Why are weddings so expensive?

This Washington Post blog post by Caitlin Dewey caught my eye, talking about a US$99 wedding dress. This lies in stark contrast to weddings in general which are terribly expensive (these ones are totally out of hand). Why?

Let's start with the simple explanation, and let's stick for the moment with wedding dresses (rather than wedding venues, catering, flowers, and other costs). If this was a story about supply and demand, the high price could be caused by high demand, or low supply. I'm not convinced there is high demand for weddings - the number of weddings is declining over time. Of course, we should consider demand in comparison to supply. There could be low supply because of barriers to entry into the wedding market, stopping potential suppliers from entering the market and driving the price down. Again, this seems unlikely unless there are wedding-dress-specific tailoring skills that are in short supply (this suggests not). You might think that wedding venues may plausibly have barriers to entry, but there are plenty of beautiful places that could become wedding venues if the price rises enough. So, the price here is not a result of a simple supply-and-demand story.

Dewey's blog post talks instead about signalling. But signalling by whom, to whom, and of what? Let's take a step back and think about the purpose of signalling.

Signalling is a solution to a problem of asymmetric information. This happens when one party (the informed party) has private information that the other party (the uninformed party) doesn't know, and (importantly) the informed party uses that information to their advantage and to the detriment of the uninformed party. The classic example that we use in ECON100 and ECON110 is the used car market. Sellers know the quality of the car, but buyers don't. Since buyers don't know whether they are being offered a good car or a lemon until after they have bought it, sellers can easily misrepresent the car as being good quality even if it is a lemon.

Crucially, asymmetric information is only a problem if it leads to market failure. In the used car market example, since buyers don't know the quality of the cars in the market, they have to assume that any car on offer is low quality. This lowers the amount that they are willing to pay for a car, and drives the good quality cars out of the market (since sellers of good quality cars can't convince buyers of the quality of their cars, and buyers aren't willing to pay enough to buy them). The market for good cars collapses (of course, the market has developed mechanisms that deal with this market failure, such as test drives, pre-purchase inspections, etc.). We call this an adverse selection problem, since those that select to remain in the market are those with the lowest quality cars (when at least some buyers want those with the highest quality cars, not the lowest quality). The description of these 'markets for lemons' was what George Akerlof won the Nobel Prize in Economics for (the original paper from 1970 is here (gated on JSTOR) or here (ungated)).

Signalling is one way that markets have adapted to deal with adverse selection problems. With signalling, the informed party finds a way to credibly reveal the private information to the uninformed party. There are two important conditions for a signal to be effective: (1) it needs to be costly; and (2) it needs to be more costly to those with lower quality attributes. These conditions are important, because if they are not fulfilled, then those with low quality could still signal themselves as having high quality. Sticking with used cars as an example, offering a warranty on the car is a good example of signalling. It is costly (since if the car breaks down, the seller must pay the cost of repair), and it is more costly to those with low quality cars (since they are more likely to break down).

As an aside, asymmetric information isn't a problem if it doesn't lead to market failure. For instance, the formula for Coke Zero is a closely guarded secret (though it almost wasn't), which Coca Cola knows but consumers don't. However, this information asymmetry doesn't lead to market failure because Coca Cola isn't using that information to the detriment of consumers (as far as we know!).

Back to weddings. Is there asymmetric information here that leads to market failure, and will signalling be effective? Dewey's blog post notes two types of signalling - couples signalling to their guests, and the wedding industry signalling to couples. Let's start with the second of those.

The wedding dress maker (or other part of the wedding industry, but let's stick with wedding dresses) knows the quality of their dresses, but the couple does not. So, in theory low quality dress makers can misrepresent themselves as high quality dress makers, and the couple wouldn't know until the big day when the dress falls apart. So, high quality dress makers need some way of distinguishing themselves from the low quality dress makers, through signalling. Does making the dress more expensive constitute an effective signal of quality? In theory price shouldn't act as a signal, because it doesn't meet both of the conditions above (and also because there are more effective signals of quality than price). Raising the price may entail some opportunity cost (through lost sales), so it may be costly. But, it is not more costly to low quality dress makers. So, in theory at least, price should not be a signal of quality. But as we know, consumers are not fully rational and it turns out that they do use price as a signal of quality (see this 1983 paper by Asher Wolinsky (gated on JSTOR) as an early example, or this more recent paper by Maarten Janssen and Santanu Roy (ungated)). So, the high cost of weddings might arise because high quality wedding dress makers (and wedding venues, caterers, florists, etc.) are trying to signal their quality by having a higher price.

Why are couples willing to pay such high prices for wedding dresses? It may be because they are signalling as well. They are trying to reveal two items of private information to their wedding guests (friends, family, etc.): (1) the quality of their relationship; and (2) their social status.

