What is your reputation worth?

(featured image credit: Evanherk/Wikimedia)

We are very protective of how others see us. How protective, and why?

Imagine you said something that you never intended to be or sound racist, but that could easily be interpreted to be blatantly so. You discover someone is willing to share that information within your community: your friends, your family, your colleagues, your neighbours and so on. How would you feel about that? Could you persuade everyone that whatever is being claimed you said was taken out of context, and that you are not in the least racist? Or would you do whatever it took to stop this message getting out in the open? What sacrifice would you make to safeguard your reputation?

Disreputable business

Reputations certainly count for businesses. A famous case from 1990 was the recall of 160 million bottles of Perrier mineral water, after excessive (but by no means harmful) levels of benzene were found in some of the product. The recall and the PR around it cost the company reportedly $250 million. Despite this, Perrier’s market share tumbled from 15% to 9%  in the US, and from 49% to 30% in the UK, and five years later, their sales were still only half of what they were at the peak in 1989. Part of the problem was that this episode revealed that Perrier water was not actually naturally sparkling – the CO2 gas was (and is) extracted separately from the source, and added to the water in the bottling plant. ‘Deception’, the consumer thought.

More recently, there is the scandal in the automobile industry. In 2015 Volkswagen was discovered to have equipped 11 million of its cars with a ‘defeat device’ to fool emissions testing equipment. And just this week Audi (which is part of the VW group) and Mercedes have joined the dieselgate alumni. The share prices of both companies (who are also implicated in a cartel investigation) has taken a battering. That is entirely due to the reputational damage which is expected to be reflected in sales figures. People don’t want to be seen driving cars that are cheating society.

rustymercedes

That’s what our reputation looks like (image: terimakasih0)

What about our personal reputations? They are pretty important for our social and professional functioning (just think what finding a new job will be like for the teacher who was alleged to have had sex with a pupil in the toilet of an aeroplane). But a good reputation was essential long before there were aeroplanes. For our distant ancestors, losing it might have meant banishment from the tribe, and surviving on your own was not easy back then.

Serious about our reputation

How can we tell how important we find our reputation? Businesses can estimate the effect of a dented reputation means on their revenue, but how do you go about it as an individual? This is something Andrew Vonasch, a psychologist at the University of North Carolina at Chapel Hill, and colleagues set out to investigate across several studies.

They found that reputation is a good that transcends nations and cultures. In a survey that ran in 100 countries, more than 150,000 participants rated moral reputation as more important than any non-moral value other than physical security, and well above being rich or having an exciting life.

Our reputation matters, and we’re willing to step up to defend it. In a range of hypothetical settings, the researchers observed that participants, given a choice between…

  • … a year in jail with a clean reputation afterwards, and perpetually being seen as a criminal by their community, 40% people chose to go to prison
  • … going through life with a prominent swastika tattoo (without being able to explain why to everyone taking you for a Neo-Nazi), and having your dominant hand amputated, 70% chose to lose their hand
  • …immediate death, and living to be 90, but with a reputation of being a paedophile (that you would be unable to disprove), 53% choose to die at once. (The average age of the participants was 35, so this represented a significant decision).

Now you could object that this is not entirely realistic. Researchers do indeed have a problem: they cannot really wreck a poor participant’s reputation for real, and less still cause them permanent physical harm. Nevertheless, the tendencies are revealing, and suggest that there is a rational trade-off being considered here. And real life, outside the safe environment of a psychology lab, sadly also has way too many examples of people committing suicide as a result of a tarnished reputation (deserved or not).

The worm turns

But the researchers came up with an ingenious experiment that would take them closer to reality. 123 undergraduate students were told the university was running an investigation into implicit racism on the campus. This would involve administering the Implicit Association Test and then disseminating the results to all members of the university, listing the names of the students, with the highest scoring ones first. The participants carried out the IAT, but were given rigged test results:  either 31 (“not very racist”) or 97 (“extremely racist”).

handworms

Thank goodness for these worms! (source: authors’ paper)

At that moment, the participants were given the option to carry out another task. If they submerged their hand in a container filled with superworms for one minute, their results would be removed from the email. 30.4% of participants in the high racism condition and 3.9% in the low racism condition opted for this task. The authors hypothesize that many participants doubted that their test results would actually be shared, and that in a real situation even more of them would have opted for a close encounter with the worms. The experiment was repeated with the worms swapped for a tank with ice water. Here 62.8% of participants iin the high-racism condition opted to endure pain to avoid reputational damage, and 8.9% in the low-racism condition.

