The Psychology of Crowds… #MallofAfrica

Following on from my post on the opening of the new Makro in Brakpan, and the opening of the new Starbucks in Rosebank, and all the mad queueing that took place (“Take me far from this madding crowd #Makroeconomics“), I’d like to endorse these tweets:

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Screen Shot 2016-04-29 at 7.08.39 AM Screen Shot 2016-04-29 at 7.09.31 AM

And let me also highlight some highlights from the “See the Huge Queues at the Mall of Africa Grand Opening” article on mybroadband.co.za:

Mall-of-Africa-2-1

Mall-of-Africa-opening-4 Mall-of-Africa-opening-3-1

I mean, queueing for opening specials at H&M and/or Clicks… 

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And I’ll repeat my original point here: can we really assume, as much macroeconomic theory does, that the actions of a crowd are simply the sum of the actions of the rational individuals within said crowd? Or, at least, that it averages out to be the case over the long-term, in general, overall, and when it matters.

Because there is a counter to that: events like the Mall of Africa Grand Openign, and mass-queuing for discounts in clothing stores on an opening day when there isn’t the same mass-queuing for similar discounts at other sales on somewhat less auspicious/marketed occasions.

But let me backtrack here and give a standard example of “rational” mob mentality…

The Rationality of Bank Runs

So if you look at the way that bank runs happen:

  1. Rumours fly around that a bank is having difficulty.
  2. Some people rush to the bank to start drawing out their money.
  3. The bank starts to run out of money to give out.
  4. The rumours are now confirmed that the bank is having difficulty, because it’s running out of money to give out.
  5. Everyone rushes to the bank to draw out their money.
  6. The bank folds. Or it gets a bailout.

And this is classic rationale at work. Each individual basically knows the following:

  1. The bank may or may not be in trouble.
  2. If I go and draw my money, I’ll have my money.
  3. If I don’t go and draw my money, and the bank turns out to be fine, then I’ll still have it.
  4. But if I don’t go and draw my money, and the bank turns out to be very not fine, then I won’t have my money at all.
  5. Logical conclusion: to be safe, let me just go down there and draw my money.

And this logic even stands up for those deep-thinkers who know that drawing money from the bank may well cause the bank’s downfall:

  1. The bank may or may not be in trouble.
  2. If I go and draw my money, I’ll have my money.
  3. If everyone rushes to draw their money and causes the bank to fold, then I won’t have my money.
  4. If the bank is fine and I’ve drawn my money, then I can always put the money back.
  5. Logical conclusion: to be safe, let me just go down there and draw my money.

And it all looks very logical, and perhaps the economists have it right, and perhaps Mall of Africa Grand Openings are just examples of people getting emotional about non-economic drama and it’s all just marketing-hype anyway.

More Logical Conclusions

So in the face of irrational queues and rational bank runs, you can conclude one of the following:

Option A: Crowds are rational. Perhaps those queues for Mall of Africa aren’t actually irrational, and perhaps we’ve just misread the internal rationalisation process of all those individuals. Like maybe I’m underestimating the pleasure and utility that people get from getting stuff on special, or the pleasure of being at an opening day and feeling like you’re part of something exciting. These are economic factors as well.

Option B: Crowds can sometimes be rational, and can sometimes be irrational. Perhaps it’s both. And really, the question to be answered here is how to tell which is which, and what the triggers are.

Option C: Crowds are irrational. Maybe we’re just rationalising the bank run process in retrospect. As in: no one really thought that much about it. Most of the crowd were just out for coffee, and saw quite a long queue at an ATM, and decided to join it because they assumed that other people in the queue must know something that they don’t. And as more people joined the queue, more people in the vicinity panicked. And then Twitter and Facebook and the news happened, and suddenly, everyone was just rushing down to the bank in a panic to get their money. You know, like that bank run scene in Mary Poppins.

For what it’s worth, my current bet is actually on Option C.

But perhaps I’m a pessimist.

