• The econlife.com Weekly Roundup

    Weekly Roundup: From Hot Hands to Sunk Costs

    Jan 24 • Behavioral Economics, Demand, Supply, and Markets, Economic Debates, Economic Growth, Economic History, Economic Thinkers, Financial Markets, Gender Issues, Government, Health Care, Households, Lifestyle, Macroeconomic Measurement, Sports, Thinking Economically • 365 Views

    Our Posts Roundup

    everyday economics, behavioral economics and exercise expectationsSunday 1.18.15 The reasons we work out less than we expect…more

     

    everyday economics, behavioral economics, expectations. a self-fulfilling prophecy.Monday 1.19.15 How our expectations affect our results…more

     

    everyday economics, behavioral economics and saving lessTuesday 1.20.15 Why we eat more cookies and save less…more

     

    everyday economic invisible hand and hot handWednesday 1.21.15 The sports streaks we might be imagining…more

     

    Everyday economics, behavioral economics and pricesThursday 1.22.15 How we judge a price…more

     

    everyday economics and sunk costsFriday 1.23.15 Why we stand in line longer than we should…more

     

    Ideas Roundup

    • behavioral economics
    • projection bias
    • marginal cost
    • transaction costs
    • pre-commitment
    • expectations bias
    • intertemporal discounting
    • saving
    • hot hand
    • streaks
    • confirmation bias
    • classical economics
    • monopolistic competition
    • frames
    • reference points
    • sunk costs
    • cost and benefit

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  • everyday economics and sunk costs

    The Eurozone Sunk Cost Problem

    Jan 23 • Behavioral Economics, Businesses, Economic Debates, Economic Growth, Economic History, Financial Markets, Government, International Trade and Finance, Labor, Macroeconomic Measurement, Regulation, Thinking Economically • 323 Views

    All too frequently, I am asked to hold for a moment during a phone call. Five minutes pass. No one returns. Then, I consider hanging up but think, I’ve already waited five minutes. So, I stay on for another five minutes. Still no one.

    Like me, do you start fixating on the time you have already invested? And perhaps wait another five minutes?

    Sadly though, by not hanging up, we are ignoring what we could be doing. Maybe instead of looking back, we should decide what hanging up gains in the future.

    Where are we going? To the sunk cost fallacy.

    But first, Greece.

    Is Greek Eurozone Membership a Sunk Cost?

    Having borrowed far beyond its means, Greece received two bailouts totaling close to €240 billion ($307 billion) from the ECB, the EC and the IMF (the troika). The deal was to get their fiscal house in order.

    So, they cut pension payouts by 40 percent and prohibited hairdressers and other people in hazardous occupations from retiring at 50 with government support. The government payroll shrunk, unemployment benefits were reduced to 12 months and previously subsidized prescription drug prices climbed 30 percent. The list of spending cuts and revenue raisers could go on and on.

    You can see the results (below). Greek unemployment remains huge and GDP growth, tiny.

    Greek austerity created sunk costs and few results

    From: ieconomics

     

    A Rationale for Ending Austerity

    Proposing free electricity and food coupons for the poor, state pensions returning to pre-crisis levels, a higher minimum wage, and higher taxes for affluent, the far left party Syriza has the lead in Sunday’s election. Abandoning austerity is their theme.

    And that takes us to a question. Should those who disagree with Syriza say Greece has invested so much in austerity that it cannot stop now? Or, citing the troika’s bailouts, should eurozone officials say too much has been committed to stop now even if Greece resists further austerity?

    Our Bottom Line: Sunk Costs

    Whether looking at a phone call on hold, a Greek eurozone exit, a disintegrating marriage or an overpaid underperforming quarterback, the attraction of sunk costs is a key consideration. A sunk cost represents our unrecoverable past time, money, energy, investment. It is called a sunk cost because it is gone. But still it tends to influence a future decision.

    Economists say the value of sunk costs is a fallacy. Instead, we should focus on future cost and benefit.

     

     

     

     

     

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  • many picture frames

    One Reason We Think a High Price Looks Low

    Jan 22 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Thinkers, Households, Money and Monetary Policy • 508 Views

    The decisions we make about bread machines, surgery and gasoline can be remarkably similar.

    Where are we going? To the influence of a frame.

    But first…

    Bread Machines

    Maybe 20 years ago, when bread machines were first introduced, one retailer started with a single model priced at $120. Faced with sparse sales, they increased interest by adding a second $80 machine.

    What happens next though is what gets the behavioral economists really excited. The retailer placed a $475 machine on the shelf and the $120 model sold like hotcakes.

    Surgery

    In an experiment at Harvard by psychologist Amos Tversky, physicians were given one of two statements about the success of a surgical procedure. Asked if they should operate, the majority of respondents said yes to the first statement. Both though are the same:

    • The one-month survival rate is 90 percent.
    • There is a 10 percent mortality in the first month.

    and finally…

    Gasoline

    Asked if $3.00 a gallon gas makes you happy, you probably would say no. But why then, a year ago, would you have been pleased?  The following graph has the clue:

    Behavioral economics and gas price framing

    Frames

    For bread machines, surgery and gasoline, our attitudes are shaped by a reference point that behavioral economists call a frame. With the bread machines, the $425 machine signaled that $120 was a good price. For surgery, when the frame was a positive statement, the response was positive. For gasoline, the direction in which prices moved created the frame. Moving downward from $4.00, $3.00 looks good but not when price rises from $2.00.

