Saturday, January 29, 2011

Dan Ariely on how people really make choices

The economics textbook story of 'rational choice' is both simplistic and complex. The simplistic part is found in the assumptions underlying rational choice. These include such things as the assumption that we have relatively stable and well-defined preferences about all the goods and services available to us and that we can make consistent choices that, given the resources at our disposal, allow us to maximize our utility or well-being. It's fair to call this simplistic because it ignores so much of what is known about how people actually make choices.
   The complexity of the textbook story is also evident to the student: the apparatus of indifference curves and budget lines, done in two dimensions on the blackboard, then mathematically in n dimensions (for n different goods), and later extended from choices made in one period of time to choices made over time as well, possibly into an infinite future. The technical complexity helps keep students focussed on mastering that; it's easy to forget to ask the broader questions of whether the entire framework is appropriate. After enough time working within this framework, it starts to look like the natural way to see things. People who see things in other ways are in other departments and disciplines like psychology, and contact with them is soon lost. This is part of how the process of indoctrination works.
   However, the good news is that in recent decades more and more economists have been paying attention to what psychologists know. My impression is that they're still a fairly small minority, but a growing one. To date, their work has had only a minor impact on the mainstream textbook content and students wanting a broader view will have to do some work on their own.
   The recent books by Dan Ariely of Duke University ("Predictably Irrational", 2008 and "The Upside of Irrationality", 2010) are a good place to start.

To get a flavour of their content, here are a couple of talks by him from
(a) a talk on "Predictably Irrational":
(b) a talk on "The Upside of Irrationality":

He has also given talks at TED:


Monday, January 24, 2011

Hidden pollution

We claim in the Anti-Textbook that externalities are not only pervasive but that they're important, are not adequately addressed by policy and are not given nearly adequate acknowledgement in the economics textbooks. If you were paranoid, you might suspect that this had something to do with a desire to make the outcomes of the economic system look a lot better than they actually are...
   As brief update, I offer this recent article from The Guardian: "Study maps chemical residues in children's diets". While that reports on food in France, I doubt the results would be much different for anyone reading this, no matter where you live.
   Closer to home, at least for me, is this report from the Canadian Broadcasting Corporation about antidepressants in the water. For me, the surprise is not that drugs from pills we ingest end up being excreted and wind up in the water supply. It was that a quarter of the population in Montreal is reportedly taking anti-depressants (like amitriptyline, whose chemical structure pictured on the right).


Saturday, January 22, 2011

Why not 'follow' the blog?

If you visit this blog from time to time, looking for a new post, you could save time by clicking on 'follow' on the top left hand corner of this page. (You see that only if you have a google account and are signed in.) You get notified automatically if there's a new post.


Advertising and the creation of wants

Back last summer when Tony Myatt and I met some textbook authors in a session we organized at the meetings of the Canadian Economics Association, the question of of how the textbooks deal with advertising. I recall that my claim about how the subject is largely ignored was met with astonishment by Chris Ragan of McGill University, co-author of one of the major texts in Canada, Ragan and Lipsey's Economics. He clearly thought I was out to lunch and didn't know what I was talking about.
   Something I was reading today reminded me of that incident and I looked up 'advertising' in Ragan's own text. There is one entry in the index: "Advertising, as entry barrier, 270-271." This appears in the chapter on Imperfect Competition and Strategic Behaviour. I double checked and there's not a word in the chapter on consumer behaviour.
  The section in pp.270-271 describes a strategy of "brand proliferation" by producers as a way of trying to deter the entry of new firms. Ragan and Lipsey note that "such brand proliferation is no doubt partly a response to consumers' tastes" -- note that the tastes are implicitly assumed to be already formed before producers act to create brands to satisfy those tastes and then start saturation advertising of the brands, raising the costs for new firms entering the market, who then have to bear high advertising costs so that consumers can hear about their products over all the noise. Here, advertising is socially wasteful: it's like all the shouting that goes on at a party; you have to shout to make yourself heard because everyone else is shouting. But here, to make the analogy more precise, others have conspired to drown you out in the hopes that you won't bother saying anything at all.
  But, Ragan and Lipsey write, advertising is not all bad. It, "of course, serves purposes other than that of creating barriers to entry. Among them it performs the useful function of informing buyers about their alternatives." No doubt they had something like this in mind...