The value of reputation is not only visible by what we are prepared to do to avoid disturbing information to become widely known. We also seek to signal positive reputational signs. Users of auction sites like eBay rely on feedback from those with whom they have done business, and sellers in particular are anxious to resolve any problems lest a buyer leaves a negative mark.  On social media sites such as Facebook and Twitter, the number of friends or followers, and the number of ‘likes’ are highly salient, quantitative signals a user’s reputation. And bloggers too seek likes or recommendations, or publicize the number of ‘shares’ of their posts.

This is by no means a recent phenomenon. For centuries, Christian church services have been featuring collections of alms. It is impossible to pinpoint the exact motivation of the members of the congregation for placing their coins in the basket or on the plate, but the ritual’s highly public nature is for sure a clever trick of those in charge to nudge churchgoers into contributing.

We humans are, inherently, traders. We trade goods and services for money, and we trade our time with others and with ourselves.  Our willingness to make sacrifices to preserve our reputation – either by seeking to enhance it, or by defending it when it’s under threat – confirms that like most other things, our reputation has a price too. What is yours?

 

 

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Make it hard

(featured image credit: Skitterphoto)

Nudging is about ‘making it easy’, but sometimes difficult can be better

We are very much creatures of habit. Unlike what neoclassical economists would have us believe, most of us are also generally not utility maximizers, but satisficers, content with what is good enough. Put these two observations together, and it’s not hard to see the origins of our status quo bias. Satisficing behaviour helps us avoid regret and hence contributes to our general sense of wellbeing, but it is hardly a strong motivation for changing our lives for the better.

Take a look at your kitchen. Many tasks require moving things between the three most important items: the refrigerator, the sink and the cooker. A well laid out kitchen is supposed to rely on the so-called work triangle to minimize the number of wasted steps. But how important is that really? Most of us would barely notice the waste of one or two more steps. So we’re not too bothered if kitchen design pays more attention to aesthetics than to efficiency.

At least as long as we’re fully mobile… and that can change quickly. A few weeks ago, my dad, a sprightly 89-year-old dude, slipped on a patch of dewy grass early in the morning, and broke his ankle. The fracture means that he should not at all use his left foot, not even to lean on. After a few days in hospital he returned home, and with the aid of two rollators (one upstairs and one on the ground floor) he manages to get about. But even covering the distance of a single step takes a lot more time and effort than without several kilos of plaster on his foot. A wasteful step has suddenly become rather costly.

During one of our daily calls he related how he has worked out the most efficient routine for making his breakfast of porridge or fried eggs. This not only involves positioning the rollator at a precise locus from where the fixed points of fridge, worktop and gas hob can be reached within one step, but also ensuring the ingredients, pots, pans, utensils and plates are within easy reach.

plastercast

Plaster on the leg = nudge for the brain

Now this is unlikely to be of great use to him when, in a few weeks’ time, the plaster is removed and he can fully use his ankle again. But the experience shows the ingenuity of the human mind when the balance of costs and benefits is suddenly changed.

Being aware of wasteful behaviour is not necessarily enough to change it, especially if it is not us directly experiencing the cost of the waste. It’s much easier to pick up a bunch of free bags at the supermarket every week than to bring our own. But introduce a charge per bag, even one so small that it pales into insignificance compared to the cost of a weekly shop, and hey presto, our behaviour changes.

Tongue twisters and budget cuts

There are other interesting examples of how making it harder can help us understand things that we’d otherwise be blind to. Non-native English speaking readers will know very well how hard it can be to express your thoughts accurately in English, and how struggling to find the right words affects your confidence and sense of competence. (Of course, the same is true for other languages as well.)

Many native English speakers have never experienced this (if only because they simply do not speak a foreign language). That means they might find it hard to empathize with colleagues, clients, or people they meet socially who don’t speak English fluently. A simulation game I have used many times in multi-lingual settings tries to address this by making speaking harder for native speakers. The principle of Redundancía is that you need to explain something, or tell a story or anecdote in your native language, with one twist: for every noun or verb (except to be or to have), you need to add a synonym. The principle/idea of Redundancía is that you need/have to explain/clarify something or tell/narrate a story/tale or anecdote/sketch in your native language/tongue, with one twist/variation – you get the idea. Just try it out for yourself and see how clumsy it makes you feel. Perhaps next time you are in conversation with a non-native speaker, you’ll have a better understanding of the challenge they face speaking in your, rather than their language.

conversation

Nice colours/tints you have there! (Image: splongo)

Another example comes from a now-retired client who used to be the Chief Technology Officer of a large multinational company. It was not uncommon for development project leaders to judge that the resources – money, manpower, or both – were insufficient to bring a project to a successful conclusion. The obvious thing for them to do was to come and ask him for more people or for a budget increase. And invariably, he would listen carefully to their argument, and thoughtfully reply that he agreed that the resources were not in line with the needs of the project.