Starting with (1), guests don't know the quality of the relationship that is about to be formalised, but the couple does (hopefully!). Does this create market failure? That is, can the couple take advantage of this information asymmetry to their advantage and to the detriment of their guests? Maybe, if we consider wedding gifts. Guests would probably give less valuable gifts if they believed the marriage wouldn't last (i.e. if the marriage is low quality), than if they thought it would last a long time (i.e. high quality). So, if guests can't be sure about the quality of the marriage, then they may assume the marriage is lower quality and buy less expensive wedding gifts (or no gift at all) as a result. So, high-quality couples need to find some way of signalling their quality, and this may be through the cost of the wedding. This may be an effective signal, because it is costly (obviously), and more costly to low-quality couples since they may expect to marry more than once over their lifetime. So, lower quality couples may be less willing to spend a lot on their wedding than high quality couples.

What about (2)? This isn't an adverse selection problem at all, since there is no market that will fail. However, there is still signalling here - the couple may want to signal their social status to the community. Higher social status is linked with wealth, which means that couples with high social status are likely to be able to afford a more lavish wedding celebration than couples with lower social status. This is of course conspicuous consumption (where spending is intended as a way of maintaining or attaining social status). And, there is at least some evidence to support this (gated, here is an earlier ungated version) - even though the evidence is from India, it doesn't seem much of a stretch that there is something similar at play in a lot of weddings in the western world as well.

So, there you have it. Weddings are most likely costly because of signalling - the wedding industry signalling couples about their quality, and the couples signalling wedding guests about the quality of their relationship and/or their social status.

P.S. I have neglected the role of marriage as a signal from one partner to another. See Chapter 8 in this book for the theoretical background to this idea.

[HT: Marginal Revolution]

Safer cars and offsetting behaviour: NASCAR edition

Classes started this week, and tutorials start next week. In ECON100 and ECON110, among other things at the start of the paper we cover the role of incentives in determining people's behaviour, and how changing incentives can change behaviour (for some people), for better or worse.

Sometimes (more often than most people think) changes in incentives have unintended consequences. One of the most famous of these in economics is the Peltzman Effect, described by University of Chicago economist Sam Peltzman in the 1970s. Using U.S. data, Peltzman showed in this paper (JSTOR gated) that mandatory safety devices on cars, such as seat belts, do not reduce traffic deaths, and actually increase the number of non-fatal car accidents. How can we explain that?

Rational (or quasi-rational) drivers weigh up the costs and benefits of driving faster. The benefits include less time wasted on the roads (an opportunity cost - you give up some time you could spend doing something else). Moreover, the marginal benefits probably decrease the more a driver speeds (because opportunity costs increase the more time is wasted). The costs of driving faster include an increased risk of a serious car accident - this cost is made up of two parts: (1) the probability of a serious accident occurring; and (2) the health and other costs of the accident itself. The marginal costs increase as speed increases, because both the probability of an accident and its seriousness both increase.

If they are optimising, the driver will choose to drive at the speed where the marginal benefit (MB) of driving faster is exactly equal to the marginal cost (MC0). This occurs at S0 in the diagram below. At this point, driving a little bit faster entails a higher additional cost than the benefit they would receive (which is why they will drive no faster than S0).

When safety devices are installed in cars (e.g. seat belts, air bags, crumple zones, side impact bars, etc.), this changes the incentives that drivers face. These safety devices by definition make faster driving safer, and so they lower the cost of driving fast (since the seriousness of the consequences of an accident are reduced). So, in the diagram above, marginal costs are lower (MC1). This increases the optimal driving speed to S1, which increases the chances of an accident. What we observe then is a greater number of accidents in total (more drivers driving faster or more recklessly), but the number of traffic deaths might not decrease at all (more accidents, but the seriousness of each accident is less). In addition to Peltzman's paper, other more recent papers have demonstrated this as well (see here or here, the first one is ungated).

So, increasing car safety leads to what economists term "offsetting behaviour", because the actions of drivers act to offset the benefits of increased safety. One way of dealing with offsetting behaviour in this situation, mischievously suggested by the economist Gordon Tulloch (or by Armen Alchian, according to Steven Landsburg in his book The Armchair Economist, which I read not long ago (the first edition, not the new second edition)), is to attach a large spike to the steering wheel, aimed squarely at the driver's heart. Then they won't offset safety by driving faster!

Anyway, the point of this post was to briefly link to this new research by Andrew Maness, which uses data from 662 NASCAR races from 1994 to 2013. Maness finds that offsetting behaviour is alive and well in NASCAR:

As driver-safety improves by 10%, competitors' recklessness increases by as much as 3.8%. More concretely, NASCAR's combination of the HANS device, SAFER barrier, and Car of Tomorrow results in a 3.6% growth in wrecked vehicles.

