Thursday, March 31, 2011

Can behavioural economics help markets to work better?

The Upside of Irrationality: The Unexpected Benefits of Defying Logic at Work and at HomeIn his book, ‘The Upside of Irrationality’, Dan Ariely claims to have identified a market failure in the online introductions market. He refers to a survey indicating that people participating in that market spent on average 5.2 hours per week searching profiles and 6.7 hours per week emailing potential partners for a payoff of 1.8 hours actually meeting them.

He comments:
‘Talk about market failures. A ratio of 6:1 speaks for itself. Imagine driving six hours in order to spend one hour at the beach with a friend (or even worse, with someone you don’t know and are not sure you will like)’.

When I read that my first thought was that it would not be particularly uncommon in Australia for young people to drive three hours to spend an hour with a friend and then drive for another three hours back to where they came from.

I think the term market failure is thrown around too loosely. The situation described clearly involves high transactions costs, but that doesn’t mean the market has failed. The existence of high transactions costs in a market should not be viewed as a symptom of market failure unless we can point to some reason why the market cannot function efficiently.

In this instance the market seems to be working well because evidence relating to the existence of high transactions costs has induced some enterprising people to consider what innovations might be introduced to reduce those transactions costs. The fact that the innovators were a university professor and his associates suggests to me that university staff may be becoming more entrepreneurial.

I think Dan Ariely has done a good job of demonstrating the potential for behavioural economics to help entrepreneurs to design innovations that may reduce transactions costs. He considers survey and experimental evidence which suggests that the high transactions costs associated with online introductions stem from the attempt to reduce humans to a set of searchable attributes. The problem is that the searchable attributes convey little information about what it might be like to spend some time with particular individuals.

Ariely and his associates developed a virtual online dating site that enabled participants to engage anonymously in instant message conversation about various images e.g. movie clips and abstract art. They found that participants were about twice as likely to be interested in a real date after meeting in person following the virtual date than following a conventional online introduction. It seems that when we experience something with another person we gain much more information about compatibility than when we just look at searchable attributes. He has discussed his research here.

It is too soon to know whether Dan Ariely and his associates have prompted a market innovation that will help large numbers of people to live happier lives. However, I think Ariely has demonstrated that behavioural economics may be able to help markets work better. As he points out, there is potential for firms to do a better job of satisfying consumer demand by conveying to consumers what it might actually be like to have the experience of using their products. I think that means, among other things, that if retail stores didn’t exist already they would probably need to be invented to give consumers the opportunity to experience goods before they buy them.

Coming back to market failure, does the fact that some consumers buy goods cheaply online after inspecting them in a retail outlet constitute a market failure? I don’t think so, even though such behaviour is evidence of positive spillovers associated with retailing. Manufacturers will work out before long that retailers provide them with a useful service by enabling consumers to experience their products in real life - and think up some way to encourage ongoing provision of that service.


Thought Bubble Ten said...

From time to time, I've trawled through profiles for a number of reasons - curiosity, entertainment and the possibility that I might find one I like :). And it was because I rarely saw anything that appealed to me or that I thought had promise, I made the decision that I wouldn't be doing it again.

I could have easily spent an hour or two with little or no *returns* in terms of actually finding someone I'd consider opening up a conversation with let alone *dating*. However, I was occasionally entertained.

Based on my experience, I would agree with Ariel that the transaction costs are prohibitive but, as you say, this may not reflect a market failure.

Meanwhile, his idea of finding compatibility using clients' responses to an image could be promising. I think it could give a more accurate sense of someone than (just) reading their personal profiles especially since the latter relies too heavily on one's writing ability.

Winton Bates said...

Thanks for your comment TBT. The thought crossed my mind that it would help me to write about this topic if I had personal experience of one of the ‘chat circles’ that Dan Ariely writes about. However, I decided that it would not be appropriate for me to do that – so I am still wondering what they are like. I also wonder whether people become addicted to that kind of virtual reality.

Thought Bubble Ten said...

Hey Winton, just because you're married (I'm assuming this is the reason for your reluctance to experience a chat/matchmaker site), doesn't mean you should deny yourself the experience of just reading profiles. Perhaps you could do this with your wife for a bit of fun ??? ;)

As for becoming addicted, I think almost anything in life is potentially addictive. You know, the more you do, the more you do...:)

Winton Bates said...

Hmm, reading profiles doesn't have much appeal to me.
You are probably right about addictions. I have argued along those lines myself. What I had in mind was that some people might get stuck in virtual reality without moving on to real relationships.

Thought Bubble Ten said...

I don't see virtual reality as unreal. It evoke the same emotions that we experience in physical reality. The relationships in cyberspace can be as powerful, meaningful and fulfilling as those in physical reality. At least, that has been my experience.

So, you could ask the same question of physical reality - Can we (Are we) we addicted to physical reality? :)

Winton Bates said...

I wonder whether you have thought through the implications of that position, TBT. Would you volunteer to spend the rest of your life in Robert Nozick's experience machine?
(See Wikipidea discussion of the thought experiment here).

Thought Bubble Ten said... it possible that simulations may relieve us of the burden of attachment to and reliance solely on the five senses?

Certainly the experiences may be different but are you certain they would not be as satisfying?

I know it's compelling to think not but I just wonder. After all, we are evolving in ways that are making us less dependent on physical experiences (like online shopping, for instance)

Would blind and deaf people have a less satisfying experience, for instance, of a forest than people with a fully functioning range of senses?

As for the Thought Machine...I don't think I'd want to sign up *for life* to anything. I'm for experiments and explorations rather than addictions and irrevocable commitments ;)

Winton Bates said...

TBT: I agree that virtual experience is coming to imitate real experience more closely. The only problem I see in that is that people may get stuck in virtual experience and lose touch with the real world. For example, will wilderness continue to have value to us if we come to believe that we can obtain the experience of wilderness by hooking ourselves up to a machine? Will the experience of being with real people continue to have value to us if we come to believe that the virtual experience of being with other people is just as good as the real thing?
Some say that we create our own reality, so virtual experience is just as good as any other experience. The idea seems to be that we can all just live happily ever after in the worlds that we create for ourselves.
I think it is a mistake to think that we create our own reality. It is true that we don’t experience it directly, but that doesn’t mean that we create it. We attribute meaning to experience. (The meaning that I am attributing to the experience of writing this at the moment is that I might be becoming boring – so I had better end here :)

Thought Bubble Ten said...

No, you're never boring Winton, at least not to me.

And I could say a bit about how we create our realities, something the Buddha also observed: With your thoughts, you create your world.

There is a classic Buddhist teaching about this relating to a *snake* and a *rope* :)

But, perhaps I might begin to be boring by going on about this. 'Nuff said then :)

Winton Bates said...

I read something by the Dalai Lama about the snake and the rope, here.
My problems with the concept of emptiness are not as great as I thought they might be. Emptiness apparently doesn't mean nothingness. Emptiness can only be understood if we first identify that of which pheomena are empty.

I can readily agree that things are not as they appear and that ultimate reality is whatever it is - beyond my comprehension and possibly beyond human understanding.

Anonymous said...

Elaborating on a point by TBT, there is definitely entertainment value in simply playing the game on dating sites, irrespective of whether playing leads to scoring. Thus, the time spent searching is not all 'cost'.

Tom N.