How economics can help us understand people better

When we think that the behaviour of others is baffling or if it seems utterly wrong to us, economics can help us take a different perspective

You may not realize it, but every time you are placing your purchases on the conveyor belt at the supermarket checkout, you are allowing everyone around you to cast a glance into your inner being. The content of your shopping trolley tells others an awful lot about you – or that is at least what a certain economic theory would say.

For every single article represents a choice – or to use the economics term, a revealed preference. The assumption is that when you put a container with washing up liquid, a box of eggs, or a tin of soup in your trolley, these are the items you prefer. And it’s not just your supermarket shop – it’s the socks you wear, the place where you get your coffee fix, the smartphone you use, the car your drive, the place you live and so on. In all these and many more domains, there are numerous options from which you could choose – so the bundle of your actual choices uniquely characterizes you, almost in the same way that your fingerprints do.

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Just look at my preferences! (photo: John Garghan CC BY)

For every single article represents a choice – or to use the economics term, a revealed preference. The assumption is that when you put a container with washing up liquid, a box of eggs, or a tin of soup in your trolley, these are the items you prefer. And it’s not just your supermarket shop – it’s the socks you wear, the place where you get your coffee fix, the smartphone you use, the car your drive, the place you live and so on. In all these and many more domains, there are numerous options from which you could choose – so the bundle of your actual choices uniquely characterizes you, almost in the same way that your fingerprints do.

What we feel, what we say, what we do

The Theory of Revealed Preference was pioneered by the economist Paul Samuelson, around 80 years ago. Samuelson hypothesized that the preferences of an individual can be inferred from observing their behaviour. That should be better than simply asking people for their preferences, especially where market research is concerned. As David Ogilvy, the legendary advertising tycoon, once remarked, “Consumers don’t think how they feel. They don’t say what they think and they don’t do what they say.” People’s actions speak louder than their words.

But there are some problems with the assumption that people’s actions really reveal their preferences. Preference over what? Few people consider all, or even most of the possibilities when they make a choice. Often, good enough is good enough, and we simply pick from a set across which we are pretty indifferent. Or perhaps our choice has nothing to do with a specific preference. Maybe we always pop into Costa for our coffee, not because we prefer its taste over that of Starbucks, but because it’s a convenient place to meet a colleague on our way to work. Or maybe it’s a case of self-herding: we once went to this coffee shop, we went back, and it became a habit for no particular reason. Maybe we are wearing blue striped socks because that is what our other half keeps getting us as gifts, not because blue stripy things are something we particularly like.

But that doesn’t mean it’s impossible to infer anything from other people’s actions. When there is good reason to believe that they have made a deliberate trade-off between two options, or that they made a clear sacrifice, we can get some sight of their preferences.

This occurred to me when I was thinking about an intriguing phenomenon in Belgium these last few weeks. Quite different from the gilets jaunes, secondary school students have been skipping school on Thursdays to demonstrate in the capital demanding more, and better action to deal with climate change. 3,000 of them turned up on 10 January, 12,500 one week later, and on 24 January there were 35,000.

While there is a good deal of sympathy for their concern over climate change (not least from King Philippe), not everyone is enamoured by the fact that they are skipping school. The head of the school where one of the instigators is a student points out that the protestors will be sanctioned for playing truant, and that they have a responsibility to themselves and their future, (which they are putting it at risk by their unauthorized absence). According to the group leader of the largest party in parliament (also a former teacher) believes “addressing one problem – climate change – with another one – skipping school – is totally wrong.” And many members of the public seem to agree as the reactions to the press article suggest (Google Translate may be your friend). Why don’t they demonstrate on Wednesday afternoons (when there is no school in Belgium), or in the weekend? Would it not be better if they boycotted the music festivals in the summer than to skip school?

Dissecting the trade-offs

Can we infer something about these young people’s motives from what they sacrifice? Some people believe skipping school is not much of a sacrifice. There are two reasons to question this view, though. If the students prefer playing truant over sitting in class, they would not need a demonstration to do so. More importantly, most of them will have to catch up the missed lessons and even risk detention. We can therefore reasonably conclude the sacrifice is real.

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My trade-off: I’d rather be labelled a truant than have a climate disaster on my conscience

So, skipping lessons is a costly signal – a concept from evolutionary biology that has found its way into economics. By showing they are willing to accept the negative consequences, they give an indication how strongly they feel about climate change. This is not unlike, say, a big bank signalling its strength through the amount of expensive marble in the lobby of its headquarters, or a male elk doing the same by carrying a huge, cumbersome set of antlers. We can trust the bank to be robust, and the female elks can trust the male to have superior genes.

When we see behaviour that we don’t quite understand, it is worth considering the sacrifice that might be involved. Someone who makes a deliberate choice will probably have made a conscious cost-benefit analysis, weighing up whether the upside is worth the cost. Why on earth, for example, would someone choose to live so far away from their work in the capital that it costs them three hours’ travelling every day, and thousands of pounds (thousands of euros, thousands of dollars) for their annual season ticket? It is probably because to them the benefit outweighs the cost. We see that cost, but we should imagine what the benefit might be, Maybe the job pays well, maybe they can live in a nicer house than they could closer to the big city, or maybe they prefer to live near their family and friends. We may not know exactly what it is, but we can reasonably infer that there is something that makes it worth it for them.