The twist came when he clarified that he thought they were excessive – and then promptly cut the overall budget by something like 5%. It gave him much pleasure to relate how the project statistics confirmed that these projects tended to deliver better results. They were less likely to overrun, and the products that came out of them were more commercially successful. It was hardly a scientific experiment, but I have more than a bit of sympathy for his conclusion that making things harder for his engineers and scientists forced them to be more creative and inventive.

The paradox of difficulty

Like water follows the path of least resistance from the mountain top to the sea, we are naturally seeking out the easy life. That congenital laziness can be a motivation to come up with clever ideas that allow us to achieve more with less effort: our houses and factories are full of labour-saving devices. But at the same time, it is when we face tough challenges that we are at our best using our imagination and resourcefulness.

My father’s predicament suggests how a designer breaking an ankle could exploit her misfortune to experience what a difference a more efficient kitchen makes when it really matters. More realistically, she might not wait for such an event, but have a plaster cast fitted to a fully intact leg. Making things harder in that way would provide a direct insight into the challenges of a disabled person in the kitchen – without the pain, but no less dramatically.

In any case, it teaches one additional lesson: no matter how old they are, always be prepared to learn something from your parents.

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

Belief without value

Our beliefs often stand in the way of better decisions – because we value them too much

The great economist John Maynard Keynes reportedly once said, ‘When my information changes, I alter my conclusions. What do you do, Sir?’ As so often with such powerful quotes, there are no reliable sources that confirm Keynes really said this. But that doesn’t detract from the profound wisdom in the guidance it offers.

It summarizes very well the basis of the scientific method (not just for the dismal science, for that matter). When a theory no longer fits the observed facts, it is discarded or adapted. Research takes place through hypotheses, which are accepted or rejected. Researchers are agnostic, and don’t care which hypothesis is right or wrong.

Bad science

Unfortunately this is not always the case. Sometimes researchers are motivated by other matters than the pursuit of the truth. The chance that a study is published is a lot higher if it describes a positive result. That leads to publication bias (the world rarely hears about a study that finds absence of an effect), and p-hacking, the massaging of the data to come to a statistically significant result.

Even ideology can be involved in the manipulation of scientific research. Some people are convinced that living near electrical power lines is the cause of serious health problems. So when, in 1992, a Swedish study by Maria Feychting and Anders Ahlbom of the Karolinska Institute found that the incidence of leukaemia among children living within 300m of such a distribution line was four times higher than normal, this was grist to the mill of campaigners.

powerlines

Hello, leukaemia? (image: Oran Viriynici)

The American PBS show Frontline investigated the phenomenon in the episode Current of Fears in 1995 (the transcript is no longer available on the Frontline site, but as so often, Archive.org comes to the rescue!). The study in question appeared to have fallen foul of the so-called multiple comparisons fallacy. Eh? Well, the Swedish researchers did not just look for a link between proximity to overhead power lines and leukaemia, but they simultaneously investigated no less than about 800 diverse risks.

Does that make a difference? Certainly. Consider this example: imagine I want to pay you with a coin, but you suspect it is false. If a fair coin is tossed 10 times, the chance it turns up heads at least 9 times is quite small (1.07%). Let’s assume that if this happens with a random coin, it is most likely a fake, so you can use that as a test.

But what if my debt was 100 coins, and you suspect there are false coins in the purse… would the approach for an individual coin be sensible for a whole bag? The chance that a fair coin turns up heads fewer than 9 times is nearly 99% (100%-1.07%). The probability that two fair coins both turn up heads fewer than 9 times is a little smaller: 98.93% x 98.93% = 97.86%. For three coins it is a bit smaller still (96.81%) and so it goes on, until for 100 coins it is just under 34%.

This means that the chance that at least one coin will turn up nine heads in a row is 66% – nearly 2/3.

It may then look as if that one coin is a fake, but that is only because we are testing so many coins at the same time. We never indicated upfront which of the coins would be fake. The fact that one coin produces an unusual result is, well, pretty unremarkable, and certainly not proof that I am out to deceive you.

The same happens when you investigate the correlation between living near overhead power lines and 800 different conditions. Even if there is nothing to worry about, a handful out of that set of 800 conditions might produce an elevated frequency. (This phenomenon is sometimes called the Texas Sharpshooter Fallacy, referring to someone who first fires at random at an old barn, and then draws the target around the bullet hole.)

So there was nothing going on in Sweden. But several groups, with good (or not so good) intentions maintained something fishy was going on, finding a fertile breeding ground among people who already believed there was something sinister about these power lines.

