Tag Archives: economic theory

Social welfare functions derived from revealed preference

The social welfare functions used in policy evaluation typically put more weight on poorer people, justifying redistribution from the rich to the poor. The reasoning is that the marginal benefit of a unit of money is greater for the poor than the rich. However, people with a greater marginal value of money are more motivated to earn and save, other things equal, so more likely to become rich. In this case, the rich have on average a higher marginal benefit of money than the poor, or a lower marginal cost of accumulating it. If the justification for redistribution is an interpersonal utility comparison, then revealed preference suggests a greater Pareto weight for richer people, thus redistribution in the opposite direction to the usual.

If the marginal utility of money decreases in wealth or income, then people earn until the marginal benefit equals the marginal cost, so the comparison between the rich and the poor depends on their marginal cost of earning, evaluated at their current wealth and income. The cost and benefit of earning may both be higher or lower for richer people. In a one-shot model, whoever has a greater benefit should receive redistributive transfers to maximise a utilitarian welfare criterion. Dynamic indirect effects sometimes reverse this conclusion, because incentives for future work are reduced by taxation.

Those with a high marginal utility of money are more motivated to convince the public that their marginal utility is high and that they should receive a subsidy. The marginal utility is the difference between a benefit and a cost, which determine whether the poor or the rich have a greater incentive to lobby for redistributive transfers. The marginal cost of an hour of persuasion equals the person’s hourly wage, so depends on whether her income is derived mostly from capital or from labour. For example, both rentiers and low-wage workers have a low opportunity cost of time, so optimally lobby more than high-wage workers. If lobbying influences policy (which is empirically plausible), then the tax system resulting from the persuasion competition burdens the high-wage workers the heaviest and leaves loopholes and low rates for capital income and low wages. This seems to be the case in most countries.

A tax system based on lobbying is inefficient, because it is not the people with the greatest benefit that receive the subsidies (which equal the value of government services minus the taxes), but those with the largest difference between the benefit and the lobbying cost. However, the resulting taxation is constrained efficient under the restriction that the social planner cannot condition policy on people’s marginal costs of lobbying.

Equilibrium response to reduced material use for plastic bags

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Probably to save material on the manufacture of the free plastic shopping bags in the US, these bags are small and thin compared to the ones in Estonia (which used to be free, but are now priced at significantly above production cost due to EU regulations on disposable plastic products). The equilibrium response of cashiers and customers to thin flimsy bags is to double-bag groceries, a practice unheard of in Estonia. After all, if one bag is sturdy enough, almost nobody will use two inside each other. I have successfully carried 10 kg in an Estonian plastic bag.

The equilibrium response to small bags is to distribute the groceries among many bags, especially the heavy or bulky items, for example to put each milk canister or large salad sack into a separate bag. Both double-bagging and the one-item-per-bag distribution lead to more bags being used in response to manufacturing each bag out of less material. It is an empirical question whether thinner, smaller bags result in less or more plastic waste overall. To incentivise reducing the one-time use of plastic bags and to encourage reuse, customers should have to pay for these, like in the EU.

One form of plastic bag reuse is as garbage bags (although it is only a one-time reuse, it is better than nothing). However, the flimsy free bags in the US come in bulk packs with the bottoms of the bags stuck together, so separating one from the stack often results in holes in its bottom an inch wide or more. The holes discourage many forms of reuse, including as trash bags, because small items (dust, crumbs, scraps) fall out. Partly the holes are due to the flimsiness of the material, partly to the way the bags are glued together to make a bulk pack.

Claims that tickets are running out

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Both for paid and free events, the organisers often advertise that only a few tickets or places remain. The ad sometimes explicitly tells the viewer to register or buy now. Such advertising is costly, so there should be a benefit to the organiser. If the tickets have already sold out, then the benefit is zero, or at least smaller than if the event is not fully booked. The positive benefit from advertising a sold-out event is to build reputation for the future as an organiser of popular events, similarly to real estate agents putting a „Sold” sign in front of a house on which they closed the deal.

Given that the benefit of costly advertising is smaller when no tickets remain, some sellers should decide to advertise if and only if the event has not sold out. More generally, the probability of advertising should increase in the number of tickets remaining. In this case, rational buyers should treat advertisements saying that limited spaces remain as signals of the opposite – frequent ads show a desperate seller facing low demand. If most buyers think this way, then such advertising is counterproductive, because buyers want to delay their purchases when the probability of being able to buy in the future is large enough. The option value of waiting comes from the possibility that the buyer’s preferences change – a better event may become available, or some emergency may prevent the buyer from attending. Getting a refund for a ticket already bought is at least a hassle and may even be impossible.