    Our Bottom Line: Competition

    In traditional economic texts, price making power increases as you move across the following continuum:

    Frames give firms more pricing power

    To enhance their price making power, firms have been able to influence consumers with frames. Now though, with Amazon and the potential for other online price comparisons, I wonder if the power to frame has diminished or at least changed.

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  • everyday economic invisible hand and hot hand

    Can Economists See the Hot Hand?

    Jan 21 • Behavioral Economics, Demand, Supply, and Markets, Economic Debates, Economic History, Economic Thinkers, Financial Markets, Sports, Thinking Economically • 681 Views

    When basketball commentators used to say, “Larry Bird has the hot hand…,” the fans knew what they meant. Because Bird was sinking basket after basket, we could predict that he will do more of the same.

    Yes?

    No, according to behavioral economists.

    Where are we going? To see how the debate over whether the hot hand exists applies to more than sports. Let’s start with hot hand research.

    Rejecting the Hot Hand

    Using Philadelphia 76er shooting records (1980-81 season) from 48 home games and Boston Celtics free throws during the 1980s, believers in behavioral economics tried to prove that there was no such thing as a hot hand. Their focus was whether “a player’s chance of hitting a shot is greater following a hit than following a miss on the previous shot.”

    Responding to doubters, researchers agreed that their data was skewed by the intensified defense from the opposing teams but still affirmed their accuracy. To others who wondered how they could challenge the opinions of knowledgeable fans, players and commentators, researchers said it was a self-fulfilling prophecy. Confirmation bias even enters the picture because the belief preceded the phenomenon that proved it.

    The Hot Hand Shakes the Invisible Hand

    Now classical economists are fighting back. Using two million observations and 10 criteria for batters and pitchers including on base bats, home runs, strike outs, and walks, a finance professor from Stanford and an economist from Berkeley found evidence of the hot hand in baseball stats. They say the data has to come from baseball because basketball has too many strategic responses to the hot hand. But even for basketball, rather than random, the hits and misses are an equilibrium adjustment.

    Our Bottom Line: Debating Behavioral Economics

    For years, behavioral economists have told us that there is no such thing as a hot streak. Basing their conclusion on their belief that many of our actions are irrational, they conclude fans are falsely bringing order to random achievements that have no predictive value.

    The economists who disagree suggest that judging the extent of order in a situation, whether sports, finance, or elsewhere, should return us to Adam Smith’s invisible hand rather than random behavior. Reminding us that we need a proper diagnosis to formulate the right solution, they cite the significance of their disagreement.

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  • everyday economics, behavioral economics and saving less

    How Chocolate Chip Cookies Explain Why We Save Less

    Jan 20 • Behavioral Economics, Economic Thinkers, Government, Households, Labor, Lifestyle, Macroeconomic Measurement, Money and Monetary Policy • 669 Views

    Let’s start with two people and two plates of freshly baked chocolate chip cookies. The first person eats one and then, thinking she will enjoy some during the next week, wraps up the rest and places them in a cabinet. As for the second individual, he sees the other plate and gobbles them all.

    Where are we going? To decisions about saving and then back to cookies.

    Saving Worries

    According to Gallup’s annual Economy and Personal Finance Poll, not having enough money for retirement is a big worry for 59 percent of us.

    Behavior economics and retirement savings

    Perhaps one reason for our worry is inadequate saving. According to St. Louis Fed statistics (below), our personal saving rate–what we do not spend from our disposable income–has remained relatively low.

    Behavioral economics and personal saving rate

    From: St. Louis Fed

    What to do?

    Saving Solutions

    Behavioral economists have several practical “nudges” that could encourage us to save more. Richard Thaler and Cass Sunstein have described a default saving option that people would actively have to reject. Or maybe the answer is some form of pre-commitment before the actual time to make the saving decision arrives.

    My favorite though is getting to know our future selves better.

    In one study, researchers said that because our elderly selves are strangers, we have less inclination to help them. By meeting our older self, though, we might display a bit less “intertemporal” selfishness and save more for him or her.

    Using virtual reality software, they tested their theory. Their basic approach was to “age morph” young people into their 70 year old selves and then to let the young person “meet” his older version. In several different study designs, researchers compared saving behavior between people who saw themselves at retirement age and others who did not. As they predicted, the individuals who saw the older version of themselves saved more. The saving even increased when experimenters had those self images respond happily or sadly to amounts of savings.

    Our Bottom Line: Intertemporal Discounting

    Whether saving cookies or money, we are looking at intertemporal discounting. Intertemporal just refers to two time periods and discounting involves giving less value to a commodity.

    People who eat cookies now rather than saving some for later have bestowed those future cookies with little value–a larger discount. So too with saving. When we decide to save minimally, we are giving the future a high discount because it has little value to us.

    In behavioral economics, by introducing us to our future selves, researchers are hoping we will give the future less of a discount. They are hoping to help us choose “larger later” rather than “sooner smaller.”

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