A thin line between belief and confirmation bias

Confirmation bias is indeed often the culprit in situations like this: we look for information that supports what we believe, rather than for facts that might falsify it. Worse still, when we are confronted with information that should make us question our beliefs, we double down. This is why beliefs like the one that Barack Obama was not born in the USA and is a Muslim, or that EU membership is costing the UK £350M per week have proved impossible to eradicate. In 2005 and 2006, Brendan Nyhan and Jason Reifler studied the tendency of people to reject arguments and evidence that contradicts their beliefs. In several cases, they found that corrections actually reinforced the misperceptions people held, especially among those who were the most committed.

This is known as the backfire effect. A 2016 study by neuroscientists Jonas Kaplan, Sarah Gimbel and Sam Harris, placed subjects in an MRI scanner and confronted them with arguments that challenged their strongly held beliefs, political and others. They found that the brain activity they observed was “signaling threats to deeply held beliefs in the same way they might signal threats to physical safety.” As Gimbel and Kaplan explain in an episode of the You Are Not So Smart podcast, the more a subject resisted changing their mind, the stronger the activity was in two areas: the amygdala and the insular cortex. “We find that the response in the brain is very similar to what would happen if you were walking in the forest and came across a bear.”

Of course we cannot switch off this response to threats: it is in our interest to engage protective mechanisms when we are under physical threat by a bear, a mugger or an out of control trolley. But we do have a choice in how deeply we hold a belief.

It is the strength of the attachment to a belief that makes us hold on to it, even in the face of unquestionable evidence to the contrary. If our belief is strong enough, we resist changing our mind as much as we would resist having an arm eaten by a wild animal.

Scientists ideally approach a subject from a neutral viewpoint, without emotional pay-off for either the confirmation or the falsification of a hypothesis. The true utility of research is to discover the truth, not to be right. But we ordinary people also sometimes have to choose between getting wiser, and hanging on to an existing belief. If we really want to pursue wisdom, then we must leave behind the idea that giving up a belief comes at an emotional cost. We have to accept that it is a good thing to lose one’s beliefs.

For belief in itself has no value. Only belief that is not being contradicted by facts can be valuable.

What with the question whether Keynes really spoke the words at the beginning of this article? Dyed-in-the-wool Keynesians might like to believe so, because the quote fits well with his character. But anyone doing so really ought to be prepared to give up that belief. Even if, one day, someone came with unequivocal proof that it was actually said by his rival, that other great 20th century economist, Friedrich von Hayek.

 

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Fairness or efficiency?

(featured image: NeuPaddy)

Yet another instance of the tension between our emotions and economic logic

Imagine a clothing retailer who charges more for an item in a larger size than for an almost identical one in a more mainstream size. While you’re at it, imagine a supermarket increasing the price of food during rush hour, and for good measure, also an energy provider with more expensive electricity at peak times.

You’d be imagining the kind of practices that quickly receive the label of unfairness. In the summer of last year, fashion retailer ASOS was found to sell a dress in size 18 for £10 more than a very similar one in size 6-16. The reactions were predictable at the time. A year on, it featured in the BBC consumer show You and Yours earlier this week, suggesting that the outcry over this kind of ‘fat tax’ has not quite died down.

Unfairness everywhere

A Mail Online article last week headlined: “Supermarkets could use ‘e-pricing’ to jack up the cost of food during lunchtime and after-work rushes”. It supports its prediction that “a shift towards surge pricing is extremely likely” with quotes from a consumer psychologist and a retail strategist. It’s not quite happening yet, but the comments below the article suggest that it would surely not be seen as a fair move. (Uber knows all about the questionable popularity of surge pricing.)

shirts

Oversize, overprice (image: sumonpcs)

And the introduction of smart energy meters in the UK enables suppliers to introduce ‘Time of Use’ pricing. This goes well beyond the conventional dual-tariff system, which charges less for electricity used during the night (when demand is low). Greenenergy UK was the first to introduce such a flexible tariff, with a night time rate of 4.99p/kWh between 11pm and 6am, and a standard rate of 12p during the day, but with a peak tariff of 25p between 4pm and 7pm on weekdays. As a paper on so-called cost-reflective pricing by Elisabeth Hobman and colleagues states: “there remains a common public perception it is harmful and unfair. In particular, variable pricing is thought to harm ‘vulnerable groups’, specifically, those segments of the community with limited capacity to reduce energy usage during peak times, e.g., low-income households, those with disabilities or medical/health issues, shift workers, and young families with many children.”

