Do economists act like the self-interested decision-makers from our models, and if so, why?

Economics models typically assume that decision-makers are self-interested, trying to maximise their own 'economic rent'. Does exposure to these models, and the assumption of self-interest, lead people who have studied economics to make more self-interested decisions? Or, are people who make more self-interested decisions more likely to study economics (perhaps because it accords with their already-established world view)?

These are questions that many studies have tried to grapple with (and which I have written about before, most recently in this 2023 post). What is needed is a good systematic review of the literature. We don't have that, but this 2019 article by Simon Hellmich (Bielefeld University), published in the journal The American Economist (sorry, I don't see an ungated version online), provides a review of the literature (up to 2019, of course).

Hellmich prefers the term "people trained in economics" rather than "economists", noting that much of the literature focuses on undergraduate students who have only taken one or a few courses in economics, and can hardly be considered "economists". Hellmich reviews the empirical literature that comes from both lab experiments and field experiments, although it is worth noting that most of the literature makes us of lab experiments. He draws three broad conclusions from the literature:

• People trained in economics behave more in accordance with the standard paradigms of their discipline in situations that are typically described in economic categories. They tend to prioritize their self-interest in games... but this is at least in part an outcome of their expectations about other peoples’ behavior and social interaction can strengthen their cooperativeness.

• Most of the experiments reviewed here involve economic decisions (i.e., involve the allocation of money); in most of the less obviously economic decisions, people trained in economics do not seem to be much less concerned with other people’s welfare and no more likely than other people to expect opportunism from other individuals. All in all... there is not much unambiguous support for the view that training in economics affects the fundamental preferences of people by making them more “selfish” or opportunistic.

• Most empirical evidence seems to be consistent with the self-selection assumption and more than half of the relevant studies—some of them providing high-quality evidence— seem to suggest that there are training effects... Probably both forces play a role.

In other words, the review doesn't really tell us much more than we already knew. People trained in economics behave in a more self-interested way, and part (or perhaps most) of the reason for that is the types of people who choose to train in economics. What Hellmich adds to this research question, though, is a concern about the way that previous research has tried to identify the effects, and in particular, the way that the research is framed (from the perspective of the research participants). He notes that:

...most of the experiments reviewed here lack sufficient consideration of the fact that human subjects in experiments do not mechanistically and passively respond to selected stimuli consciously created and controlled by the experimenter, and in so doing reflect their fundamental preferences. Instead, human subjects tend to interpret cues given to them—perhaps unconsciously— by the experimenter or the environment and what they might know about the theories underlying the experiment... In social dilemmas that involve decisions that are clearly identifiable as being of an economic nature (e.g., because they involve the allocation of money), people compete more than if this trait is less clear... In market-like contexts, there is broad acceptance of self-interest. It may even constitute the social norm to follow...

In other words, perhaps people trained in economics act differently in these experiments because the lab environment, and the wording of the decisions, induces them to apply their economics skills. This would explain why, in the field experiments conducted in more naturalistic settings, the behaviour of people trained in economics differs much less from other people than it does in the lab experiments. Hellmich is essentially arguing for more investigation of real-world decisions, and how they differ between people trained in economics and people who are not. That seems like a sensible suggestion.

However, the overwhelming result from Hellmich's review is that people trained in economics are "different" in meaningful ways (including higher levels of self-interest), and that difference should be recognised. He concludes that:

...as provisional steps, we should perhaps try to make students more aware of the fact that most economists understand key elements of neoclassical theory—like the homo economicus—as an instrument to explain macrophenomena rather than as a normative model of micro-behavior and how other elements of the “culture” of the discipline might make their judgments deviate from that of other groups.

In other words, our students (and other people) need to understand that self-interested behaviour is an assumption that we make in economic models, and not an ideal to strive for.

Read more:

• Does education in economics make politicians corrupt?
• The impact of business and economics education on moral competence
• This study tells us nothing about whether studying economics make students less ethical
• Does studying economics make you selfish?

