Thursday, September 30, 2010

Credibly Committing to Lose Weight

Ian Ayres of the Freakonomics blog is making an economically interesting choice in his effort to stay at a healthy weight. He is auctioning off his right to gain weight.

I’m predicting that I will not be paid very much. Even though I’ve had a hard time staying below 200 pounds in the past (and even include a picture of myself in one of my heavier phases), I, like Subway’s Jared, have all kinds of incentive to keep my weight in check. I’m probably one of the few eBay sellers who warns bidders not to bid too much:

If I fail in each and every week, the auction winner could receive as much as $26,000. But beware: my weight on August 4, 2010 is about 180 lbs. I intend to make sure that my weight stays below 185 lbs throughout the 52 weeks – so it is possible, even probable, that the auction winner will not receive any forfeiture money. It would be foolhardy to bid very much on this item.

The idea for this auction comes from James Hurman, a New Zealand advertising executive, who in 2008 successfully sold his smoking addiction. You can learn more about James and how you can sell your weaknesses in chapter 3 of my book.

I like the idea, but I wonder if there are some important differences between keeping weight off and quitting smoking.

With quitting smoking, the goal is to not smoke at all. That is because smoking is truly an addiction (meaning that a cigarette today makes the smoker more intensely want to have a cigarette tomorrow). Because of this addictive feature, if you want to quit smoking, the optimal contract is to sell the right to receive payment if you smoke at all.

Gaining weight isn't an addiction in the same way as smoking. That is, it isn't true that if I gain a pound today, I will want to gain more pounds tomorrow.* For this reason, the best contract to keep Ayres' weight in check probably isn't $500 payment if the weight is greater than 185 lbs and zero if it is less. If I were to sell my right to regain weight, I think I'd structure it as follows:

  • $500 if weight is greater than 185 lbs and less than 190 lbs
  • $600 if weight is greater than 190 lbs and less than 195 lbs
  • $750 if weight is greater than 195 lbs and less than 200 lbs
  • $1000 if weight is greater than 200 lbs

To see why this contract could be better than Ayres' contract, suppose that Ayres has a busy fall and lets himself go for a few weeks (as he admits that he is prone to do; see the original post). On account of this, his weight creeps up to 195 lbs (10 lbs over his cutoff). Under my contract, Ayres could save himself $250 per week by dropping 6 additional pounds, and $150 per week if he drops just one pound. Those are realistic intermediate goals that might discipline him into having better habits in the event that he has to play catch up.

But, under his contract, dropping marginal weight (less than 10 lbs) saves him nothing, and he runs the risk of just writing off $500 per week (maybe it would be too costly to drop the extra weight; After all, losing 10 lbs should take about a month.). $500 for every week he is over 185 lbs might be enough incentive to undertake an intense weight loss regimen, so it isn't like the payment does nothing for his incentives. I just suspect that having some intermediate cutoff points would make the contract more salient, and therefore, more effective.

In other words, Ayres contract gives him the right incentives to keep off weight as long as his weight is around the cutoff he chose, but it does less good for his waistline if he fails to keep off the weight. It is a great idea, and it isn't a terrible contract. But, if he's doing the auction next year, he might want to consider this modification.

*It might be true that if I gain a pound today, that signals something about my diet and exercise that implies that I am more likely to gain a pound tomorrow. But, that's not the same thing as wanting to gain more weight tomorrow, which is the essence of an addiction.

Wednesday, September 29, 2010

Some Calorie Math

Yesterday, I played racquetball with a friend of mine. I immediately noticed that he was significantly thinner than he was when I had seen him last. Once we got to talking, he told me that he had lost 25 pounds over the last 10 weeks. When I asked him what he has done differently, he told me that it mostly has to do with eating better. And, because he cut the junk out of his diet, he is dropping the pounds rapidly on his way to a healthier weight.

Of course, exercise burns calories. Unburned calories equal extra pounds, so exercise is the key to losing weight, right? Not quite. Although it is important, exercise isn't a quick fix to a weight problem. A better diet is usually the key to success.

As I could stand to lose some weight myself, I did some simple math to figure out the best way to get to a healthier weight. There are plenty of great resources online for this.

Disclaimer: I am no nutritionist and I'm overweight, so do not take my post to be "expert advice." Think of it as me reporting what I have learned over the past week.

Losing Weight By Expending Calories

Consider two facts:

1. A person must burn 3500 calories more than he/she consumes to lose a single pound of weight.
2. A 230-lb man (that's me) can burn 184 calories running a mile (Go to the website. Type 230 in for the weight, 8 minutes for the time, and look for "Running 7.5 mph").