Yet the importance of fairness in economic transactions is not a new topic. In Fairness as a Constraint on Profit Seeking: Entitlements in the Market, a paper from 1986, Daniel Kahneman, Jack Knetsch and Richard Thaler describe a classic lab experiment. They read the following scenario to 107 participants: “A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20.” When they asked the participants to judge the action of the store owners, 82% thought that it was unfair or very unfair.

Emotionless economics

Conventional economic theory does not take into account such emotional judgements, focusing instead on efficient allocation of resources. By raising the price of what has become a scarce good, the hardware store owner ensures that the shovels will be bought by those to whom they are most valuable. In other words, the shovels should end up where they provide maximum utility.

Economic efficiency is of course also behind differential pricing for energy. The technical constraints of the way energy is generated mean that it is tricky and costly to ensure supply always matches demand. Peaks and troughs are therefore best avoided, and a dynamic price is a simple and effective way of signalling this to the consumers. They can then choose to adapt their consumption accordingly. The same applies to (currently still hypothetic) surge pricing in supermarkets. The need for extra staff during rush hour is expensive. If this is not recharged to the peak time consumer, it raises the overall cost for everyone. So here too the price signal may work as an incentive for consumers to consider shopping at a less busy time.

The argument for more expensive ‘plus’ size clothes is slightly different. Larger items may require a bit more material, but that justification is hard to maintain if the price for sizes 6 and 16 is the same. More plausible is the explanation is that demand for outlier sizes is considerably less than for mainstream ones, and therefore also more volatile. This volatility represents a risk for the retailer. The clothes rails at the end-of-season sales tell the story: they tend to contain mostly the less common sizes. As the proportion of unsold items that now need to be discounted is higher, one way to sustain overall profitability is to sell them at a higher normal price. Failing to do so would mean that the other prices would need to be higher in compensation.

Perception versus reality

But we are very sensitive to unfairness – even if it is perceived rather than real. We resist being taken advantage of. We don’t care that there are good economic arguments for surge pricing – we think it is not just unfair, but unethical and unconstitutional.

But we can be a bit selective with our insistence on fairness. We may be happy to demand from businesses that they take a financial hit to treat us and others more fairly, but if it is within our own power to do so, we seem less keen to put our money where our mouth is. For example, the proportion of fair-trade coffee sold in the UK is 20% (just 4% for instant coffee). At the same time, we seem pretty content with dearer train tickets at peak times, and with having to pay more for a cinema ticket on a Saturday night than on a Tuesday afternoon or for a holiday during the school breaks.

crossmark

How much for that mark?

Maybe the conflict between the real world with our messy emotions and that of economic theory, where only the logic of resource allocation counts, is largely a matter of perception. Loss aversion would explain a lot. Having to pay more for something that we see as the same version of a cheaper option feels as an unjustifiable loss.

If that is the case, it is remarkable indeed that suppliers are not always and everywhere framing the highest prices as the standard, and the lower prices as discounts. A nice story shows how reframing a price when people think they’re being taken for a ride can make them change their perception:

steinmetz

True, myth busting site Snopes considers it a legend, but legends often contain important and enduring lessons. Maybe, with the right framing, we may yet see the fairness in market transactions.

 

Posted in Behavioural economics, Cognitive biases and fallacies, Economics, Emotions | Tagged , | Leave a comment

Honesty in a box

(featured image credit Tim Green)

Acting dishonestly often pays. So does acting honestly go against our own self-interest?

Travelling along Britain’s rural roads one doesn’t just encounter octagonal former toll houses (and real tolls). Something else that was unfamiliar to me (having grown up in a different country) is the honesty box. On the roadside you see improvised racks with boxes of eggs, fresh produce, pieces of cake, jars of chutney and such like. A piece of cardboard announces the prices, and passers-by are expected to leave the exact money in box provided for that purpose when they take one of the items on offer.

Seen through an economist’s eye, the fact that this practice is as widespread as ever suggests that there is both a steady demand and a persistent supply in this peculiar market. If the goods on offer did not appeal to the customers, the tradition would wither. But as personal experience confirms, the eggs are generally super fresh, and the cakes can be to die for. Similarly, if the trust of the providers of the stuff was misplaced and they didn’t get a decent return, they’d have long given up on the idea.

Give a little, take a little

And yet… There are no official statistics about the size of the honesty market, but a couple of recent anecdotes indicate that all is not well in honesty box land. Earlier this year, a couple was caught on CCTV camera, stealing £40 from an unattended farm shop’s honesty box and a sack of potatoes. A few months later a woman was seen taking the contents of a box to collect charity donations in return for a bag of duck food.

