Putting the Fun into Fungibility

My apologies for my recent silence, I've been working hard on my MSc dissertation (now successfully finished). The topic of my dissertation was 'fungibility'. My next few posts will explore fungibility and why being aware of it may help you make more rational decisions.

Fungibility is the principle whereby economic agents treat all units of money as equal and as perfect
substitutes, regardless of where they came from.

Violations of fungibility occur when individuals use money differently because of the way it was earned, stored or labelled. Violations of fungibility can cause us to make suboptimal decisions and are thus termed irrational.

Take the example of an €8 gift voucher at an expensive restaurant. For some customers the voucher can be spent on beverages (the 'labelled' voucher) while for others the voucher can be spent on either food or beverages (the 'unlabelled' voucher). As almost all customers spend at least €8 on beverages the gift is 'nondistortionary'.

Johannes Abeler and Felix Marklein (2013) ran this field experiment and found that customers who had the labelled voucher spent on average €3.90 more on beverages than those with the unlabelled voucher.

The label attached to the money had changed behaviour (even though, rationally speaking, both groups should have spent the same amount on beverages as the voucher was nondistortionary). This 'labelling effect' violates the principle of fungibility.

So the next time you receive a labelled voucher think to yourself 'Would I have spent that much on ... anyway?' 'How much was I originally prepared to spend on ...?'

It might just help you avoid be more rational in how you spend your money.

Air Regulation

A recent paper by two economists (Aguirregabiria and Ho) caught my eye.

Typically, in America, airlines operate 'hub and spoke' networks. That is, an airline will have a main airport (the hub) and all the other cities in the network (the spokes) only fly to the hub. Why do airlines tend to do this?

There are three main possibilities that the paper explores:

1. Passengers prefer large airports which tend to be more efficient, so are prepared to fly via the hub airport.
2. Airlines benefit from lower running costs (economies of scale) at a hub airport.
3. Airlines find it easier to deter competition by operating out of a hub airport.

Aguirregabiria and Ho find that airlines do benefit from costs savings of a hub airport. But they also find that airlines running a hub and spoke network tend to run more loss making services. They interpret this as a way of large airlines stopping smaller competitors from starting to run those 'spokes'. They also find that by having a hub airport an airline can drive up the cost of other airlines running services to that particular airport.

Thus hub and spoke networks could be a way airlines deter competition. 

If proven, air industry regulators should look into how airlines manage their networks and whether they illegally deterring competition that would benefit passengers.

Who Are We Really?

Behavioural economics finds it's significance from the way it reframes the economic perspective of human beings. We are no longer simply called homo economicus. We are allowed to selfless, confused and cooperative.

But that is not entirely satisfactory. The economic paradigm is still in place. We are still primarily consumers. We exist to consume, and consume to exist. We may occasionally give some of our consumption to others, but our primary purpose is unchanged.

There are, as I see it, two main drivers of this consumption complex. Our philosophical leaders (economists and their mindless followers; politicians) who tell us that consumption is everything. And us, who seemingly have an innate drive to get more stuff. More stuff than we had yesterday, more stuff than our neighbours have today.

The problem is that consumption isn't everything. We are more complex than that. Happiness is not just a function of consumption (c.f. friends, family). We cannot be reduced to one-dimensional, consuming robots.

And if that were not enough to make us think twice, limitless consumption is not actually achievable. Our environment has limits. The planet has limits. There are only so many fish in the sea. As Stewart Wallis (of the think tank the new economics foundation) recently said in a TED talk, we need to move on from seeing ourselves as consumers to stewards. Based purely on pragmatism, a serious change in our self-image is needed.

Temptation

The neoclassical economics way of viewing people involves assuming that people are fully capable of making the best decisions for themselves. If a neoclassical economist were to see someone (lets call him Nick) blowing all their savings in a Las Vegas casino he would simply assume that Nick had done all the sums and had concluded that his own personal benefit was maximised by gambling his life savings away.

That may be the case.

But behavioural economists tend to think not.

What if Nick knows what is best for him but chooses not to do it?

What if Nick has finite powers of self-control?

What if Nick hasn't even done the sums properly? He might be aware it's not the best option for him, but not just how disastrous it is.

Behavioural economists use the term 'bounded rationality' to refer to instances where people are clearly less than perfect (often by their own admission). If Nick may overly value short term fun over long term welfare. He knows he's being irrational, but he might need a helping hand to maximise his long term welfare. This is why people are increasingly offered commitment devices - in a rare moment of clear thinking Nick could opt into a scheme which bans him from casinos.

Corporate decision making can also fall foul of self-control issues. A timely example is the over-fishing of EU waters. If politicians really had the long term welfare of fishermen (and of the fish!) in mind then they would restrict the amount of fish that can be caught.