That means that I would have to run 19.02 miles at 8 minutes per mile to burn enough calories to lose a single pound. For someone who is out of shape (and looking to get into shape), that seems like a lot of work to go from 230 pounds to 229 pounds.

Note: It is more about distance than effort. By that same website, I could walk a mile at 4 miles per hour and burn 124 calories. That means I would have to walk 28.22 miles to lose one pound. The extra 60 calories per mile must come from elevating your heart rate and moving your arms more. An economist like me would rather run, anyway, because there is an opportunity cost to time spent exercising. If you expend more calories in a shorter amount of time without making it unbearable, that's an economical exercise routine.

Losing Weight By Dieting

A Costco apple crumb muffin

and a cup of coffee have been my breakfast every weekday this summer. Only yesterday did I discover that this delicious muffin has 690 calories. What if I cut the muffin in half? That's shaving 345*5 = 1725 calories off of my diet every week. That's almost half a pound per week.

If the only goal is to lose weight, calories not consumed are just as good as calories expended through exercise (FYI: I'd also like to get in shape). With that in mind, compare running to the "half-muffin diet." I could run 10 miles in a week (2 miles per weekday) and burn 1840 calories per week (same website: 8 minute miles).

Which is easier for me? I think I'll cut the muffin in half, and a little exercise wouldn't hurt either. By that same calorie expenditure website, my racquetball match yesterday (40 minutes to an hour) burned 515 calories. It was fun too. Is anyone up for a game?

Monday, September 27, 2010

A Hidden Cost of Wiretapping

There were several interesting bits of economics in this fascinating article on wiretapping the Internet. According to the article, law enforcement officials are having an increasingly more difficult time investigating crimes because criminals are communicating over the Internet, rather than phones. Law enforcement officials are struggling with this switch because Internet communications providers are not required to have message interception capabilities (unlike phone providers).

Although any communication provider has to comply with a legal surveillance request, there are plenty of technologies on the Internet that do not lend themselves well to government surveillance. The article reports that law enforcement officials are seeking a policy with three requirements on communications service providers:

¶ Communications services that encrypt messages must have a way to unscramble them.

¶ Foreign-based providers that do business inside the United States must install a domestic office capable of performing intercepts.

¶ Developers of software that enables peer-to-peer communication must redesign their service to allow interception.

These requirements could be costly, and as we would expect, the service providers are fighting the proposed regulations. After all, internet providers are expected to bear most of the new costs, many of which will be borne in compliance of the law:

Susan Landau, a Radcliffe Institute of Advanced Study fellow and former Sun Microsystems engineer, argued that the proposal would raise costly impediments to innovation by small startups.

“Every engineer who is developing the wiretap system is an engineer who is not building in greater security, more features, or getting the product out faster,” she said.

In other words, every hour an engineer spends on adapting the system for easier government surveillance is a cost, but it isn't the sort of cost that shows up in government calculations. This whole discussion reminds me of a wonderfully eloquent article by Frederic Bastiat, What Is Seen and What Is Not Seen:

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

Bastiat wrote this in 1848, but it is a timeless classic.

Friday, September 24, 2010

An Amusing YouTube Feature

YouTube provides its users with a wealth of information about how the video is being viewed. Video creators have access to demographics of viewers, the attention span of viewers (relative to other videos of the same length), information on how the users found the video, counts by country and region among other information.

Recently, I noticed another feature that would be especially useful for someone who receives thousands of comments: visual comment clouds. These comment clouds are a presentation of the most used words that viewers put into comments on the video, but the words' sizes are in proportion to their frequency of use. For users who gets thousands of comments, this is probably a really efficient way to understand the impact their videos had on the audience.

I get plenty of comments on my YouTube channel, but not nearly as many as some of the main YouTubers. Despite having comments in the 10s rather than the thousands, my top five videos have some interesting/amusing comment clouds that I thought would be fun to share:

1. My most popular video on Marginal Rate of Substitution has this comment cloud:

2. My video on Cost Minimization using calculus has this comment cloud:

3. My video on Income and Substitution Effects has this one:

4. My video on Budget Constraints and Utility Maximization has this comment cloud:

5. Finally, my video on the Slutsky Equation has this cloud:

Wednesday, September 22, 2010

Relationship Advice in Economics Form

This week, Jeff Ely wrote a wonderful post on how men and women view relationships differently. Here is an excerpt:
For her, relationships are all about adverse selection. It’s not his actions per se, it’s what they reveal about his type. She’s perfectly willing to forgive his missteps, she believes him that he’s trying hard and that he didn’t know he was being a louse, but that’s precisely the problem. If he weren’t such a lemon he would know the right way to say things, she’d always be in his thoughts, and she’d always be his highest priority.
Click through to see how men are different.