If you’d like to do a bit of extra reading though, I had fun on this wikipedia page: Crowd Psychology.

Happy Weekend.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.

The Economics of Free Stuff

Note: based on the great response to yesterday’s post, I wanted to share a somewhat-related post that I wrote a few years ago. Here goes…

For a while now, I’ve been wanting to write a post on the economics of free stuff. Because empirically speaking, the gap between “FREE” and “$0.99” is exponentially larger than the same ±$1 gap between the $7.99 and $8.99 that I’d pay for an album off iTunes.

I’ll give you an example: I’m a big user of the pro-HDR app on my phone. It’s one of the first apps that I ever purchased – and it has made every holiday and food-outing since a better, brighter and more braggable experience. But whenever I show someone a pro-HDR photo, and I tell them what app I used, the first question I get asked is “Was it free?”

“No,” I say, “but it was the best $0.99 that I’ve ever spent on this phone. Download. Download it now. It will change the way that you have holidays.”

At which point: vacillation.

That is: my endorsement is always followed by a conversation about whether it’ll be used enough, and whether it’s worth it, and aren’t there any free apps that do the same thing, and “I don’t really take that many photos anyway” (Well obviously – because your photos don’t look nice. If you used a better camera app, then you’d take nice photos, and then you’d take more of them.)

Eventually, the decision is taken to delay making a decision, and then we order another G&T instead. Which usually costs about six times the price of the pro-HDR app. #ButItsFineBecauseWe’reOnHoliday.

What Should Happen, and What Actually Happens

free stuff

Economist Dan Ariely, famous for his faith in our irrationality, often talks about the following experiment:

  • He set up a stand in a busy cafeteria to sell chocolates
  • He was selling Lindt chocolate truffles for 15 cents, and Hershey kisses for 1 cent each.
  • People could choose only one type of chocolate.

Because the Lindt chocolate truffle was particularly excellent and highly discounted (it normally retails for 50 cents), 73% of the people that came to the table opted to pay the premium and buy the Lindt chocolate.

A short while later, he dropped the price of both products by 1 cent – the Lindt chocolate truffle now cost 14 cents, and the Hershey kiss was free. And despite the fact that the discount on the Lindt chocolate truffles was the same, demand reversed and 69% of people opted for the Hershey kiss.

Which seems oddly irrational – if our preference is for Lindt chocolate truffles at the discounted price, then 1 cent should make no difference. And yet there was a major shift in demand between 1 cent and “free”.

Of course – there is a potential flaw in Mr Ariely’s experiment. It’s perhaps possible that the demand shift was a result of a changing market: when cost was involved, you only got real chocolate lovers at the table; but when one of the chocolates was suddenly free, the market expanded to include everyone that wouldn’t normally pay for chocolate but would quite willingly take it for nothing.

Yet even that flaw would reinforce the irrational mania around the concept of “free”. If you wouldn’t pay 1 cent for a chocolate – why flock to have one if it’s free? Clearly, they’re not important to you. So why the sudden personality shift?

How That Translates Into Real Life

A list of services that cost nothing:

  • Google
  • Gmail
  • Facebook
  • Twitter
  • Skype

Question: what would happen if one of these suddenly started charging a subscription after I’ve been used to having it for free?

Just consider Whatsapp – new users are asked to pay a subscription after the first year, but the older users that downloaded it when it was free are never going to be charged for it. Because if we were, we would just stop. We’d maybe start using iMessage a bit more. Or Facebook Messenger. Even though the real cost of doing that would be high (not everyone has iMessage or Facebook Messenger, so we’d have to use multiple messaging programs for a while, and so on).

So How Do Companies Transition From Free To Not Free?

They offer supplementary services for a fee. You get in-app purchases for more options; or you can buy boosters in Candy Crush; or Skype allows you to call landlines and mobiles if you buy Skype credit.

I think that’s why we tend to look for “the catch”.

