Economics

Posts related to economics & finance

Behavioral Finance: The More We Make, the Better We Want

/ Adam Nash / 4 Comments

I actually got a chance this evening to read the New York Times Business section in careful detail, and I found this gem of a column by Robert H. Frank, economist at the Johnson School at Cornell University:

The More We Make, the Better We Want – New York Times

This is a wonderful piece, because it captures three things that I find equally fascinating in one, elegant piece:

  • Classical Economics can fail in prediction when it does not take into account the uniquely emotional relationship that people have with money. It’s funny in retrospect, but I remember reading about John Maynard Keynes prediction of productivity growth leading to a shorter and shorter work week, and an excess of leisure time. Like Lamarkian evolution, this type of economic thinking meets the initial “sniff test” for critical thinking, but because it gets the base mechanism wrong, fails in the critical scientific goal of not only explaining the past, but predicting the future. Outside of small enclaves in France and Marin, there are likely few who actually believe that increased productivity should lead to a shorter work week… but why? This is the first article that to me clearly articulated the concept that as productivity rises, so do incomes. And as incomes rise, an “insatiable demand” for increased quality follows. This is a behavioral finance insight in my book: an insight into the predictably emotional behavior of people and money.
  • Flaunting superiority is not the only reason people spend money on luxury goods. Living in the Silicon Valley, where people measure revenue per employee in the hundreds of thousands (and market capitalizations per employee in the millions), this insight is instantly recognizable. While it is of course true that people to some extent will spend money for status symbols and competition, this explanation does not really explain everything that people spend money on. This article ascribes this to pursuit of “increased quality”, which is a touch idealistic, but it still rings true. Do people spend thousands of dollars on computers and Plasma TVs just to have one “as good or better than others?” Possibly in some cases, but in many cases it is because people spend a lot of time with these goods, and they have the income to spend on making that time higher quality. What are the limits here? Are there any? If there really is no end to the consumption demands of individuals, that really validates some of the brightest and darkest theories about human happiness.
  • American vs. European Spending Patterns. When you look at the recent economic evolution of the major western economies, one of the striking divergences between Europe and the United States has been the balance between growth & productivity vs. stability & social welfare. After the malaise of the 1970s, the divergence becomes incredibly acute – the incredible growth of the United States, on top of an already incomparably large US economy has been astounding. I am personally skeptical of “purchasing power parity” methods for ranking international incomes for a large number of reasons. But leaving that topic aside, this article explains to me a lot of what I’ve personally experienced during my brief stay in France. You have many people, quite happy with a dorm-room sized refrigerator, a water heater the size of a waste basket, and a 19″ television. In the US, a similar person, in a similar economic decile (or lower), somehow has a 50 gallon water heater, a 25 cu. ft. refrigerator, and now probably a large, flat panel television. The easy answer is to say that all Americans are gross, disgusting over-consumers, who put all their value in material things. This article puts some basis behind an alternative explanation – higher productivity and incomes in the United States have allowed people increasing amounts of disposable income to spend on higher quality products & services. More importantly, that process is a never-ending cycle, leading to more productivity gains, and an ever-increasing standards bar for the quality of goods & services.

This seems like an incredible economic advantage, and it speaks to the recent incredible growth in the luxury goods market as a secular trend. Economies that continue to generate outsized productivity growth may in fact establish a powerful strategic moat based on their insight into the “next level” of quality in goods & services. That certainly seems to be part of what continues to happen on an ongoing basis in 21st century Silicon Valley.

One of the truly great aspects of economics is being able to read decades and centuries of theory – some of it incredibly insightful, some of it woefully wrong. The reason it is wonderful is because, unlike the hard sciences, economics is fundamentally a study of people – individuals, crowds, and their interactions. As a result, understanding the history of economics and the reasons why very intelligent economists ended up with the wrong predictions is incredibly edifying.

This is an article worth reading, and then letting it digest, and re-visiting again. I also find this line of thinking a portent of an upcoming golden age of economics, as ground-breaking for this area as Max Planck was for particle physics.

As a side note, I also learned that finding an article on the New York Times website is nearly impossible. I did a direct search for this title on Google, Yahoo, and on the NYT site itself, on the homepage and in the business section. No luck. It was only through some very intricate checkboxes and sub-filtering of the NYT search that I was able to find this article – I have the printed copy sitting right next to me!

You have to love the Internet – you can find everything that you didn’t know existed, and you can’t find the one thing you know exists and want.

Economic Mythology & The Strength of the US Economy

/ Adam Nash

Interesting article on Smartmoney.com on Friday:

Ahead of the Curve: Economic Mythology

I find this type of article interesting, even though I do not completely agree with the conclusion that there are no debt-related issues for the American consumer.  Right now, you could assign me to the camp that thinks the Federal Reserve has been playing this cycle fairly well.  However, it has been striking to me how the current economic cycle, which on paper has been unbelievably strong, has also been surrounded by an incredible amount of negativity.

The United States continues to deliver economic gains in gross domestic product (GDP), GDP per individual, productivity and wage gains that would be impressive for an economy one tenth the size.   In fact, the US went from a $9.76 trillion dollar economy in 2001 to a projected $13.23 trillion dollar economy in 2006.  That’s a 35.5% increase in just five years!  For all the fear and admiration of the growth of China, the US basically just added 133% of China’s 2006 economic output, in just the last five years!  (Actually, that number is bigger than the size of the GDP of even the #3 economy, Germany)

Don Dodge sometimes will remark about how hard it is for Microsoft to show the spectacular growth numbers that younger companies do.  When you have $40B in revenue, you have to grow a $4B business every year, just to deliver 10% growth.

