Tag: irrational exuberance

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The Economics of Sludge and Dark Patterns

Many of you may have heard of nudge – the idea that governments can help people make better decisions by carefully designing the way a policy is structured and presented. Have you heard of sludge?

The most widely cited example of a nudge is changing a default option. The default option is what happens if you do nothing. For example, when you start a new job, are you automatically enrolled into the pension scheme or do you have to do something (i.e. fill-in an on-line form) to opt-in to the scheme. Changing the default option to one of being automatically enrolled in a scheme seems to have a big impact on the choices people make.

Recently, policy makers have started referring to ‘sludge’. Sludge is the opposite of nudge: i.e. characteristics about design and presentation that make it more difficult for people to make good decisions. Some businesses may use sludge to encourage consumers to spend more on their goods than they ever intended.

One interesting application of sludge is in the design of websites – referred to as Dark Patterns. The following are a number of different categories of dark pattern:

The last example, Forced Continuity, refers to the use of free trial periods and automatic renewal of contracts. Many people sign up for a free trial or special offer with the full intention of cancelling before the account automatically switches to the standard price.

How often do people simply forget or never quite get around to cancelling these deals when the time comes? Some recent evidence comes from a YouGov Survey. Forty-seven percent of respondents to this survey reported having accidently signed up for an annual subscription because they either forgot or were unable to cancel their account. The estimated total cost of unwanted subscriptions per year was £837 million. The same YouGov survey found that one in eight people kept paying for over four months before finally getting around to cancelling.

One business has recently seen an opportunity to help people deal with this problem. Free Trial Surfing is a new App developed by the company, Do Not Pay. It became available via Apple’s App store in September but is not yet compatible with Android devices. It works in the following way.

When customers download the app, they receive a new credit card number and a false name. Although Do Not Pay register the card details to their own business, the customer can use the information to sign up for a free trial of a good or service. In effect, Do Not Pay acts as an intermediary between the firm offering the promotion and the user. Once the free trial period ends, the app automatically cancels the subscription. Importantly, the new credit card details only work when someone signs up for a free trial. Consumers cannot use it to purchase any other products. Obviously one major drawback to the app is that a consumer would have to sign up again with their own personal credit card if they wanted to continue to use the service after the free trial ends. Businesses may also try to block the use of Do Not Pay credit card numbers for their services.

It will be interesting to see if other businesses come up with interesting ways of helping us to deal with sludge.

Articles

Questions

  1. Give three different examples of nudges.
  2. What policies do government typically use to change peoples’ behaviour? How do these traditional approaches differ from nudge?
  3. Identify some biases from behavioural economics that might help to explain why so many people fail to cancel subscriptions once a free trial period ends.
  4. Choose two other types of dark pattern and explain how they might prevent people from making decisions that maximise their own welfare.
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Irrational exuberance

Both the financial and goods markets are heavily influenced by sentiment. And such sentiment tends to be self-reinforcing. If consumers and investors are pessimistic, they will not spend and not invest. The economy declines and this further worsens sentiment and further discourages consumption and investment. Banks become less willing to lend and stock markets fall. The falling stock markets discourage people from buying shares and so share prices fall further. The despondency becomes irrational and greatly exaggerates economic fundamentals.

This same irrationality applies in a boom. Here it becomes irrational exuberance. A boom encourages confidence and stimulates consumer spending and investment. This further stimulates the boom via the multiplier and accelerator and further inspires confidence. Banks are more willing to lend, which further feeds the expansion. Stock markets soar and destabilising speculation further pushes up share prices. There is a stock market bubble.

But bubbles burst. The question is whether the current global stock market boom, with share prices reaching record levels, represents a bubble. One indicator is the price/earnings (PE) ratio of shares. This is the ratio of share prices to earnings per share. Currently the ratio for the US index, S&P 500, is just over 26. This compares with a mean over the past 147 years of 15.64. The current ratio is the third highest after the peaks of the early 2000s and 2008/9.

An alternative measure of the PE ratio is the Shiller PE ratio (see also). This is named after Robert Shiller, who wrote the book Irrational Exuberance. Unlike conventional PE ratios, which only look at average earnings over the past four quarters, the Shiller PE ratio uses average earnings over the past 10 years. “Because this factors in earnings from the previous ten years, it is less prone to wild swings in any one year.”

The current level of the Shiller PE ratio is 29.14, the third highest on record, this time after the period running up to the Wall Street crash of 1929 and the dot-com bubble of the late 1990s. The mean Shiller PE ratio over the past 147 years is 16.72.

So are we in a period of irrational exuberance? And are stock markets experiencing a bubble that sooner or later will burst? The following articles explore these questions.

Articles

2 Clear Instances of Irrational Exuberance Seeking Alpha, Jeffrey Himelson (12/2/17)
Promised land of Trumpflation-inspired global stimulus has been slow off the mark South China Morning Post, David Brown (20/2/17)
A stock market crash is a way off, but this boom will turn to bust The Guardian, Larry Elliott (16/2/17)
The “boring” bubble is close to bursting – the Unilever bid proves it MoneyWeek, John Stepek (20/2/17)

Questions

  1. Find out what is meant by Minksy’s ‘financial instability hypothesis’ and a ‘Minsky moment’. How might they explain irrational exuberance and the sudden turning point from a boom to a bust?
  2. Is it really irrational to buy shares with a very high PE ratio if everyone else is doing so?
  3. Why are people currently exuberant?
  4. What might cause the current exuberance to end?
  5. How does irrational exuberance affect the size of the multiplier?
  6. How might the behaviour of banks and other financial institutions contribute towards a boom fuelled by irrational exuberance?
  7. Compare the usefulness of a standard PE ratio with the Shiller PE ratio.
  8. Other than high PE ratios, what else might suggest that stock markets are overvalued?
  9. Why might a company’s PE ratio differ from its price/dividends ratio (see)? Which is a better measure of whether or not a share is overvalued?