Economics

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Read: A History of Economic Thought

I was not there.

I would have been five and would not have understood a single word. Still, I feel like I missed something.

Not too long ago a few colleagues of mine and I noticed that there are too few courses on economic history and history of economic thought in economics curricular today. Often, there are none. This is bad. Without the historic context we are bound to misinterpret and repeat mistakes. Without the historic context we do not know why we are where we are right now in economic science. Many approaches, assumptions, and conventions that seem obvious and natural today once were not, maybe they should not be today as they constrain our thought and handicap heterodox scholars.

Lionel Robbins must have been a great teacher. “A history of economic thought” edited by Steven Medema and Warren Samuels is a transcript of a lecture series Robbins gave at the LSE between 1979 and 1981. I am glad I have read it.

It is of course not a comprehensive history of economic thought; it is not “the” history, it is “a” history (Yes, please note this subtle modesty). It’s a history of economic thought as Robbins saw it. Although Robbins most of the times explicates the topic in an objective yet passionate way, he does not spare the occasional judgment. Always, however, he warns his audience that he is about to share an opinion and not an historic fact. Of course, the selection of focus is also a matter of personal judgment. In some cases, on the other hand, there is little room for choice. You have to cover the Scots. Nevertheless, he gives credit where credit is due. (And I have to admit that I have been negligently ignorant of some of the finer details.)

As a result of this excellent text I now feel motivated to embark upon further readings in economic history and history of economic thought – what may be a nice diversification to all the quantitative texts I read. I might even give a seminar on it…

Read: Priceless: The Myth of Fair Value (and How to Take Advantage of it)

Just looking at the title and subtitle, it is not obvious that Priceless is another popular behavioral economics book. And yes, I indeed expected something a little bit more (different) than the standard enumeration of cognitive biases, preference reversals, and priming effects that Priceless actually contains.

Though, I have to admit that Priceless also stands out. Additionally, it offers a historical perspective on behavioral decision theory. It is rather focused as it links everything to the perception of prices and choice behavior. And the more than 50 chapters are rather coherent and connected as opposed to some of the other pieced together collections of anecdotes that are currently available.

There is one thing I did not like. In the book, Poundstone makes an implicit assumption – or the original researchers made it and Poundstone just adopted it – prices have an absolute, intrinsic meaning. They have not. In a free market economy prices are just an indicator of relative value (as implied by relative scarcity).

When people are asked to attach values to different objects these values are not even (market) prices. They are just valuations. Therefore, it is absolutely no surprise when people are asked to attach values to different objects that these valuations, i. e. the absolute numbers, differ across different people. And, it is no surprise that when people have an idea about the relative scarcity of the objects that the ratios of valuations are relatively stable over different individuals. If they have no idea, or a different idea due to different environmental cues, the valuations will of course differ. This is how prices are defined, they (their ratio) describe the rate of exchange in a market, they are only unique up to a scaling factor. You need an anchor (a numeraire good) to get absolute prices in some specific units. The reported studies show exactly that. Further, there is no irrationality or cognitive deficit if individual valuations of a non-standardized good (may that be an apartment or an used car) in an experiment differ from a market price and are influenced by environmental cues.

Nonetheless, there are of course many factors that have an unduly influence on individual valuations. Many of these are discussed. What, in the end, makes Priceless a well written, instructive lesson on consumer psychology and initiation into modern price setting strategies.

Some of the material in book was also published in a (short-lived) blog. The author’s heart is, however, somewhere else. The last entry is already one year old by now. The blog thus served only as a pre-release promotion tool.

Read: How we decide

(Economic) decision making and emotions seem not to mix. Homo oeconomicus is a cold, emotionless computer of utility. Always maximizing, and when endowed with all information always finding the optimal course of action, be it which house or car to buy or what ice cream to pick at the gelato house. That is simple decisions that involve comparisons of only a few or just one characteristic of the available choice options as well as complex decision problems that involve a high dimension of interdependent characteristics all invoke the same process: Conscious optimization.

And that ain’t true.

In “How we decide” Jonah Lehrer explores the cognitive and emotional side of decision making. Following the standard recipe of popular science books Lehrer introduces the reader to a number of different case studies – or anecdotes – to show how emotions allow us to decide at all, how and under what circumstances emotions and subconscious deliberations help improving our decisions and how and when emotions impair our decision making. All the anecdotes are accompanied by brief explanations of the underlying mechanisms inside the brain, the underlying neuroscience.

Lehrer’s narrative is clear and intriguing as he – as so many others before him – understands to arrest his readers’ attention by counterintuitive advice. For instance, complex problems are solved best by not contemplating about every detail and carefully considering all dimensions of the decision problem. We tend to get our “decision weights” wrong and focus on the wrong characteristics (like the size of the house instead of the length of the daily commute). Letting the subconscious mind work on the problem and than pick what feels right will often result in a better long-term choice in such complex decision problems. Simple choices, however, can benefit from actual, conscious, optimizing behavior.

