Good overview by CNBC on what GDP is and how it is calculated. It is also useful to hear why it tends not to be a good measure of standard of living.
Good overview by CNBC on what GDP is and how it is calculated. It is also useful to hear why it tends not to be a good measure of standard of living.
Diane Coyle wrote a piece on the Project Syndicate website discussing that computers are designed to think like economists. Artificial intelligence (AI) is a faultless version of homo economicus as it is a rationally calculating, logically consistent, ends-orientated agent capable of achieving its desired outcomes with finite computational resources. They are perceived as much more effective than a human in achieving the maximum amount of utility for an individual. Coyle does go onto say that economists today cannot offer a measure of actual utility.
Jeremy Bentham’s famous formulation of utilitarianism is known as the “greatest-happiness principle”. It holds that one must always act so as to produce the greatest aggregate happiness among all sentient beings, within reason. John Stuart Mill’s method of determining the best utility is that a moral agent, when given the choice between two or more actions, ought to choose the action that contributes most to (maximises) the total happiness in the world. However this assumption can produce some unease.
There is no doubt in certain aspects of society AI is extremely useful and can cut down bureaucracy and lead to improved efficiency in everyday life. The real issue extends beyond the use of algorithmic decision-making in corporate and political governance, and strikes at the ethical foundations of our societies. As Coyle points out we need to engage in self-reflection and decide if we really want to encode current social arrangements into the future.
You maybe aware that the rugby game this morning (NZ time) between Ireland and the New Zealand All Blacks in Dublin created history. It was the first time that Ireland have beaten the All Blacks on Irish soil. Remember they did beat the ABs in Chicago two years ago.
Irish supporters, including myself, will take great pleasure in talking about such a result – lets face it we lost it in the last few minutes 5 years ago on Irish soil at Croke Park in Dublin. What all this alludes to is the fact that as part of this entertainment comes without the public paying for it, the public benefits from an externality.
Those who travelled to Dublin (and those local supporters) for the game and will have no doubt spent a significant amount of Euros tonight in the bars and restaurants around town. Nevertheless the satisfaction (utility) derived in Euros from the game would have been much greater than the price they paid for the ticket. This suggest that there is a lot of consumer surplus present – the difference between the price that a consumer WOULD BE WILLING TO PAY, and the price that he or she actually HAS TO PAY. The success of the Irish team will boost merchandise sales and interest for the World Cup next year in Japan but more importantly it has been good for rugby in general with throwing the World Cup wide open. When the All Blacks play overseas there are significant externalities whether it be the revenue generated in hosting the match or the social benefits to society. Furthermore the lead up to the game brings about a sense of delayed gratification (Behavioural Economics). Looking ahead the fact that people have paid for tickets to the World Cup means that they can reap the pleasures of anticipation of being there. Research (Smarter Spending – see previous post) shows that owning material things from expensive homes to luxurious cars turn out to provide less pleasure than holidays, concerts or even witnessing Ireland beating the All Blacks – where were you when Ireland beat the All Blacks in Dublin? With Ireland’s win national pride increases, along with patriotism and people feeling better about themselves. This is turn brings people together and boosts well-being of the nation. As for the All Blacks they will learn from this defeat as they did against the Springboks earlier in the season. All in all it makes for a great World Cup with supporters experiencing the pleasures of anticipation.
Action bias is a situation where we would rather be seen doing something than doing nothing. This has been the case in numerous government elections as the voting population like to see some action from politicians when in some cases the best option is to let the economy run its course. President Nixon (US President 1969-74) was a great one for doing something even though it would have been better to do nothing – I refer to the wage and price controls introduced in 1971 – the controls produced food shortages, as meat disappeared from supermarket shelves and farmers drowned chickens rather than sell them at a loss. So when the economy is doing badly the government maybe tempted to intervene, even if the risks associated with the changes not necessarily outweigh the possible benefits. Furthermore if an economy is doing well policy makers may feel that they shouldn’t do anything even though the changes could improve the economy further.
According to classical assumptions in economics, when a people face decision problems involving uncertainty, they should choose what to do according to their utility from the possible outcomes and the probability distribution of outcomes that follows each possible action. Bar-Eli, Azar, Ritov, Keidar-Levin, & Schein, 2007
In a 2007 study, Michael Bari-Eli at the Ben Gurion University of the Negev, Israel, analyzed 286 professional soccer penalty kicks. They discovered that goalkeepers almost always jump right or left because the norm is to jump — a preference for action (”action bias”). The goalkeepers jumped to the left 49.3% of the time, to the right 44.4% of the time, but stayed in the centre only 6.3% of the time. Analysis revealed that the kicks went to the left 32.2%, to the right 39.2% and to the centre 28.7% of the time. This means that the goalkeepers were much more likely to stop a kick if they had just stayed put – see table below.