So it is for many of the thousands of kids skipping school to demonstrate for more robust climate action. For some it may just have been social proof, joining in with their friends, but many will have made a deliberate choice, signalling how important their demands are to them by what they give up.

And that is not the only way economics can help us understand them. Imagine we don’t care all that much about climate change, and we strongly believe that it’s definitely not worth skipping school for. Now let’s ask ourselves whether there is nothing – not a single cause – for which we would think playing truant is justified. There probably is. Instead of thinking “they shouldn’t do that”, or “I would never do that”, we had better think “what would make us do that?” Once we have identified what would make us believe skipping lessons and risking detention is worth the trade-off, we have a much better idea of the strength of these students’ conviction.

Economics is sometimes called the dismal science. But if it can help us understand our fellow human beings better, that seems perhaps a little harsh.

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

Unwitting mental time accountants

(featured image credit: alles/pixabay)

Are we better at making good use of our time than at making good use of our money?

What is an hour worth to you? If you are in work, a reasonable approximation would be your equivalent hourly wage. After all, that is what you are willing to go to work for. Failing that, let’s take the median hourly wage – just under £14.50 before tax (about $18 or €15) in the UK.

If I asked you to take part in an experiment, which would need one hour of your time, would you do it if I paid you that amount of money? Perhaps. But what if my experiment would require you to spend this time at a moment of my choosing? It could be in the middle of the night, during a day out with the family, or 59 minutes before you have to catch a train (so you will be 1 minute late and miss it). You would probably want more than the standard rate, in those cases.

The value of your time (and that of everyone else) is clearly not uniform. Overtime (as well as work during weekends and nights) tends to be paid at a higher rate than comparable work during ‘normal’ hours. Extra hours come out of your spare time, and that carries a higher price tag. Likewise, people demand more money if they have to work when they could be socializing or sleeping.

A play with money

Time is money, they say, but in this respect, they are quite different. Money is entirely fungible: a pound, a euro or a dollar has the same value, irrespective of where it comes from, or in which bank account it sits. There is, as we saw, a good case for mental accounting with time – treating a minute of work time differently from a minute of leisure time, or a minute of sleep. Yet with money, we do just as much mental accounting – we put it in imaginary jars, and are reluctant to move it from one to the other.

In one of their amous papers, Daniel Kahneman and Amos Tversky describe an experiment in which they give the subjects one of the following two vignettes:

  • Imagine that you have decided to see a play and paid the admission price of $10 per ticket. As you enter the theatre, you discover that you have lost the ticket. The seat was not marked, and the ticket cannot be recovered. Would you pay $10 for another ticket?
  • Imagine that you have decided to see a play where admission is $10 per ticket. As you enter the theatre, you discover that you have lost a $10 bill. Would you still pay $10 for a ticket for the play?

Would you give the same answer in both cases? In principle you should, because the two situations are entirely equivalent as far as gains and losses are concerned: if you want to see the play, you’ll be $20 poorer, rather than the $10 you had envisaged (and if you decide not to see the play, your loss has made you $10 poorer). But if you didn’t, you are not alone: Kahneman and Tversky found that 46% would buy another ticket in the first situation, while nearly twice as many people (88%) would do so in the second case.

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Does admission cost $10 or $20? (photo: Brent Moore CC BY)

Why this difference? In the first situation, the expense of the ticket had been placed in the theatre or maybe entertainment mental account. Buying another ticket would mean putting an additional $10 in this account, and that might violate your budget for entertainment – $20 for a play? In the second situation, the money was still unallocated in your purse. As it had not yet been put in the mental entertainment jar, buying the ticket and taking the loss would not affect your entertainment budget. (This amusing video is a nice example: Gene Hackman and Dustin Hoffman talk about how they managed their money when they were impoverished young actors. It features actual jars of money, rather than mental ones.)

But it is not because we have better reasons to engage in mental accounting with our time, that doing so is always entirely rational.

Time framing

Last Saturday morning at the crack of dawn, I was driving to the supermarket for the biweekly shop. I have two good reasons to want to to get there early. If I went later, I’d have to make my way through swarms of shoppers impeding my progress (and costing me time). And as I live in the town centre close to the local shops, I’d also find it impossible to park my car anywhere near my house on a Saturday morning after 9am.

So when I got stuck behind a learner driver who had already failed to proceed through a green traffic light twice, annoyance was creeping up on me. Those seconds (maybe even minutes!)  I was wasting felt incredibly valuable. But were they really? How much would I be prepared to pay to be able to overtake the learner and carry on my journey unhindered? Not much, really, I concluded. Yes, that couple of minutes represented perhaps 10% of my return trip. But I could easily waste a similar amount of time looking for an obscure item on my shopping list. And it’s not as if a few minutes would make any difference in either the rush at the supermarket or my chance to find a parking space on my return. Besides, compared to my entire shopping expedition, rather than just the ‘travel’ mental account, those minutes would represent barely 3%, not 10%. Nothing to get worked up about.

I relaxed and continued to trundle behind the L-plated car for another kilometre or so. The driver behind me was less patient, however. All of a sudden, a Porsche shot past me on the wrong side of the road, overtaking me and the slow car in front. But barely 10 seconds later I ended up just behind the sports car, having to give way to the traffic on a busy roundabout (the learner was now standing in a different lane). Of course, the Porsche driver could have been lucky and be a mile ahead of me by then. Yet I still felt, a little smugly, that my deliberate mental accounting had trumped the impulsive, unwitting mental accounting there.

