[photo by cliff1066]
I took the Metro into Washington, D.C. today and had a fabulous lunch at Clyde’s ; the one on Capitol Hill, just north of the U.S. Navy Memorial.
The food was great and the company was even better. I was there with a group of University of San Diego alums who are now all working in D.C. as consultants, defense contractors and congressional staffers.
One generous member of our group announced he was putting the entire meal on his expense account so don’t hold back. We didn’t.
My biggest dilemma was whether to get the New York steak or the Alaska halibut.
In addition to the great food, there was great conversation.
The discussion was convivial and topical but also slightly intellectual in the way really smart people like to talk with each other. (For instance, when I’m talking with intelligent people I use words like convivial because it lets them know I’ve still got it.)
Talk at the table turned from cultural trends to international politics and headed into more theoretical and philosophical realms from there.
But my thoughts were on economics.
Some background
I studied economics as an undergraduate but always had a problem with the classic economic model. The Homo economicus, rational decision maker just didn’t sit well with me.
A few years ago my father gave me a copy of Freakonomics because he thought I might like it. I did, and it led me to seek out another popular economic book of the time, Dan Ariely’s Predictably Irrational. It was life changing.
I began seeing economic transactions in ways I hadn’t thought of before. I also became more aware of the ongoing conflict between conventional and behavioral economist. Apparently, not everyone “got it” like I did.
One of the psychological disadvantages behavioral economists have to overcome in this contest is the fact people who advocate the conventional economic view staunchly believe they’re right. And because they believe they’re right it strengthens their conviction, since they believe they’re coming to a rational conclusion.
Behavioral economic apologists, on the other hand, are weakened by their convictions. If they truly get what the behavioral economic advocates are saying, it undermines their convictions. The converted proponents of behavioral economics understand they are irrational and their views subjective.
This leads to the understanding they are probably being swayed by the strength of the selective data the author presents and they way he chooses to present it.
This makes the advocates less rigid in the defense of behavioral economics.
Such was the case with me and I needed to read an equally compelling book by a conventional economist to see if I were swayed into the other camp again.
Those who have been reading my blog very long know I’m a big fan of Tim Harford. In an effort to balance my mental scales I read his book The Logic of Life. I love reading Tim Harford’s books and this was no exception. It was almost as compelling as Dan Ariely’s book and even more comfortable because it was the philosophy I had been weaned on.
In the end however, I continue to lean strongly toward the behavioral economic premise.
Which brings me to Clyde’s
As I debated my selection, I looked over the choices on Clyde’s lunch menu. I read it over from a hedonistic point of view and I examined it from an economic perspective. The average price of all the lunch entrees was about $15. The most expensive item was the Grilled New York Strip Steak at a cost of $23.95.
So what did I want to eat for lunch and how would my selection be affected by the fact someone else was paying for it?
The conventional economist would say, among all the gastronomically acceptable choices, a rational person would choose the one which costs the most. This is because the value of the meal would increase their economic wellbeing the most and the foregone value of a more expensive meal would be less than optimal.
You could see it as someone placing small piles of money on the table and asking which one you wanted. You’d take the largest stack every time.
Since I enjoy steak, the New York Strip should have been a no brainer.
But enter the behavioral economist. The choice, they would say, should be the entree with which you are least certain of the outcome. That is, the meal you know the least about your enjoyment.
If you know you don’t like it or you know that you do, there is little risk and the opportunity to gamble without fear of loss would be wasted. By selecting the meal you are least certain you would enjoy, you get a free taste to see whether you like it or not. Since it’s not your money you’ve got nothing to lose.
Well, nothing except the foregone better meal you could have had. And that’s where the behavior economic theory comes in. You would never take this risk with your own money. The only time it’s feasible to give it a whirl is when you get a free spin.
The chance you’re being given is the opportunity to try something unknown without losing any of your own money. In this case, the greater the uncertainty of the outcome, the more valuable the gift.
Given my tastes, my choices were to maximize my utility by getting the New York Strip Steak according to conventional economic theory or maximize the value of my opportunity by getting the Pan Roasted Alaska Halibut.
I had the halibut for $16.95.
And it was delicious.
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I probably would have had a crab salad or equivalent.
ReplyDeleteThese days when someone else is picking up the tab, I just get what I want. Often, that's a cheeseburger.
Certainly, there are many ways to approach this decision. Probably foremost is the social etiquette involved in spending someone else’s money on our own pleasure. My goal here was simply to lay out the issue from an economics perspective, not to tell people what they should do.
ReplyDeleteI assume when you say you’d get what you wanted most, that you would get what you thought would taste the best. But you could also mean what you thought would maximize your utility the most which is a different question.
What is interesting for me to contemplate is whether our preferences change when someone else is paying. Our pure desires are always constrained by economic considerations.
Thanks for stopping by Dave.
I like the Clyde’s on Capitol Hill, just north of the U.S. Navy Memorial; I've never eaten there, but I have a curious affinity for round buildings. They make me smile. Like these spectacular images of London's Fabergé egg.
ReplyDeletePart of the decision is, how common is the experience? Is someone else paying almost every time you have lunch, or, for some people, does someone else pay for every meal?