The real question is how Facebook plans to monetise Whatsapp…

My guess – in the same way as Skype. Free calls and Whatsapp credit. And then maybe there will FINALLY be a proper application that can successfully cross between my lap top and my phone.

But only as long as it’s still mostly free.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.

Take Me Far From This Madding Crowd #Makroeconomics

Two things from last week:

  1. The opening of the new Makro in Brakpan; and
  2. The opening of the new Starbucks in Rosebank.

Scenes from the new Makro Brakpan parking lot:

Makro-Carnival-5-640x360 Makro-Carnival-3

Admittedly, there were some good tech deals available for the first 100 or so customers:

Although, these are about to go on sale at the iStore anyway, because the new models are due out...

Although these are about to go on sale at the iStore anyway, because the updated models have just been announced…

But most of those customers would have been in that queue far behind the point at which the good deals would all have been gone.

Then Starbucks:

People queueing from midnight.

What is this madness?

I mean, I can almost understand queueing for over 24 hours to buy a heavily-discounted Macbook Air. But missing a night’s sleep to stand outside a new Starbucks for a distinctly over-sweet “Iced Sparking Mint Espresso” – just to be the first to have one on South African soil – seems like a poor use of one’s time.

It reminds me of this section in Richard Thaler’s book “Misbehaving: The Making of Behavioural Economics”:

Linnea is shopping for a clock radio. She finds a model she likes at what her research has suggested is a good price, $45. As she is about to buy it, the clerk at the store mentions that the same radio is on sale for $35 at new branch of the store, ten minutes away, that is holding a grand opening sale. Does she drive to the other store to make the purchase?

On a separate shopping trip, Linnea is shopping for a television set and finds one at the good price of $495. Again the clerk informs her that the same model is on sale at another store ten minutes away for $485. Same question… but likely different answer.

Excerpt From: Richard H. Thaler. “Misbehaving: The Making of Behavioral Economics.” W. W. Norton & Company, 2015-05-10T22:00:00+00:00. iBooks.

It really calls everything into question, doesn’t it?

One minute, you’re coasting along, thinking that everyone is fairly rational and mostly consistent and trying to make the best decision within their realm of knowledge.

Next minute, you’re caught in a traffic jam outside a Makro in Brakpan, where thousands of people are standing in line for hours on end in the hope that they might get to take advantage of a tech special that will have disappeared long before they even enter the store.

It really makes you question whether economists have a firm enough grasp of the macroeconomic picture. Because it’s scenes like this that should get us a little concerned about that “we’re all just rational individuals making rational choices, and the economy is just the cumulative sum of those choices” way of thinking.

I mean: perhaps the crowd is its own kind of thinking beast?

#makroeconomics

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.

The Laffer Curve…

Following on from last week’s “Cut Taxes To Boost Economy and Reduce Inflation” post, I thought it might be worth re-visiting one of those economic theories that gets applied a little too broadly: the idea that decreasing tax rates can raise tax revenue. Which is the principle behind the Laffer Curve.

The Laffer Curve For Beginners

The Laffer curve is based on the assumption that all governments want to maximise the tax revenue that they collect. Given that – what tax rate should they impose? Does it always logically follow that the higher the tax rate, the more revenue you collect?

This was a question that plagued Mr Laffer, who began to engage in some hypothetical scenarios (for the benefit of Mr Reagan, who would eventually follow this conclusion into radical tax cuts):

  1. If the tax rate is set at 0%, then there will be zero tax collected. That makes sense – you can’t collect tax if there is no tax to collect.
  2. If we go to the other extreme, and set the tax rate at 100%, then you will be asking your people to work for benefits (ie. communism). And that’s not really good for incentives – because if you were working only for benefits, and everyone else gets the benefit regardless of how much work they do, then you might fairly assume that no one would work, and thus, no taxes would be available to be collected.
  3. Therefore, we have boundaries: tax rates of 0% and 100% will likely result in no tax revenue.
  4. As you step from 0% to 1%, you’re going to start earning tax revenue. And people will be generally quite willing to continue working and pay that 1% – it’s not a huge imposition.
  5. At 2%, it’s still not unreasonable. And the higher tax rate will mean higher revenue – because most people would prefer to comply rather than not.
  6. On the other end, if you drop the tax rate from 100% to 90% – you’re going to get a bit of revenue. That is: there is some incentive to work a bit harder than the next guy, because you’ll get your standard benefits, plus a bit extra. So in this case, lowering the tax rate will increase the amount of revenue collected.
  7. So Mr Laffer drew a graph:

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At least, that’s the rough approximation of what it looks like in economics textbooks – as though, somehow, the optimal rate is somewhere in the 50% region.

The green line is my general suspicion of what it actually looks like in practice:

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My reason for that: the higher the tax rate, the greater the incentive that exists to evade it. And if you take into account the cost, risk and effort of tax evasion, I think you’ll find that people will rapidly become willing to bear that cost as soon as it becomes economically cheaper to evade tax. Which means that there’s an earlier maximisation of revenue collection than Mr Laffer’s curve predicts.

And I think that the skewing of the Laffer Curve is something that gets worse as you try to take advantage of it. If you lower a tax rate to try and capture more tax revenue, you reset people’s expectations of what tax they’re willing to pay – because the minute there’s talk of a tax increase, people just threaten to go underground on you. Even though, 10 years ago, they were paying the same amount that you’re asking them to pay today.

Republicans VS Democrats

That opinion aside, when you hear the Republicans arguing for lower tax rates (or tax breaks), they’re still of the opinion that America’s tax rate for high income earners sits somewhere to the right side of the peak (and therefore, lowering the rate will increase tax revenue because more people will become compliant). The Democrats, when they argue for closing tax loopholes, are effectively saying that the current tax regime places America on the left-hand side (so increasing the tax rate will increase tax revenue collection).

Hauser’s Law

Going back to something I mentioned last week, after Mr Laffer drew his curve, successive American presidents have used it to argue in favour of lowering tax rates. So the USA is really the best empirical example of what happens when the Laffer Curve is applied in practice.

Unfortunately, this graph:

Back in 1993, William Hauser (an investment analyst) pointed out that for all the Laffer theory application, tax collection as a percentage of GDP has not really moved off the 20% mark of GDP mark since the 1950s.

And what this seems to suggest is that the populus will pay in tax what it will pay in tax. The tax law can change – but if it gets too draconian, people will find ways around it. And when it becomes less draconian, people will stop finding ways around it, and just pay what they’ve always paid.

Or the Laffer Curve should actually look like the orange line:

20130716-182804.jpg

And if you think about it – it makes more intuitive sense than anything else. Because would people really stop working if a government imposed 100% tax?

Not at all. Private enterprise always tends to find a way. What’s more likely to happen:

  1. Everyone continues to work as they did before.
  2. But they only declare some of their income.
  3. The rest gets hidden, spent, or smuggled into a more reasonable tax jurisdiction.

And then, over and above that, I think that you’ll find the “tolerable” tax threshold (as a percentage of GDP) is largely driven by the corresponding “benefit” that is received by the taxpayer. So the Scandinavian countries, which provide a lot of social benefits for your tax buck, are able to pull in higher taxes. And other jurisdictions face a much more hostile tax base…

Just a thought.

Happy Monday.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.

 

Hedonism: It’s Hard Work

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I took a time-out this week to write a little something about holidaymaking for the girls across at travelwhores.co.za. Read it here:

Holidays Rule: The Professional Guide

I apologise in advance to any sensitive readers (and my mother): the appropriate tone required the occasional f-bomb.

And while you’re rifling through the Travel Whores’s website and being amused by all the “undercarriage” reference, don’t forget to like them on Facebook and follow them on Twitter. Those ladies are wicked, as is their writing.

PS: you may want them on your pub quiz team. Unfortunately, they’re taken. Sorry.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.