But what if it involves bigger chunks of time? My daughter and her family have moved house, and the drive there is now about 15 minutes longer. For my wife this feels like a really bad deal, while for me it’s pretty insignificant. The difference is entirely a matter of mental time accounting.

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How much is 15 minutes? (photo: Ansgar Koreng CC BY)

Her argument: it’s half an hour more (for a return trip – making the current total about 1.5 hours). That is 50% more travel time. We usually spend around 3 hours for a visit in total, so instead of taking one hour’s drive for two hours with them (a ratio of 1:2) we now devote 1.5 hours to the journey for just 1.5 hours there. That extra half hour travelling means half an hour less with them – that relative opportunity cost means it’s almost not worth it.

My argument: 15 minutes is nothing. Like any frequent traveller, I’m delighted if a plane is delayed by no more than 15 minutes. Even going to our daughter’s old place, we often didn’t quite make it in 30 minutes – that was like a best-case time. 15 minutes is 1% of a day, 0.15% of a week, so in the bigger picture it is entirely insignificant (we don’t even go there every week). But most importantly, there is no reason why we need to ‘pay’ for the extra travel time by shortening our time with our daughter’s family – to move time from the ‘spend time with family’ mental account to the ‘travel’ account. We can easily travel 15 minutes earlier and come back 15 minutes later, and spend half an hour less on some other activity (if need be, get up 15 minutes early, and go to bed 15 minutes later).

Does that settle the debate? Not really. But this difference in opinion shows how strongly our perception can be influenced by how we mentally account for our time. And that is a choice we can make – we may be mental accountants, but we don’t have to be unwitting mental accountants.

Posted in Behavioural economics, Economics, Emotions, Psychology | Tagged , , | Leave a comment

The unequal struggle between facts and conviction

(featured image credit: stevepb/Pixabay)

When we argue on the basis of a conviction, we should be seeking to verify our position, rather than to confirm it

“When the facts change, I change my mind. What do you do, Sir?” This statement has been attributed to many great people – most frequently to the economist John Maynard Keynes. That is probably incorrect, but let us not be distracted by the question who might the originator of such a pithy and powerful symbol of evidence-based practice in everyday life.

It’s the kind of thing many of us wish we could say ourselves, or even that we believe we could actually legitimately claim to do. Who wants to stubbornly stick to a conviction in the face of facts that contradict it?

And – you can probably see where we’re going – yet, what people think they do and what they actually do are often two different things. In a recent episode of the BBC radio show More or Less, one of the topics was the overconsumption of sugar as a public health concern. Have the people of Britain really been eating and drinking too much of the sweet, sweet stuff? And does that warrant new regulation and taxes? Sugar consumption is calculated in different ways, but whichever way you look at it, the trend seems to be firmly downwards. According to the Family Food Survey consumption per capita has fallen from 92 to 71 g/day since 2001, the UN Food and Agriculture organization calculates it dropped from 45kg annually per person in the early 1960s to less than 35 today.

Annoying facts

The key measure that is used in public health is the proportion of our energy intake derived from sugar (as it is deemed to be linked to obesity). This too has steadily dropped – the National Diet and Nutrition Survey suggests adults get just over 11% of their energy from sugar, down from close to 15%, but still way above the guideline of 5%. However, that was halved from 10% in 2015 – a move of the goalposts, cynics might observe. The justification for this cut is intriguing, as the committee responsible found insufficient evidence for a link between sugar consumption and key bad health outcomes, like cardiovascular disease, colorectal cancer and type 2 diabetes. The main reason seems to have been that, apparently, if we reduce our sugar consumption, we do not compensate by consuming more calories in a different form. By that mechanism, cutting down on sugar will reduce overall energy intake, and hence obesity.

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Are you sure that extra lump won’t take you over the guideline? (image: rawpixels)

All interesting facts. But the reasoning of the Head of Nutrition Science at Public Health England, the body that lowered the guideline, appears to be motivated more by convictions than by these facts. (It is worth listening to the interview snippet in question – it is about 4 minutes long, starting at 7:20). Despite multiple valiant attempts to bring the facts into the discussion, show host Tim Harford is met with the impenetrable stubbornness of the people who are convinced they are right.

Another example comes from a recent Wiki Man column by Rory Sutherland in the British weekly The Spectator. Perhaps the gilets jaunes, the Five Star movement in Italy, and even the Brexit or Trump supporters are not – as the media keep maintaining – evidence of resurgent nationalism and populism, he argues. Maybe they represent a sensible, overdue reaction against the multitude of changes that ideologically motivated elites have imposed on the world: economic globalization, free movement of people, the euro, large-scale immigration – too much, too fast. And the economists, who usually make such decisions, with little regard for either time or scale, get the brunt of the blame.

Identity matters

The economists’ central problem is the apparent neglect of the concept of identity. Economists pay too much attention to material wealth, and not enough to the fact that people seem to instinctively value their collective identity, their affiliation with groups (nationality, race, social class etc) just as much as the acquisition of wealth. And while the latter scales easily, the former doesn’t – “There is no logical reason why people cannot say ‘I support all the football teams in the north-west of England’ but nobody ever does.”

