Tag: utility

One of the key developments in economics in recent years has been the growing influence of behavioural economics. We considered some of the insights of behavioural economics in a blog in 2016 (A nudge in the right direction?). As the post stated, ‘Behavioural economists study how people’s buying, selling and other behaviour responds to various incentives and social situations. They don’t accept the simplistic notion that people are always rational maximisers.’ The post quoted from a Livemint article (see first linked article below):

According to behavioural economists, the human brain neither has the time nor the ability to process all the information involved in decision making, as assumed by the rational model.

Instead, people use heuristics. A heuristic technique is any approach to problem-solving, such as deciding what to buy, which is practical and sufficient for the purpose, but not necessarily optimal. For example, people may resort to making the best guess, or to drawing on past experiences of similar choices that turned out to be good or bad. On other accasions, when people are likely to face similar choices in the future, they resort to trial and error. They try a product. If they like it, they buy it again; if not, they don’t.

On other occasions, they may use various rules of thumb: buying what their friends do, or buying products on offer or buying trusted brands. These rules of thumb can lead to estimates that are reasonably close to the utility people will actually get and can save on time and effort. However, they sometimes lead to systematic and predictable misjudgements about the likelihood of certain events occurring.

In traditional models of consumer choice, individuals aim to maximise their utility when choosing between goods, or bundles of goods. The context in which the choices are offered is not considered.

Yet, in real life, we see that context is important; people will often make different choices when they are presented, or framed, in different ways. For example, people will buy more of a good when it is flagged up as a special offer than they would if there is no mention of an offer, even though the price is the same.

The recognition that framing is important to choices has led to the development of nudge theory. Indeed, it underpins many marketing techniques. These seek to persuade people to make a particular choice by framing it in an optimistic way or presenting it in a way that makes it easy to decide.

Governments too use nudge theory. In the UK, the Coalition government (2010–15) established the Behavioural Insights Team (BIT) (also unofficially known as the Nudge Unit) in the Cabinet Office in 2010. A major objective of this team is to use ideas from behavioural economics to design policies that enable people to make better choices for themselves.

The podcast linked below, looks at the use of nudge theory. The presenter, Mary Ann Sieghart looks at how we are being encouraged to change our behaviour. She also looks at the work of UCL’s Love Lab which researches the way we make decisions. As the programme notes state:

Mary Ann is grilled in UCL’s Love Lab to find out how she makes decisions; she finds taking the pound signs off the menu in a restaurant encourages her spend more and adding adjectives to the food really makes it taste better.

Walking through the Nudge Unit, she hears how powerful a tiny tweak on a form or text can get be, from getting people back to work to creating a more diverse police force. Popular with the political left and right, it has been embraced around the world; from Guatemala to Rwanda, Singapore to India it is used to reduce energy consumption, encourage organ donation, combat corruption and even stop civil wars.

But the podcast also looks at some of the darker sides of nudging. Just as we can be nudged into doing things in our interests, so too we can be nudged to do things that are not so. Politicians and businesses may seek to manipulate people to get them to behave in ways that suit the government or the business, rather than the electorate or the consumer. The dark arts of persuasion are also something that behavioural economists study.

The articles below explore some of the areas where nudge theory is used to devise policy to influence our behaviour – for good or bad.

Podcast

Video

Articles

Questions

  1. Explain what are meant by ‘bounded rationality’ and ‘heuristics’.
  2. How may populist politicians use nudge theory in their campaigning?
  3. Give some examples from your own behaviour of decisions made using rules of thumb.
  4. Should we abandon models based on the assumption of rational maximising behaviour (e.g. attempts to maximise consumer surplus or to maximise profit)?
  5. Find out some other examples of how people might be nudged to behave in ways that are in their own interest or that of society.
  6. How might we be nudged into using less plastic?
  7. How might people be nudged to eat more healthily or to give up smoking?
  8. To what extent can financial incentives, such as taxes, fines, grants or subsidies be regarded as nudging? Explain.
  9. Would you advise all GP surgeries and hospital outpatient departments to text reminders to people about appointments? What should such reminders say? Explain.

Guest post by Hazel Garcia from InvestmentZen

An oft-repeated quote is that money can’t buy happiness. But according to multiple studies, yes, it can. The key is what you spend that hard earned cash on. When researchers asked individuals to reflect on their recent purchases, those who had made experiential purchases i.e. trips, lessons, events, etc. were much happier compared to those who had made material purchases.

Why is this the case? According to a 20 year study at Cornell, our excitement from new purchases fades quickly over time. That new watch you bought quickly becomes a part of your everyday life. This is what psychologists call the “hedonic treadmill,” which describes the way we return to our normal state of happiness after a momentous occasion. However, buying a new chair will return you much quicker to that state than an adventure across the Rocky Mountains.