And, do you expect that situation to continue? If you know that it's the last time, e.g. assignment over, per-diem ending, then it's the steak & lobster for sure.
The hilarious, absurd, ironic thing about staunch defenders of the Homo economicus paradigm is that they are being absolutely irrational in defense of a model of pure rationality. In a failing common to scientists and other researchers, they have forgotten that any model, no matter how useful, is only a representation of reality - it's not ACTUALLY reality. It's a MODEL, an algorithm, a symbolic abstraction which allows manipulation to gain insight.
The Homo economicus model allows us to predict what most people might do in a given situation, but it's trivial child's play to find a hundred examples of such predictions being falsified by history.
A great example of this would be the recent housing mania. Homo economicus, when shopping for a mortgage, might consider an ARM if interest rates are at, or higher than, the historical average, and might consider a teaser-rate, zero-down mortgage if home prices have been stable. But it's extremely irrational to choose an ARM if interest rates are at generational lows, for they have nowhere to go but UP, and if home prices have already risen 100% in five short years, then a teaser-rate zero-down is potential suicide, as at least the possibility of a downturn in housing prices, leading to an inability to refi out of the payment reset, must be considered.
Which is to say, adjustable-rate and interest-only mortgages are sophisticated instruments which DO NOT have universal applicability.
What does the historical record tell us? That in EXACTLY the situations where Homo economicus would shun ARM and IO mortgages, THE MAJORITY OF MORTGAGES ACTUALLY ISSUED IN THE REAL WORLD WERE ARMs AND IOs!!!
The precise opposite of what would be predicted under the Homo economicus model.
Real-world humans have neither perfect knowledge, perfect perception, nor perfect analytical ability.
"The chance you’re being given is the opportunity to try something unknown without losing any of your own money."
ReplyDeleteThat's explored at length by Chris Anderson in "Free: The Future of a Radical Price" - Free! Why $0.00 Is the Future of Business, in Wired magazine
Those are two links above, btw - as published, it could be mistaken for only one.
ReplyDeleteMulti-posts to work around Blogger's anti-spamlink policy...
Malcolm Gladwell reviews "Free", by Chris Anderson, in The New Yorker (hat-tip to Nolayan Herdegen) & a review of "Free" in the Financial Times (free reg. req.)
Some good reading in the above links for anyone scanning the comments section.
ReplyDeleteI have read Chris Anderson’s work before and find it an intriguing possibility. I haven’t yet read his full book to be able to comment intelligently about his premise.
(I believe I’ve lent it to Nolayan.)
Behavioral economist have shown, in my opinion conclusively, people act differently when things are free. That is, they act irrationally.
I think the “free” effect may be partly to blame for the irrational housing market behavior mentioned above. When people perceive their interest rates to be lower than they actually are (as in IO and ARM mortgages) they perceive it as “free” money and act accordingly, making irrational decisions and taking irrational risks.
It was NOT irrational to lend them money however, because the mortgage market was so liquid banks could offload these mortgages the next day.
So as far as the banks were concerned they might as well have the steak, someone else was buying.
I do not believe this is the way that I would make the decision, being more like Dave. I do not get the distinction you are trying to make when you say that choosing for taste is different than choosing for utility. Unless this is a choose-to-maximize-which-metric distinction. Was the point that traditional economic models attempt to maximize monetary value while behavioral models attempt to maximize opportunity?
ReplyDeleteAssuming that all meals are equal except for pleasure and price, the traditional model states that the choice would/should be the highest priced item within the highest pleasure group of entrees. The behaviorist states that the choice would/should be the entrée with the greatest margin of error within the highest pleasure group. My approach would be to choose the item with the highest value after accounting for the loss of the preferred item (and the karmic damage of eating meat). Which is what I understood Dave to say, with fewer words. Moreover, why should this be any different than a banquet where all the dishes are the same price? At a buffet, should one continue to try the dishes that might be good but are unfamiliar until all are known?
A final question: Did you choose the Pan Roasted Alaska Halibut because of your analysis or because someone else ordered the Grilled New York Strip Steak while you were thinking about it?
Ha ha, I love this comment.
ReplyDeleteYou bring up a lot of good points. My analysis was most certainly incomplete.
As for the buffet, I would say conventional wisdom is to avoid the starches and fill yourself on the high priced protein, namely meat. Even accounting for the karmic damage you’re most likely to get your money’s worth that way.
I got the halibut because I wanted to try something I probably would not have bought if it were my own money, but I get the Dan Ariely reference. Nice.
It’s a pleasure to hear a “unique” perspective. Thanks for stopping in.
I find Ariely's work a little more impactful than Freakonomics was (although Levit started the movement). I also disagree with the idea of Homo Economicus. That's not true. I believe economic man exists; I just don't believe he is also human.
ReplyDeleteAlong this vein, I'd encourage you to check out Thaler & Sunstein's Nudge. It basically explores how we can frame choices to take advantage of Ariely's predictably irrational human.
Thanks for the suggestion David. Nudge has been on my BTR list for a while now.
ReplyDeleteIt’s really amazing how different our choices are depending on how they’re framed. I find myself thinking about it a lot, but it’s like a visual illusion that is impossible to see beyond even when you know your eyes are deceiving you.