The economics of love

My latest piece in the Dom post was about the “economics of love” – where I compared a relationship to a firm, and worked out some basic conclusions.

Now, the article in the Dom was focused on relationships, specifically marriages.  However, there are times where the optimal formation for a relationship is more akin to a set of “independent contractors negotiating and renegotiating each time they want to work together to provide a product”.

So what factors are likely to be behind this?

  1. Option value:  Available and interesting individuals appear in your life, of a varying quality, according to some probability distribution.  If you commit to a relationship, it is very difficult/costly to take up a “better” person if you run into them.  By saying as an individual contractor, you are able to take advantage of these opportunities.
  2. Diminishing marginal utility:  Often, the more you consume something, the less additional value you gain from it.  Setting up your relationship profile such that you enter temporary contracts with a number of different individuals may provide higher overall satisfaction than committing to only one permanent contract.
  3. Diversifying risk: Focusing on one relationship involves taking on all the idiosyncratic risk associated with that individual – if you set up an appropriate portfolio of relationships, you may be able to remove this risk while still achieving the same expected return.

So the optimal solution to the formation of your relationship is a complicated issue – there are the benefits of a strict relationship mentioned in the article, and benefits for non-strict relationship status as mentioned here.  I have only covered some of the very basics, in comments feel free to add some more 😉

  • Bill

    Given that I am offering a perishable product whose quality will decline over time at an unknown rate, I figure it’s consumption-smoothing for me to lock in promises of a future relationship. Of course, that arrangement creates moral hazard, but she always has a potentially costly exit option that tends to militate against taking advantage of the contract.

  • “For an economist, a relationship can be viewed in the same way as a firm. Just like a firm, a relationship involves a number of individuals (usually two) who can work together to create a good or service – in this case the service created is the benefit of a relationship.”
    No, the relationship isn’t like a firm. it is a household. Households involve individuals creating goods or services and a household is formed by the parties in a relationship. As Demsetz has argued the important – and for him defining – characteristic of a firm is that it produces for (and only for) those outside the productive unit. Households produce for those inside the unit. The relationship is formed to produce services in those in the relationship.

    • Hi Paul,

      I do not disagree with that fact – but to be fair the article was tongue-in-cheek.  Both firms and households involve the inter-relationship of individual agents, and the only real purpose was to show how the same methodology can be applied to thinking about romantic relationships – typical Becker.

      Also, if we view the firm as creating a good outside the firm we also need to recognise that this only occurs because there is some expected benefit from selling said good – benefit that is internal to the agents in the firm, in the same way that “at home” production by households creates internal benefit.  After all, it is this fact that allow us to use the same methodology in the first place.

      • “Relationships are like households” just doesn’t quite have the same ring to it…

  • Agnitio is right the household version doesn’t sound as good! As to profit being internal to the “firm” as Demsetz notes (at least from memory I think it as Demsetz) profits are zero in equilibrium so the residual claimant really plays not role in the standard neoclassical model. Also even if profit (there are no on-the-job benefits) is the motive for production a firm is unnecessary to achieve the end, within the neoclassical model. As Foss (2000) notes “With perfect and costless contracting, it is hard to see room for anything resembling firms (even one-person firms), since consumers could contract directly with owners of factor services and wouldn’t need the services of the intermediaries known as firms” . All this follows from what Spulber (2009) calls the “neoclassical separation theorem”, which he says makes three assertions: “(1) firms maximise profits, (2) firms generate gains from trade compared to autarky, and (3) firm decisions are separate from consumer decisions”.

    • The structure of the firm depends on the incentives of individual agents, and therefore on the type of contracts they make in that environment given the endowment of resources and other institutions.  This process is the same as the evolution of any social structure – and it was merely that metaphorical point I was aiming to get at in the article.

      Now I’m waiting for someone to point out that using the term metaphor to describe the process of economic modeling is inappropriate, because we do not really believe our models represent reality that directly – instead they should be seen as a caricature, as they exaggerate a given element so we can explicitly describe and discuss the behaviour of said element.

      It is all this constant debate that makes blogging awesome 😉

      • Whoah, are you trying to start a Sugden vs McCloskey methodology war here?! I think that deserves a post of its own 😉

        • Isn’t that the next stage where I say caricature is inappropriate?

  • Lady in Red

    I love how its all men commenting here.

    • Men obviously think hard about how to conceptualise love – that’s probably a good thing right.

      Personally I think hard about anything to do with economics, so that’s why I’ve been commenting here.