Researchers identified several key reasons why this is the case. One reason is that an object is just an object and can never become a part of your identity (at least, not a healthy one), whereas experiences shape us over time. In addition, because by definition unique experiences are only short-lived, we don’t adapt to them the way we might with a new phone or watch. They do not become part of the routine and as such are usually viewed in a special light.

Interestingly, researchers found that even a negative experience could be rated more highly than purchasing a luxury good. In the study, participants were asked to describe a bad experience they had recently and a few weeks later, they were asked again about it. Over the course of just a few weeks, most people’s opinion of that moment had changed.

This is because the human brain has a tendency to reduce the impact of stressful situations. In fact, a significant portion of those polled even stated that in the end, they were happy to have had the negative encounter as it gave them a fresh way to look at things. When similar questions were asked to those who had purchased a high-end item, their levels of happiness were consistently lower as time went on.

So when it comes to the age old question of “Does money buy happiness?” the answer is a resounding yes – provided you spend it on the right things. But of course, you should still aim to make every dollar go as far as possible in pursuit of great experiences. Take a look at the infographic below to see a visual summary of the research on money and how it can buy happiness.

If you want to be happy, spend money on experiences, not things

Blog

If You Want To Be Happy, Spend Money On Experiences, Not Things InvestmentZen news, Hazel Garcia (23/1/17)

References

Why You Should Spend Your Money On Experiences, Not Things Forbes, Travis Bradberry (9/8/16)
The science of why you should spend your money on experiences, not things Fast Company, Jay Cassano (30/3/15)
To feel happier, talk about experiences, not things Cornell Chronicle, Susan Kelley (29/1/13)
The way we shop now: the revolution in British spending habits The Guardian, Katie Allen and Sarah Butler (6/5/16)
Just do it: the experience economy and how we turned our backs on ‘stuff’ The Guardian, Simon Usborne (13/5/17)

Questions (by JS)

    1. Why does buying material goods not buy happiness? Does this apply to all material goods?
    2. What is different, in terms of happiness, about buying experiences? Does this apply to the consumption of all services?
    3. Is the consumption of experiences subject to diminishing marginal utility (a) for specific experiences; (b) for experiences in general? Explain.
    4. Why do we seem not to care as much about the “Jones'” vacation as about their income or possession of material goods?

Economics is about choice – and choices occur in all parts of our lives. One area is personal relationships. Are we making the best of our relationships with family, friends and sexual partners? Increasingly economists are examining human behaviour in such contexts and asking what factors determine our decisions and whether such decisions are rational.

A recent book looks at the economics of marriage and goes under the title of ‘Spousonomics‘. Its authors, Paula Szuchman and Jenny Anderson, use economics “to master love, marriage and dirty dishes”. As they say:

Every marriage is its own little economy, a business of two with a finite number of resources that need to be allocated efficiently.

They look at ways in which such resources can be allocated efficiently. They also look at apparently irrational behaviour and seek to explain it in terms of various ‘failures’ (akin to market failures). They also examine how these failures can be rectified to improve relationships.

So is this economics stepping on the toes of relationship counsellors and psychologists? Or is this the legitimate domain of economists seeking to understand how to optimise in the context of scarce resources – including time and patience?

Spousonomics gets to heart of the matter Belfast Telegraph (19/1/11)
Run your marriage with ‘Spousonomics’: A new book says applying economic rules with transform your relationship Mail Online, Lydia Slater (31/1/11)
Spousonomics: How Economics Can Help Figure Out Your Marriage Book Beast (31/1/11)
Spousonomics Lesson #1: Loss Aversion YouTube (15/1/11)
Economist’s Explanation For Why Getting Married Isn’t Rational Huffington Post, Dan Ariely (15/1/11)
How Economics Saved My Marriage Newsweek, Paula Szuchman (30/1/11)
Want your marriage to profit? New York Post, Sara Stewart (29/1/11)

Spousonomics: blog, Paula Szuchman and Jenny Anderson

Questions

  1. How would you define ‘rational behaviour’ in a personal relationship?
  2. Why may marriage be a better deal generally for men than for women?
  3. Give some examples of asymmetry of information in marriage and why this may lead to bad decision making?
  4. Give some examples of risk averse and risk loving behaviour in personal relationships?
  5. Why are many actions in marriage apparently irrational? Could such actions be explained if the concept of ‘irrationality’ is redefined?
  6. Why may a simple demand curve help to explain why sexual relationships tend to wane in many marriages?
  7. Why does moral hazard occur in marriage? Does a combination or moral hazard and asymmetry of information help to explain divorce?
  8. Should marriage guidance counsellors study economics?!

