Tim Harford The Undercover Economist

Articles published in May, 2007

Under the hammer

You might think that if there’s one thing an economist should be able to tell you how to do, it’s successfully list an item on the auction website eBay. Auction theorists are, after all, celebrated in the profession; one of them, Susan Athey, won the John Bates Clark medal in April. (Clark medallists, who include Paul Samuelson, Joseph Stiglitz and Steven Levitt, are scarcer than Nobel laureates.)

Yet although the theory of auctions is well-developed, its predictions are sensitive to wrinkles in reality. For example, the standard economic assumption that people are rational is usually a good one: when the price of beer rises, most people drink less beer. But auctions require ”if he thinks that she thinks that I think that he thinks” chains of reasoning that tend to have weak links. Those links can easily break if any bidder has any reason to suspect that any other bidder is irrational.

Another theoretical conundrum is entry to the auction. Most auction theorists assume a fixed number of bidders, all poised and ready to bid. But while economists can assume bidders into existence, eBay sellers have to go out and hook them.

This is no minor oversight of auction theory. Paul Klemperer, one of the economists behind the massive ”3G” auctions for mobile phone operators, has shown that trivial-seeming features of an auction can have big (and disastrous) effects by repelling bidders. For these reasons and others, wise auction theorists would avoid predicting how a specific auction design will work without knowing much more about the context.

Fortunately for economists, eBay offers solutions as well as problems. With hundreds of thousands of auctions starting every day, the auction site provides masses of data. And if the publicly available data isn’t enough, it’s also easy to conduct an experiment ”in the field”, studying bidders in their natural habitat.

David Reiley, an economist at the University of Arizona, has been studying online auctions since before eBay existed. In a recent paper with Rama Katkar, he investigated whether reserve prices in eBay auctions should be open or secret.

Auction theory offers an argument that a secret reserve price is better. A secret reserve price allows bidders to see each others’ gradually ascending bids and thus draw confidence that they are not alone in prizing the item. Even though the bids are too low to beat the reserve, they serve an important purpose of reassuring bidders that others are also interested. An open reserve price on eBay makes that reassurance impossible; nobody can submit a bid below the open reserve, and lacking any signs of confidence from other bidders, there is a danger that nobody may submit a bid above it either.

There are too many imponderables to tell whether this theoretical argument is what really counts in practice. So Katkar and Reiley put the theory to the test by simply selling 50 matched pairs of collectible cards, half with an open reserve price and half with a secret reserve price of the same level. Their conclusion, contrary to the theoretic argument, is that secret reserve prices are counterproductive. Far from stimulating interest they seem to put off bidders,who perhaps fear that a secret reserve is secret because it is far too high. Not wishing to waste their time, many of them just click ”back” on their browsers and find somewhere else to bid.

The conclusion may not shake the world but the method is important. David Reiley was one of the first economists to realise that the internet was generating vast amounts of researchable data. Now that data, from sites ranging from eBay and Amazon to Match.com, is enriching the study of economics. It may enrich a few eBay sellers, too.

First published at ft.com.

Girls or grades

Dear Economist,

I am 17 years old and studying A-level economics. A lot of my friends are getting into serious relationships and I’d like to get a girlfriend myself, but I am also concerned about getting distracted from my studies. How does the cost-benefit analysis work out?

Ben, Buckinghamshire

Answer at ft.com, subscription free.

26th of May, 2007Dear EconomistComments off

Sauce and Badminton

Dear Economist,

I am 38 years old, rather bored with my husband, and for the past two months I have been flirting like mad with another man. We often meet up for a drink and the talk has started to get quite saucy. I’m sure I could take things further if I wanted. Should I?

Sheila, London

Answer at ft.com, subscription free.

19th of May, 2007Dear EconomistComments off

Urban neutral

This magazine recently presented a rather touching portrayal of Ashton Hayes, a village in Cheshire with the aim of becoming ”carbon neutral” – that is, emitting no unnecessary carbon dioxide at all, and perhaps making up for all that troublesome breathing by planting a few trees. That will take some work because the villagers’ current emissions of carbon dioxide are about 25 per cent higher than the national average. In an effort to cut this to something more respectable, the villagers are urging each other to switch off unnecessary electrical items, insulate their lofts and trade in big cars for small ones.

This is all laudable stuff, so it feels a little mean to point out that the villagers could dramatically reduce their carbon footprints by bulldozing Ashton Hayes and moving to London. Yes, London: the ”big smoke”, the richest region in the European Union, is a city whose environmental statistics make it look dangerously like some hippie commune.