I like the post because it puts into simple terms the distinction between moral hazard and adverse selection, which is usually explained in the context of insurance and car markets.

Union Hires Non-Union

The other day I saw this excellent video on unions at The Daily Show:

The Daily Show With Jon StewartMon - Thurs 11p / 10c
Working Stiffed

Daily Show Full EpisodesPolitical HumorTea Party

If you don't care to click through, the story is about a union that is doing such a good job placing its workers that it can't spare any workers for its picket-line protest of Walmart.

What's a union to do in a situation like this? They hire temporary workers at minimum wage for part-time jobs with no benefits. I'm sure these temporary workers were happy to have a job, just like the Walmart workers on the other side of the picket line.

Friday, September 17, 2010

The Bachelor's Dilemma

This week's finale of Bachelor Pad set up a game with some interesting ramifications (I will try to avoid giving too much away if you want to see it; here). I tell my economist friends that I watch the show for the strategy. Here's my chance to explain why the show's strategy is interesting.

All season, attractive bachelors and bachelorettes have been competing with one another for an opportunity to win $250,000. About halfway through the season, the competition broke from an individual-by-individual competition into couples competing against couples. The idea was to generate a TV romance along the way, and for the final couples, it looks like it might have worked.

At the finale, the two individuals who were a part of the winning couple were given a choice: keep or share. If both chose share, they would split the $250,000. If both chose keep, they would get nothing (and the contestants who didn't "win" would get to split the money). If one chooses share and the other keep, the one who chose share would get nothing while the one who chose keep gets the whole $250,000.

They were sent to their own private deliberation rooms to make their choice and they weren't allowed to communicate their intended choice before making one. If you would like to see a payoff matrix, here's what it looks like:

So, that's the game. Notice that regardless of what the other person picks, you can get as much (0 versus 0 if she picks keep) or more money (250K versus 125K if she picks share) by picking keep.

But, that's a naive solution to this game. There are three ways that this can be made more realistic:

1. The contestants are in a budding relationship with one another. Picking keep might destroy their chance at love. People don't just put value on money. They also value relationships. For this to be a game changer, the contestants would have to value the cost of picking keep at greater than $125,000. Depending on the person, that's possible.

2. The game takes place on television. Picking keep might make the person look selfish. To the extent that these individuals value their public image (and plenty of them make a living from their image), picking keep could be toxic professionally. Even if the two contestants are not in love, looking like they are in love can be profitable.

3. Finally, the two individuals could be in a loving and lasting relationship. To see why this matters, suppose that they're going to live together forever. Then, it doesn't really matter how the couple earns $250,000. In this case, they value the money in their partner's hands as much as the money in their own because either way, they'll get a say in spending it in the long run. If this is the case, it is never in the interest of the individual to say keep because it has the chance of destroying the couple's chance of earning the money.

So, while the game tempts you to say keep, there are very good reasons to stick to sharing. Instead of making this a poll like I usually do, I'll leave it open ended. If you haven't seen the show, what do you think happened? If you have watched the show, what would you do? What do you think would be your strongest motivator in this situation?

Wednesday, September 15, 2010

Apple: Pricing Tricks or Pricing Treats

Yesterday, I came across this article on pricing by Apple via Freakonomics. Here's how it begins:
Next time you're sitting at an airport bar and hear two businesspeople debate whether Apple is a technology or design company, chime in: "Nope. What Steve Jobs sells is pricing."

Pricing? You bet.

The article goes on to cite numerous behavioral economics "tricks" to get customers to buy more and at a higher price. Although it is interesting to think about "pricing trickery," the article as deeply flawed because it does not reference the standard explanation for strategic pricing: price discrimination.

As long as Apple is insulated from competition,* it has the ability to price discriminate (video here). Apple's ability to charge different prices for seemingly the same product is where Apple's true genius in pricing shines through. Apple is a master of market segmentation, which is is a better explanation for many of the pricing examples the article brings up.

For example, the article brings up the 7-inch screen mini iPad.
The Economic Daily News of Taiwan reported in August that Apple has started to build smaller, 7-inch versions of its iPad tablet, timed to hit U.S. shelves before Christmas. If you wonder why in the world Apple would add yet another potentially cannibalizing product to its lineup of iPods, iPod Touches, iPads, laptops and computers, realize that this gadget is likely a decoy.

Decoys, in marketing, are products, services, or price points that a business doesn't really want you to take, but rather use as a reference to make another product look better.

I usually appreciate cynicism, but it is overly cynical to suggest that Apple would produce a product that it doesn't really want to sell, just to "cloud your judgment." If the company made a living by swindling its customers, people would catch on and that would be the end of Apple because no one likes to be a sucker.