Qantas tries to execute a break-out of Air New Zealand's locked-in customers

As I noted in this post last week, customer lock-in occurs when consumers find it difficult (costly) to change once they have started purchasing a particular good or service. Having locked-in consumers is quite profitable for firms. They can raise their prices without fear of losing those consumers, or they can leverage their locked-in status to sell them other things.

Of course, if another firm wants to compete with a firm that has locked in its consumers, the competing firm may need to find some way of breaking those consumers out of being locked in. That usually involves trying to lower the switching costs that are keeping the consumers locked in. We saw an example of this late last year, when Qantas made a bid to lure away Air New Zealand's frequent flyers, as reported in the New Zealand Herald in November:

Qantas is targeting Air New Zealand’s upper-tier Airpoints members as it looks to grow its loyalty programme here beyond one million members.

As part of an aggressive push into New Zealand, Qantas will fast-track Gold members of other airline loyalty programmes into its scheme.

Those who hold Gold or higher equivalent status with other ‘‘select airlines’' can fast-track to Qantas Gold by earning 100 status credits in 90 days on flights with Qantas, Jetstar and partner airlines.

Gold status is usually obtained by earning 700 status credits in a membership year.

In addition, participating members will get access to the airline’s network of Qantas Club lounges and extra checked baggage during the 90-day fast-track offer...

Qantas is also targeting a wider range of New Zealanders to ensure they take advantage of points they already have.

Qantas Frequent Flyer will remove the $60 join fee on its website later this month.

Loyalty schemes, like frequent flyer programmes, lock consumers in because if they switch to a different programme, they lose the benefits that their current programme provides, and their frequent flyer points or airmiles will eventually expire (those are the switching costs). Qantas is trying to reduce those switching costs by fast-tracking Air New Zealand Gold Airpoints members to Qantas Gold, meaning that consumers who switch wouldn't lose their frequent flyer benefits (or wouldn't lose them for long). The switching costs aren't eliminated, because their Air New Zealand frequent flyer points will eventually expire, but they are substantially reduced. The lower cost of switching would probably attract at least some Air New Zealand frequent flyers to make the switch. As the article notes:

Qantas made a similar offer to Air NZ Gold members in 2020 which [Qantas Loyalty chief executive Andrew] Glance said had been successful.

Taking advantage of switching costs and customer lock-in is an important way that firms use to increase their profitability. It isn't surprising that firms have discovered countermeasures to restrict their competitors' ability to lock-in customers. What might be more surprising is that Air New Zealand didn't appear to retaliate by offering a similar deal for Qantas frequent flyers!

This week in research #69

Here's what caught my eye in research over the past week:

• Altindag, Cole, and Filiz (with ungated earlier version here) find that students' academic performance is better when their race matches their teachers, but that this is only true for students who are younger than their teacher, and not for students who are a similar age or older than their teacher (role models clearly matter)
• Calamunci and Lonsky (open access) find that, between 1960 and 1993, an Interstate highway opening in a county led to an 8% rise in total index crime, driven by property crime (burglary, larceny, and motor vehicle theft)
• Achard et al. (open access) find that individuals living close to newly installed refugee facilities in the Netherlands developed a more positive attitude towards ethnic minorities and became less supportive of anti-immigration parties compared to individuals living farther away

Mobile phone providers and the repeated switching costs game

This week, my ECONS101 class covered pricing and business strategy, and one aspect of that is switching costs and customer lock-in. Switching costs are the costs of switching from one good or service to another (or from one provider to another). Customer lock-in occurs when customers find it difficult (costly) to change once they have started purchasing a particular good or service. The main cause of customer lock-in is, unsurprisingly, high switching costs.

As one example, consider this article from the New Zealand Herald last month:

A new Commerce Commission study has found the switching process between telecommunications providers is not working as well as it should for consumers...

The study found 50% of mobile switchers and 45% of broadband switchers ran into at least one issue when switching.

The experience was so bad that 29% of mobile switchers and 27% of broadband switchers said they wouldn’t want to switch again in future...

The commission’s latest consumer satisfaction report found that 31% of mobile consumers and 29% of broadband consumers have not switched because it requires ‘too much effort to change providers’...