The Office for National Statistics reports that Londoners produce much less household waste than anywhere else in the UK. From the same source I learn that London’s households are the most likely to have no cars, and the least likely to have two or more cars. Even before the congestion charge came into force few Londoners commuted by car.

London’s Mayor’s office informs me that London emits 40 per cent less carbon dioxide a person than the national average – which would be less than half the rate of ”carbon neutral” Ashton Hayes. All this from a city that is hugely dynamic, innovative and, frankly, disgustingly rich…

Continued at ft.com, subscription free.

Applause

Dear Economist,

At the end of concerts the performers leave the stage to the sound of applause. I prefer to save my energy, especially when many of my fellow concert-goers are applauding on my behalf.

From a strictly economic viewpoint I believe that my behaviour is rational but why do others not behave as I do? Please do not fob me off with the explanation that the applause is thanks for an excellent performance.

I bought my ticket in the expectation of an excellent performance and the delivery of that is the performers living up to their side of the bargain.

Kind regards,

S.C. Li, via e-mail

Answer at ft.com, subscription free.

12th of May, 2007Dear EconomistComments off

For better or worth

The price of the first serving of Coca-Cola was five cents in 1886, which is about a dollar (50p) in today’s money. Coke no longer sells for a nickel, and that is not terribly surprising. What is surprising is that it took more than 60 years for the price of Coca-Cola to change.

Economists call this nominal price rigidity. My salary is not tweaked each month to reflect the latest inflation figures, and neither is yours. Restaurants do not reprint their menus, nor wholesale companies their catalogues, if the cost of their inputs changes by a penny.

That might be a problem. Prices keep the economy running smoothly by adjusting to reflect demand and the underlying costs of production. If prices don’t adjust smoothly for any reason then the economic consequences could be serious. If wages can’t fall in a recession then people will lose their jobs instead. If prices can’t fall when demand does, sales will collapse with much the same effect.

Coke was clearly an exceptional example of rigid prices. Daniel Levy and Andrew Young, the economists who analysed the case, report that Coke’s price stayed at five cents a serving while the price of other products bounced all over the place. The price of sugar tripled after the first world war before falling back somewhat; over the six decades, the price of coffee went up eightfold. Coke itself was taxed first as a medicine, then as a soft drink, and survived sugar rationing. All the while the price stayed at a nickel.

Part of Coke’s problem was the cost of replacing vending machines that accepted only nickels…

Continued at ft.com, subscription free.

Selling Prophecies

There is a legend about the last king of the Romans, Tarquin. An old witch came to Tarquin, and offered to sell him nine books of prophecy at an exorbitant price. Tarquin laughed at the offer. The witch burned three of the books, and then offered to sell him the remaining six for the original price. Tarquin refused again.

The witch burned three more books and offered to sell Tarquin the three books that were left for the original price that she had demanded for nine. This time Tarquin was scared that he might be losing something precious, and bought the remaining three books for the price that the witch asked. What sort of demand curve is that?

Chris McMahon, by e-mail

Answer at ft.com, subscription free.

5th of May, 2007Dear EconomistComments off

What Gives?

I wrote recently about people who live on a dollar a day. Now, I have a dollar or two to spare, and so, dear reader, do you. So why not spread the wealth around? Good question. For one thing, there’s the fear that the money would reach the wrong people: corrupt charlatans, not-really-poor people, addicts…

Then there’s the ”curse of the free lunch” – or what a more strait-laced economist would call ”rent exhaustion”. It works like this: I fly somewhere deserving – say, Dar es Salaam – and hand out dollar bills to strangers. I’ll do it next Tuesday, starting at noon; please form an orderly queue. This would be guaranteed to produce a long line of people. Someone who made a dollar an hour would be willing to queue for up to an hour; someone on a dollar a day would be willing to queue for a day.

At least the people who found it worthwhile to queue would be poorer than those who didn’t. But many in the queue would surely be better off earning it by doing something productive. Each dollar I gave away would be worth only a few cents once you subtracted the cost of the recipient’s time – by trying to get the handout, they are destroying much of its value.

Rent exhaustion is no economists’ fantasy – go to any place with rich tourists and poor locals (Dar es Salaam, the first African city I visited, fits the description nicely), and you’ll see lots of people waiting for the one generous tip or overpriced taxi fare. If the tourists become more generous or gullible, the local guides don’t get richer, they just multiply. The bigger paydays become less frequent…

Continued at ft.com, subscription free.

5th of May, 2007Undercover EconomistComments off

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