So it is perhaps not unsurprising that a Scottish farmer decided to replace honesty boxes with solid vending machines. A few years ago, newsagents’ chain WH Smith also got second thoughts about its own version of honesty box based newspaper vending after finding customer integrity was not quite as expected. And councils in rural areas are now also replacing age-old honesty boxes in car parks with conventional ticket machines. In the BBC radio consumer programme, You and Yours, the head of Recreation and Access at one of the UK’s largest national parks stated last week that the average amount paid per car is just 15p. The facts speak for themselves: on one location, the annual takings with an honesty box were £5,000. Since installing a ticket machine, they are £23,000.

honestybox2

Free parking? (image: Peer Lawther CC0)

Maybe the mystery is not why some people are so dishonest as to steal money and potatoes, or who cannot even muster the £1 it costs for 3 hours’ worth of parking. How come so many of us actually are honest – even if it costs us money?

This question is related to other situations where we give money when there is no obligation or enforcement, like Pay what you want (PWYW). This pricing strategy has been tried many times, notably by restaurants, but it has rarely been a runaway commercial success. One notable exception, it seems, is Radiohead’s In Rainbows album, which ‘sold’ 1.2 million copies in this way in 2007. But even in this case widely divergent claims are made about how much the typical downloader offered (I paid £7 at the time).

Honesty on the balance

Why didn’t everyone simply download the album for free? Even though too many people pay too little in PWYW restaurants, how come not everyone simply eats for free? One explanation comes from Philip Graves, the author of Consumer.ology, a book on consumer behaviour. In the same BBC radio show he points out that we are not unconditionally honest. Honesty does not confer an evolutionary advantage if it means we are sacrificing resources that could be beneficial for ourselves. But as we evolved into social beings, unmitigated selfishness had to compete with our desire to remain a member of the community. Cheating our fellow members could lead to being ostracized, so we learned to balance these two conflicting forces.

Fear of ostracism is perhaps less of an issue these days. But we do experience a similar tension between doing what is beneficial for us, and what is ‘right’. Charitable donations are an intriguing example: there is no obligation to pay, and we obviously get nothing material in return.

This is supported by an interesting experiment conducted by Ayelet Gneezy, a behavioural scientist at the University of San Diego, and her colleagues. The riders of a rollercoaster in a theme park were, as is often the case, photographed in full swing, and they were offered the chance to purchase a print. In one condition, a simple PWYW arrangement, 8.39% of the riders purchased the photo at an average price of 92 cents. The second condition was similar, but with the added message that half of their voluntary payment would go to a nationally recognized patient-support foundation. Only 4.49% of riders bought the photo, but at an average price of no less than $5.33.

rollercoaster

The price also goes up and down (image: curious fish CC0)

Morality and self-interest

The feeling (or the knowledge) that one is doing the right thing seems to be quite powerful in counterbalancing the economic loss of making a payment. But how come there is still so much variation in how honestly different people behave, or even how the same people act in different circumstances?

Maybe the answer lies in a recent post by philosopher Filip Spagnoli. In There is no morality, and that is a good thing, he observes that despite more than 2000 years of trying, moral philosophers have utterly failed to come up with a convincing objective moral framework. He speculates that their failure stems from the fact that they have been seeking to explain something that simply doesn’t exist.

That doesn’t mean we don’t have a sense of right and wrong. These intuitions may not proof of an external morality, but they still give us guidance of what is in our self-interest. This is the ‘warm glow’ that represents the utility we get from making ‘altruistic’ sacrifices without getting a material benefit. Simply: doing what is right benefits us.

Where does our moral sense come from? There is no clear answer to this. It is very hard to separate nurture from nature, even though education and social norms do seem to play an important role in its development. Easier to answer, however, is the question, does the warm glow of behaving honestly outweigh the economic benefit of £40 and a sack of potatoes?

That, like so many other choices, is a trade-off which is matter of personal preference*. We all have our own, unique box containing our honesty.

 

*: and of course of the context

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Misunderstanding rationality

(Featured image credit: Les Colporteurs CC0)

It is tempting to equate ‘rational’ with ‘right’, and ‘irrational’ with ‘wrong’, but that is mistaken

The lottery is sometimes called a tax on the stupid. The logic behind this opinion is that the expected net gain is negative. In a post entitled ‘The irrationality of Euromillions’, blogger Robert Sharp works out that buying a £2 ticket is only economically rational when the jackpot is £190 million or more. Yet I am pretty sure that the anonymous Belgian who pocketed £134 million on 2 June (the highest Euromillions win so far this year) will not be too concerned about whether the purchase of that ticket was irrational or not.

Another situation that is often wheeled out as an example of irrationality is fear of flying. The headline of an Independent article  from 2009, “Why fear of flying is just plane stupid”, is pretty blunt. And the facts seem to support it: the risk of dying in a car crash is 100 times higher than that of perishing in an air disaster.