The table above suggests that the decisions taken by the kicker and goalkeeper are made roughly simultaneously. The fact that the directions of the kick and the jump match in 43% of kicks rather than in 0% or 100% of the kicks suggests that neither kicker nor goalkeeper can clearly observe what the other chose when choosing their action.
A goalkeepers’ decision making.
In order to suggest a best option for goalkeepers it is necessary to examine the probability of stopping the ball following each combination of kick and jump directions. The table below presents the average saving chances using the formula
Number of penalty kicks saved ÷ Number of penalty kicks x 100
Jumping left = 20 ÷ 141 x 100 = 14.2%
Staying Centre = 6 ÷ 18 x 100 = 33.3%
Jumping right = 16 ÷ 127 x 100 = 12.6%
The research conclusions state that goalkeepers jump to the right or the left during penalty kicks more than they should. In analysing the 286 kicks Bar-Eli et al show that while the utility-maximising behaviour for goalkeepers is to stay in the goal’s centre during the kick, in 93.7% of the kicks the goalkeepers chose to jump to their right or left. This non-optimal behaviour suggests that a bias in goalkeeper’ decision making might be present. The reason that they suggest is ‘action bias’. However you also need to look at the psychological aspects of a goalkeeper. Arsenal and former Chelsea goalkeeper Petr Cech said that he never liked to stay in the centre as it might look to the fans that he wasn’t trying. Although he would be in a good position to save a penalty that was kicked down the centre, he would feel a lot worse if he stayed in the centre and the ball went into the goal either side of him.
Bar-Eli, M., Azar, O. H., Ritov, I., Keidar-Levin, Y., & Schein, G. (2007). Action Bias Among Elite Soccer Goalkeepers: The Case of Penalty Kicks. Journal of Economic Psychology, 28(5), 606-621.
I was interested in an article about approaches to pricing – ‘Good, Better, Best’ by Rafi Mohammed from the September – October 2018 Harvard Business Review. Know as G-B-B pricing it involves adding or subtracting product features to create variably priced bundles targeted to customers of varying economic means or those who value features differently. This model is very evident with many products and services – for instance the airline industry:
However with all three tickets the basic service is the same – e.g. flying a passenger from Auckland to Doha. Below is another example with an oil change. Some G-B-B strategies are more general responses to consumer psychology.
In giving consumers too much choice a lot will feel overwhelmed and confused – the paradox of choice which Barry Schwartz studied in his book of the same name. However a G-B-B plan helps consumers focus on particular aspects of each option and direct them to consider the incremental value and spending. With three choices consumers tend to decide whether to buy the product or not and they typically see the ‘Good’ as the default option which makes them amenable to an upgrade.
One of the key insights to behavioural pricing is that items that don’t sell can change what does. The William-Sonoma chain once offered a fancy bread maker for $279. They later added a somewhat bigger model, pricing it a $429. The $429 model was a flop as unless you require it for major catering purposes. However the $279 model nearly doubled. Clearly, they were people charmed by the idea of a quality breadmaker from William-Sonoma. The only thing that stopped them from buying was the price. It seemed high at $279. Once the store added the $429 model, the $279 machine was no longer seen as such an extravagance. It could be rationalised as a useful product that did nearly everything the the $429 model did, at a bargain price. Adding another price point, even though hardly anyone chose it, increased the price consumers were willing to pay for a breadmaker. William-Sonoma didn’t plan things this way but since then retailers have gotten wise to contrast effects of prices. Tversky and Simonson (1992) identified two rules of manipulative retail pricing.
1. Extremeness aversion – this means that when consumers are uncertain, they shy away form the most expensive item offered or the least expensive: the highest quality or the lowest quality; the biggest or the smallest. Most favour something in the middle therefore the way to sell $800 shoes is to display some $1,200 shoes next to them. The same product may appear attractive on a background of less attractive alternatives and unattractive on a background of more attractive alternatives.
