A friend reads the Meta Opinion so I don't have to

Background:  The FTC’s case against Meta rested on a familiar monopolization narrative: Meta supposedly dominates “personal social networking” and preserved that dominance by buying Instagram and WhatsApp before they could blossom into competitive threats. For the theory to hold, users must be trapped on Meta’s platforms despite wanting something different, and Meta must be quietly degrading quality because—secure in its monopoly—it can.

After a full trial, the court found none of this matched the evidence. A friend of mine, who celebrated the opinion’s release with a glass of single malt, sent along a set of remarks that form the basis of this post.  

The European regulators required Meta to offer an ad-free Facebook and Instagram for €5.99 per month. Fewer than 0.01% of users subscribed. If consumers were truly desperate to flee the “oppressive” ad-supported model, one might have expected more than statistical noise. As my friend put it, this was not exactly the behavioral evidence one hopes for when arguing that users are crying out for an alternative.

Europe contributed another natural experiment when regulators mandated a choice screen for search engines on Android. Under the FTC’s theory, Google’s dominance stems largely from being the default—the search engine pre-selected for users who supposedly never bother to change it. So regulators removed the default entirely and required every user to make an active choice. Yet when presented with a perfectly neutral menu, over 98% still selected Google. It was a useful reminder that consumer preferences sometimes favor the incumbent for reasons unrelated to default settings.

The profits evidence fared no better. The FTC treated Meta’s high profits as proof of monopoly power, but did not rule out the more mundane explanations—efficiency, innovation, or providing products people actually like. Since Meta’s returns do not look unusual relative to other successful tech firms, the court concluded that “monopoly” was doing more work in the FTC’s theory than in the real world.

Then there was the “quality degradation” argument. The FTC suggested Meta raised its “quality-adjusted price” by making its apps worse over time. The record instead showed steady feature additions and billions in R&D investment. If Meta is secretly degrading its products, it is doing so in a very expensive and user-pleasing way.

Finally, the court noted that one FTC expert had previously urged the agency to bring this exact case. As my friend observed, this made the testimony feel less like neutral analysis and more like a very committed book report.

In the end, the court’s conclusion rested on the distance between the FTC’s theory and the evidence. The agency described a world in which consumers were effectively captive and Meta behaved like a textbook monopolist; the record pointed to something far less dramatic. Confronted with the gap, the court went with the evidence.

HT:  My friend supplied the irony. 

US leads the world in single-parent households...

... and the results are statistically disastrous.  

Summary of three pieces on Economist Melissa Kearney's Research

• Freakonomics Radio: When did marriage become a luxury good?
• Related: Why Did You Marry That Person? (Replay)
• Related: Why Does the Richest Country in the World Have So Many Poor Kids? (Update)
• Related: The Fracking Boom, a Baby Boom, and the Retreat From Marriage
• NYTimes: The Explosive Rise of Single-Parent Families Is Not a Good Thing
• Children from single-parent homes have more behavioral problems, are more likely to get in trouble in school or with the law, achieve lower levels of education and tend to earn lower incomes in adulthood. Boys from homes without dads present are particularly prone to getting in trouble in school or with the law.
• Income differences are not the only driver of differences in outcomes. A second committed adult in the home can contribute considerable time and energy to taking care of children.
• We can and should do more as a society to try to compensate for these gaps in parental investments. But again, it is highly unlikely that government or community programs could ever provide children from one-parent homes with a comparable amount of the supervision, nurturing, guidance or help that children from healthy two-parent homes receive.
• That means a generation of children will grow up more likely to get in trouble and less likely to reach their potential than if they had the benefits of two parents in their homes.
• NYTimes: The One Privilege Liberals Ignore
• Families headed by single mothers are five times as likely to live in poverty as married-couple families.
• Children in single-mother homes are less likely to graduate from high school or earn a college degree. They are more likely to become single parents themselves, perpetuating the cycle.
• Almost 30 percent of American children now live with a single parent or with no parent at all. One reason for the sensitivities is large racial disparities: Single parenting is less common in white and Asian households, but only 38 percent of Black children live with married parents.

Should we trust behavioral scientists?

Not if we believe in science (cite) :

...psychologists significantly overestimated the replicability of published psychology research in the reproducibility study. In general, behavioral scientists overestimate not only the effect of nudges, but also the impact of psychological phenomena and the replicability of published behavioral science research.