Most Apple customers are enthusiastic about their iProducts rather than feeling cheated. How do we reconcile this? Instead of being a decoy, Apple's 7-inch tablet is a method to more effectively segment the market. A 7-inch iPad appeals to a different group of customers than the full-sized iPad. Upon hearing the announcement, customers who have especially high demand for the 7-inch size screen will wait for the smaller tablet. Apple knows this and they can price better with this knowledge. And at the end of the day, the 7-inch tablet customers will be enthusiastic about their product. After all, it was designed for them.

Better pricing and happier customers. Unlike trickery, that's a good long-term business strategy.

The second main example that the article brings up is charging different prices over time. The author tries to label this technique as "setting a high reference price":

Apple has played this game with itself by launching products such as the iPhone at artificially high reference prices - the iPhone cost $599 when it first hit the streets - and then rapidly lowering that price. Today, a $199 iPhone seems like a steal; Apple in essence is using its first-iteration pricing as a reference to make its current products feel affordable. You may be on the fence for a $499 iPad, but if it drops to $399 by Christmas, won't you feel better?

Just like pricing decoys, the logic of setting a high reference price requires that people wouldn't ever want to buy it at the high price. If it were trickery, no one would line up for the absurdly high priced new product until the price went down, yet Apple always sells out its new product offerings. Usually when a product sells out, an economist would tell you that the price isn't high enough. But, reference prices only work if they are too high.

This is market segmentation, not trickery. Companies start with a high price and slowly decrease the price over time because the high price is for the customers who can't wait; the low price is for customers who signal they are price sensitive by waiting it out. You may even get a higher price because the company has to put a rush on the assembly line to get the product out during a busy time (and that costs more). Either way, customers pay for impatience.

On a final note, I am disappointed by the spirit of the article. The article suggests that pricing tricks are a great business strategy, but the problem with tricks is that someone has to be tricked for it to work. That's not a sustainable business strategy. Market segmentation need not be tricky. It can be about providing a product that people want or improving an existing product. That creates value and creating value is the only great long-term business strategy.


*The article starts off by claiming that Apple faces "fierce competition." This can't be true. Although Apple isn't truly a monopoly, it isn't right to say that competition is fierce. If this were literally true, Apple wouldn't have the ability to set prices: Any competition will undercut the profitable component of a pricing strategy. For pricing to be an issue with Apple, it must be the case that Apple is insulated from competition, so let's start from that assumption.

Friday, September 10, 2010

Poll: How do you best absorb information?

As I write this post, I am listening to a fascinating podcast conversation between Russ Roberts and Daniel Pink about what motivates individuals to do work. It is a 79 minute conversation, which leads me to wonder how many people have listened to the entire conversation. On one hand, audio is a great format for the commute, but on the other hand, it is hard for most people to commit to listen to a 79-minute conversation about economics (even the most fascinating economics of what motivates us).

I love these weekly podcasts, but I wonder how much of that love is particular to how I absorb information. If I hear a conversation, I tend to remember it better than if I read a transcript of the conversation. Even in video form, the audio explanation is what resonates most with me. Even in studying, I have never been much for reading and scouring textbooks for information, but listening comes naturally to me.

On the other side of the story, I have found that video content can have more success in attracting a large audience than written content.

That brings me to my poll question of the week:

How do you best absorb information?

(a) Reading written material
(b) Listening to audio material
(c) Writing notes
(d) Watching live or video material

As with all polls, this one is open for a week. So, vote early and often (the poll is on the sidebar). Tell your friends to vote (write them, call them, or if it works best, video conference them). I'm interested in hearing what you have to say.

Wednesday, September 8, 2010

Lines and Prices and Bandwagons, Oh My!

Here is a quote from Gary Becker in a note he wrote in 1991:
Why doesn't the popular restaurant raise prices, which reduces the queue for seats but expands profits? Several decades ago I asked my class at Columbia to write a report on why successful Broadway plays do not raise prices much; instead they ration scarce seats, especially through delays in seeing a play. I did not get any satisfactory answers, and along with many others, I have continued to be puzzled by such pricing behavior. The same phenomenon is found in the pricing of successful sporting events, like the World Series and Superbowls, and in a related way in the pricing of best-selling books.
Becker goes on to describe how bandwagon effects can explain why popular restaurants charge a low price in spite of long lines. If everyone's demand increases on account of a large number of other individuals consuming the same good (no one likes to go to a baseball game that no one will attend), then raising the price has two costs: (1) it drives customers away (the usual cost), (2) it reduces the demand of everyone else on account of driving customers away, which drives even more customers away (driving more away).