2. Trade-off contrast – go into a leather a leather goods store and there will be dozens of handbags, none of them indisputably the best by anyone’s standards. One bag can be:
The customer being loss averse is uncomfortable with the abundance of choice and fear that she will pick the wrong bag. The trade-off contrast rule says when item X is clearly better than an inferior choice Y, consumers tend to buy X – even when there are many other choices and it’s impossible to say whether X is the best choice of all. Just the fact that X is better than Y is a selling point, and it carries more weight than it reasonably should. Apparently the shopper tries to reduce anxiety by choosing an item that can be justified – she is able to talk herself into X because it’s so much better than Y.
G-B-B pricing structure
The G-B-B pricing structure for most companies will be to identify a product which is Better and subtract features to create Good and add features to create Best.
Better – features = Good
Better + features = Best
As mentioned earlier too much choice is risky. Research by Sheena Iyengar and Mark Lepper which offered samples of jam to shoppers in an upscale grocery store – results:
Before a company can begin to identify the potential benefits of G-B-B it must address 3 questions:
1. Does the feature have mass appeal or low appeal?
2. How would adding or subtracting it affect the cost of producing the good or offering the service?
3. And is it a “fence” attribute—one that constitutes a barrier preventing existing customers from crossing over to something cheaper?
Many retailers focus on the Best option as they see this as the greatest opportunity to generate revenue but fence attributes is an area that is the most challenging task to G-B-B because of the risks of existing customers moving to lower priced options and thereby reducing sales. Fence attributes prevent this, by making the downgrade a difficult, unpleasant, or painful choice. For instance, when the New York Times launched its digital subscriptions, in 2011, it moved to a G-B-B model in which the physical paper (which many subscribers were loath to discontinue, and which is costly to print and deliver) served as a fence attribute. That fence is effective enough to support a hefty price differential: An all-access digital subscription currently costs $324 a year, whereas adding print delivery brings the price to $481 and up, depending on location.
G-B-B and The Economist subscription
I recently received a letter from The Economist (see image below) concerning the renewal of my subscription. Could the same pricing system of the New York Times be applied here? Does the print package acts as the fence attribute and is it effective enough to support the price differential? The combination of high appeal and high cost means that if the feature is part of the Better but not the Good offering, relatively few people accustomed to Better (that is, existing customers) will consider Good—but those willing to do without the feature can enjoy a significant discount. 1 year Subscription is:
Good – Digital Package – NZ$460
Better – Print Package – NZ$530
Best – Print + Digital Package – NZ$640
Most companies could implement some form of G-B-B. Every company already offers the equivalent of a Better offering, and even if some firms can’t implement both Good and Best, many could gain new customers, additional revenue, or both by adding either a Good or a Best to their lineup.
‘Good, Better, Best’ by Rafi Mohammed. September – October 2018 Harvard Business Review.
Priceless (2010) – William Poundstone
Below is an excellent video by Gillian Tett of the FT looking at banking culture. She discusses the ‘flaw’ in Alan Greenspan’s thinking and how culture has been overlooked at the cost to the global economy 10 years on from the financial crisis. By understanding the role of culture in banking, are we more resilient to another crisis now? She also talks of trust in the modern economy and in order to build it you must understand it and how human culture works. And once trust or credit is lost it is very hard to regain.
Conspicuous consumption was introduced by economist and sociologist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status.
Economists and sociologists often cite the 1980’s as a time of extreme conspicuous consumption. The yuppie materialised as the key agent of conspicuous consumption in the US. Yuppies didn’t need to purchase BMWs or Mercedes’ cars for example; they did so in order to show off their wealth. This period had its origins in the 1930’s with Austrian economists Ludwig von Mises and Fredrick von Hayek – the latter being the author of “The Road to Serfdom”, in which he said that social spending rather than private consumption would lead inevitably to tyranny. Margaret Thatcher (UK Prime Minister 1979-1990) and Ronald Reagan (US President 1981-1989) believed in this ideology and cut taxes and privatised the commanding heights in a move to a free market environment.
So-called Veblen goods (also as know as snob value goods) reverse the normal logic of economics in that the higher the price the more demand for the product – see graph below
Over the last three decades conspicuous consumption has accelerated at a phenomenal level in the industrial world. Self-gratification could no longer be delayed and an ever-increasing variety of branded products became firmly ingrained within our individuality. The myth that the more we have the happier we become is self-perpetuating: the more we consume, the less able we are to tackle the myth.
