(credit for the background image: Jennifer Stahn BY/CC)

(Behavioural) economics through sunglasses

When you’ve embraced economic thinking, even a summer break from work doesn’t stop you seeing how profoundly we humans truly are economic beings

This summer I have once again been wearing my trusted economics sunglasses. As before they supplied some interesting observations, confirming how good economics is at describing and explaining a lot of our behaviour.

In my home town (and much of England), we would on average get 8 rainy days per month in June and July. That’s two a week. Of the other days, not all are warm and sunny, so really nice days are generally quite scarce. Not so this year: we had 41 consecutive dry days between the middle of June and the end of July. Most of these were genuine summer days (30 with a temperature above 25 degrees C). In June we had 75 hours more sunshine than average, and in July that was nearly 100 extra hours.

Scarcity is a core concept in economics: when a resource becomes relatively scarcer, market prices tend to go up. This helps ensure that the resource is allocated to those who value it the most, and encourages suppliers to increase their supply. We cannot buy or sell good weather, of course. But scarcity is also an important factor in behavioural economics: we tend to be attracted to, and overvalue what is scarce (and undervalue what is abundant). Shrewd suppliers exploit this, for example by telling us only a few hotel rooms remain available at a bargain price, and thus making us buy.

How boring can the weather get?

And scarcity along with abundance in weather patterns too influence our behaviour. During an ordinary summer, a forecast of a couple of warm, dry and sunny days would easily encourage us to plan a day out, to maximize enjoyment from a relatively rare opportunity. But this year every day was a summer day …and as a result we didn’t go away even once. This shows how a sense of abundance can make us more likely to be wasteful. If you can get away any day, in the end you don’t get away at all, and so all the nice days are lost.

The unusual weather has also reset the benchmark against which we rate summer days (in a process similar to anchoring). It’s late August now and while the temperatures are still above normal, and should otherwise be making me very happy, I can’t help feeling a tad disappointed. Value is relative, in the weather as in the shop.

Differential pricing is the holy grail for retailers. When you offer your goods or services at the same price to everyone, you exclude every prospective customer whose willingness to pay (WTP) is below that price. Moreover, you’re giving it away to cheaply to everyone willing to pay more than your price.

Some industries have become very good at targeting different customers and pitching their prices close to the WTP in the different categories. Airlines are a prime example: identical seats on the same flight, costing the company exactly the same, are offered (and bought) at very different prices.

This is not so easy to achieve in groceries, but the astute owner of the local shop where we were staying (who has featured before hereabouts) successfully introduced differential pricing this year. How does he manage to charge 15% more for one bottle of mineral water than for another, identical one? Presumably it was the weather that brought inspiration to the crafty shopkeeper. Thirsty people would prefer cooled drinks, he must have thought — and be willing to pay for it. So he simply added another 20 cents to the price of a bottle of water from the fridge, compared to one from the ordinary shelf.

Admittedly, this is not entirely cost free to him: chilling the water needs energy, and it displaces some other stuff to make space for the bottles. But I have no doubt that it pales into insignificance compared to the extra 20 cents he makes on each one during the summer of 2018. When you make the perceived value salient, the WTP goes up, and so do your profits.

Rubbish collection in a seaside town with lots of holiday makers over the summer is a complex affair. Most municipalities in Belgium operate a ‘polluter pays’ principle: inhabitants buy rolls of refuse bags which carry a rubbish levy, and only those bags will be taken by the collectors. The more rubbish you produce, the more therefore you pay. Fair enough, and environmentally sensible.

But each town runs its own scheme, so as a tourist renting a place for maybe a week or two, you’re unlikely to want to buy a whole roll. And even if you did, you’d still have to find a way of disposing of the waste at the end of your holiday, as the next collection may not be for several days.

Just you try to squeeze a refuse bag through that hole!

So, many tourists started resorting to surreptitiously sneaking out after dark, and dumping their rubbish in the public bins. The municipalities retaliated by placing bins with small holes, to prevent entire rubbish bags being inserted. Undeterred, the tourists then began to transport their rubbish to the ubiquitous bins in small enough quantities to fit the holes — several times per day.

The next move from the town was radical: remove the public bins altogether. With no bins next to the benches and along the streets, people with small bits of waste — an empty bottle of cold water from the grocer’s, say, or the paper bag in which they brought fruit or wonderful Belgian pastries — have two choices: take it home, or just drop it. It doesn’t take many people to follow the latter course to create a real problem. And so every morning, a large team of street cleaners must turn out in force, embarking on the Sisyphean task of sweeping up the litter left lying around in the previous 24 hours. (The story now begins to resemble the old song, There’s a hole in my bucket.)

Cause (L) and consequence (R)

This provides us with a minor economics treasure trove, illustrating several concepts. The tragedy of the commons is the phenomenon where people acting selfishly (not bothering to take their litter home and simply leaving it behind) spoil the collective welfare (leading to a dirty environment for everyone). Rubbish collection could be treated as a public good. Funded out of the public purse (perhaps by a tourist tax), it could be unconditionally accessible to everyone (it’s non-excludable), and use by one person does not reduce the availability to another one (it’s non-rivalrous). But this raises the possibility of free-riders: people who either benefit without contributing to the cost, or who overuse the resource (and thus add to the overall cost). It is this free-rider problem that the municipalities want to eliminate. But in doing so they’ve created the need for more of another public good: street cleaning. Time will tell whether this system is optimum.

We also see how the conscious choices behind out behaviour are often a precarious balance. On the one hand we have the extrinsic motivations of our neoclassical economics pursuit of self-interest. All else being equal, we seek to follow the path of the least effort, of the lowest cost, and of maximum benefit. On the other hand, we experience the intrinsic motivation of our personal ethics and morality, urging us to do what is right. Going by the amount of litter on the pavement every morning it would seem not everyone strikes this balance in the same way.

As in earlier years, I return from holiday with a reinforced sense of the profound economic nature of how we choose and how we act. Human behaviour is extremely complex and varied, but (behavioural) economics offers insights that can enhance our understanding. And that understanding can only be helpful if we want to make our lives, and the world a little better.

Or perhaps all of this is just my confirmation bias having a ball while my System 2 is on holiday…

Originally published at koenfucius.wordpress.com on August 24, 2018.

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Accidental behavioural economist in search of wisdom. Uses insights from (behavioural) economics in organization development. On Twitter as @koenfucius