Thursday, July 25, 2013

Martyrdom and Charity

One of the main forces driving behavioral economics is a desire to explain the irrational behavior of individuals. This week I'll be discussing a paper authored by Christopher Olivola and Eldar Shafir which delves into one of the more heroic quirks of human behavior, martyrdom.

Before getting into the research let's establish some premises.  First of all, rational individuals should prefer pleasurable activities over painful activities. This premise is a main driver of nearly all social sciences and is taken as a given for the purposes of this posting (if it's disproved there are far greater implications than the inaccuracy of this article). Secondly, rational individuals should be willing to pay more (or at least the same amount) for activities they prefer. Combined, these premises amount to "Individuals should be willing to pay more for pleasurable activities than painful activities all other conditions being equal."

If these premises are correct than why would an average person pay more to participate in a lengthy run than enjoy a picnic in the park?  After all, picnics are generally pleasant, provide nutrition, and are far less strenuous than running.  Yet Olivola and Shafir found that under certain circumstances study participants were willing to pay more for the strenuous running option than the pleasant picnic.

These researchers conducted four experiments investigating how the difficulty or unpleasantness of a charity event influenced donation amounts. The first experiment was a simple questionnaire provided to a bit over one hundred college students. Each questionnaire described a future charity event, either an outdoor picnic or a five mile charity run. In the case of the picnic participants were told that to attend they would be required to donate any amount of money greater than zero dollars. This voluntary admission fee would be matched by a third party. In the case of the charity run participants were informed that they would have to donate to attend but their donation would only be matched by a third party if they completed the run.

Participants were then asked two simple questions. "Would you attend the fundraiser?" and "How much would you donate to attend the fundraiser?". Recalling our previous premises we would expect that more people would be willing to attend the picnic (as it is pleasurable rather than strenuous), and participants would be willing to donate more to attend the picnic than the run.  As expected significantly more participants responded that they would attend the picnic than the charity run (86% versus 76%). However, those who responded that they would participate in the run claimed they would donate nearly twice as much as picnic attendees ($23.87 versus $13.88).  It's perplexing why anyone would pay more for an experience which is generally considered inferior (as indicated by participation rates).  Luckily the remainder of Olivola's and Shafir's research lends some insight.

The second martyrdom experiment involved participants playing a public goods game. In this game participants were given five dollars and asked if they would contribute any of the gifted funds to a common pool. Any funds they did not contribute to the pool they kept. Contributed funds were doubled and dispersed to the entire group at the end of the experiment. Group sizes ranged from three to five, thus in no case was contributing to the pool beneficial to the individual (a contribution of $1.50 for example would be doubled to $3.00 then divided among three group members resulting in each received a dollar. The contributor is thus left $.50 worse off while the rest of the group gains a dollar each.) Participants were not allowed to speak with each other or in any other way communicate in order to avoid strategic group decisions.

The public goods game is a common experimental tool used by economists.  However, this example had an interesting difference.  Half of the participants were informed that if they contributed to the group pool they would be required to undergo an unpleasant cold pressor task (cold water immersion of the hands for 60 seconds) or their contribution would not be doubled. These participants could easily avoid the cold pressor task by simply keeping all of their gifted funds if they desired.

Despite the pain and risk involved, individuals in the cold pressor groups contributed significantly larger amounts.  In fact the cold pressor group contributed their entire $5 gift 67% of the time as opposed to 28% of the time for the control group.  What is it about an unpleasant condition that drives a willingness to contribute? Olivola and Shafir conjectured that perhaps having a difficult or strenuous fundraiser might be a social cue that a cause was worthy of the difficulty, and by association greater contributions.  However, in this experiment participants were asked what their expectations were for contributions from others in their group. No significant difference was found between those whom believed everyone was receiving a cold pressor task and those who had no knowledge of the task. If difficulty acted as a social cue of value that drives donation amounts we would have expected to find a difference between treatment groups.

The third martyrdom experiment was extremely simple conceptually and in implementation. Subjects were presented with a questionnaire very similar to the one discussed in experiment one. The primary difference was the length of the charity run varied between questionnaires. The goal of this experiment was to determine whether the degree of adversity had a significant impact on contribution rates or if the phenomenon was more binary in nature. Results indicated that length of the charity run had little effect on contribution rates.  The researchers interpreted this mean that the degree of adversity is of minimal importance as compared to presence or lack of an unpleasant condition.

