Saturday, November 12, 2016

Letter To Judith Donath

This morning I listened to Russ Robert's excellent discussion with Judith Donath about signals.  Here's the e-mail that I just sent her...

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Hi Judith,

I just finished listening to your talk on Econtalk.  I really enjoyed it.  It's a very fascinating subject.  Plus, you have a nice voice!  :)

I'm very interested in the relationship between signals and willingness to pay (WTP).  Let's say that Netflix gave me the opportunity to divvy up my $10/monthly fee however I wanted between all my favorite content.  This really would not be easy to do!  It's one thing to give my favorite content 5 stars... but it would be another thing to give my favorite content my fees.  This is simply because my fees are limited.  A penny that I spend on Chungking Express is a penny that I wouldn't be able to spend on The Man From Earth.  In economic terms... there would be a very high opportunity cost.

I refer to this system as the pragmatarian model.  In theory, the benefit of the pragmatarian model is that it would allow us to more honestly reveal/communicate the strength of our preferences to consumers/producers.  When we can accurately know the actual strength of each other's preferences... then it would allow society's limited attention/brainpower to be efficiently allocated.  With the current system... we don't accurately know the actual strength of each other's preferences... which means that society's limited attention/brainpower is being inefficiently allocated.

What comes to mind is the three wise men following the star.  The three wise men were following the star because it was so much brighter than the other stars.  It stands to reason that if the "wise men" (brainpower) in our society can't see how bright the "stars" (value signals) truly are... then they will follow the wrong ones.  Nobody truly benefits from the inefficient allocation of society's limited brainpower.

If it makes sense to apply the pragmatarian model to Netflix... it would also make sense to apply it to Amazon Kindle Unlimited (AKU).  AKU subscribers would spend $10/month but they could choose which titles they spent their fees on.  By far my favorite book in the world is the Wealth of Nations (WON) by Adam Smith...

It is thus that the private interests and passions of individuals naturally dispose them to turn their stocks towards the employments which in ordinary cases are most advantageous to the society. But if from this natural preference they should turn too much of it towards those employments, the fall of profit in them and the rise of it in all others immediately dispose them to alter this faulty distribution. Without any intervention of law, therefore, the private interests and passions of men naturally lead them to divide and distribute the stock of every society among all the different employments carried on in it as nearly as possible in the proportion which is most agreeable to the interest of the whole society. - Adam Smith, Wealth of Nations 

This is the Invisible Hand (IH).  Unfortunately, what Smith really never clarified about the IH is that the benefit of the outcome/allocation... depends entirely on the accuracy/honesty of people's payments.  

Even though the WON is by far my favorite book in the world... I've never even spent a penny on it.  Why buy the cow when I can get the milk for free?

valuation: $$$$$$$$$
allocation: $0

allocation <<<<<< valuation

The amount of money that I've spent on the WON is a LOT less than my valuation of it.  And my valuation of the book is so high because I perceive that there are no books like it.  Valuation is our perception of relative scarcity.

What's so tricky is that, in economic terms, we could say that I've derived a ton of consumer surplus from the WON.  However, deriving so much consumer surplus could also be considered theft and/or the free-rider problem.

What if the pragmatarian model was applied to AKU?   If the WON was one of the titles... then I'd have absolutely no reason for my allocation to be less than my valuation.  Each month I could spend my entire $10 fee on the WON for the rest of my life.  Each month my mountain of consumer surplus would be marginally smaller.  Smith has been long dead though... so who would get the money?  Who cares!?  I wouldn't be trying to influence/change/alter/modify/improve Smith's behavior... I would be trying to encourage more consumers to read his book and more producers to stand on his shoulders in order to create even better books.

Of course, if I'm the only subscriber of AKU who was spending so much of his fees on the WON... the change in people's behavior would probably be vanishingly small.  But the more subscribers who spent more of their fees on the WON... the brighter its value signal... and the greater the change in people's behavior.

It stands to reason that if intra-good valuation is important... then so is inter-good valuation.  Netflix would add books and/or AKU would add movies/shows.  Amazon Prime already streams movies/shows so you'd figure that Amazon would be able to get the jump on Netflix.

Each month I'd pay Amazon $20 dollars... but I'd be able to choose which books/movies/shows that I spend my fees on.  Chunking Express is my favorite movie and the WON is my favorite book.  Every penny that I spend on WON is a penny that I can't spend on Chunking Express.  OUCH OUCH OUCH!!!

I value WON more than I value Chungking Express.  This is simply because the supply of good things is subordinate to people's understanding of the importance of honest/accurate spending signals.

With the benefit of inter-good valuation in mind... it would make sense for Amazon and Netflix to also add music and software.  But why stop there?  Why not simply move all digital goods into the public sector but give people the freedom to choose where their taxes go?  For all intents and purposes... taxes are simply fees.

Then I'd be able to decide which is more important... the WON or space colonization.  When you clicked on my profile page you'd be able to see all my favorite public goods sorted by my valuation of them.  At the quickest glance you'd have the greatest grasp of what's truly important to me.  Well... at least as far as public goods are concerned.

With this system... we'd be able to freely share and read every book.  Books would be public goods.

With the current system... if you think about it... it's entirely backwards.  You buy a book before you read it.  If we think of buying as valuating... then how can you accurately valuate a book that you've never even read?  With books in a pragmatarian public sector... you'd valuate the book after you read it.  The greater your perception of the book's relative scarcity... the higher your valuation... and the greater your willingness to sacrifice the alternative uses of your tax dollars.

I've shared this concept with a few economists but they seem to balk at the idea.  In all textbooks... consumer surplus is a good thing.  Then again, in all textbooks... the free-rider problem is a bad thing.  Economists seem unwilling to confront this inherent/blatant contradiction regarding the importance/necessity of honest/accurate spending signals.

It would be wonderful if you could carefully consider the concept and share your thoughts on it.

Sincerely,
Xero

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