Saturday, July 22, 2017

A Penguin Introduces Henry Farrell To Ronald Coase

I'm a penguin.  I do normal penguin things... like swimming and fishing.  But I also appreciate Ronald Coase.  So I took a break from my normal penguin activities and read Henry Farrell's recent blog entry... Why Coase’s Penguin didn’t fly.  Who was Coase's penguin?  Am I?

The entry has a couple of main characters in it... Alex and Pat.  We don't actually know their gender.  As a penguin I find this to be a problem.  But it's easy enough to fix... Alexander and Patricia.

The couple wants to do something together.  She would prefer to watch a movie while he would prefer to take a walk in the woods.  Here's what does not happen in Farrell's entry.  She gets her phone out, opens the relevant app, finds Alex, clicks on his name, clicks "New" and then enters the two options...

1. Movies
2. Walk

After doing so she clicks "Create".  Alex's phone goes *bleeeling!* and he gets it out.  He opens the app and decides how much he'd be willing to pay to have his way.  She decides how much she'd be willing pay to have her way.  When they are both finished the app displays the result...

1. Movies: $3
2. Walk: $7

Alex is willing to pay more.  Therefore, the most valuable option is for them to go for a walk.  Since Pat isn't getting her way the app doesn't transfer $3 from her account to his.  But it does transfer $7 from his account to hers.

The couple bared their hearts to each other.  This is Ronald Coase.  He's a really great guy.

Admittedly, I do have a bird brain.  So maybe I'm misunderstanding that the problem with social cost is that it's hidden.  Maybe Coase didn't perceive that costs need to be seen and known in order for mutually beneficial decisions to be made.  And maybe I can't fly.

11 comments:

  1. Interesting, but incomplete!
    You would really also need to rate the opposite, ie how much would you pay (or indeed need to be paid) to *not* pursue a particular option.

    And then you'd run into the problem Dan Ariely describes here: http://danariely.com/2012/05/08/turning-the-tables-fdr-tom-sawyer-and-me/ - value is not objective.

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  2. When Pat is deciding how much she'd be willing to pay for her preferred option (going to the movies) she also takes into account how much she'd need to be paid to walk in the woods. So her $3 dollars WTP for going to the movies is also her minimum willingness to accept (WTA) for walking in the woods.

    Is it necessary to unbundle WTP and WTA? Let's imagine that the previous day two hikers were killed in the same woods by a pack of wolves. In this case there might be a huge disparity between Pat's WTP for going to the movies and her WTA for walking in the woods.

    If the two things are bundled then perhaps the amount she enters for her preferred option is $100 dollars.

    Alex: Wow, you REALLY want to go to the movies!
    Pat: Naw, I just REALLY don't want to take a walk in the woods!

    But in reality, Pat would probably ask Alex to choose an alternative activity that didn't involve the chance of being eaten by wolves.

    The main issue is where/when it's beneficial to use sacrifice (or willingness to sacrifice) to accurately signal the value of things. Ariely's article, while interesting, doesn't really address this issue. He doesn't say, "Here's exactly when, where and why we're better off NOT knowing the social value of things."

    From my perspective, it's always necessary to know the social value of things because society's resources are always limited. The time that Alex and Pat spend walking in the woods can't also be spent going to the movies... and vice versa. In order to spend their time as beneficially as possible, it's necessary for them to use sacrifice to accurately signal/reveal their valuations.

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  3. Are you excluding the option of neither the movies or the walk?
    I think that in practice it's perfectly possible to have a WTP to do something and a different WTA *not* to do something (and vice versa).
    Pat might prefer the walk in the woods, willing to pay $3 to do so, and wanting $5 to forego the opportunity. That doesn't mean she will take $5 to go to the movies. Maybe she also likes the movies, only less so, and shed even be WTP $2 for it, or maybe she thoroughly loathes it and would want no less than $10 to go to the cinema.

    The relevance of Ariely's article is that our preferences are often shaped by the framing. It's not that there are situations where we're better off not knowing the social value of things, it's that the social value of things is fuzzy, and probably unknowable. The accuracy with which you can signal your preference belies that fuzziness.

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    1. Would Alex want to use the app if he wasn't at all interested in either activity? Why wouldn't he simply suggest an activity that he was interested in?

      One point of the app is to provide a mutually beneficial solution to a conflict. Alex wants to go for a walk with Pat in the woods. She'd prefer to do something else. There's a conflict, albeit rather small. In the absence of the app, he might try and bribe her by offering to cook dinner... and do the dishes. If she accepts, then the conflict was resolved by a mutually beneficial trade. His willingness to sacrifice (cooking/cleaning) quantified and showed her how important it was to him for both of them to go for a walk. She was willing to accept his sacrifice/gift and give him what he wanted in exchange. What if she decided that the gift was too small? Then she could reject it and he could decide whether it was worth it to offer a larger gift.

      The app eliminates the need for any negotiation or figuring out a suitable non-cash reward. They both simply put their cards on the table. Whoever is willing to pay more for their preferred option wins, and compensates the loser accordingly.

      Dan Ariely's article showed that framing affects our valuations. Therefore, Netflix shouldn't be a market? Same with your local grocery store? What I want is a coherent story. Most economists have absolutely no interest in supplying one. There have been precious few exceptions... such as James Buchanan and Murray Rothbard. They both perceived that people's valuations were equally important/necessary for private goods and public goods. The difference is that, unlike Buchanan, Rothbard never appreciated that taxation and valuation were not mutually exclusive.