The widespread claims of limited space remaining suggest that these ads boost purchases. One reason may be buyer attention – ads make them notice the opportunity to buy, which some of them wish to take advantage of. However, any ads draw attention to the event, so raising awareness cannot be the reason for the specific claim that tickets are running out.

For most events, buyers do not want to coordinate with the largest possible crowd, only with their friends, so do not prefer a fully booked event to a half-full one. Thus claims that the event is almost sold out are difficult to explain by the seller trying to coordinate buyer actions.

Some irrationality of buyers or the seller seems necessary to explain messages that demand is low. Either the buyers take the claim literally instead of using Bayes’ rule to infer the opposite, or the seller advertises despite ads decreasing demand.

It is an empirical question whether the target audience of ads saying that space is running out interprets these as signalling high or low demand, and whether these messages make people delay their purchase or speed it up.

Mugs, pens and USB sticks as advertisements

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Several universities I have visited give free mugs to seminar speakers as advertisements for themselves. Similar branded objects (pens, USB sticks, T-shirts, baseball caps) are handed out by firms and political campaigns as part of their marketing.

The idea of giving people practical objects instead of flyers, junk mail or banners is to make the recipients use these objects (as opposed to throwing these away or storing them at the back of a closet), preferably in a public setting, and thus increase the visibility of the advertiser. For this, the more usable the handout, the better.

Unfortunately, the people ordering these objects in bulk and paying for the brand logo to be printed on these are busy administrators who do not connect the overall purpose the marketing campaign to the properties of the objects. Specifically, the mugs should have a large handle that lets more than two fingers hold it, the mug should be short with a wide mouth for easy filling and washing, and should not be too fragile.

Pens should write well and be ergonomical, not angular or too narrow. I have seen branded pens violating all these suggestions. For example, the Australian National University pens are of flimsy plastic, create ink splotches and the ink runs out quickly.

The USB sticks handed out by the University of Queensland had a metal cover which increased the USB drive’s bulk and scratchiness. Also, the USB was wide and thick, making it impossible to plug in side by side with another USB. The small capacity of the USB was also behind the times.

To advertise with an object, it would make sense to print the advertiser’s name and other relevant information in large readable font on the object. The logo is not useful unless it is already widely known by the target audience and associated with the advertiser. The readability suggestion is violated by the Singapore Management University’s mug, which has SMU written on it in complicated calligraphic script that is difficult to decipher even for someone who knows what the abbreviation SMU means.

For people to develop a positive view of the advertiser, the object should not seem too cheap or bad quality. By contrast, most free T-shirts are the cheapest ones that could be bought wholesale, made of the most threadbare and transparent cotton, which discourages their use.

Delivered food and restaurants are unhealthy due to moral hazard

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Consumers observe the taste and cost of food directly, but checking the ingredients for healthiness takes extra effort and time. Rational inattention then implies that eaters are unlikely to verify the health claims. Thus food suppliers are subject to moral hazard: consumers buy based on the healthiness they expect, not the actual ingredients the seller chooses, so the seller has an incentive to improve taste, reduce the production cost and cut price even when this makes the food less healthy.

The standard solutions to moral hazard from economic theory are verification, repeated interaction and vertical integration (selling the firm). In the context of food, safety standards and truth-in-advertising laws restrict the substances manufacturers may add and claims they can make. Regulators verify claims made and punish for illegal additives or false advertising. Also, if a food supplier is found to use unhealthy ingredients (or amounts of sugar, salt and fat), then some consumers may switch to alternate providers, which is a repeated game punishment for the original seller.

The weakness of both verification and repeated interaction is imperfect monitoring: small increases in unhealthy substances are difficult to detect, because tests are noisy and food composition varies naturally. The variation sometimes makes the amount of an ingredient exceed the healthy limit, so honest suppliers would also be punished with positive probability. Incentives are created by the difference in payoffs, so reducing the payoff of the honest decreases their motive to stay honest. The imperfect monitoring allows unscrupulous sellers to outcompete the providers of healthy food on taste and price, for example by using various tricks to circumvent the legal requirements on labelling (https://sanderheinsalu.com/ajaveeb/?p=728).