“How we decide” is a well balanced, instructive text. It might get you interested in neuroscience and its close relative neuroeconomics…

Read: Why We Make Mistakes

Here is another book that while discussing topics related to cognitive psychology will be attributed to the wildly popular meme behavioral economics. It is not reporting the author’s original research. Indeed, much of the observations that Hallinan illustrates with well chosen examples are pretty old. Nevertheless, the book is entertaining as well as instructive. There is a central theme, everything seems to fit well to it and the material is well arranged. Not the messy clutter of unconnected anecdotes that you will find in some other books of the same genre.

Yet, of course, there are shortcomings. Most importantly, the book does not answer to its title. The “why” is not really discussed. At least not up to the level of detail where is would get interesting. Hallinan illustrates a number of cognitive biases that will lead to sub-optimal decisions. Why we show these systematic biases is a question that remains unanswered.

The Upside of Irrationality

A successful publication calls for a follow-up. The Upside of Irrationality is the successor to Dan Ariely’s successful Predictably Irrational, one of the best selling popular behavioral economics books of the last few years.

Despite its title, the book is not a thorough exploration of instances where irrationality leads to better decisions: As in his previous book, Dan reports here mainly on his own academic research relying on laboratory and field experiments covering topics ranging from the adverse performance effects of high powered financial incentives to the impact of empathy and emotions on decisions. More than before he interweaves his narrative with personal anecdotes that illuminate his choice of research topics; he reveals how his experience of being a burn patient in his youth shaped his future career and how normal day-to-day annoyances and more pleasant experiences led him to devise testable hypotheses about human behavior. This is perhaps also the most surprising aspect of the book. Dan’s highly personal way of sharing his thoughts and knowledge is also highly unique. This is not a dumbed-down version of academic research for the masses to make a quick buck [in case it is intended as such a thing it’s execution is brilliant]; this is something very personal. It is not only for the reader, rather, it seems to be also something important for the writer, a way of coping maybe. (And indeed, Dan does not only share his pain, he also reveals his darker side for revenge.)

I have a few quibbles. Only a few and very minor ones.

The Upside of Irrationality is divided into two parts. The first part is supposed to relate to the work domain, the second part to the non-work domain. Yet, the first part contains a chapter on revenge that would have fitted much better to the material on emotions that Dan discusses in the end of the second part.

All but one chapter are primarily based on Dan’s own research. On the topic of empathy, he did not even have an article of his own to include in the additional readings list. Though, of course, the topic may be very dear to him, this somehow interferes with the otherwise very personal exposition.

In the chapter on revenge, he mentions that he would not want people to live by the biblical rule “an eye for an eye”. Why not? This is a rule of moderated response. If you do not punish those who hurt you, you may invite further harm. This, Dan himself discusses in this chapter. If you punish in moderation, that is “not more than one eye for an eye”, you avert inefficient escalation. So, why not?

The title of the book and the subtitles of chapters promise more than Dan finally delivers. Where are the benefits, you wonder. Why do we do that? Dan demonstrates very compellingly behavior that is inconsistent with utility maximization and identifies behavioral quirks that lead to counter-intuitive recommendation for improving our overall happiness. He does not really explain why we do what we do. He does not really show benefits of irrationality. OK, the last is not entirely true. Our irrationality makes us human, he reveals at last.

In spite of the above, a great book. I would not dare to say that it is better or worse than Predictably Irrational. It is different.

Read: Experimental Economics - Rethinking the Rules

In contrast to what some economist today still say and believe, economics is an experimental science. At the latest, when the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was award to Daniel Kahemann (a psychologist) and Vernon Smith (an economist) in 2002 they should have acknowledged it.

Economic experiments have been proven useful in informing theory and testing (new) economic institutions before their implementation on a broader scale, e. g. the design of spectrum auctions that generated unprecedented revenues for the states running them. Unfortunately even within the community of experimental economist their use and purpose is not without controversy. Some, let’s call them experimental economists in a narrower sense see the main use of experiments in economics in showing that the theory works (well) and finding instances of when it works best. The other group, let’s call them behavioral economists see the economic experiment as one method to investigate the underlying assumptions of economic theory in order to inform theory building and inspire the revision of economic theories so that they may move more towards a positive than a normative model of the world.

With Experimental Economics a group of six British experimental economists now tried to critically assess the current state of the field that constitutes an invaluable tool for research in all areas of economics.

In a series of chapters they address the method and methodology of experimental economics, the domain of economic theory (where and when does it apply?) and the limits of experimental tests in terms of what can be said about the theory and the external validity of the experimental observations; and also how experiments are used as rhetorical devices, “exhibits” that reliably show some particular behavior of their participants illustrating a specific point. Two further chapters address the important issue of financial incentives in experiments (when are they needed, how should they be implemented?) and different sources of noise in the data that requires bespoke statistical treatment.

The last point, noise in the data and heterogeneity between subjects is in my opinion a very important one as this is still often a neglected topic in most experimental studies today. Of course, a well designed experiment may allow the authors to show their main point without any fancy statistics. On the other hand, in order to move to a positive theory of economic behavior the individual and not the aggregate behavior should be the focus of the analysis. This necessarily requires a more advanced statistical treatment of the data. As well as laboratory and field experiments (and happenstance data) are complements so are theory, experiments, and statistics complements.

In sum, even though I may not agree with some of the more specific points Bardsley, Cubitt, Loomes, Moffatt, Starmer, and Sugden make their book is an excellent text that will make it on the reading list for my courses in experimental economics.

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