Cognitive errors…

It is hard to estimate with any accuracy how many people choose alternative modes of travel out of fear, but the terrorist attacks of 9/11 led to a large-scale natural experiment that does shed some light. In the months following the events, there was a marked drop in the number of passengers across the USA, and an increase in the number of road traffic casualties. This is strong evidence for the thesis that some people swapped the car for the plane. The estimate of the number of ‘excess’ traffic deaths in the last three months of 2001 varies a bit – 344 (Blalock et al), 353 (Gigerenzer), and 1018 (Sivak and Flannagan) – but it over that period it is significantly higher than the 266 passengers and crew who were killed in the planes.

We often take decisions based on what we see as their possible direct consequence. The lottery ticket buyer has the fabulous prize in mind, the person avoiding air travel is guided by the horrible prospect of dying in an air disaster – irrespective of the likelihood of either event.

Rationalists would be quick to point out how this relies on two common apparent cognitive errors. The salience effect or saliency bias refers to situations where our actions are influenced by what is highly visible and prominent. This makes both the lottery player and the aviophobe overestimate the likelihood of the desired (or undesired) event. Outcome bias makes us evaluate the quality of a decision on the basis of its result. If you win the jackpot, you’re unlikely to say you made the wrong choice buying a ticket. You may even attribute your good fortune to the clever way you decided to choose your numbers. And if you never fly as a matter of course, whenever there’s a crash you will be relieved that could never happen to you.

…or not?

But does that mean these choices are truly irrational? Not really.

For just by looking at the choices we don’t know what reasoning is behind them. If a lottery player’s cost is negligible to them, and the thrill of the draw provides ample enjoyment in return, there is really nothing irrational about their behaviour. Likewise, if avoiding the sheer terror of sitting in a steel tube 30,000 feet up in the air is well worth the inconvenience (and added risk) of driving long distance, and of not being able to visit another continent, that is a perfectly rational course of action for someone with fear of flying.

planecrash

“You’ll never get me into a plane” (picture: David Eun CC0)

The normative evaluation of how we make decisions seems to have been strengthened by Daniel Kahneman’s popular book Thinking Fast and Slow , in which he describes a model of two modes of thinking. The Wikipedia entry tags System 1 as “emotional, stereotypic, and subconscious” (traits we associate with impulsive, poorly thought through decision-making). System 2 is “logical, calculating, and conscious” (characteristics of wise, reasoned and well-considered decision-making). These terms barely conceal the implication that the latter is superior to the former.

Yet we have survived and prospered for tens of thousands of years with both systems working in tandem, making mostly the right trade-off between the speed of one and the thoroughness of the other. That demolishes any suggestion of inherent superiority.

Rationality is a matter of preference

Acting rationally also does not imply any moral rectitude. The work of economist Gary Becker, crystallized in his essay Crime and Punishment: An Economic Approach, shows that it is perfectly possible to be rational and criminal at the same time. David Friedman, a law professor at the University of Santa Clara, summarizes it clearly in a chapter in The New Economics of Human Behaviour: “Criminals are rational. A mugger is a mugger for the same reason I am a professor – because that profession makes him better off, by his own standards, than any other alternative available to him.”

And the rationality in the behaviour of a mugger relieving a passer-by of the contents of his wallet is not different from the rationality of, for example, the Member of Parliament voting for an income tax increase on the well-heeled. Both extract resources from someone else to further their self-interest.

So if we are tempted to look down on someone because we believe they are acting irrationally, we really ought to pause for a moment, and consider not what they’re doing, but why they’re doing it. When we see someone buying a lottery ticket, and on that basis alone decide they’re not being rational, we’re arguably being influenced by outcome bias ourselves. Unless we really know people’s preferences, we cannot judge their rationality.

Whether what they’re doing is right… that is a matter of our preferences.

 

Posted in Behavioural economics, Cognitive biases and fallacies, Economics | Tagged , | 1 Comment

What’s the price?

(featured image: pexels)

Internet companies are trying to charge different prices for the same thing depending on who you are. Is that a problem?

Prices are a funny concept. We unthinkingly treat them as if they are a physical attribute of an item – like the weight or the height. To some extent that is not even so crazy. Even if we know that they can be a bit fuzzy, we’ll have an approximate idea of what something costs (certainly for stuff we buy regularly), and so what we’re prepared to pay. Or do we?