The remaining solution to the moral hazard problem is vertical integration of the buyer and the supplier, i.e. home cooking. Of course, the ingredients bought to be cooked at home are subject to similar moral hazard – unhealthy substances can be added at any stage of the production process. The risk could in principle be even larger than for processed foods and restaurant meals, but in practice, it seems that simple and unprocessed ingredients are more difficult to manipulate than prepared meals, which are a mixture of many components. Adding sugar, salt, fat or monosodium glutamate to flour, rice or dry beans without mentioning it on the nutrition label is easier to detect than the same (amounts of) additives in shrimp fried rice, bread or a burrito. Raw meats and fish do have extra salt and food colouring added, but usually less than for ready-to-eat meals.

Relative prices are another reason why there may be less manipulation of ingredients than processed foods. There is a per-unit cost of adding unhealthy substances, as well as a fixed cost due to the risk of lawsuits and fines, especially if the additives are not declared on the label. Unprocessed ingredients are less differentiated, so the price competition is more intense. The increase in the price that customers are willing to pay if an ingredient tastes better than the competitors’ may be small if price is the main dimension of competition. The slightly higher price may not justify the per-unit cost of the additives. In contrast, for processed foods the margin may respond greatly to taste, motivating manipulation of the ingredients.

The taste of the final dish is likely to respond less to manipulating one ingredient than to altering the composition of the entire food, both because the ingredient may be only a small part of the final dish and because the taste of a dish is largely determined by the seasoning and the cooking method. In this case, additives to ingredients do not improve taste that much, reducing the profitability of manipulating these.

Intense price competition motivates cost-cutting, including by substituting cheaper ingredients or using additives (e.g. preservatives) that reduce the manufacturing cost. However, if the additives cost more than they save on production cost (such as preservatives for dry goods that already keep indefinitely), then they are unprofitable to include.

Demand for cooking ingredients may also respond less to price and taste than for restaurant meals or delivered food (raw ingredients may even be an inferior good, but eating out is more like a luxury good). In this case, there is a range of fixed costs of unhealthy substances for which adding these to ingredients is unprofitable, but to processed foods profitable.

Pill testing, placebos and illegal market efficiency

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Testing illegal drugs for the active ingredient differs from testing for poisonous adulterants. Both tests have opposite effects on drug use before and after buying. After the pill has been purchased, testing reduces use, because sometimes the drug fails the test, whether correctly or not, and is discarded. Before purchase, the option to test for and avoid adulterated or inactive drugs reduces the buyer’s risk, thus increases use.

In the longer term, testing benefits the dealers of purer, more predictable and less toxic drugs, putting some suppliers of fakes out of business. Pill predictability reduces overdoses – a health effect similar to lower toxicity. If old drugs can be tested, but new ones not, then buyers experiment less and the incentive to invent new narcotics decreases.

The avoidance of poisonous adulterants is good for public health, but purer pills not necessarily so. Inactive drugs undermine consumer confidence in the illegal market, reducing use, prices and casual purchases. Trust then requires a long-running relationship with the seller, which has multiple benefits. It motivates dealers to care about the health of their loyal customers, simplifies policing and gives researchers and social workers better long-term access to the at-risk population.

One claimed benefit of party drugs is that they reduce anxiety, increase the user’s confidence and social interaction, thus improving mental health. Evidence from psychiatric medicines suggests that many such benefits are due to the placebo effect. Users are quite inaccurate in estimating the purity of ingested drugs, and factors like price and place of purchase strongly influence their perception of purity. The price per pure gram is negatively related to purity in some markets, further supporting the placebo interpretation. If inactive pills boost confidence similarly to illegal drugs, then there is a clear case for flooding the market with harmless placebos. The availability of pill tests for the active ingredient reduces this opportunity to make the illegal market inefficient. Tests for toxic adulterants, however, actually favour harmless placebos.

Spam deterrence by boycotting

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The obvious reason for spam of any kind (emails, texts, phone calls, unsolicited mail) is that it is profitable. Thus spam must raise the probability that its target buys or otherwise complies with the spammer’s wishes, e.g. leaves a review. To deter spam, the incentive for it must be reversed – the targeted people should not give in to spammers, but do the opposite (not buy, not leave a review when receiving a „reminder”). I try to follow this strategy. If I remember that a business spammed me, then I try to boycott it, unless it is by far the best option (usually not, spammers are typically shady businesses and bottom-feeders).