Gilbertson said a lack of comprehensive protocols between the “gaining” service provider and the “losing” service provider was a central issue with the current switching process.

This led to a number of problems, including double billing, unexpected charges, and delays.

The difficulty of changing from one mobile phone provider to another is a form of switching cost. It's not a monetary cost, but the time, effort, and frustration experienced by consumers wanting to switch makes the process of switching costly. And because the process is costly, mobile phone consumers are locked into their current provider.

It is clear why a mobile phone provider would want to make it difficult (costly) for its consumers to switch away from it and use some other provider. However, why don't mobile phone providers try to make it easier to switch to using their service instead? Maybe they could have staff whose role is to help consumers to navigate the process of switching to their service. That would allow the mobile phone provider to attract consumers and capture a greater market share. The answer is provided by considering a little bit of game theory.

Consider the game below, with two mobile phone providers (A and B), each with two strategies ('Easy' to switch to, and 'Hard' to switch to). The payoffs are made-up numbers that might represent profits to the two providers.

To find the Nash equilibrium in this game, we use the 'best response method'. To do this, we track: for each player, for each strategy, what is the best response of the other player. Where both players are selecting a best response, they are doing the best they can, given the choice of the other player (this is the definition of Nash equilibrium). In this game, the best responses are:

1. If Provider B chooses to make switching easy, Provider A's best response is to make switching easy (since 3 is a better payoff than 2) [we track the best responses with ticks, and not-best-responses with crosses; Note: I'm also tracking which payoffs I am comparing with numbers corresponding to the numbers in this list];
2. If Provider B chooses to make switching hard, Provider A's best response is to make switching easy (since 8 is a better payoff than 6);
3. If Provider A chooses to make switching easy, Provider B's best response is to make switching easy (since 3 is a better payoff than 2); and
4. If Provider A chooses to make switching hard, Provider B's best response is to make switching easy (since 8 is a better payoff than 6).

Note that Provider A's best response is always to choose to make switching easy. This is their dominant strategy. Likewise, Provider B's best response is always to make switching easy, which makes it their dominant strategy as well. The single Nash equilibrium occurs where both players are playing a best response (where there are two ticks), which is where both providers make switching easy.

So, that seems to suggest that the mobile phone providers should be making switching to them easier. However, notice that both providers would be unambiguously better off if they chose to make switching hard (they would both receive a payoff of 6, instead of both receiving a payoff of 3). By both choosing to make switching easy, it makes both providers worse off. This is a prisoners' dilemma game (it's a dilemma because, when both players act in their own best interests, both are made worse off).

That's not the end of this story though, because the simple example above assumes that this is a non-repeated game. A non-repeated game is played once only, after which the two players go their separate ways, never to interact again. Most games in the real world are not like that - they are repeated games. In a repeated game, the outcome may differ from the equilibrium of the non-repeated game, because the players can learn to work together to obtain the best outcome.

So, given that this is a repeated game (because the providers are constantly deciding whether to make switching easier or not), both providers will realise that they are better off making switching harder, and receiving a higher payoff as a result. And unsurprisingly, that is what happens, and it doesn't require an explicit agreement between the players - the agreement is 'tacit' (it is understood by the providers without needing to be explicit). Each provider just needs to trust that the other providers will make switching hard (because there is an incentive for each provider to 'cheat' on this outcome). Any instance of cheating (by making switching easier) would be immediately known by the other providers, and the agreement would break down, making them all worse off. So, there is an incentive for all providers to keep switching hard for the consumers. Even a new entrant firm into the market, which might initially make it easy for consumers to switch to them in order to capture market share, would soon realise that they are then better off making switching more difficult (it is not so long ago (2009) that 2degrees was a new entrant in this market).

The Commerce Commission is correct that the difficulty of switching mobile phone providers (the switching cost) keeps consumers with their current provider (customer lock-in). The result is that the mobile phone providers can profit from increasing prices for their lock-in consumers. The only solution to this situation would be to find some way to force a breakdown of the tacit arrangement. Then the market would settle at the equilibrium of all providers making it easy to switch to them. This may be an instance where some regulation is necessary.