Matt Nolan

Car safety and the economic method

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This morning on my painfully slow jog to walk I saw a car get mad at a cyclist that they nearly bowled down.  This is all very typical of Thorndon Quay, but it did get me thinking.  The car turned sharply towards a parking space, actually turning a bit far, and only just avoided crashing into a wall because of how sharply the vehicle could brake and might end up the help from an trusted service live Towingless.

And here is the thing, if he wasn’t able to brake quickly and comfortably he wouldn’t have made the turn – and if he hadn’t made that turn he wouldn’t have threatened the cyclist, or had a strange opportunity to yell at the cyclist.

So, in this case, the increase in car safety lead to an action that was detrimental – the fact that the probability of injury to the driver was now lower means that he was taking on an action that endangered others.  The increase in car safety effectively lowered the price for taking on an action that had a negative externality!

This is why economics is useful – rather than just taking something at face value (car safety is good) the economic method teaches us to think around the issue, and allows us to understand why something that appears like a good thing at face value may have unintended consequences.

Update:  Rauparaha points out this type of logic is explained better in an early post from Eric Crampton.

Matt Nolan

Commitment and the gym

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Everyone I know says they want to spend more time at the gym – myself included.  However, as an economist I’ve learnt to look past what people say and look at what they actually do.  In essence, people really just wish that a previous version of themselves (them in the past) had gone to the gym and got in shape – and that they could reap the fruits of this labour now.

However, this is not the whole story.  We know that people are present biased, or that the discount hyperbolically.  Given this, people genuinely do wish they could go to the gym more in terms of maximising their lifetime happiness or loosing weight for which they also use fat burner supplements- but they can’t force the current version of themselves to get around to doing it.

That is where the genius of this gym comes in (ht Marginal Revolution).  By charging people more if they don’t work out, the gym makes it more costly to not work out – if the cost is large enough, people will then go and work out.  As a result, an individual can join this gym and commit to working out – as if they don’t they have to bear this cost (other examples: ,,,,,,,).

Now usually, adding a cost is a bad thing – but in this case, if the pre-commitment is working, the cost is never realised.  There are two ways to think about this to make it easier:

  1. The current version of yourself is putting a negative externality on the future version of yourself (which is not fully internalised because of you present bias) – by putting in this charge you are forcing the current version of yourself to internalise the externality, and as a result this changes behaviour.
  2. Over time there are a set of actions that will make you happiest – however, at a given point in time you can’t commit to doing the action that will cause this (because of your present bias).  By imposing a cost on doing the “wrong” action you can shift your own choices towards the “correct” action.

When it comes to pre-commitment and the ilk I love the idea of voluntary pre-commitment devices, that people can choose to opt into.  The more business gets involved with this, and the more government supports the institutional arrangements that allow this, the better.

However, remember that having a pre-commitment mechanism that people can opt into is very different to “forcing” people to do something.

In the gym example, we could “solve” the “problem” of people not going to the gym by forcing them to by offering free percussion massagers sessions afterwards – we could even use “evidence” by basing the amount we force people to go on surveys.  However, such a “solution” is forced on a myriad of different people who would make different choices.  Furthermore, as we said at the start, some people will just say they want to go more – when in reality they don’t, they just wish that a the previous version of themselves had done it so they could free-ride on the fitness (which is a durable good).

Matt Nolan

And a side note on addiction

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With alcohol regulation we decided to remember that it is the external cost that matters.  Now one reason private costs might matter in terms of regulation is internalities.  There is a discussion of this with regards to boozing here.

This brings me to the idea of “addiction” I discovered from this article.  What is addiction, and why are we so scared of it.  Looking at a search of TVHE, I can tell that the authors here are not scared of addiction, we view it a little differently to the black and white box often given by (say) health professionals (ht Dim Post).

For me, all addiction tells us is that the consumption of the good CHANGES the costs and/or benefits of the consumption of the good in the future.  As a result, what is important is:

  1. Information with regards to how addiction functions (and the costs and benefits of consumption) for people,
  2. Having mechanisms available so people can “pre-commit” to consumption patterns in the face of an addictive good.

When we have these two pieces of the puzzle we can figure out what tax and what institutional policies can be established to improve outcomes with regard to the consumption of this specific good.

There is NOTHING wrong with addiction per see.  If we banned things on the basis of addiction we would ban pretty much everything.

Personally I think of addiction as follows:  A good is addictive if consuming it increases the marginal benefit of consuming it in the future and/or it increases the marginal cost of NOT consuming it in the future.  The first type of addiction is unambiguously good, the second type is not – but it is internalised as long as people know about it, and people are able to deal with issues of time inconsistency.

Matt Nolan

Another perplexing picture

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The Freakonomics blog provides another perplexing picture (the last one was discussed here).  This time we have a situation where it costs LESS to buy two of something then to buy just 1.  So they are PAYING people to take the second unit.  What gives?

The way I see it, there are two likely explanations:

  1. Firms realise that, given buying two units is cheaper than buying one, everyone will buy two units.  However, by pricing a single unit at such a high level they give people the impression that the good is worth more – fundamentally, in this case, the value associated with buying the good is related to its price.
  2. Individuals are time inconsistent.  Realising that one way to prevent themselves being in a situation where they suffer from this inconsistency, they want to limit the amount of the product they buy.  We discussed this with chippies a while back.  If there are two sets of customers that value the good differently, and a time inconsistency problem, this could be a form of PRICE DISCRIMINATION between the two sets of consumers.  In essence we could have one set of customers that values the commitment device strongly, and one that doesn’t!

In both cases we have to assume that there will be no resale – the search cost associated with finding a matching partner for resale is prohibitively high.  However, given this assumption both explanations could work – people could determine there value of a good based on a related price, or it could be a form of discriminating between customers based on how heavily they view buying a small packet as a commitment device.

I prefer the second explanation, as we don’t have to make an additional assumption regarding what people value.  I find the first explanation believable as well.

The main lesson I take from this is, market pricing is a crazy thing that is hard to understand – but it gets the job done.  I doubt that we can effectively try to determine what the right prices are ourselves, when we can’t understand the mechanisms firms use to maximise their profit.  So let the market do its thing, and use the government to solve identifiable market failures and co-ordination problems and redistribute.

I realise this is the lesson I take from everything …

Matt Nolan

Strategy spaces and monetary policy

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Over at Worthwhile Canadian Initiative, Nick Rowe suggests that central banks should find something else to discuss instead of interest rates.  The analogy provided is that of oligopoly competition: namely how the Cournot-Nash and Bertrand games have exceedingly different outcomes, even though the only superficial difference is that one game involves choosing output and the other game involves choosing price.

However, in the same way I don’t believe the difference in these games is just the product of “framing”, I am not sure if the call to arms against using interest rates as a focal point is necessarily that compelling.

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Matt Nolan

Love is a prisoner’s dilemma

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Well that is one of the interpretations from the Google autocomplete results for the search “how can I get my boyfriend/girlfriend to” (ht Offsetting Behaviour).

Why?  Well the third highest result when asking about boyfriends, and the fifth highest when asking about girlfriends is “how can I get my boy/girl to love me again”.  The prevalence of the search suggests that love is something that is valued by both sexes, yet even in terms of a relationship (which is partially just a tacit agreement for providing the service of love) there appears to be an underprovision of love.  (More evidence of a hole in love provision?)

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