     I got curious about what things were like back in the days when I was a student. I first studied economics from Richard Lipsey, Gordon Sparks and Peter Steiner's Economics (2nd ed., 1975). I don't have that any more, but I have got the 3rd edition from 1979.
     Sure enough, advertising first appears there in the chapter on Industrial Organization and Theories of Imperfect Competition. There's nothing in the earlier chapter on Household Consumption Behaviour. But that's not the end of the story. This 1979 book had a chapter on "Who Runs the Firm, and for What Ends?" It gives space to a critical discussion of Galbraith and Nader's views, including ideas about the extent to which demand is influenced and shaped by advertising (pp.308-310). An extensive discussion of what's there would take this post too far afield, but this little sample suggests that things have changed, and not for the better. The issues that Galbraith and Nader raised have not gone away, but an acknowledgement of them in the textbooks has.


Friday, January 21, 2011

Unsustainable fisheries and the power of industry over policy

One of the things we tried to do in The Economics Anti-Textbook was to point out some important problems in the world that are not being adequately addressed by policy and, at the same time, are being strangely ignored or underplayed by economics textbooks. A big issue, in our view, is the on-going depletion and destruction of wild fisheries around the world.

   On 31 December, The Guardian Weekly reprinted this piece from The Washington Post's environmental reporter, Juliet Eilperin, under the headline "Fishing in the wild is heading south." It reports that "some of the nations that have traditionally sought out the most seafood, or depend on it as a primary food resource, are resisting steep cuts in fishing quotas", going on to quote some typical bullshit from a spokesman for the Japanese Fisheries Agency.
   The textbooks are generally loathe to point out the realities of corporate power and the supine nature of governments in the face of such narrow interests. Probably the one major exception is the story of 'regulatory capture' where government regulators get unduly influenced by the industries that they are supposed to be regulating. Here's an example from a leading Canadian text in a section on 'Regulation of Oligopolies':
The record of postwar government intervention into regulated industries seems poorer in practice than its supporters had predicted. Research by the University of Chicago Nobel Laureate [sic] George Stigler (1911-1991) and others established that in many industries, regulatory bodies were 'captured' by the very firms that they were supposed to be regulating. As a result, the regulatory bodies that were meant to ensure competition often acted to enforce monopoly practices that would have been illegal if instituted by the firms themselves. [from Christopher Ragan and Richard Lipsey, Microeconomics, 13th ed., p.296]
This fits nicely into the story some like to tell of government as serial bungler when it comes to dealing with market failures. Naturally, the 'captured by regulators' line becomes in their hands an argument for deregulation and letting corporations do as they want! An alternative approach is that of Ralph Nader, who has proposed simple and cheap ways of organizing consumers of regulated industries to defend their interests and counterbalance the power of industry.


Saturday, January 15, 2011

The Economics Anti-Textbook reviewed

A lengthy review of The Economics Anti-Textbook on followed by an extensive discussion. (The book has not yet been reviewed in professional journals.)


The Circular Flow, in context

I'm giving a course this term that includes some introductory macroeconomics this term. It begins with the usual circular flow picture:

[Source: here]

This picture of an economy is fine as far as it goes, but it lacks a broader context.
  The text I'm using (Mark Lovewell's Understanding Economics, Toronto 2009) does the old trick of describing "environmental sustainability" as one of the central 'economic goals' in Chapter 1, and then, after that one paragraph, never mentions the troublesome concept again. This tactic (what we call "note and forget" in The Economics Anti-Textbook) is a good way for authors to defend themselves against the charge that they ignore a critical issue. ("There it is on page 20! What more do you want?")
  I still remember the impact of actually seeing for the first time in a diagram a picture of that circular-flow economy embedded in the broader ecosystem. It was in an article by Herman Daly, one of the pioneers of ecological economics, and it looked something like this:

  The picture neatly summarizes the limited nature of the matter to which we have access, raises questions about the capacity of the ecosystem to absorb matter (waste) discharged into it from the economy, the extent of recycling, and the what limits there might be to the growth of the economy within the ecosystem. By altering the size of the 'economy' box relative to the size of the ecosystem, it can illustrate the transition we've made from the 'empty world' to the 'full world', where our demands are pressing up against the limits of the ecosystem to supply them. (On the last point, for further references, see The Economics Anti-Textbook, p.253).
  If the text I'm using were serious about saying anything meaningful about "environmental sustainability", it would have a diagram like this in it.