HT MarginalRevolution.com

The Peltzman Spike

Over 40 years ago, Sam Peltzman studied the behavioral changes from the 1968 adoption of a mandatory seat belt law. Before then, seat belts were an option that many new car owners had forgone (like the original owner of my first car, a 1964 VW bug). Engineers had estimated thousands of lives would have been saved had crash victims only been restrained. Their estimates were high. They had not accounted for the additional crashes. Once drivers were safer given a crash, they could drive a little faster and a little more recklessly and still be just as safe as without the seat belt. The net effect of more drivers surviving crashes, but more of them, was a smaller reduction in auto fatalities than had been predicted.

Peltzman's findings were controversial at the time but spawned a slew of research into how safety regulations affect behavior. The story goes that at one presentation, Walter Oi noted that car crashes also cause negative externalities. That is, often you crash into someone else causing harm to them as well as to yourself. The usual remedy for negative externalities is to make the reckless behavior more expensive, not less. Oi suggested that instead of seat belts, we should include a sharp spike on the steering column. The possibility of impaling oneself on "The Peltzman Spike" would focus the mind on avoiding crashes.

Trust only 1/3 of the results from Pscyhology, but 2/3 of the results from behavioral economics

Dan Ariely (psychologist and behavioral economist) was forced to retract a well-cited paper based on fraudulent data. Ariely, a frequent TED Talk speaker and a Wall Street Journal advice columnist, cited the study in lectures and in his New York Times bestseller The (Honest) Truth About Dishonesty: How We Lie to Everyone — Especially Ourselves. We have blogged about Ariely's work and want to warn readers that we may have retract the blog posts, pending the outcome of an internal investigation.  

Professor Ariely's problems are part of a larger "replication crisis." It began when the journal Science found that only 1/3 of the psychology experiments underlying the most cited papers in the field of psychology  could be replicated.  A bigger and more recent study finds much the same thing.  [Behavioral Economics does better than psychology, as 2/3 of the results can be replicated.]

Contributing to the crisis is what is called HARK, Hypothesis After Results Known.  Due to the pressure to publish statistically significant results, researchers do science backward.  They begin by looking for a statistically significant result (p hacking).  Then, they specify an hypothesis to explain it.  Now, good practice requires that researchers register hypotheses before testing them.  Note that a similar problem plagues non-experimental data as well (regression fishing).

We regularly blog about deviations from the rational actor paradigm, and include some of the more useful results in our textbook, notably loss aversion (losses hurt more than gains help), and hyperbolic discounting (overweighting the present).  To the extent that these findings cannot be replicated, we could be wrong.

For the sixth edition, we will do our best to determine whether these Behavioral Economics results can be trusted.  For now, place a 2/3 weight on them being right.  

Bias in forecasting, e.g., US presidential election

The Financial Times has an article on why the forecasters were so wrong about the election, and referenced some research by behavioral economists on bias:

At Oxford university’s Centre for Experimental Social Science, Mayraz ran experiments in which participants were told that they were either “farmers”, who would be paid more if wheat prices were high, or “bakers”, who would be paid more if wheat prices were low. They were then shown a graph, purportedly tracking the wheat price, and invited to forecast the future price, with a cash reward for accurate forecasts. Despite the fact that they were being paid for accuracy, the farmer-participants systematically forecast higher wheat prices than the bakers. Everyone predicted what they hoped would happen. Does that sound familiar?

Psychological bias and bad decisions

Using Behavioral Economics to motivate workers

What's the difference between Keurig Coffee and Nashville city government?

Sunk-cost fallacy in real estate

Psychological pricing in action

Is Mark Sanchez a sunk cost?

Beware the Experts

How to Fight Cognitive Bias

Loss aversion

Rational actors?

Airline Revenue Part 2

Top posts of 2010

1. Incentives matter -- dump your sick employees into the govt. exchange
2. How do insurers identify good drivers?
3. Vertical integration and tax avoidance
4. Pub owners support minimum alcohol laws
5. How many economists does it take to eliminate discrimination against women?
   
6. Using Behavioral Economics to motivate workers
7. Compensating risk differentials for prostitution are small
8. Job openings in China for fair-faced foreigners
9. Product Market Size and the Returns to Innovative Effort
10. Do tourists pay more than locals?