Incentives are created by the difference in payoffs, not their level. Thus to deter spam, the buying probability should be lower for a spamming business than for a non-spamming competitor. To create this payoff difference for non-monetary actions, e.g. reviewinig, I leave a review with positive probability when not asked to do so, but certainly avoid reviewing when spammed with reminders.

If the whole society followed the strategy of boycotting spammers, then one possible concern is that spammers would start to use reverse psychology. They would spam in the name of their competitors to make them look like spammers. If customers start boycotting the competitors as a result, then demand shifts to the spammer, which is profitable.

The reverse psychology is unlikely to become a serious problem, because there are typically many competitors and the spammer would have to make most of them look bad to increase its demand significantly. Also, the law usually punishes the use of a fake name more harshly than unsolicited contacting. The competitors whose reputation is tarnished by spam under their name have a stronger incentive to sue its source than consumers just annoyed by the spam.

Formal clothing is a bad equilibrium of a coordination game

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What clothing happens to be considered formal is an equilibrium of a coordination game: if most others think that a given clothing item is formal, then a person who wants to be seen as formally dressed is better off choosing that garment. If enough people who aim to dress formally choose certain clothing items, then those garments will be interpreted as formal. Different cultures and eras have considered different clothes formal, e.g. tights for men were formal in Europe during Napoleonic times, but are not now.

Current formal clothing is a bad equilibrium because suits and shirts are difficult to clean, labour-intensive to iron or press, and restrict movement. A better equilibrium would be to interpret as formal some garments that are comfortable, environmentally friendly, easy to care for and cheap. It is unfortunately difficult to change equilibria in a society-wide coordination game, because a majority of people would have to change their beliefs in a short time.

The reason why suits are seen as formal is historical: these were fashionable at the height of the British Empire, which was the richest and the most powerful country in the 19th century, thus a trendsetter in the first era of globalisation. British fashion was copied in North America and Europe, spreading to the colonies from there. Labour-intensive clothes were a way for Victorian nobility to signal wealth, because only the rich could afford to hire enough servants to make and care for their clothes. In many cultures, wearing impractical clothes (toga, long dress restricting leg movemen) has been a way to signal that one does not have to work. Similar signals of leisure were pale skin (because most work was outdoors), soft clean hands (because most work was manual and dirty), straight posture (because work often involved stooping). More extreme signals of leisure were physical changes that made most jobs of that era and region difficult or impossible: women’s foot-binding in East Asia, mandarins’ long fingernails in China.

Contrary to pale skin demonstrating leisure in Victorian Britain, in modern developed countries, a suntan is a signal of wealth, because most work is indoors and most trips to tropical places or simply outdoors are costly and time-consuming vacations. A similar reversal of the meaning of a signal is that a fat belly showed wealth when food was scarce, but in modern developed countries with an obesity epidemic, developing an athletic physique takes time and effort, so being fat is statistical evidence of poverty.

Signals of wealth have always invited cheaper imitations. For example, solariums provide suntanning cheaper than travel to the tropics. Slimness can be faked with liposuction, a corset or less drastically with a tailored waist and vertical stripes that are closer together or narrower at the waist area. The appearance of broad shoulders is achievable by wearing a suit jacket with padded shoulders.

One reason for why a business suit looks the way it does is to make the man wearing it appear taller, slimmer in the waist, and broader-shouldered, thus more masculine and attractive. The V-shape formed by the lapels uses the well-known visual perception error that an object at the open end of a V looks larger than an identical object at the tip of the V. The front of a suit jacket thus creates the appearance of a slim-bellied, muscular man. If the wearer’s belly allows, then a suit jacket usually also has a tailored waist, which further visually narrows the middle of the body. The vertical lines created by the tie and the creases of the pants make the wearer look taller and slimmer, which is often accentuated by vertical stripes on the suit. It is very rare to see a suit with horizontal stripes.