This is an interesting argument (I would of course say so, as I have written before about both the importance of identity and the effect of it on voting). An experiment from nearly 30 years ago by Charles Perdue and colleagues illustrates the strength of the sense of identity and belonging. The participants in their study (who were told it was about verbal skills) received a list of nonsense syllables (like xeh or yof) paired with either in-group words (us, we, ours), out-group words (them, they, theirs), or neither (he, she, his, me etc). The subjects then had to assign a ‘pleasantness’ score to each nonsense syllable. The result? People for whom a given syllable had been paired with an in-group word rated it as significantly more pleasant than the neutrally-paired syllables; and syllables paired with an out-group word were deemed the least pleasant.

So how come people overlook the importance of identity? We generally believe our own argument for or against something to be rational, so we tend to selectively support it with factual evidence. Those who disagree (and who must therefore reject our rational argument) are evidently irrational. This definitely was, and to some degree still is, a common Remainer narrative following the Brexit referendum. There was no strong pro-European identity on that side at the time, and the principal case for staying in the EU had a material foundation: the economic advantages of remaining were overwhelming, and the downsides of leaving were dramatic. How could reasonable people vote Leave? If they did so, how could it be explained other than by nationalism and populism, by xenophobia and nostalgia for a time when Britannia ruled the waves? Identity didn’t figure as a legitimate reason for wanting to leave.

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Right identity, but shouldn’t a proper British passport be blue? (image: Holiday Gems CC BY)

Rory Sutherland even states that this is a principled argument for a hard Brexit. A provocative counterfactual claim like his can be rather useful: challenging longstanding and deep-rooted beliefs needs a proper shake-up, not a timid tap on the shoulder.

But when we confront blind partisanship, confirmation bias, selectivity and so on in this way, we need to be careful that we do not succumb to the same problem as the people we have in mind. When we observe what we judge to be faulty reasoning – especially if we feel strongly about it, we can start to believe our own reasoning is inherently and objectively correct. And that overconfidence can make us lose rigour in arguing our case.

There are undoubtedly economists who have no interest in social preferences like identity, but when the entire profession is presented as the villains, is that actually true, or just a stereotypical conviction that we no longer think needs to be verified? Unsurprisingly one economist took issue with such a broad-brush accusation:

metcalfetweet

Overstating the case by understating the facts

Identity may not be a mainstream topic in conventional economics, but overstating the case (by claiming it doesn’t figure at all) risks weakening its credibility. And of course, when – rightly –identity is introduced in the decision-making process, it needs to be weighed up against other elements, not least the economic consequences. Identity is only a principled argument if it is valued more highly than the corresponding economic loss. Such trade-offs between the immaterial (social and emotional preferences) and the material (economic outcomes) are very much the domain of economics and economists. (And arguably, not all proponents of Brexit motivated by identity had come to their decision with full recognition of all the facts.)

So we have the official being dismissive of the facts that question the reasons for cutting the sugar intake guideline by 50%, we have a simplistic Remainer narrative that ignores the fact that identity can play an important role in decision-making, we have a simplistic Leaver narrative that only looks at identity and brushes off the economic facts… And we have a critique of the Remainer narrative which, while essentially valid, is perhaps a bit quick to condemn a group of people, and that sounds a little uncritical to the simplistic Leaver narrative.

Ironically, among the better ways to avoid bias in such reasoning is a core instrument in the toolkit of the reviled economists: the economic way of thinking – the good old ‘on the one hand’ and ‘on the other hand’. If we want to avoid countering a one-sided argument with a one-sided argument of our own, we have to be critical of ourselves. It is not because others are wrong and we can point out why, that what we say is right just because we say it.

We still need to make sure we’re not falling in the same trap of believing that our argument is entirely rational, when our reasoning is mostly motivated by our own preferences, convictions and beliefs.

And perhaps most importantly we should always check our own facts. (I hope I did.)

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

Strange excesses: on insurance and probabilities

How insurance can sometimes be a gamble in more than one way

Are you a gambler? Let’s not count lottery draws, or even the occasional punt on a horse or the result of a football match. If we exclude these, chances are you wouldn’t consider yourself the gambling kind. And yet…

…we are all gamblers. When we take out insurance, we gamble. We bet against the insurer that our house will burn down, that we will die prematurely, or that we will crash our car. If our house never catches fire, we live to be 90, or we are very safe drivers, we lose: all our premiums are ‘lost’. The insurance company takes the opposite bet: it loses if it needs to pay out for the insured event if that amount is larger than the premiums we have paid.

And when we don’t take out insurance – say travel cover – we gamble too. We save ourselves the premium, but there is a risk that we fall over and break our arm, catch malaria or whatever. Should that happen, we have to bear all the costs.

Quirky phenomena

Yet few among us have any idea of the actual risk that our house will burn down, that we’ll die before the kids have flown the nest, or that we will collide with another vehicle. We may not know the risk, but it is vital for insurance companies to do so: to stay in business, insurers need to be very, very good at estimating the risks involved. If they overestimate them, they’ll charge premiums that are higher than they need to be, and end up more expensive than their competitors who are better at judging it. If they underestimate the risks, they will quickly go bankrupt.

Still, we come across quirky phenomena in the insurance market. If you’ve every used a comparison site to see what it would cost to insure your car, you will have noticed that, as you scroll down from the best quotes at the top, the premiums go up to twice, three times even six times or more the cheapest premium. As these quotes are based on exactly the same information, you would expect insurers to provide if not identical, then at least similar quotes – unless they classify the various risk factors very differently.