Dan Ariely Interview

John Heins, publisher of Value Investor Insight interviews Dan Ariely, the author of Predictably Irrational and the forthcoming The Upside of Irrationality (drops June 1). He concludes with a comment on the impact on the financial crisis on his work.

Do you think the financial crisis has made the book more popular?
It’s hard to find comfort in this, but there’s no question the financial crisis has been a good thing for behavioral economics. A few years ago people assumed markets drove out all this irrationality we were seeing. That assumption isn’t nearly as prevalent today.

Improve Your Strategic Decision Making

The latest McKinsey Quarterly includes an article, "The Case for Behavioral Strategy," that advises you on how to improve strategic decision making in your company. Looks like important advice considering a recent McKinsey survey indicated that only 28% of executives rated the quality of their company's strategic decisions to be good, 60% thought bad decisions happened as often as good ones, and 12% thought good decisions occurred infrequently.

The high-level advice for countering known biases:
1. Decide which decisions warrant the effort (of trying to deal with biases)
2. Identify the biases most likely to affect critical decisions
3. Select practices and tools to counter the most relevant biases
4. Embed practices in formal processes.

It’s Not the Incentives, Stupid?

One of the consistent themes on this blog is the power of incentives to motivate behavior. Well, here’s an article from Dan Ariely (behavioral economist and author of Predictably Irrational) in the most recent issue of Wired UK magazine discussing how monetary incentives might not increase the quality of activity, only the quantity. Ariely and a couple of co-authors conducted some experiments that had subjects completing tasks that required creativity, attention, memory and concentration. The subjects were split into three groups that were offered different levels of bonuses for doing well: a day’s pay, two weeks’ pay, and five months’ pay. It turns out that the first two groups performed about the same while the last group (the high bonus group) performed the worst.

If our tests mimic the real world, then massive bonuses clearly don't work. They may not only cost employers more but also discourage executives from working to the best of their abilities. The financial crisis, perhaps, didn't happen in spite of the bonuses, but because of them.

Using Behavioral Economics to motivate workers

If you are going to adopt incentive compensation, try the following.  Instead of promising workers increased pay for performance, tell them that they have been "provisionally" awarded a bonus, but that the bonus will be taken away if they do not perform.  As predicted by prospect theory,

The fear of loss was a better motivator than the prospect of gain (which worked too, but less well). And the difference persisted over time: the results were not simply a consequence of workers’ misunderstanding of the system. Economists have always been advocates of using carrots and sticks. But they may not have emphasised appearances enough. Carrots, this research suggests, may work better if they can somehow be made to look like sticks.

Where were the economists last fall?

Out to lunch, opines Paul Krugman, in this well written intellectual history ranging from Adam Smith to Ben Bernanke.

Until the crisis, efficient-market advocates like Eugene Fama dismissed the evidence produced on behalf of behavioral finance as a collection of “curiosity items” of no real importance. That’s a much harder position to maintain now that the collapse of a vast bubble — a bubble correctly diagnosed by behavioral economists like Robert Shiller of Yale, who related it to past episodes of “irrational exuberance” — has brought the world economy to its knees.

According to Krugman, our focus on "beauty" caused us to miss the "truth" of the credit, real estate, and asset bubbles.  His conclusion reminds me of one of Ronald Reagan's favorite sayings: "an economist is someone who sees something in practice and then wonders if it can exist in theory."

Should you get a personality assessment before you invest?

12 minute "chat" with Greg Davies about how insights from Behavioral Finance are being used to design investment strategies and products to accommodate investor's irrational behavior, like "loss aversion."

Loss aversion

In the new edition of our textbook ,we have a discussion of psychological theories of pricing, including what is known as "loss aversion" from prospect theory. Apparently this behavioral theory explains why pro golfers make more par putts than birdie putts:

Even the world’s best pros are so consumed with avoiding bogeys that they make putts for birdie discernibly less often than identical putts for par, according to a coming paper by two professors at the University of Pennsylvania’s Wharton School. After analyzing laser-precise data on more than 1.6 million Tour putts, they estimated that this preference for avoiding a negative (bogey) more than gaining an equal positive (birdie) — known in economics as loss aversion — costs the average pro about one stroke per 72-hole tournament, and the top 20 golfers about $1.2 million in prize money a year

Rational actors?