Here’s an interesting example of oligopoly – one you probably haven’t considered before. It’s the art market. And it’s not just one market, but a whole pyramid of markets. At the bottom are the ‘yearning masses’ of penny-poor artists, from students to those struggling to make a living from their art, with studios in their attic, garden shed or kitchen table. At the top of the pyramid are those very few artists that can earn fantastic sums of money by selling to collectors or top galleries. Then there are all the layers of markets in between, where artists can earn everything from a modest to a reasonable income.

The pyramid is itself depicted as a work of art, which you can see in the linked article below. It’s worth studying this piece of art carefully as well as reading the article.

A guide to the market oligopoly system Reuters, Felix Salmon (28/12/10)

Questions

  1. Identify the increasing barriers to entry as you work up the art market pyramid.
  2. Are there any other market imperfections in the art market that you can identify from the diagram?
  3. What are the key differences between the ‘primary market, tier 1’, the ‘primary market, tier 2’ and ‘the secondary market’?
  4. Are artists ‘rational maximisers’? If so, what is it they are trying to maximise? If not, why not?
  5. How would you set about determining the ‘worth’ of a piece of art? How do possible future value of a piece of art determine its present value?

Happiness and unhappiness are central to economists’ analysis of consumer behaviour. If we define ‘utility’ as perceived happiness, standard consumer theory assumes that rational people will seek to maximise the excess of happiness over the costs of achieving it: i.e. will seek to maximise consumer surplus. In fact, this analysis can be traced back to the work of the utilitarians, Jeremy Bentham and John Stuart Mill. Bentham reffered to it as hedonic or felicific calculus (see also and also).

Now, of course, whether people actually behave in this way is an empirical question: one that behavioural and experimental economists have been investigating over a number of years. Nevertheless, it remains central to neoclassical analysis of ‘rational behaviour’.

But if happiness is central to a large part of economic analysis, how is happiness to be measured? At a micro level, this has proved problematic as it is virtually impossible to have inter-personal comparisons of utility. As a result, consumer theory uses indifference analysis, characteristics analysis, revealed preference and other approaches to analyse consumer demand.

But what about at the macro level? How is a nation’s happiness or well-being to be measured? There is general acceptance that GDP is a relatively poor proxy for national well-being and is more a measure of production. There have been various indices developed over the years (see, for example, Box 14.7 on ISEW in Economics, 7th edition) as alternatives to GDP. None has been adopted by governments, however, with the exception of a Gross National Happiness index in Bhutan.

Recently, however, there has been renewed interest in developing an index of well-being. In France, President Sarkozy commissioned two Nobel economists, Joseph Stiglitz and Amartya Sen, to examine the issues in developing such a measure. In the light of the Stiglitz/Sen report, David Cameron has asked the Office of National Statistics to measure the UK’s general well-being. The articles below look at the difficulties that could arise in producing an index of well-being, of meauring the elements and in using it for policy.

Articles
UK Prime Minister Cameron Moves on UK Happiness Index Triple Pundit, Kristina Robinson (17/11/10)
David Cameron’s happiness index finds support despite impending decade of austerity Daily Record, Magnus Gardham (16/11/10)
How can we measure happiness? Telegraph, Philip Johnston (16/11/10)
David Cameron aims to make happiness the new GDP Guardian, Allegra Stratton (14/11/10)
An unhappiness index is more David Cameron’s style Guardian, Polly Toynbee (16/11/10)
Happiness is a warm baguette? The Economist (13/1/08)
‘Stiglitz-Sen Moving in the Right Direction, but Slowly’ IPS, Hazel Henderson (18/9/09)
The Rise and Fall of the G.D.P. New York Times Magazine (13/5/10)
Happiness doesn’t increase with growing wealth of nations, finds study Guardian, Alok Jha (13/12/10)
Should governments pursue happiness rather than economic growth? The Economist (25/11/10)
M&S’s Sir Stuart Rose among UK’s expert happiness panel BBC News (27/1/11)

The Stiglitz/Sen/Fitoussi report
Report by the Commission on the Measurement of Economic Performance and Social Progress, Joseph Stiglitz, Amartya Sen, Jean-Paul Fitoussi (September 2009)

Questions

  1. What are the shortcomings of using GDP as a measure of a nation’s well-being?
  2. Summarise the main findings of the Stiglitz/Sen/Fetoussi report.
  3. What items would be included in a happiness or well-being index that (a) are not included in GDP; (b) not included in Stiglitz and Sen’s proposed net national product measure? How would such an index be compiled?
  4. Would it be satisfactory to compile such an index purely on the basis of survey evidence? Why might such evidence prove unreliable?
  5. What are the political advantages and disadvantages of using such an index?
  6. Is utilitarianism the best basis for judging the progress of society?