However a recently published book The Sum of Small Things: A Theory of the Aspirational Class by Elizabeth Currid-Halkett looks at how the power of material goods as symbols of social position has diminished due to their accessibility. Although the lower income groups must dedicate a greater proportion of their income to basic necessities, they spend a higher share of their income to conspicuous consumption than the rich do. Between 1996 and 2014 the richest 1% fell further behind the national average in the percentage of their spending dedicated to bling. The middle income quintile went the other way: by 2014 they spent 35% more than the average as a percentage of their annual expenditure.
According to Elizabeth Currid-Halkett the higher income groups have moved away from buying stuff – materialism – to more subtle expenditures that reveal status and knowledge. The most common of them being education for their children.
Those in the top 10% of income earners now allocate four time as much of their spending to school and university compared to 1996, whereas for other income groups spending has remained fairly constant. However one could say that fees for both school and university have increased over that period of time. The upper class also invest heavily in domestic services such as housekeepers, freeing up time that the less fortunate must spend on chores.
Rather than frittering away that precious leisure time on frivolities, as Veblen’s leisure class did, they devote it to enriching experiences, like attending the opera, holidaying in far-off lands and working out at fancy gyms. Their children, by tagging along and thus absorbing this “cultural capital”, develop the sophistication needed to win admission to selective universities, vastly increasing the odds that they will form the next generation’s elite. The modern equivalent of Victorian worsted-stocking wearers are hipsters, who imitate the wealthy’s penchant for farmers’ markets and fair-trade lattes, even if they cannot afford a cruise to Antarctica. Source: The Economist – August 5th 2017
A recent research paper entitled “The Smile-Seeking Hypothesis: How Immediate Affective Reactions Motivate and Reward Gift Giving” by Adelle X. Yang, Oleg Urminsky discussed the fact that when we decide on gifts for others we often do not choose what the recipient really desires. It is assumed that the person giving the gift wants to be rewarded with a non-monetary currency called ‘gratitude’ – this can be in the form of hugs, kisses and smiles. It is the latter (smiles) that the research focuses on and asks the question is gratitude creating poor incentives. Prior research has generally explained such preference mismatches as decision makers mispredicting recipients’ satisfaction. They propose that “smile-seeking” motive is a distinct cause for these mismatches in the context of gift giving.
The gift giver has the choice of getting an affective reaction to the gift versus the gift’s long-term utility – satisfaction. Adelle X. Yang, Oleg Urminsky framed an experiment around Valentines Day. They picked 3 pairs of appropriate gifts – one of which would be more likely to induce an appreciative response versus a gift more likely to have more long-term satisfaction:
They recruited 295 volunteers online on 13th February, the day before Valentine’s Day, in order to standardise and have an appropriate mood. They were asked the following:
Men seemed to go for the gift that would induce hugs and smiles over the long-term satisfaction of the present. Women on the whole were the opposite except for the biscuits and the fruit – the majority of women preferred the sugar boost over the long-term benefit of healthy fruit. This is despite what they had said about the long-term value of fruit.
If the gratitude market was working correctly the long-term option would be more appropriate.
Cash as a gift – is it rational?
I have blogged on this topic before using an episode of Seinfeld. It seems rational that Jerry gives Elaine $182 for her birthday but it really is inappropriate. Cash replaces social norms by market norms and ruins the feelings usually evoked by a typical non-cash birthday gift. The deadweight loss of giving is the loss of efficiency that occurs when the value of the gift to the recipient is less than the cost of the gift to the giver. In this case, economists argue that cash would be a more efficient gift. See video below.
Source: The Economist ‘The Economics of Gifts’ – June 30th 2018
The Oxford University Press ‘Very Short Introduction’ series are excellent publications and particularly useful for extending students at A Level. Below is a video of Michelle Baddeley, author of Behavioural Economics: A Very Short Introduction, who gives her top 10 things you should know about the science of behavioural economics and how it relates to our everyday lives. You can find more videos on VSI here.
Traditional economic measures, such as gross domestic product (GDP), productivity and economic growth remain fundamentally important but they’re not the whole picture. We think economics is ultimately about improving people’s living standards but you can’t look at GDP as the indicator to focus on.
US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile.
The introduction of the living standards framework in New Zealand takes into account environmental resources, individual and community assets, ‘social capital’ – which includes cultural norms and how people interact – and human capital, such as people’s health, and their skills and qualifications.
By living standards, the NZ Treasury means more than income; it’s people having greater opportunities, capabilities and incentives to live a life that they value, and that they face fewer obstacles to achieving their goals.
Limitations of GDP as a measure of standard of living – see list below.