In past posts we have discussed the shortcomings of the rational actor paradimg and the challenge that behavioral economics poses to traditional benefit-cost analysis. Now we have some evidence that consumers are not as dumb as we thought they were, particularly when making inter-temporal tradeoffs between current and future consumption. In particular, consumers do NOT count chickens before they hatch:

Households with high measured risk aversion consume less out of future income. All households, on average, consume more out of the more predictable sources of future income, such as future Social Security benefits.

Airline Revenue Part 2

If you haven't flown lately, you may not have heard of one of the newest cost-cutting moves: no more free snacks. While your average airline passenger may not be very pleased with this idea, it makes a lot of sense to me. Why were we all subsidizing people to eat snacks that they valued less than their cost? I know there have been plenty of times on an airline when I wasn't particularly interested in a snack, but heck if it's free I'll chow down a few peanuts or pretzels. Now, only those who really value a snack buy, and the rest of us don't have to subsidize our fellow passengers' snacking habits.

One thing the airlines seem to be missing, though, is a lesson from behavioral economics. Framing things as losses tends to irritate people much more. By charging for snacks, airlines lead passengers to focus on the tragic loss of their free snacks. Imagine the reaction, instead, if airlines offered everyone who skipped the snacks a $5 discount on their airfare. Same situation but a very different passenger reaction I would imagine. The loss of snacks is now framed as a gain (the $5 you save).

More on gas tax holiday--everyone wants to go to heaven but no one wants to die.

From a former student:

We all know that the consumer would never see the benefit of this reduction. The oil companies would move the price of gasoline up to capture this revenue along the supply and demand curve. The consumer would actually suffer due to the lasting effects of under funding our aging infrastructure.... [But] some states are seriously considering this proposal.

The question of whether consumers will see a price reduction from a gas tax holiday can be answered theoretically or empirically. Theoretically, you have to choose between two models, perfect competition vs. oligopoly, and then compute the pass-through rates. The advantage of perfect competition is that it gives you a definite answer (less than 50% pass-through); the disadvantage is that it is not very realistic. Oligopoly models are much more realistic, but the pass-through rates depend on the "curvature" of demand, something that is very difficult to estimate.

My preference is to go with the empirical estimates, like the Illinois gas tax holiday. There we saw a pass through somewhere between 60-80%.

On the policy side, Governments are caught between inconsistent consumer preferences for both a government policy to slow global warming and against higher gas prices.

And for the most part, the politicians favor cap and trade because it is an indirect tax. A direct tax – say, on gasoline – would be far more transparent, but it would also be unpopular. Cap and trade is a tax imposed on business, disguising the true costs and thus making it more politically palatable. In reality, firms will merely pass on these costs to customers, and ultimately down the energy chain to all Americans. Higher prices are what are supposed to motivate the investments and behavioral changes required to use less carbon.

Is deception profitable?

In previous posts, we have talked about the use of testimonial advertising by fraudsters, and this raises the question of how widespread and profitable deception is. Some presidential candidates have blamed deception as a cause of the subprime lending crisis. Eugenio Miravete studies this, and finds some deception by long distance phone companies,

Imagine that you moved to Texas in the middle of the 1990s and wanted to sign up for a long distance telecommunication carrier. After fifteen minutes of answering questions about your personal details, the operator asks you which carrier you choose for long distance calls. You say “I do not care,” .... two months later, when you get your first bill, you realize that you are indeed subscribed to “I Do Not Care, Inc.” which by the way is charging astronomical rates for your long distance calls.

But consumers quickly learn about the deception and react appropriately.

...while consumers often fail to subscribe to the least expensive plan for their usage profile, these mistakes are not systematic, and subsequent plan switching is best explained as an explicit attempt to reduce monthly bills.

This leads Miravete to conclude that

Deceptive behavior is just one of many such quality characteristics – and given sufficient competition, consumers who are unhappy with this particular characteristic can choose to take their business elsewhere. So long as sufficient competition exists, there is no need to impose standards of behavior on firms or to provide step-by-step guidance to consumers in making their decisions: consumers can and will make sensible decisions for themselves.

Professor Miravete testified at the FTC's conference on behavioral economics which provides a nice summary of what we know about behavioral biases of consumers and how they should (or should not) affect policy. It also highlights the behavioral research that FTC staff economists do, leading to innovations like the prototype mortgage disclosure form.

Thanks to Joe Mulholland for the heads up.