In his 1983 paper Transaction Utility Theory, behavioural economist Richard Thaler describes a thought experiment that goes something like this. You’re on the beach on a hot day with only iced water to refresh you, and for the last hour you’ve been imagining a nice cold bottle of your favourite beer. Your friend next to you gets up to make a phone call (this is 1983!) and offers to bring you a beer from a place close to the phone box. But of course, beer at the beach might be expensive, so he asks you the maximum price you’re prepared to pay, and promises to only buy you a beer if it costs no more than your limit (which economists call the reservation price). What would you be willing to pay?

Beer money

When it was stipulated that the only place selling beer was a fancy hotel, people were on average willing to pay $2.65; when it was a small, run-down grocery store, their average limit was just $1.50 (1983 prices of course). Thaler points out that this is inconsistent with standard economic theory. There is no material difference between both situations that would explain the difference, let alone one of this size.

So, we don’t really know the value of a beer – nor of pretty much everything else we regularly, or seldom, buy. Prices are emergent. In an individual transaction both parties may bargain until they settle on a price that both are happy with (and there is a whole range that would qualify). In a larger market, economists talk of the market clearing price, the price at which supply and demand are exactly equal.

This bugs suppliers, though. Obviously, at this equilibrium price, those for whom it is too high will not buy. But there are lots of people who would be prepared to pay more than the market price, but who don’t need to. The supplier is leaving money in the customer’s pocket.

So inventive sellers come up with ways to separate price sensitive customers from those with a higher reservation price. Three decades ago, for example, it was rumoured that companies supplying both computer equipment and medical systems used to charge a hefty premium for PCs for hospitals, simply because they were painted white instead of the drab Pantone 413 beige that was the norm back then. That may be a tall story, but one industry that has long been successfully using price discrimination instruments is airline travel.

The art of discriminating

An aeroplane is essentially a bunch of seats flying from A to B. And yet the people whose bums are on those seats may have paid a price that differs by a factor 20 or more. Low cost airlines correctly assume that people who need to fly at short notice will be prepared to pay more. So prices start low if you book months in advance, going up as the date of travel gets nearer. Premium airlines offer different classes (while often the seats are exactly the same), but more importantly, they try to distinguish cheapskate tourists from business travellers with deeper pockets by restricting cut-price tickets for travellers staying a weekend.

seats

Cheap and expensive seats – can you tell which is which? Picture: StelaDi CC0]

One company (no longer in existence) was even more creative. GetGoing.com asked you to pick two different destinations. You didn’t know which of the two you’d be flying to until the moment you paid. This kind of offer would clearly only sensible for a price-sensitive holidaymakers, with no risk that even the most astute among people prepared to pay full whack would snaffle a huge discount. This is also why you see student or senior citizens’ discounts, reduced-price train tickets for families and so on.

 

Now with big data, of course, companies can simply rely on user profiles to figure out whether we’re a tightwad or a big spender. Amazon was exposed as early as 2000 using cookies to set the price according to whether you were a regular or a new customer. They apologized and vowed never to test prices based on customer demographics. But even if Amazon is lying low in this respect, others have happily been playing around with price discrimination, according to a study by Christo Wilson and others at Northeastern University.

Most recently, Uber (who else?) has been in the news again, as they too are looking to charge you what they think you’re willing to pay. And perhaps Amazon too is back dabbling with price discrimination, as economist Cyril Morong wonders, looking at their latest move in their battle with Walmart where they offer a discount to their Prime service if you are receiving government assistance.

Do those who cry foul at this kind of manipulative trickery have a point? Few people seem to have a problem with more conventional forms of price discrimination. On this basis, the criticism of more modern approaches seems a bit inconsistent.

Consumer power

That may be the case, and perhaps it is indeed economically sensible, rational and perfectly legitimate for companies to seek ever more sophisticated ways to channel as much of the economic surplus of a transaction into their coffers. That is not without danger though. Misguided as the suspicion of consumers may be, a company that is seen as manipulative and devious risks losing its reputation, and its customers to the competition.

But what if the competition too resorts to ever cleverer price discrimination methods? Will we eventually all pay our reservation price for everything we buy?

It is unlikely we will get to that point any time soon. A Bloomberg article about Uber’s latest ploy hints at ways in which riders can fool the algorithms that try to guess our willingness to pay: feed it confusing signals. Open the app at random and check prices, even if you have no intention to ride – just to make yourself look price-sensitive.

We consumers are on the whole a reasonable and tolerant lot. We don’t mind a bit of advertising, and we’re OK with websites using cookies – even if it is to help companies make more money. But when we think this kind of stuff is going too far, we strike back. In with the ad blockers and with our browser’s private mode to prevent sites tracking our moves.

And so it is more generally with the experience we get from internet companies. It’s great that we can take a ride with Uber, but any company that underestimates the resourcefulness of people who feel they’re actually being taken for a ride does so at its own risk and peril.

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