23 September 2013

How Free is Free Choice?

Free choice is one of the foundation stones of capitalism and democracy, two philosophies that dominate life in today’s world. The freedom to choose is supposed to do two major things. First it is supposed to ensure the maximization of benefit (or utility as economists call it) for the individual. By being free to choose whatever the individual wishes and assuming that the individual knows best what he wants and what is best for him, a person will maximize their benefit and overall well-being.
Second, free choice is supposed to power the free market mechanism. Because the individuals are free to choose whatever they want, the suppliers who provide the products and services best suited to clients’ needs are going to be favored, while the suppliers who provide unsuitable products and services will be eliminated from the market.
In theory, free choice sounds like the best possible thing that can exist in the world. It helps people maximize their well-being and at the same time rewards the companies which sell the best products while at the same time punishing the companies which sell the worst ones. Isn’t it great?
As you may know already, free markets and maximization of well-being are more theoretical concepts than real life. This is not to say that somehow-free markets and increasing well-being do not exist in real life, but rather it is to say that there are no absolutely free markets and no real maximization of well-being.
In the eyes of economics science the human is a near perfect reasoning machine, with established and stable preferences, who has full information (knows everything), who continuously makes cost-benefit analyses, who has absolute self-control and who lives with only one goal in mind, namely maximization of utility or self-benefit. In a nutshell, economics views man as homo economicus.
This view on human nature is not restricted to the field of economics. It is widespread in most aspects of social life, especially in the western world. Democracy functions on pretty much the same principles, but despite its shortcomings, up to now there is no better way to organize society.
The homo economicus view of human nature has spread even in areas of social life that until recently were more paternalistic.  Take for example medicine and health-care. Most of us are used to go to the doctor and say that we feel bad, then the doctor would do some tests, think a bit and come up with a diagnose. After this the doctor would tell us what to do. This is paternalism. In some parts of the world, now, doctors give patients the choice between two or more treatments. In other words, there is a shift from paternalism (the doctor telling you what to do) to libertarianism where the patient is free to choose between treatments. Is this the way it should be? It is up to each and every one of us to give the answer.
Apart from the more philosophical question in the paragraph above, I believe there are more significant questions to be answered. First, we should see if man is actually homo economicus. Are we really those rational agents that we are believed by economists to be? The answer is quite simple and it is “No”. This is not to say that humans are perfectly irrational, but rather to say that the assumptions of all the characteristics of homo economicus are not fully met.
For example, it is impossible for someone to hold complete information. This may be due to the abundance of information and to the fact that our minds have limited capacity; or it can be due to the fact that in many cases we do not make the extra effort to search for all the information on a certain topic. Imagine that you want to buy shoe polish. Would you go to all shops in the city to search for shoe polish, collect all the information on quality, price and quantity, then make a thorough cost-benefit analysis, choose one option and then go back to the shop and buy it?
Unlimited self-control is another thing that people do not have. We can exhibit self-control, but by far we do not have an unlimited supply of it. We, quite often, yield to temptation and to impulse when our self-control resources are low.
Homo economicus is assumed to have one goal in mind namely maximization of self-benefit. But, does this really happen? Sometimes it does sometimes it doesn’t, but this is not to say that people do not want to have as much self-benefit as possible. Rather it is to say that we quite often settle for good enough solutions and not go for the best solution. It is a difference between maximizing and sufficing and most of the time we are happy with sufficing.  
The second question we should answer is how free is free choice? Are we actually free to choose anything? The answer to this question is both “yes” and “no”. Freedom of choice in itself is usually not restricted in many countries, so in principle we are free to choose anything. At the same time what we choose is very much influenced by factors other than our own free will.
Let me give you a simple example. If you go out for dinner at an Italian restaurant, you will end up eating some kind of Italian food and for sure you will not have Chinese food. The mere existence of a choice set, in this case the restaurant menu, limits one’s free choice.
If you believe that the idea of not having Chinese food in an Italian restaurant is silly, consider the following example. In school cafeterias in the UK fried potatoes are not any longer on display, but are available if someone asks for them. To put things simply, the option of eating chips is available but not salient. The result of this change was the decrease of consumption of chips.

In the aforementioned examples, free choice is not so free because some options are not in the choice set one is presented with. At the same time, (free) choice is influenced by the composition of the choice set beyond not choosing what is not in the choice set; it is influenced by how the choices are presented.

4 September 2013

We Are Willing to do the Right Thing, but Only in the Future - NOW Vs. LATER Effect

The “NOW vs. LATER” effect (or simple time discounting) is quite simple and it can be illustrated with the following pair of choices:

Choice: What do you choose between?
A. 100 Euros Now and
B. 110 Euros in two weeks.

Most people choose “A” and forgo the extra 10 euros for not waiting.

Now, consider the following choice:
C. 100 Euros in three months from now and
D. 110 Euros in three months and two weeks from now.

In this case, most people choose “D”. 

If we take a look at the two options from the rationality perspective we see that the options are in essence identical. In each case there is a 10 Euro premium for waiting another two weeks.

The fact that preferences changed from one pair to another is a violation of rationality and is extremely useful for understanding human nature. In other words it is the “NOW vs. LATER” effect. 

When we have to choose between a smaller positive outcome now and another bigger positive outcome later, we take the small one right now. However, when we have to choose between two future outcomes – one smaller and sooner and one larger and later – we tend to go for the larger one. 

This is because we think something like this “if I have to wait for three months to get the smaller reward, then I can also wait for another two more weeks to get the extra reward.”

The implications of the “Now vs. Later” effect are quite significant. I would say that the most important thing is that people are willing to do “the right thing” in the future and experience difficulties for doing so in the present. In other words some actions are better to be delayed. 

A very nice example comes from Shlomo Benartzi and Richard H. Thaler with the “Save more tomorrow” program. In short, people were asked to save more money for retirement (in the US), but starting at their next pay-raise. By delaying the moment of the actual saving more money, more people were willing to sing the contract, than if they would be starting right now.