The final experiment sought to establish if perhaps the martyrdom effect was partially due to a sort of empathy with victims of a disaster.  In other words, would arduous tasks still increase donations if the charity cause was not meant to relieve suffering, but instead promote pleasure. In this study participants were again given a simple survey which represented one of four treatment groups. Each survey informed participants that a charity, either a public park construction project or a feeding starving children effort, was to host a charity event. The event was represented as either a public picnic or a thirty hour fast. Thus the four possible surveys given to participants were park project hosting picnic, park projecting hosting fast, starving children relief hosting picnic and starving children relief hosting fast.  With the exception of the change in questions the procedures remained the same as in experiment one.

If the martyrdom effect is in fact based upon an empathetic link with victims of disasters then we would expect to see that in the case of fasting for child hunger, donations would be much higher than in the case of fasting for public park construction. In fact, this experiment demonstrated exactly that. For the public park construction project the picnic option resulted in a larger donation amount on average than the fasting option. Contrarily, for the hunger relief project the fasting option yielded higher donation amounts. Between projects the picnic option showed no statistical difference in donation amounts but the fasting option nearly tripled. This may indicate (though evidence is weak) that a pleasurable experience such as a picnic is minimally influenced by charity cause while a strenuous task such as a fast or run will only yield large donation amounts when combined with a charity which seeks to relieve suffering.

Curiously it seems as though the results are experiments two (ice pressor public goods game) and four (picnic verus fast survey) are somewhat contradictory. Experiment four seems to show that the martyrdom effect is most profound when individuals believe their efforts go towards relieving the suffering of others. However, in the ice pressor experiment it's hard to imagine that participants believed their contribution to the community pool resulted in any relief of suffering. One possible interpretation of this curiosity is that charity cause impacts the magnitude of the martyrdom effect and that fasting has a negative real value.  In experiment four a picnic was valued at approximately $15 regardless of cause. This value represents a certain value of the picnic plus a value attributed to a charity relief effect.  In other words, if you give $15 you likely value the picnic at some lesser amount and give the remainder as an act of generosity. Viewing the fasting option from a similar perspective but starting with a negative value results in a model which agrees with both experiments two and four. Assume that normally someone would have to pay you $20 in order to induce you to participate in a thirty hour fast.  Then when asked how much you would pay to participate in the same fast for the benefit of a public park you answer $10. This is a $30 difference from the implied value of the fast alone but still a lesser amount than the $15 donation for a picnic. In other words we still see a larger net change in value due to the martyrdom effect, but a smaller overall donation.  When the charity cause is changed to one which alleviates suffering we then find the martyrdom effect increases in magnitude resulting in a higher overall donation while the picnic option donations remain unchanged.  This theory is consistent with the data presented by Olivola and Shafir but requires experimental verification to be confirmed. Interestingly, it does suggest that the martyrdom effect is greater than shown by the majority of these experiments as the value change would be calculated from the negative value associated with the unpleasant experience rather than a zero value.

It's important to note that the martyrdom effect did not seem to have much effect on whether people donated or not, only how much they donated.  In fact, unsurprisingly in most experiments less people chose to participate in the unpleasant tasks. However, it is a curious quirk of human nature that under some circumstances we are willing to pay more to suffer than we would pay for enjoyment. Olivola and Shafir offer some interesting data that give hints to what might cause this particular irrational behavior but stop short of offering a suggestion of mechanism or cause. Hopefully their continued research will result in substantial answers to the questions raised by their recent work.

More economics next week, until then stay safe and rationale.

Wednesday, July 17, 2013

Regulation and Innovation

To say the topic of government regulation is controversial would be an understatement.  Opinions on the matter vary from "Let the free market rule!" to "The only fair economy is a managed economy." Like most of the public my personal opinion falls somewhere between the extremes.

The majority of the rational populace would agree that some regulation is at least helpful if not necessary. Few people wish to purchase medical drugs that haven't been proven to be safe or effective.  Likewise most people agree that it's likely a good idea to ensure pilots can actually fly a plane before being allowed to ferry passengers from New York to LA. Yet, venture into the domains of healthcare insurance, banking or pollution control and you'll find debates aplenty as to what, if anything the government should be doing to guide these industries.