The premium takes into account many different aspects, including your age, your occupation, where you live, the car you drive (how old it is, what type, what it’s worth) and so on. Converting these factors into risk is more black magic (with a sprinkle of statistics) than hard science, but it is what makes the distinction between profit and loss for an insurer.

Yet we are not entirely stuck with the insurer’s assessment of the risk we pose. We can convince the insurer that we are a better risk than they think, and get to pay a lower premium. That is what the voluntary deductible excess is for – the part of any claim that we will pay ourselves before the insurance pays out.

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Apart from this minor collision with a submarine, I am a safe driver, really. (image: Marinmuseum Karlskrona CC BY)

A few weeks ago, I needed to renew my own vehicle insurance, and I wanted to see what the effect was of the voluntary excess on the premium. Is there an optimum excess amount? I opened a spreadsheet, and ended up spending an instructive couple of hours.

I reasoned that, if I am a very safe driver, a high excess will hardly bother me, as I am unlikely to have to dip in my piggy bank for it. This is, in effect, a wager between the insurer and me. Their stake is the discount to the premium, and they bet that I will make a claim. If that happens and the claim is larger than the excess amount, they win that amount (in that they cut the pay-out by that sum). For me it’s the opposite: if I don’t make a claim, I pocket the discount, but if I do, I lose the excess.

Signalling a lower risk

Is opting for a voluntary excess a good deal? That depends: a £500 excess that gets you a reduction of just £1 would seem to be a terrible deal. But we can actually work out what would make a deductible excess an attractive proposition. Imagine a driver whose risk profile predicts that, on average, he will have on average an accident once every 10 years (hence, a 10% chance they will make a claim this year – this is the UK average), with an average claim size (in the UK) of £3,000.  With no excess, the breakeven point for the premium would then be £300 per year (let us ignore the insurer’s costs and profit margin to keep things simple). With an excess of £100, the average pay-out would drop to £2,900 – so the breakeven premium would be reduced to £290 per year.

Such a deal would be neutral: what you gain in lower premiums, you would lose in the excess when you make a claim. To really gain through a voluntary excess, you’d need to look for a deal where you get a larger cut in the premium. For my chosen insurer, I found that an excess of £150 reduced the premium by nearly £24. If we apply this to the UK averages, then the pay-out would now be £2,850 (£3,000 – £150), and the annual premium would be £276 (£300 – £24). The original risk of 10% (£300/£3,000), has now dropped to £276/£2,850 or 9.68%. The lower premium signifies that agreeing to a £150 excess has improved my risk profile.

And that does indeed make me better off: my gross saving is £24 per year, of which I must use £15 as a provision to cover he excess. Over 10 years (the average period in which I make one claim – 10%, remember?) I will have accumulated the £150 I need to pay myself, but also an additional £90. Hurrah!

But wait, we’re not finished yet: what if we increase the voluntary excess? Raising it to £250 cuts the premium by a further £11. My risk profile improves a little (to 9.64%: £265/£2750) and I now pocket £10 per year (I need to hold back £25 to cover the excess over 10 years). How about a £350 excess? Now things are getting strange: the premium is now down to £258, which means my gross saving is £42. But I also need to set aside £35 to cover the excess, so my net saving is down to £7. And it gets worse: raising the excess to £450 cuts the premium by just over £1. With a premium of £257, my risk level is 10.08%, higher than I started with! And that is reflected in the fact that I no longer make a net saving: I pay £43 less than originally, but I need to hold back £45 for the excess, so I am losing out to the tune of £2 per year.

excesstable

What do we learn from this? First, a voluntary excess can indeed be a strong signal that I am (or at least believe to be) a lower risk than standard – and that I am willing to put my money where my mouth is. If I am happy to pick up the first slice of the claim (and not make frivolous claims for minor dings) the insurer is happy to reduce my premium.

More importantly, we should not take anything for granted. Insurers can exploit the fact that we cannot intuitively distinguish a good deal from a bad deal – we may be taken in by a reduction in the premium that does not properly reflect the reduction in the risk. In this case, there was clearly an optimum at the £250 level. I would have lost out had I gone for the highest excess.

And most important of all… thank goodness for the reward of intellectual and moral satisfaction. I realized a net saving of £10 on my premium, and I could have ended up £2 worse off. That result hardly justified playing around with a comparison website and a spreadsheet for a couple of hours. But the knowledge that I saw through the insurer’s shenanigans? Priceless!

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

A more care-less year

Can caring be a bad thing?

Caring is a strong motive for quite a big chunk of our behaviour. If we care about something (or somebody), it means we are willing to put energy into it, effort, time and cost. It often acts as an inherent basis for action, beyond material incentives. But is caring an unconditional force for good?

It certainly has a good reputation. Many of us look up to people in a ‘caring profession’, who help others, like nurses, school-teachers, or who work with vulnerable people. Similarly, folk who volunteer for to help the poor or clean up the environment (because they care) tend to get respect in society. And of course it is hard to imagine how that society could a function at all if we did not care for our children, siblings, (grand)parents, friends, neighbours or colleagues.

Too much of a good thing

If caring is such a good thing, can there be too much of it? We want to protect the object of our caring from harm, or to make things better for it. If the effort we put in with that intention delivers the desired effect, we are rewarded for our input, we experience a positive emotion, and all is fine. Seemingly, even when we do things just because we care, we still remain economic beings, and we need the costs to balance the benefits. But what if we care too much, and the implicit goals that follow are too big for us, or simple unattainable?

