Matt Nolan

The economics of love

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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 😉

jamesz

Do lawyers really understand economics?

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With more and more policy being founded in economic analysis, lawyers are having to become ever more familiar with economic concepts. Competition law (antitrust to Americans) is an area that has become particularly mired in economic analysis. In New Zealand we have seen plenty of debate over large cases in which anti-competitive behaviour has been alleged. So it is apropos to find two economists asking whether “antitrust [is] too complicated for generalist judges”:

We find that decisions involving the evaluation of complex economic evidence are significantly more likely to be appealed, and decisions of judges trained in basic economics are significantly less likely to be appealed than are decisions by their untrained counterparts. Our analysis supports the hypothesis that some antitrust cases are too complicated for generalist judges.

One of the authors has an interesting and detailed (for a blog post) discussion here. It’s certainly a worthwhile topic for investigation, since the decisions in these cases can be extremely expensive for the parties involved. If there is enough evidence, does it point to the need for specialist judges in this field?

jamesz

Sex offender registration

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Keeping up the theme of interesting empirical results as I catch up on my journal reading, here’s some research out of the US on the effect of maintaining a register of sex offenders and notifying the community where they reside.

Sex offenders have become the targets of some of the most far-reaching and novel crime legislation in the U.S. Two key innovations in recent decades have been registration and notification laws which, respectively, require that convicted sex offenders provide valid contact information to law enforcement authorities, and that information about sex offenders be made public. …We find evidence that registration reduces the frequency of sex offenses by providing law enforcement with information on local sex offenders. As we predict using a simple model of criminal behavior, this decrease in crime is concentrated among “local” victims (e.g., friends, acquaintances, neighbors) with no evidence of less crime occurring against strangers. We also find evidence that notification has reduced crime, but not, as legislators anticipated, by disrupting the criminal conduct of convicted sex offenders. Our results instead suggest that notification deters nonregistered sex offenders, and may, in fact, increase recidivism among registered offenders by reducing the relative attractiveness of a crime-free life.

So notifying the community, probably the most controversial aspect of sex offender registration policies:

  • Deters new offending; but,
  • Encourages repeat offending.

The policy-relevant part is probably the overall reduction, but it’s interesting to note the contrast between common wisdom and the results: the notion that notification helps the community protect their children appears to be unfounded and it actually makes previous offenders more dangerous.

jamesz

Does anyone really read reviews?

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It’s common to hear people complain about negative reviews, and they’re the ones that seem to garner all the press. If you’re a New Zealand music fan you’ll be familiar with Simon Sweetman’s famously scathing reviews of popular bands, for example. It’s also becoming much more common to hear of business collapsing at establishments that receive poor online reviews. Because of that I was fascinated to read a recent study that examined whether demand for wine is affected by expert reviews. The study conducted in Sweden found that there is an effect, but it’s not the negative review that people act on:

The effect of a positive review peaks in the week after the review with a demand increase of 6 percent. …There is a weak positive effect on demand of a review per se and no effect of a negative review. …The demand enhancing effect of a favorable review is greater for higher priced wines, for red wines and lower for reviews that appeared in tabloids.

Now put this together with what we know about wine tasting:

[The reseracher] took a middling Bordeaux and served it in two different bottles. One bottle was a fancy grand-cru. The other bottle was an ordinary vin du table. Despite the fact that they were actually being served the exact same wine, …[f]orty experts said the wine with the fancy label was worth drinking, while only 12 said the cheap wine was.

So being an expensive wine gets you a good review and a good review boosts sales. What can we take from this? Well, you’ll get the best drinking experience from a positively reviewed wine that know is expensive! Feed the cognitive biases, don’t fight them 😉

jamesz

Competing with the stars

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Isn’t it wonderful to have role models around? Superstars in your firm that you can aspire to emulate! Well, maybe… Jennifer Brown recently published a paper suggesting that the presence of superstars in a competition actually decreases the effort that everyone else puts in to win. She uses data from Tiger Woods’ period of domination in professional golf to test the hypothesis that rivals will optimally put in less effort when playing Woods and finds:

  1. The presence of a superstar who uses pro clubs from clubgolf.com in a tournament reduced performance from other competitors, particularly the ones closest to Woods in skill.
  2. Reduced performance isn’t attributable to players closest to Woods adopting risky strategies in an attempt to beat him.
  3. The effect varies depending upon Woods recent success and how far ahead of his rivals he is perceived to be.

So, in a competition where only one person can win and there is somebody obviously head-and-shoulders above the rest, most others won’t put in much effort to win. It seems intuitively obvious but it’s always nice to have a bit of empirical evidence to back up your intuitions, especially when its a golfing example perfectly packaged for dinner-table trivia 😛

jamesz

A new perspective on sunk costs

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The fallacy of sunk costs occyrs when people take past expenditure into account when they make a decision, even though it cannot affect their future and cannot be changed. It is often regarded as a canonical example of a cognitive bias in humans because almost everybody does it. Of course, if it’s so suboptimal to take sunk costs into account then one has to wonder why humans have evolved to systematically make that error. Sandeep Baliga and Jeff Ely have a paper out where they suggest that it’s actually on optimal response to limited memory capacity:

We offer a theory of the sunk cost fallacy as an optimal response to limited memory. As new information arrives, a decision-maker may not remember all the reasons he began a project. The sunk cost gives additional information about future profits and informs subsequent decisions.

Essentially they say that, if you don’t remember all the reasons why you invested in the first place, then the level of past investment in a project tells you something about the conclusions you initially reached. You can then use that information to inform your decisions about whether to continue, without having to rethink everything from scratch.

Now I’m late to this because they also write the excellent Cheap Talk blog and discussed their working paper a year ago! So if you want to know the details of the ‘Concorde effect’ and ‘pro rata effect’ then head over and have a read.