In order to highlight how even well intended and beneficial regulation can go astray I'm going to discuss the fascinating world of the taxi cab driver. I want to make clear that I do not believe taxi regulation is a bad thing. Over the past decades it has done a great deal to make transport in major cities reasonably efficient and safe.  However, currently in many cities taxi regulations are being abused for the profit of a few rather than the benefit of many. 

Let's briefly touch upon a few points that a consumer desires when looking for a cab.

1. The consumer wants a cab to be available OR have assurance that a cab is en route AND know approximately that cabs time of arrival.
2. The consumer wants to know the approximate cost of the trip before arrival at the destination.
3. The consumer wants a safe, efficient, pleasant ride.

The local government of course wants the consumer's desires satisfied but has one additional concern. Namely:

4. The government wants traffic congestion kept to a minimum.

This desire is inextricably linked with the consumer's third desire as sitting in traffic is neither efficient nor pleasant. 

So given these desirable traits how does taxi regulation improve the situation? Generally taxi regulation goes something like this:

Local Government: "Alright guys, we're going to require a special limited license to drive a taxi. We're also going to require you all charge the same rates per mile or minute of wait time. If you work with us you'll get your license and will have limited competition since all the licenses will already be issued to existing drivers. Don't work with us and we'll just give your license to someone else and you'll be out of business."

Taxi Companies: "Sounds great."

The end result is that the consumers second desire is fully met, since prices are uniform everyone knows charges before the service is complete. The consumer's third desire is reasonably met, drivers generally aren't serial killers, are easily identified for complaint and are prohibited from running up the meter. The government's desire to minimize congestion is met, taxis are artificially limited. Finally, the consumer's first desire for an available cab is initially met but generally deteriorates as demand increases with population growth but the taxi population remains constant. Notably the taxi population could be grown with new permit issues but such action always meets with strong opposition from the taxi companies whom of course have the closest relationship with taxi regulators.

Additionally, the value of taxi licenses generally begins a rapid climb. In several major cities a taxi license approaches a million dollars if not more despite a cost of only a few hundred dollars annually. Rents from licenses are in fact so lucrative that most are held as investment vehicles in New York City. 

So under the current system of regulation we end up with a reasonably safe and profitable taxi system without roads swarming with cabs to the point that other traffic is impossible. On the downside there's nearly zero incentive for a driver to do anything beyond the bare minimum of transport the consumer from point A to point B as quickly as possible. As long as the owner holds the license the cab will keep operating regardless of how clean it is, how pleasant the driver, or loud the radio.  

A brief summary of what we've learned so far:

Current Regulation Pros:

  1. Safe
  2. Predictable Cost
  3. Limited Traffic Congestion

Current Regulation Cons:

  1. Limited Incentives for Owners
  2. During Peak Times Supply and Demand Disparity
  3. Regulation Often Abused to Stop Competition

So how can we develop a better system? As is often the case technology as developed an answer.  Most people in major cities at this point already carry a communication device that knows their location. Why not simply have a phone app that lists available cab companies (along with prices for your trip), contacts the company to provide your location and then tracks the cab en route to pick you up so you know it's arrival time.

When combined with the removal of current regulations, with the exception of driver licensure and identification rules, this improves on the current system in a variety of ways. Road congestion is further reduced during non-peak times (there's no reason for an empty cab to drive around looking for fares). Supply and demand are balanced as competitors can freely enter and exit the market. Competition incentivizes superlative performance at the firm level. Consumers will be more easily able to obtain a cab in areas taxis are less common. Direct price competition will allow for a more accurate representation of costs (which may lead to higher or lower prices). 

This innovation ends up leaving everyone except current taxi license owner's better off. However, it's exactly this group that has been opposing development of such systems in major cities. A company called Uber has attempted to implement such a service in major metropolitan areas throughout the US. Unsurprisingly they've been met with opposition with each attempted launch. 

Uber utilizes mostly limousine services to do their pickups. The primary difference between a limousine and a taxi from a regulatory perspective is a limousine is not allowed to simply drive around and pick you up on a street corner. You must make a reservation to be picked up by your driver.  Therefore the most common avenue of attack against a service like Uber has been to place a minimum time that must pass after a reservation is made before a limousine may transport you. For example, in Miami you must make a reservation at least one hour before your desired pick up.  As a result an on demand service like Uber loses a great deal of appeal compared to a standard cab which is immediately available.