      From my perspective, it's extremely weird for Ariely to focus on framing/fuzziness and entirely neglect the big picture of market effectiveness compared to the alternatives. If you get a chance check out my recent blog entry about NPR. The simple question I ask is... how should we determine the importance of books? No system is perfect... but which system is the best?

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  4. 1. You're still not addressing the reality of the fact that people can have both a WTP and a WTA in a potential transaction. Let's say we want to go to a concert together. There are two gigs on the same day: Foo Fighters and Taylor Swift. You like both, but you like Taylor more. I like the Foo Fighters, but I wouldn't want to see Taylor Swift it the gig was free... you'd need to pay me to go and see her. Your app would need to reflect that.
    Incoherent preferences are not incompatible with a market, as the reality around us confirms. But they can be problematic in individual transactions if you want a "coherent story". (Will read your NPR blog as soon as I have a minute. Unless you pay me :-))

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    1. (Forgot to put a 2. before the second para) (And I've now read the NPR piece :-)

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    2. I already addressed it. I didn't see an issue with bundling them together. In my Classtopia Coasianism entry you can see real life examples. In the last example there were around 30 students trying to decide which student, out of 10, should be in charge of their Justice Dept. Each student only entered their valuation for their most valuable option (MVO). Christopher won because his total valuation was the highest. He only received one valuation, from himself. Of course he couldn’t know beforehand what the valuations for the other candidates would be. If he had lost, then he would have been compensated. Instead, he won, and ended up compensating everyone else.

      It was wonderful how shocked everyone was that Chris had single handedly bought/won the election. How many of the students calculated the possibility of Chris winning into their valuation for their MVO? I have no idea.

      Lots of people were certainly shocked when Trump won the election. Did you read this article by Carey Morewedge… Why You Should Bet Against Your Candidate? If supporters of Clinton had bet against her, then they would been compensated by her loss. It would have been a win-win situation. Either they’d get their preferred candidate, or they’d be compensated.

      It certainly would be interesting if each student had entered their valuation of each candidate. That would be a total of 300 valuations though. But you’re probably correct that the optimal solution/option depends on determining each participant’s valuation of each option.

      Thanks for reading my entry about NPR. Scarcity (limited resources) means that it’s necessary to determine the importance of each book. But what’s the best way to do so? Direct Democracy? Representative democracy? Markets? This is what I mean by the need for a coherent story.

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  5. Not sure where you addressed it - please point me in the direction.

    Let me restate why I think both are essential:
    1. While the walk in the woods and the cinema are mutually exclusive, there is a third option, the status quo, from which the change in utility should be calculated. In either case these could be positive or negative, and therefore reflect a WTP or WTA.
    2. Even if there is no "do nothing" option, this is necessary. We knew that either Trump or Clinton would become president, but while I might be willing to pay say $100 to see Clinton elected, I might need $100,000 to compensate me for a Trump presidency.

    I didn't read the Morewedge piece, but I was well aware of that possibility. Did you know that @leighblue did exactly that on the day of the Brexit referendum (just before the polls closed)?

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    1. It was the reply that contained this...

      Alex: Wow, you REALLY want to go to the movies!
      Pat: Naw, I just REALLY don't want to take a walk in the woods!

      So your WTP for Clinton would be $100,000...

      Me: Wow you REALLY want Clinton to be elected!
      You: Naw, I just REALLY don't want Trump to be elected!

      The WTP is the same thing as the minimum amount of compensation you'd accept if you didn't get your preferred option.

      Here's a real world scenario. You should join Econhub and respond to my threads and create your own. If this is something you're already willing to do then there's no need for the app. But if it's something that you're really not interested in doing?

      Unfortunately this is something we can't test out without an app! But let's pretend that there was one.

      I'd input my WTP into the app and you'd input your WTA. Of course, we could only see each other's amounts after we had both submitted our own.

      Me: $10 dollars
      You: $5 dollars

      My WTP is greater than your WTA so we'd have a deal. You'd receive $10 dollars and I'd receive your Econhub participation.

      Let's get more complicated. I prefer for us to discuss economics on Econhub. You prefer for us to discuss economics on Medium. So we get the app out...

      Me: $15 dollars
      You: $12 dollars

      In this case we bundled our WTP and WTA together. We could separate them...

      Me: WTP $10 (for Econhub), WTA: $15 (for Medium)
      You: WTP: $12 (for Medium), WTA: $7 (for Econhub)

      ...but then I'd brainfart on the math! :/ It's less of a mental challenge for me to just compare my WTP and my WTA and just make the bigger number my WTP. If I win, I overpay, but if I lose, I don't have to worry about being undercompensated. Heh. I'm sure it's some type of bias... right?

      I didn't know that @leighblue hedged his Brexit bet. That's super cool!

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  6. I think most people would not see WTA to have Trump as a president as the same as WTP to have Clinton. Exhibit A is Russ Roberts statements on Twitter that he abhorred Trump (⇒ WTA > 0) but could not bring himself to vote for Clinton to help avoid that prospect.
    Moreover, what if there are more than two candidates? How would you turn the WTA for trump into a WTP for the other candidates?

    I had a quick peek at Econhub when you first mentioned it. Looks interesting but haven't had the time yet to explore it.

    Is the $7 in your example a typo?

    The way it'd work out is like this:

    Discussing economics on Econhub: delta(welfare) = +$10(you) -$5(me) = +$5
    Discussing economics on Medium: delta(welfare) = -$15(you) +$12(me) = -$3

    By doing it this way we allow for the situation that there is no transaction that enhances welfare.


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