The spark that lit the fire in Tunisia

The sudden toppling of the brutal and kleptocratic regime of former Tunisian President Zine el Abidine Ben Ali was a highlight of last week. The Guardian described how it began:
The man who set off the chain of events that has shattered Tunisia's carefully constructed facade of stability is Mohamed Bouazizi, a 26-year-old living in the provincial town of Sidi Bouzid, who had a university degree but no work. To earn some money he took to selling fruit and vegetables in the street without a licence. When the authorities stopped him and confiscated his produce, he was so angry that he set himself on fire and died. 
Ten days of demonstrations in Sidi Bouzid followed, then spread to the capital, Tunis, 160 miles away, and grew from there.

Within four weeks of Bouazizi's fiery suicide, it was game over for Ben Ali and he fled to Saudi Arabia.

  The sequence of events reminded me of "Sparks and Prairie Fires: A Theory of Unanticipated Political Revolution" an elegant and insightful paper by Timur Kuran, now at Duke University, that I read with pleasure twenty years ago.
  Here's the paper's abstract:

A feature shared by certain major revolutions is that they were not anticipated. Here is an explanation, which hinges on the observation that people who come to dislike their government are apt to hide their desire for change as long as the opposition seems weak. Because of this preference falsification, a government that appears unshakeable might see its support crumble following a slight surge in the opposition's apparent size, caused by events insignificant in and of themselves. Unlikely though the revolution may have appeared in foresight, it will in hindsight appear inevitable because its occurrence exposes a panoply of previously hidden conflicts. 

In this particular case, private dissatisfaction with Ben Ali's regime was no secret, but it could not find a proper public expression. Kuran's paper neatly shows how a 'bandwagon effect' develops and a revolt can snowball from an initially small demonstration in a provincial town to mass demonstrations in the capital that can topple governments.


Postscript: As a brief follow-up, the Guardian reported today (17 Jan.) on a series of further fiery suicides in other countries by people no doubt hoping to spark another successful revolt. As a comment to the original post points out, rising prices -- particularly for food -- is playing a role in sharply rising discontent.
   These political gasoline-fueled suicides bring to mind the powerful 1979 novel by Polish novelist Tadeusz Konwicki, A Minor Apocalypse, about a man wandering through Warsaw with a can of gasoline on the last day of his life, preparing to set himself on fire in front of Party headquarters.

Thursday, January 6, 2011

Predictable Irrationality

With another year comes another introductory economics course. I'm using Understanding Economics. A Contemporary Perspective (by Mark Lovewell of Ryerson University) for a one-term course in which the students are supposed to learn something of both intro micro and intro macro. It was discouraging to read the following in the very first paragraph:
Economists assume that people customarily engage in rational behaviour, meaning that each one of us makes choices by logically weighing the personal benefits and costs of every available action, then selects the most attractive option based on our individual wants.... [T]he assumption of rationality is ... significant. As long as it is met, human behaviour can be fruitfully analyzed and predicted.
This clearly implies that if behavior is not rational, human behaviour can't be fruitfully analyzed and predicted. But that's just not correct. Irrational behaviour doesn't mean that behaviour is random and unpredictable. Instead, people can make systematic mistakes: mistakes that are therefore predictable.
  Dan Ariely, a professor of psychology and behavioural economics at Duke University, has made that case very persuasively in his entertaining and informative book, Predictably Irrational. He's also got a thought-provoking blog here.

  Of course marketing people know all about predictable irrationality too. For example, in his 2010 book, Priceless: The Myth of Fair Value (and How to Take Advantage of It), William Poundstone has a whole chapter on how restaurant menus are put together to influence people's purchase decisions. He reports that a Westin hotel in Manhattan has a truffle and goji berry bagel on the menu for $1,000. Things being what they are in Manhattan, some might actually be sold to hungry hedge fund managers looking for a quick bite, but the main function of a menu item like that is to make the other overpriced things on the menu look cheap by comparison. Tricks like this really work. In contrast, in the theory offered in the standard microeconomics textbook, the presence of such an irrelevant alternative as a $1000 bagel would have no effect on your rational choice among the other items. 
  As we note in the Anti-Textbook, behavioural economics has yet to make any real impact on the textbooks, but -- today at least -- I'm feeling optimistic that reality can't be overlooked for too much longer.