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Could she care too much for her patients? (image: National Museum of Health and Medicine) CC BY)

No individual can single-handedly end hunger and poverty, deliver world peace, or fix the IT system at work. We have to bring what we want to achieve, and hence how much we care, in line with what we can do in practice. Thankfully, such major mismatches are not a widespread problem: most people are pretty good at using how much they care, just like medication, it in the right doses to boost or sustain motivation. If it does happen – particularly at work – it’s worth bearing in mind one of the old adages of Change Management: never work harder than your change sponsor. More generally, don’t put in more effort than the person with overall responsibility, however much you care. Without their active engagement, there’s no way we will be able to achieve whatever the overall goal is. Sure, it won’t get done and we may end up frustrated, but at least we won’t end up burning ourself out.

Sometimes we just say that we care too much (usually accompanied with an exasperated sigh). This is not quite the same as what happens when our aspirations are too big for our capacity. Instead, it is what can happen when what we see as our reward is not commensurate with the effort we feel we are devoting. Typically, this involves another person by whom we are trying to do good, but who doesn’t appreciate our concern. Maybe that person is an ungrateful so-and-so, and if we do not get enough intrinsic compensation for our energy, perhaps it’s time to trim it down a little and focus our attention on more deserving causes.

But maybe the reason they don’t heap gratitude on us is that we are actually not helping them, or at least not in the way they need. We are, that goes without saying, not in the least a control freak, but perhaps we are acting more out of a desire to see them do what we think is best or, heaven forfend, to direct this other person’s life for them (in their interest of course). Or perhaps we are being an interfering busybody after all. So, whenever we hear ourselves say (out loud or under our breath) that we care too much, it may be time to wonder what is our true motive. Is it really because we care? Or are we sneaking in something else?

The dark side of caring

The more serious situations where caring too much can derail us and work against our own interest probably lie elsewhere, though. Caring about something or someone means we are prepared to make sacrifices to help and protect them: if necessary, we happily give up our time, energy or money to do so. But is that all we sacrifice? Society may judge us leniently if we sacrifice the principle that we should not harm other people, when one of these other people is threatening to kill a child of ours and we act to protect it. But might we perhaps be tempted to sacrifice our own sense of justice, in order to keep the same child out of jail, for example by providing a false alibi, or failing to report vital information to the police? If our best friend told us she had hit their neighbour’s car, but that she had driven off without notifying them, would we care so much about our friendship that we would not tell the neighbour? These are pretty tough questions – and that is because we care.

A little more innocent (but no less questionable) is the situation where we care so much about a particular belief or conviction, that we try to protect it from the truth. That can be exhibited through confirmation bias: when we believe something – and in particular if we want that belief to be true – we tend to seek out information that confirms and strengthens that belief, rather than information that could contradict it.

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If you need this kind of fortress to protect your idea from the truth, you may be caring too much (image: SBA73 CC BY)

You may have come across the ‘2, 4, 8’ game, a wonderful illustration of how much we appear to do so. If so, feel free to skip this paragraph. Still here? Right, it goes something like this: there is a rule that the sequence of numbers ‘2, 4, 8’ obeys. You have to guess that rule by suggesting other sequences of three numbers, and you will learn whether or not they obey the rule. Many people start with the assumption that the rule is: the second and the third number are double the preceding one. They then proceed to give a sequence for which this assumption is true (e.g. ‘5, 10, 20’), and learn that it does indeed obey the rule they’re looking for, but that their assumption is incorrect. This video shows how people continue to look for confirmation rather than for disconfirmation (and gives the solution – if you want to play yourself, here is an online simulation).

When we care profoundly about a particular idea, belief or hypothesis, this can begin to feel as if it is part of our identity, part of us almost – like our children. And our instinct to protect it means we overlook, or dismiss evidence that contradicts it. We cast doubt over the sources of insights that refute it. And ultimately we end up caring more about this, than about the truth. Is that a good thing? Another tough question…

Caring is deep in our nature, and is behind a lot of our decisions and behaviour. But it’s easy to get carried away with it so we lose our sense of balance. Keep on caring, but care just enough, and be careful (!) what you sacrifice. May the coming year, whenever you are verging towards caring too much in whichever way, be a bit more care-less.

Happy 2019!

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

Why are we giving gifts?

(Featured image credit: Peter Dutton CC BY)

Lifting the veil over a mysterious custom

This is the time of the year when it is obligatory for any piece with even the vaguest reference to Christmas, gifts, or economics to mention economist Joel Waldfogel and his classic paper, The deadweight loss of Christmas. In it, he explains why the habit of giving each other presents at Christmas has an overall negative economic effect (to the tune of $25 billion worldwide per annum in 2009). There, that’s me done.

But is our collective engagement in an activity so detrimental to the economy proof that we are irrational beyond redemption? That is not so sure. Much of our behaviour that looks, superficially, as if it is irrational – in the sense that it appears to be a deliberate action that goes against our own self-interest – is nothing of the kind. Sometimes there is more to economic transactions than a material balance sheet showing a consumer surplus (in human language: we value the goods or services we have bought more than the money we paid for it).

Giving gifts is one of those transactions where this may well be the case. Let’s look at some reasons beyond material gain why it may make sense to buy someone a present.

