Tuesday, April 29, 2008

Isn't that what EDUCATION is for?

Article in the LA Times from January 2008, which I had missed.


Would you rather earn $50,000 a year while other people make $25,000, or would you rather earn $100,000 a year while other people get $250,000? Assume for the moment that prices of goods and services will stay the same.

Surprisingly -- stunningly, in fact -- research shows that the majority of people select the first option; they would rather make twice as much as others even if that meant earning half as much as they could otherwise have. How irrational is that?

This result is one among thousands of experiments in behavioral economics, neuroeconomics and evolutionary economics conclusively demonstrating that we are every bit as irrational when it comes to money as we are in most other aspects of our lives. In this case, relative social ranking trumps absolute financial status. Here's a related thought experiment. Would you rather be A or B?

A is waiting in line at a movie theater. When he gets to the ticket window, he is told that as he is the 100,000th customer of the theater, he has just won $100.

B is waiting in line at a different theater. The man in front of him wins $1,000 for being the 1-millionth customer of the theater. Mr. B wins $150.

Amazingly, most people said that they would prefer to be A. In other words, they would rather forgo $50 in order to alleviate the feeling of regret that comes with not winning the thousand bucks. Essentially, they were willing to pay $50 for regret therapy.

Regret falls under a psychological effect known as loss aversion. Research shows that before we risk an investment, we need to feel assured that the potential gain is twice what the possible loss might be because a loss feels twice as bad as a gain feels good. That's weird and irrational, but it's the way it is.

Human as it sounds, loss aversion appears to be a trait we've inherited genetically because it is found in other primates, such as capuchin monkeys. In a 2006 experiment, these small primates were given 12 tokens that they were allowed to trade with the experimenters for either apple slices or grapes. In a preliminary trial, the monkeys were given the opportunity to trade tokens with one experimenter for a grape and with another experimenter for apple slices. One capuchin monkey in the experiment, for example, traded seven tokens for grapes and five tokens for apple slices. A baseline like this was established for each monkey so that the scientists knew each monkey's preferences.

The experimenters then changed the conditions. In a second trial, the monkeys were given additional tokens to trade for food, only to discover that the price of one of the food items had doubled. According to the law of supply and demand, the monkeys should now purchase more of the relatively cheap food and less of the relatively expensive food, and that is precisely what they did. So far, so rational. But in another trial in which the experimental conditions were manipulated in such a way that the monkeys had a choice of a 50% chance of a bonus or a 50% chance of a loss, the monkeys were twice as averse to the loss as they were motivated by the gain.

But....why not educate people about what it means to be rational? Why take the vice of envy and elevate it to the status of a virtue, and call it a taste for "equality"? Equality is nearly always inequitable. The fact that our stone age minds (and it appears that Hillary Clinton has bigger stones than the rest of us) make us value our own relative position doesn't make it right.

Feel free to double my income, and multiply Angus's by 10, any time. Though I would probably want him to pay for lunch then, I admit.


David Zwerdling said...
This comment has been removed by the author.
David Zwerdling said...

I wonder what the sigma was on those results...

Dirty Davey said...

I find I have an odd attitude about salaries--I'd like to know that other people are making more than I am. I work for a company where salaries aren't really public knowledge and aren't discussed--so what I'm most aware of is my own salary.

But I have this strange logic: if there are a good number of people making more than I am (and if some are making significantly more than I am), then there's a good likelihood I'll get a decent raise in the near-term future.

But if I'm fairly high on the ladder, then I see there are fairly few rungs left and conclude my future holds mostly inflation adjustments--big raises are unlikely.

I mean, given the original question:

"Would you rather earn $50,000 a year while other people make $25,000, or would you rather earn $100,000 a year while other people get $250,000?"

my answer would be the second option--lots of room there to get a raise!

(Maybe it's that all the time spent in grad school left me more attuned to future earnings than to current compensation.)

Norman said...

Psychologists throw experiments like this out frequently as evidence that microeconomic utility functions are worthless. But doesn't this result at most say that our specifications should include a term for relative wealth level?

And does it seem likely that choice disparities like making 50k and being ahead of the curve and making 100k and being behind the curve are pretty rare in the real world (can we choose the average income level of those around us)? These results may be true, but are the relevant?

Anonymous said...

Ego matters right - I am better than someone and that trumps my bottom line. It's not important that I get more, it's important that some idiot who I saw drunk at the office Christmas party who I know constantly leaves late is making more. It's JUSTICE! It helps to confirm my view that the world has rules that reward some behaviors and punish others. (NOTE: not a defense, but an explanation).

Maybe being in Econ grad school leads to a significant atrophy in the justice gene.