious thing is that, even though the economic utility of an increase in wealth is realized just once, the corresponding hedonic utility seems to be reusable. Finding $10 means “our expected future consumption goes up”, as Moshe calls it – that’s the economic utility. We can spend it once, and then it is gone. Alongside, we experience the joy at our surprise and luck of obtaining money for nothing. But on top, buying a tasty lunch with this found money can provide more pleasure than doing so with money for which we’ve had to work. And quite likely actually eating that free lunch (there obviously is such a thing!) will fill us with additional delight compared to one paid with hard-earned money.

The money itself seems to be of little or no consequence in this. Imagine Moshe had found an object that had value to him – say a hammer, or a beautiful shell during a walk on the beach. He would feel delight at the find, but he would also experience pleasure every time he used the hammer, or admired the shell on the sideboard in his lounge. Arguably, he would feel more enjoyment than if he had had to buy these objects with his own money.

In charge

Are we double counting anything? I don’t think so – hedonic utility does not seem to follow the same algebraic rigour as economic utility. It is as if the event by which something that provides utility (money, a tool, an aesthetic object) is acquired somehow can endow it with extra hedonic power, which can be drawn potentially indefinitely.

Much of this hedonic stuff happens within our mind, but that doesn’t mean there is no connection with economic utility. We may not get a huge amount of specific pleasure getting paid a salary for a month’s work, but the knowledge that we have more spending power as a result does make us happy (and not getting paid would definitely make us pretty cross). Economic utility generally does not leave us indifferent, so we actually experience it as hedonic utility. In addition, we could figure out how much money would compensate us for the loss of the hammer or the pretty shell, to estimate their hedonic utility.

But while economic utility is objective in nature (a pound in your pocket or your bank account is worth exactly one pound, to you or to any other person), hedonic utility is not. The amount of pleasure we derive from our economic transactions (what we buy and sell – including our time at work), from our interactions with fellow humans (what we do for, and with, others), and from events (finding bank notes, experiencing a sunrise over a misty field) is largely of our own making.

We may not be able to control directly how much economic wealth we have, but we are in control of our subjective hedonic utility. It’s up to us to decide how much joy we get from finding $10, seeing a small child taking its first steps, a hug from a loved one, or the picture of our parents on the wall.

In a very real sense, we are in charge of deciding how rich we are.

*: There is something fishy about an economist finding money on the ground, of course. As the old joke goes, if there was a bank note on the ground, somebody would have already picked it up.

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About koenfucius

Wisdom or koenfusion? Maybe the difference is not that big.
This entry was posted in Behavioural economics, Economics, Psychology and tagged , . Bookmark the permalink.

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