Multiple beholders

They say value is in the eye of the beholder, and with gifts, there are often multiple beholders. There is not only the lucky recipient, but there is also you, the generous giver, and there are any number of bystanders, people who see or learn about your gift.

The material effect to the beneficiary is pretty clear – with a net gain of a jumper they are economically better off. You, on the other hand, are giving something away, so the material result of the transaction looked at in isolation is negative. But there are of course immaterial aspects to it. Picture the gift is a really nice surprise to the recipient, and they show this with great gusto, through genuine signs of gratitude. That’s the kind of stuff you cannot buy for money – except indirectly by giving such a wonderful gift. Is that alone worth the expense? Quite possibly. You can surely imagine how the elation of a loved one upon receiving such a brilliant gift might give you immeasurable happiness.

christmas jumper

The perfect gift? (Note the bonus woolly hat) (photo: Stuart Chalmers CC BY)

But there is more. Perhaps you have ulterior motives. Reciprocity is a social psychology concept that describes how a positive action is often encouraging an equally positive response. So by giving a gift, you “buy” a future favour of some kind (or simply some amount of social credit). A third possibility is that you value the warm glow – the emotional satisfaction of doing something good (like giving someone a jumper).

 

The signalling gift

What about the bystanders? Giving gifts can function as a signal. Nature is full of such signalling messages – from male birds building a spectacular nest to attract a mate, to gorillas thumping their chest to show their dominance. Now it is rare for people at Christmas to, say, build a house as a present for the one of their dreams, or to stand up during dinner and perform a chest-beating drum solo to show who’s boss. But a big, fat, expensive gift does signal to all and sundry that you are well off and generous, and that may be worth advertising (if that is your thing). A quirky, witty gift is a sign that you’re a quirky, witty person, and may be useful to build or maintain a certain reputation. Such messages too can have value.

But perhaps the weightiest signal a gift can send is not to others, but to the person receiving your gift. It is the sacrifice you make that shows how much you care. Part of this is the money you spend, but it may also be the time you’ve spent tracking down that rare David Bowie album, or indeed the amount of effort you put into knitting that unique jumper. It is important to bear in mind that it is the perception of your sacrifice in the eye of the recipient that matters, though. It must look meaningful, and that means not just anything will do. Your gift may be evaluated against the typical Christmas present (whatever that may be), or compared with other gifts (what are you giving to others, what are others giving to the recipient, or even what are others giving to others?).

Maybe what you are aiming to get in return for your present is prominence in the recipient’s mind? It’s all well and good to make a big impression on Christmas day, but if your gift is then promptly forgotten forever more, it’s a bit of a waste. In that case, you may want to consider something that they will use (or at least see) every day, providing a frequent reminder of your generosity and perspicacity. But subtlety is probably advisable: a life-size sculpture of yourself to put in the front garden may be a little too much.

Too complicated?

christmas market

Behold, an orgy of wealth destruction (photo: Alexander Baxevanis CC BY)

With this multitude of possible reasons to give gifts, it’s not surprising that, for many people, this is a stressful affair. Giving cash – according to Dr Waldfogel the best way to counter the “orgy of wealth destruction” – would avoid all the confusion. The signal it sends, apart from the magnitude of the sum, is simply that you’re not into playing games and that you value economic efficiency. Then again, it may also reveal something about your personality, as economist Rachel Meager confessed in a tweet:

 

Who knows, the overriding reason why we give gifts at Christmas might not be found in the various potential motives, or in what we believe we get in return. Among the strongest behavioural drivers is social proof, a term coined by Robert Cialdini in his classic book Influence. We tend to copy the actions of others, especially when we have no strong, clear preferences. And there is something to be said for that if you find it all a bit complicated: if you let yourself simply be guided by what others do, you are freed of all these other considerations, and you can enjoy a truly peaceful Christmas.

Merry Christmas and a Happy New Year!

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

Don’t be defensive (be surprised)

(featured image credit: Henry Burrows CC BY)

We should be pleased when what we observe contradicts what we believe to be true: wisdom arises when the unexpected happens

We people are simple at heart. We are of course incredibly complex machines – just think about the elements of your anatomy that allow you to read these paragraphs: the muscles, tendons and bones in your hands and fingers, your eyeballs that can turn left, right, up and down, with their diaphragms that can adjust to the light level, the nervous system that connects the lot together, and the brain with its billions of neurons to control it all and make sense of what you see. Yet we like the world to be simple… too simple perhaps.

A possible reason for this desire for simplicity is that we tend to prefer certainty over uncertainty. The dependable straight lines of the exclamation mark in ‘That’s the way it is!’ are so much more comfortable than the circuitous bends of the question mark in ‘What on earth is going on?’ We like our world to be predictable.

It’s the law!

Laws give us that certainty, which is why we are so fond of them. We expect moving objects to always obey Newton’s law, or we expect the economy to always follow the law of supply and demand. And where there are no such laws, we just construct our own. We form beliefs based on what we are taught or what we observe: BMW-drivers never use their indicators, or politicians are all crooks out to line their pockets. Pretty much we treat such beliefs as laws too.

hertogjan

The law of nice Dutch beer: there is no such thing as nice Dutch beer. Or is there?