The visual illusion of attractiveness that a suit creates provides a extra incentive to stay in the equilibrium in which suits are considered formal clothing. To ease the transition to a new equilibrium in which the clothes perceived as formal are more practical, the new formal clothes should improve the wearer’s looks even more than a suit. This is not difficult, because many garments may have V-shaped patterns printed on the upper body, vertical stripes on the lower, have a tailored waist and shoulder pads. The patterns and cut may be designed based on psychology research to maximise the athletic appearance of the wearer. Anything achieved with a suit may be replicated and further optical enhancements added, for example printed outlines of muscles and puffed upper sleeves.

Avoiding an animal on the road

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When a bike or car heads towards a squirrel, the squirrel first dodges to one side and then runs away in the other direction. Birds fly directly away from the oncoming vehicle, so stay in front of the vehicle for a few seconds. These behaviours are presumably evolutionary adaptations to avoid predators. For example, the squirrel’s dodge probably misleads a predator to alter course in the direction of the dodge. The larger predator then has more difficulty than a small agile squirrel in switching direction to the opposite side of the dodge.
In avoiding vehicles, these escape patterns are counterproductive. A predator tries to collide with the prey, but a vehicle tries to avoid collision. A squirrel’s dodge confuses the driver or cyclist, who then tries to pass the animal on the opposite side of the initial feint, which is exactly the direction the animal ends up running in. The best way to avoid collision may be to just keep going in a straight line and let the animal dodge out of the way. A constant direction and speed is easy to predict, which lets the animal avoid being in the same place at the same time as the vehicle. Keeping one’s course and speed also avoids accident-prone sharp turns and sudden stopping.
If a predator was smart and knew about the dodging behaviour, then it would go opposite the initial dodge. But then the squirrel would benefit from not switching direction. In response to the squirrel just running in one direction, the predator should run in the direction of the squirrel’s initial movement, etc. This game only has a mixed strategy equilibrium where the squirrel randomises its direction and whether it dodges or not, and the predator randomises its response to the squirrel’s initial movement direction. Dodging takes more energy than just running to one side, so the dodge must have a benefit that outweighs the energy cost, which means that the predator must be less successful when the squirrel dodges. Some factor must make it difficult for the predator to swerve opposite the squirrel’s initial direction. For example, if most prey keep running in one direction instead of feinting, then the predator may be on average more successful when following the initial movement of the prey. The cognitive cost of distinguishing squirrels from other prey must be too large to develop a different strategy for chasing squirrels.
The same game describes dribbling in soccer to avoid a defender. It would be interesting to look at data on what proportion of the time the attacker feints to one side and then moves to the other, as opposed to just trying to pass around the defender in the initial movement direction. It is more difficult for both players to switch than to keep moving in one direction, but presumably the player with the ball finds it relatively more complicated than the defender. In this case, to keep the other player indifferent, each player only has to switch direction less than half of the time, but the defender relatively less frequently. If the attacker feints and the defender does not switch direction, then the defender looks clumsy and the attacker a good dribbler. Reputation concerns of soccer players (who are after all entertainers) may make them switch direction more often than a pure winning motive would dictate.
Similarly, soccer players may use flashy moves like scissor kicks more often than is optimal for winning, because the flashiness makes the player popular with fans.

Poaching reduction using lab-grown ivory

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Poachers kill elephants for tusks and rhinos for horns because these can be sold for a high price on the black market. The killing has occurred both in the wild and in zoos, and thieves have broken into nature museums to steal rhino horns from exhibits. Sometimes news reports describe how police crush or burn seized illegal ivory, which seems counterproductive, because it reduces supply and thus drives up the price. A higher price increases future poaching. Perhaps the police are in the pay of some illegal ivory dealers and are deliberately helping drive up the price by destroying competing dealers’ products.
Instead, the price of ivory and rhino horn should be reduced so that poaching becomes unprofitable. Many organs have been grown in the lab using a collagen scaffold seeded with stem cells from the appropriate tissue (bladder, skin, heart). Growing elephant tusks or rhino horns in the lab should be feasible using similar techniques. Flooding the market with cheap lab-grown horns and tusks would eliminate the incentive to poach.
The demand for ivory and rhino horn is mostly due to silly beliefs about their medicinal properties, so the buyers may not want lab-grown substitutes, believing these to be ineffectual (which these are, just like wild-type horns and tusks). In this case, the lab-grown horns and tusks should be made indistinguishable from animal-derived ones and inserted into the illegal supply chain covertly. The dealers on the black market are not too honest people and would probably be happy to lie to their customers that lab-grown products are from wild animals.