Well, the United States has to basically grow in economic output the equivalent of the entire country of India every two years – just to deliver a 3% growth number.

All this, with almost negligible inflation. It’s almost unfair to say unprecedented, since an economy the size of the United States today is unprecedented itself.  But it was only three decades ago in the 1970s that a majority of sophisticated economists thought that it was impossible for an economy the size of the United States to show meaningful growth.

Given the struggles that Europe and Japan have had in the past 20 years to show meaningful growth, it’s obvious that there is something incredibly special about the US economy.  Something that is worth understanding thoroughly, before belittling it or complaining about it.

Given my respect for the US economy, I tend to enjoy articles like the one in SmartMoney.  The press tends to be sensationalist about economic trends, and the recent housing boom and resultant wealth effect is no exception.  There are so many interesting ways to look at the health of the economy, it’s always great to see an article like this one offer yet another.

Behavioral Finance, Anchoring & eBay Auction Starting Prices

/ Adam Nash / 7 Comments

There is a great article today from Alex Goldfayn in McClatchy Tribune papers, like the Sun Herald in Mississippi:

The Sun Herald | 08/27/2006 | Starting price is key in eBay auctions

It quotes some recent research from the Kellog School of Management, including Associate Professor Adam Galinsky on the behavior of buyers in auctions.

Now, as someone who has been selling on eBay for over 8 years, and working for the company since early 2003, the conclusions of this study are fairly obvious. It turns out – yes, it’s true – that auctions that start with lower starting prices result in higher final sale prices.

Why is this interesting? Well, it turns out one of the staples of modern negotiation theory and behavior finance is the concept of anchoring. Anchoring, loosely defined, is the irrational human process where people will gravitate towards a number – any number – and use it as a sub-conscious basis for what they consider a fair price.

Example: it has been shown time & time again that the higher the original price quoted by a salesperson, the higher the final price that the buyer will end up paying for the exact same item.

Even more disturbing, experiments have shown that even quoting random numbers, like the last four digits of your social security number, can actually affect the answer the people give to seemingly unrelated questions, like estimating the number of doctors in New York.

What’s interesting about this research in relation to eBay is that you would expect, based on anchoring, that the higher the auction start price, the higher the final price of bidders.

However, what the Kellog research shows is that there are other, more important emotional factors in auctions. The low price lowers the “barrier to entry” for people, and then once they are involved, they continue to bid based on the “sunk cost” of their time spent already on the auction.

I personally believe a third factor comes into play with auctions, which is competitiveness based on a false sense of ownership. People find an item they like, and that message, “You are now the high bidder” is powerful. Getting the message that you have been “Outbid” is inflamatory – it signals a primal part of your brain that triggers fear and anger that someone has “stolen” your item away from you.

I think that there has been so little academic research on the largest and more varied global marketplace (eBay), so I love to see these papers that trickle out that begin to help scratch the surface of understanding how human beings interact with each other in marketplaces other than the stock and commodity markets.

Please, if you see other research like this, send me links or documents. I find this type of analysis incredibly interesting.

Why Psychohistory?

/ Adam Nash / 8 Comments

The first question that people ask me about my blog is:
“Why is it called Psychohistory?”

This is, of course, a great question, and I think it ties closely to the first question that I had to ask myself when I decided to start blogging again: “What am I going to blog about?”

I’ve been fortunate enough in my academic and professional careers to have had exposure to a wide variety of subjects and businesses. However, I’ve realized in the past decade that my primary interest has always been the intersection of the rational (technology & economics) with the irrational (people).

As a software engineer, my primary interest was in human-computer interaction and the recognition that technology is useless without significant thought given to how people perceive and interact with it. As my interests shifted to the study of economics, I developed a deep fascination with the study of behavioral finance and the recognition that classic economic models fail to predict activity in many cases because people are often not rational actors.

These insights are fascinating to me because I firmly believe that in fact, there is a method to the madness. People are irrational in many situations, but in many cases predictably so. In my recent professional roles in early stage venture capital and product management, I have been repeatedly astounded with the level of value generated from insights into human behavior with technology and economics.

When I was in junior high school, I voraciously read the works of Isaac Asimov, and to this date I remain a fan of his intellect and insight. In his “Foundation” series, he introduced a fictional science called Psychohistory, which was based on the idea that even though individual humans were not statistically predictable, large groups of humans were. This was a direct analogy to the growing awareness of the impacts and contradictions inherent in quantum mechanics: there is uncertainty when evaluating the velocity and position of a single particle, but yet we can still accurately predict where a large mass of them (a baseball) will go when dropped.

When I think about the topics I will blog about here, I know since it’s a personal blog that there will be a fair share of “books I’ve read” and “baby/puppy/family” posts. But in the end, my guess is that the relatively unique theme to most of what I share here will lie somewhere in the intersection of my passions for technology and economics and my fascination with people and their motivations. This means common topics will likely include:

  • Personal finance
  • Economics
  • Venture Capital
  • Product Design & Product Management
  • Silicon Valley
  • Software
  • Science Fiction & Future Technology
  • Video Games

As a result, I decided that Isaac Asimov’s simplistic vision was probably the best title to capture the essence of my personal blog.

As I mentioned yesterday, I’ll be experimenting with a new post to this blog every day for the next 30 days. We’ll see how close my guesswork here comes to the actual topics I post to this blog.

Thanks for reading.
Adam

BTW I do realize that there is now an actual field of study called psychohistory which is defined as the study of the psychological motivations of historical events. Obviously, I think that this is unfortunate nomenclature, and I’m siding with Asimov on this one.