Sunday, November 04, 2007

Economics for Dummies

You set out to buy a TV and discover that for the £100 TV you have your eye on, you can save £10 by driving half an hour across town. You do so because you save 10%. That's obviously a bedroom TV so you also look for a main-room TV, this time for £2000. You discover that this TV is also on sale across town - for £1990. But you decide your time is worth more than that 0.5% saving, so you don't go.
According to my book on Economics you are being irrational. Your time is either worth £10 or it isn't.

I can see the point of view, but I'd wager that most people would act in line with the above. I wouldn't call this irrational: it's rational so long as you understand what people are deciding upon. And that is happiness, a psychological measure that standard Economic theory isn't altogether good at. People are happier when they think they're getting a great deal. They will spend 10 minutes on online price comparisons to save 50p on a DVD, but won't walk 100 extra yards to a shop that's 50p cheaper for orange juice, even if that only takes 2 minutes.

The discipline's de facto get-out-clause is that, however distasteful its proposed rules, if it accurately predicts the real-world, its a good theory. So there's surely a problem for it here. People don't think of money in the strict mathematical sense that Economics would like them to.

Its time for more subtlety in modern economic theory - and a change perhaps in some of its fundamental ground-rules. This is one of the thoughts of Richard Layard, Professor Emeritus at LSE. He's at a St Paul's Institute Event on Tuesday and I'll be there to report back.


Martin Garthwaite said...

There are two things going on here, firstly transaction cost theory, closely realted to perfect information within a market (or lack of it). It is certainly irrational NOT to save £10 if the opportunity presents itself and should not be considered as a function of % saved. £10 will always be £10, but when compared to the transaction cost i.e. the cost finding the bargin, the cost of getting there, cost of parking, time it takes to stand in line the list goes on...

Anonymous said...

what you have quoted is a pretty basic concept of neoclassial economics that no practising economist would currently expound as factual truth in reality the mathematical principles behind this version of economic rationality just looked too god to resist and is therefore unfortunately taught to almost every undergraduate economics in this country. it's good to hear that lse has staff that are happy to point out that there are far more components that go into determining purchasing behaviour to be fit into such a neat tractable formula as the marginal propensity to consume gives us.