And what do we do when we are confronted with facts that violate one of these laws? We have plenty of ways to eliminate the cognitive dissonance that we would otherwise experience. We can ignore it, or dismiss it as an anomaly that doesn’t count.  “A nice Dutch beer? Ah, you mean La Trappe? But that’s a Trappist beer, which is a Belgian beer really!” We can question the validity of the facts, or of the person who raised them. (“Who mentioned a nice Dutch beer? Oh, Fred? But he knows nothing about beer!”) We can declare them to be outside our scope. (“Hertog Jan? Yeah, very nice, but they call it a barley wine, and I was talking about lagers!”)

What would happen if we didn’t immediately pull up the defences, but actually engaged with the apparent conflict between new facts and our beliefs? A few weeks ago, I came across a captivating discussion on Twitter, which featured a clip from a nature documentary. In it, a young female leopard that has just killed a baboon discovers that her prey was carrying a new-born young. Remarkably, rather than eating it, she proceeds to protects it from a bunch of hungry hyenas, taking it up into a tree, and keeps looking after it.

Some people may dismiss this film as fantasy, staged by the makers, in defence of the belief that leopards inevitably will kill and eat helpless little baboons. But if you trust it to be truthful and suspend that belief, an interesting question arises: what might be behind the behaviour of the young female? Clearly, she did not lack the instinct to feed herself, having just killed (and not even eaten yet, so she was still hungry) the baby baboon’s mother. Are we witnessing a stand-off between two instincts – one for survival, and one for maternal care?

It’s hard to tell. But what is obvious is that the primary instinct we associate with hungry predators is not the only driver for their behaviour. Even if we don’t suddenly see young leopardesses routinely starting to fostering orphan baboons, this single unusual, unexpected, frankly surprising event tells us something: it can happen. The belief that a hungry leopard will always kill and eat any prey animal, and never safeguard it, has been dented.

Progressive insight

If this can happen with beliefs about animal behaviour, then we can expect the same with human behaviour. In a recent episode of the Freakonomics podcast, one of the guests was Sheena Iyengar, a psychologist renowned for her work on choice. Her research lies at the basis of the so-called paradox of choice. Early in her career, she and Mark Lepper investigated how children react when they can choose from a multitude of toys. They found that, instead of being elated and engaging in play, the children “would look at all these toys and stare outside the window”. This went against the prevailing scientific belief at the time: more choice produces more intrinsic motivation, higher satisfaction and a greater sense of control. Iyengar and Lepper also conducted the now famous jam study, in which shoppers at a prestigious supermarket were shown a choice of 6 types of jam in one condition, and 24 kinds in the other condition. 60% of people stopped to taste with the larger amount of jams on display, while only 40% did so when just 6 jams were presented. But of the people who saw the 24 jams only 3% actually made a purchase, while 30% of those who stopped for the smaller display went on to buy jam. It seems we enjoy choice because we value the multitude of opportunities, but we don’t like the cognitive load of actually having to choose between too many options, like the children or the shoppers confronted with 24 jams.

lotsofjam

Jam today, tomorrow, and all year, really. But is it too much? (image: Joanna Poe CC BY)

Iyengar and Lepper’s experiments alone would be a good example of unusual, unexpected behaviour, which challenges a prior belief (“more choice is better”), and which gives rise to new insights. But it is just the beginning of the story: a lot of choice is not always too much choice. As Rory Sutherland once said, “if you’ve driven 27 miles around the North Circular (a notoriously unpleasant London road) to visit a place called World of Jam, you’re probably not going to walk in and go ‘Oh Jesus! There’s just too much jam.’” Context matters.

But does choice overload really exist? A meta-analysis, conducted by Benjamin Scheibehenne at Basel University and colleagues, cast doubt over its very existence, finding a mean effect size of virtually zero (albeit with wide variation). At the very least, the researchers concluded, it is complicated: not just the number of options available but also the structure, and the decision processes matter. And this finding too was not the last word. A further meta-analysis, by Alexander Chernev, a psychologist at Northwestern University, and colleagues, identified four factors (choice set complexity, decision task difficulty, preference uncertainty, and decision goal) that have a reliable and significant impact on choice overload.

Sheena Iyengar’s remarks in the Freakonomics podcast clarify what might be happening here. We don’t necessarily just shop when we go to a store. For instance, even if most of the time we routinely put the same products in our trolley, week in, week out, we still to some extent be on the lookout for new. In addition to replenishing supplies, we are then looking to update our knowledge on the available options, deliberately seeking variety and novelty. If one of our goals is to discover new options, then more options will be benefiting us. In contrast, when we go into your habitual coffee shop in the morning, we are not in updating mode at all: just give us exactly what we’re having every day, and leave out the choices.

Assumptions, better than beliefs?

Assumptions are often reasonable as a first order approximation in most circumstances. Classical music is more likely to feature violins than accordions; most popular Dutch lagers are pretty bland; people prefer more choice over less choice. But if they are turning into beliefs, it is much harder to accept there may be nuances we are missing.

If we are truly concerned with understanding the world better, whether it is in academia, trying to replicate social science experiments, or more generally, in our manifold interactions with our fellow humans, assumptions are more useful than beliefs. When beliefs are contradicted, we feel a strong need to defend them.

Assumptions, on the other hand, allow us to keep our mind open for the unusual, the unexpected, and the surprising. To paraphrase Paul Saffo’s ‘strong opinions, weakly held’ mantra, it is thanks to strong assumptions, weakly held that we learn that not all Dutch beers are bland, not all BMW-drivers are inconsiderate maniacs, and we can be doing more than just replenishing our pantry when we go shopping.

That is how we learn.

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