The result is an unstable situation where restaurants (or producers of bandwagon goods) fear raising prices because the long term effect on sales is disastrous. Thus, restaurants that are popular cultivate this popularity by pricing so that there is always a line. For the same reason, college rivalry game tickets (or playoff tickets in the FCS) are more expensive than regular games, but not nearly enough to ration demand. Other methods, such as priority availability of tickets, are needed to make quantity supplied equal quantity demanded.

In extreme cases, suppliers prefer having a low price with a line to having a high price with no line. That's because the high price with no line feels like an empty restaurant. Hence, they'll expend resources to cultivate lines.

As an example, Sprinkles cupcakes (which I mentioned on Saturday) has a sign on the door to keep the door closed and form the line outside of the shop (presumably to keep the cupcakes fresh). This sign has a side benefit for a business like Sprinkles: It makes the line seem longer (and therefore, the cupcake experience seems more like the "it thing" and people are more willing to line up). It is a strange paradox that arises from bandwagon effects.

This logic also explains why baseball teams give out goodies to the first 10,000 people to show up to the ballpark. If it is Elvis night (Friday, Aug 13), it is comforting to know that at least 10,000 other people will have Elvis glasses with sideburns (because they were handed out at the gate). That's fun. It might even be so much fun that it makes it worth going to the game tonight. That's what the team is hoping, anyway.

Monday, September 6, 2010

Poll: Is the cupcake market a fad?

About a month ago, my wife brought to my attention a new craze that is sweeping the nation: cupcake boutiques. These little shops sell cupcakes -- no cookies or brownies -- just cupcakes (and maybe a glass of milk to complement them). My wife told me that there was a new cupcake shop in downtown Chicago called Sprinkles Cupcakes, and we just had to try it.

At first, I couldn't imagine that a store selling only cupcakes could do well, but after hearing about it once, I saw other signs that cupcake boutiques are on the rise. Not long ago, there was a Groupon advertising another cupcake boutique (there's more than one downtown), and just yesterday, I saw a "cupcake van" parked at the corner of Michigan and Wacker, selling cupcakes to an eager line of customers (I believe the saying on the back of the van was "follow me to the corner of ooh and ahh").

Back to Sprinkles Cupcakes, my wife went there with her friend, and the line went around the corner. The wait was 45 minutes.... for cupcakes. When you get inside, the small shop has a wide variety of different decadent cupcakes. And, the typical price is $3.25 for a cupcake. I had to see what the craze was about, so I tried one the other day. It was the most delicious cupcake I had ever eaten.

Even so, I had never thought about a cupcakes-only store until I heard of Sprinkles. It makes me wonder about the long-term success of cupcake boutiques. I have some more ideas on the economics of the cupcake craze, which I will share in my Wednesday post, but I wanted to put this out there as this week's poll question.

Do you think that cupcake boutiques are going to be successful in the long run?

(a) No. It's a fad.
(b) Yes. Cupcake shops are here to stay.

As with all polls, this one is open for a week. Vote early and often. Tell your friends to vote. If you're standing in line at the cupcake shop, tell your fellow cupcake aficionados to vote as well. With a wait of 45 minutes, you'll have plenty of time to vote. I'm interested in hearing what you have to say.

Wednesday, September 1, 2010

Price Discrimination and Car Rentals

Yesterday, I read this interesting post on the Freakonomics blog from Daniel Hamermesh:

My son is renting a car in December. He’ll drive it for two days in Orlando, then he’ll drive to South Florida for an eight-day stay. With the drop-off charge, the price is $900. But if he drops the car off in South Florida when he arrives and rents a new one from the same company, the total price is only $500. He values his time spent dropping off the car at less than $400, so he’ll do it.

The prices are similar at all the car rental companies. Why this deal? It costs the companies more—they have to process two reservations/returns, clean two cars. This can’t be cost-based price-discrimination, it must be demand-based; but it’s difficult to separate markets, as my son’s behavior shows. Except for an old example, creating the 386SX chip by lobotomizing the 386DX to reduce its capabilities and charging less for it than for the intact chip, are there any other equally clear examples?

This is a fascinating example of price discrimination (charging different prices for the same product), and the comments on the post add a lot.

There are plenty of people who wouldn't check into returning the vehicle in the middle of a 10-day trip. People who actually look into this option (or options like these) clearly separate themselves as people who respond to the price. Because they are probably also looking into other options for the South Florida rental, they're most likely to flee to another car rental agency. Hence, it makes sense to offer this type of consumer a discount while charging exorbitant rates to people who don't bother to check various pricing options.