Similar regulations are being passed or contested in major cities throughout the country. On one side of the battle stands new innovators like Uber who seek to improve the existing system (and of course make a profit doing so). On the other are the old guard taxi companies attempting to protect not only their current business, but in many cases the value of the licenses which amount to millions of dollars. The consumer will likely be better off if Uber and it's like prevail, but overcoming the inertia of the existing regulatory system is a daunting task.

That's all for this week. Until next time stay safe and rational.

Thursday, July 4, 2013

Breaking the Rules of Supply

Economics 101 has a simple explanation of how markets work. Consumers have a cumulative demand function that expresses how much of a product they will purchase as a given price level. Suppliers have a cumulative supply function that expresses how much of a product they will supply at a given price level. The intersection of these functions represent a market equilibrium that determines how much of a product will be produced and purchased. Easy, right?

Unfortunately, the real world is rarely ever so tidy.  Rent ceilings, taxes, subsidies, natural monopolies, and a hundred other distortions warp our simple representation of market interactions. Today, I'm going to discuss one distortion that is a result of nature more than man.

There is a sort of commodity known as rare earth elements (REE). The specifics of this commodity are relatively unimportant to this discussion except for these facts; REEs are mined from the earth and are generally found together with distinct rates of abundance. For example, one sort of rare earth ore may have twice as much cerium as neodymium.

The difficulty with REE markets is that the supply of all elements in an ore is dictated by the scarcity and demand of the most needed.  For example, in light rare earth element (LREE) ores neodymium is the most valuable and rarest REE. Thus LREE ores are mined at a rate which satisfies the market for neodymium. However, this also results in the production of cerium, praseodymium and samarium at rates that exceed equilibrium market demand; resulting in a non-optimal price.  In this unusual circumstance the prices of the less desired LREEs are very much influenced by the demand for neodymium, despite the fact that the elements are generally not substitutes for one another.

There are essentially three possible production points. We can produce REEs to the point that the demand for all REEs are met. We can produce REEs at the point which maximizes the suppliers profits. Or we can produce REEs to the point that no excess REEs are produced.

In the first case, production of REEs to the point that demand for all is met, we end up with a large excess of the more prevalent and/or less desirable rare earth elements. This leads to an increase in price for all REEs due to the cost of extraction being shared by all REEs in a given ore group as well as costs associated with stockpiling. Clearly this is non-optimal as consumers are paying more and suppliers are earning less profit.

In the second case, profit maximization, we end up with a shortage of some elements and an excess of others. Here supplier profit is maximized but consumers must deal with high prices for some REEs due to high price inelasticity and higher overall prices for the reasons discussed in the paragraph above. This supply point is a middle ground which features the negative aspects of the other two supply points, but to a lesser extent.

The final case, production resulting in no excess, is likely the worst of all.  It sets the price of the most abundant or least used element at a market equilibrium.  However, every other REE will have a far higher than necessary price due to price inelasticity and market shortages. This supply point benefits no one as suppliers do not profit maximize and consumers of all but the least useful element pay far higher prices than they must.

The easiest solution economically speaking is to produce at the point that demand for all REEs is met and then find uses for the excess REEs.  However, technologically that becomes a much more difficult problem. Unfortunately our grasp of alchemy has not yet risen to the point of transmutation of one less desirable resource into a more useful one. So how do we deal with the problem?

Interestingly, the answer here may very well be recycling.  After REEs are used in industry their production costs are no longer associated.  Thus recycling of rarer or more useful elements increases their supply within the market space. This then allows for lower rates of associated ore extraction and thus lesser excess production of less demanded REEs. This solution allows us to meet demand (good for consumers) while moving production towards the profit maximizing rate of supply (good for suppliers) by increasing supply of more demanded REEs without increasing supply of the excess REEs as well.

Balancing the REE market is a difficult task. However, it does seem manageable through either innovative use of excess REEs or advances in REE recycling. One way or another the market's needs will be met.

As an interesting aside, apparently rare earth elements with an even atomic number are more common than those with an odd atomic number. Once again nature meddling in man's efforts to set rational prices.  Until next week, stay safe and rational.