jamesz

Anticipating a kiss

/1 Comment/in , /by

Matt posted earlier today about someone who gains utility from thinking about buying something even if they never actually buy it. There’s actually quite a lot of work that’s been done on utility gained from anticipation. George Loewenstein’s 1987 paper reports a study in which people were willing to pay more for a kiss they received in three days than they would be willing to pay for the same kiss today. They gained pleasure simply from thinking about the kiss and anticipating how good it would be. I don’t think the students in the study ever actually got the kiss so he doesn’t mention whether it lived up to expectations. Interestingly, this idea of utility from anticipation only seems to hold over non-monetary items. Nobody values receiving $1000 in three days more than $1000 today: monetary gains are discounted as one would normally expect.

Of course, if you get benefits from anticipation then that might affect your consumption of ‘real’ items. Botond Koszegi has a working paper in which he models a ‘personal equilibrium’ which describes the interaction between anticipated and actual consumption. Two phenomena which he identifies as arising from his model are self-fulfilling expectations and behaviours which depends upon unchosen alternatives. Both of these are commonly observed: the second in particular is often referred to by psychologists as a criticism of the standard economic model of consumer choice. We value consumption differently depending upon the proximate reference points: for instance, if you go on a fantastic holiday then even if the next holiday is good it is a disappointment. If incorporation of anticipation into our models of behaviour can make them that much more representative of reality then it’s certainly worth thinking about.

Matt Nolan

Utility of the means

/1 Comment/in /by

Economists will often look at outcomes and associate values to things based on the outcome. Often other disciplines (namely Sociology and Anthropology) criticise our focus on outcomes, stating that we do not pay enough attention on the means of deriving those outcomes.

A post over at Stackelberg follower (love that blog name) discusses the utility he derives from shopping for a product, even a product that he may not actually buy. This made me think again about the issue of means and outcomes.

I don’t believe that economists forget about the means when describing the payoff from outcomes. The utility gained from receiving a pie (I love pies) by legitimate means will likely exceed the utility from a pie gained by killing someone. I tend to think that the means of getting to a certain point, or consuming a certain product, influences the payoff associated with the consumption of that product.

In the case that the Stackelberg follow guy showed, the consumption choice was to NOT buy the game. It might sound weird, but in that case he choose to not purchase anything and that was still some form of consumption. Now the utility associated with that consumption comes from the direct value of that consumption (having nothing) and the means to that consumption (shopping). Another way of looking at it is to change the idea of what was being consumed. In the Stackelberg follower case he choose to consume shopping rather than consume sit in the park.

As a result, I think the means to an outcome are important. However, economists do not ignore them (like some disciplines think we do) as the means to consumption influences the value of that consumption activity. Ultimately, the pie I brought and the pie I could have potentially killed for are different products, with different values, even if there is no physical difference in the pies.

What do you guys think? (assuming more than one person reads this 😉 )

Matt Nolan

OCR review preview

/4 Comments/in /by

The October official cash rate review will be on the 25th October.

The main points that will be driving RBNZ policy are:

  1. Strong economic growth (including revisions) in the June year.
  2. The surprising strength in the export industry, even before the TOT shock has fully eventuated
  3. A weak CPI reading, however many of the shocks driving down the number where one-off and so will be over-looked
  4. Credit market uncertainty and the volatility of the dollar
  5. Weakness in the housing market – Potential weakness in domestic demand

It seems more than likely that the RBNZ will keep rates steady. Any cuts would be irresponsible in the current climate, while a rate rise would seem heavy-handed given weakness in some domestic indicators. The probability of a hike is greater than the probability of a cut, given underlying inflationary pressure.

Matt Nolan

Banning fossil fuel plants

/in , , /by

The government has decided to ban the construction of new fossil fuel plants for the next 10 years, as they believe that they are unnecessary.   However, I feel that this policy is unnecessary.

I do believe that if we left power generation to the free market, too much CO2 would be produced, and our liability under the Kyoto protocol would be ‘too high’.  But wasn’t that why the government introduced a carbon trading scheme?

In economics terms, the externality from fossil fuel plants is greater than the externality from Hydro, or wind power generation.  The government can try to fix this externality by putting an externality charge on unit production (which is what a tax or a carbon trading scheme does) or by directly regulating the industry.  As the carbon trading scheme is coming into place, the firm producing the power will have to pay the full social cost of producing the power.  In this case, if the firm still decides to build a coal power plant instead of a wind farm, it must be because the full social cost of the coal plant is lower than the full social cost of the wind farm.  As a result, banning the construction of fossil fuel plants seems unnecessary, as in this example, society is better off with this coal plant than with the wind farm.

jamesz

Too much of a good thing?

/5 Comments/in /by

My attention has been drawn (thanks Paul) to an article which describes how one might find the optimal number of members of parliament in a representative democracy.

In a nutshell, a parliament with too few representatives is not “democratic” enough, possibly leading to an unstable political system, in which various undesirable forms of political expression, including of course violent ones, will develop. In contrast, too many representatives entail substantial direct and indirect social costs, they tend to vote too many acts, interfere too much with the operation of markets, increase red tape and create many opportunities for influence, rent-seeking activities and corruption.

In their paper the authors derive a formula in which the optimal number of representatives is approximately proportional to the square root of the population of the country.

They test their formula against the data and find that Israel, New Zealand, the Netherlands and the USA have far too few representatives. I’m not sure how this correlates with their predictions about the instability of under-represented democracies: all four countries are very stable, non-violent democracies as far as I’m aware. I don’t have access to the CEPR paper but I’d be curious as to whether they address this issue. Their model makes some predictions which are easily falsifiable and I’d like to know how it stacks up against the evidence.

jamesz

Economists tackle ‘the surge’

/1 Comment/in , /by

Economists like to claim that their discipline is about providing tools for analysis, not answers to ready-made problems. OK, so they’re hardly alone in that but Dani Rodrik links an interesting paper by Michael Greenstone that walks the walk. Greenstone

…shows how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of today’s Iraq surviving into the future. In particular, I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. After the Surge, there was a sharp decline in the price of those bonds, relative to alternative bonds. This decline signals a 40% increase in the market’s expectation that Iraq will default. This finding suggests that, to date, the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it.

I really like how he uses modern economic and econometric techniques to tackle important public policy issues. However, we shouldn’t rely too heavily on the wisdom of the market in evaluating the effectiveness of the surge. While the aggregation of information that occurs in market pricing might be a better indicator than anecdotal evidence, ‘The Market’ doesn’t have superpowers that grant it access to information nobody else has. Many of the decision makers in that market likely have little more access to information about the surge than you or I. Aggregation tends to dampen the influence of extreme views but it doesn’t guarantee accuracy.