So, just like drivers in general, professional racecar drivers offset increases in safety by driving more recklessly. And not just NASCAR drivers, the same effect is observed in Formula One (gated).

[HT: Marginal Revolution]

Climate change and conflict

One of my research streams is on the impacts of climate change. Specifically, I am interested in the impacts of climate change on population dynamics, especially migration (which I will talk about in a future post, but if you are interested the large MBIE-funded research programme that I am involved in is described here).

Last year, I ran across this paper in Science (ungated version here), entitled "Quantifying the Influence of Climate on Human Conflict", by Solomon Hsiang of Princeton University, and Marshall Burke and Edward Miguel both of University of California, Berkeley. Essentially, the authors conduct a meta-analysis to investigate whether climate variables cause conflict. Meta-analysis is a method of combining the results of many previous studies to generate a single (and usually more precise) estimate of the effect size. As a method, it is common in medicine and rapidly gaining currency in quantitative social science.

As an aside, definitively identifying causality is a problem (as I've outlined before). At least in this case, reverse-causality (conflict causing climate change) is a little implausible (having said that, of course, it depends on the nature of the conflict and these would probably have some impact on climate), and contemporaneous causation (where some other variable causes both climate change and conflict) is also fairly unlikely.

The authors found that:

...large deviations from normal precipitation and mild temperature systematically increase the risk of many types of conflict, often substantially, and that this relationship appears to hold over a variety of temporal and spatial scales... The standardized effect of temperature is generally larger than the standardized effect of rainfall, and the effect on intergroup violence (e.g. civil war) is larger than the effect on interpersonal violence (e.g. assaults).

In other words, higher or lower than normal rainfall, and warmer temperatures increase conflict. How much more conflict? From the paper:

Nearly all studies suggest that warmer temperatures, lower or more extreme rainfall, or warmer El Niño-Southern Oscillation (ENSO) conditions lead to a 2 to 40% increase in the conflict outcome per 1σ in the observed climate variable.

This is quite a substantial effect. Which leads us to climate change, where the pattern of rainfall is expected to change (increase in some areas and decrease in others), and where temperature is expected to increase significantly. Again, from the paper:

These large climatological changes, combined with the quantitatively large effect of climate on conflict - particularly intergroup conflict - suggest that amplified rates of human conflict could represent a large and critical impact of anthropogenic climate change.

So, as climate change kicks in we can expect more violent conflict. What does that mean for New Zealand? Matching the effects up with this MFE publication by Brett Mullan of NIWA and co-authors leads to some interesting effects. More violence and intergroup conflict on average across the country (through increases in winter and summer temperatures), and more violence in the west of the North Island (which is expected to have both wetter winters and drier summers). Look out New Plymouth!

Does exposure to markets make us more, or less, rational?

We know that people are not fully rational - they try, but they are subject to predictable cognitive biases. These biases form the basis of behavioural economics.

One of these biases is the endowment effect. The classic experiment that demonstrates this effect was run by Daniel Kahneman, Jack Knetsch, and Richard Thaler. Kahneman describes the results in his book (Thinking, Fast and Slow):

Mugs were distributed randomly to half the participants. The Sellers had their mug in front of them, and the Buyers were invited to look at their neighbor's mug; all indiated the price at which they would trade. The Buyers had to use their own money to acquire a mug. The results were dramatic: the average selling price was about double the average buying price, and the estimated number of trades was less than half of the number predicted by standard theory.

Rational decisionmakers, who are willing to pay up to $10 to gain an item, should also be willing to sell that same item for $10. So, on average we would expect buying and selling prices not to diverge greatly. But they do, as shown in the experiment (and in a great many other experiments besides).

There are several explanations for this, but I will concentrate on one in particular - loss aversion. In general, people are loss averse because we value losses more than we value gains. Gaining $10 makes us happier, but losing $10 makes us unhappier to a greater extent than gaining $10 makes us happier. How does this relate to the endowment effect? Using the experimental example above, the sellers have a coffee mug, which they own. Let's say that they would have been willing to pay $10 to get their mug. Giving up their mug creates a loss (they lose their mug), and because of loss aversion they value that loss at more than $10. So, they would only be willing to sell their mug for some amount that is more than $10.

Other experiments have demonstrated that the endowment effect reduces as people gain more experience at trading in the market. The work of John List (surely a future Nobel prize winner) in the markets for baseball cards demonstrates that endowment effects reduce with trading experience (see here for a nice summary, or the gated article here). Given that these results show that market experience reduces the endowment effect, a commonly held belief among economists is that exposure to markets makes us more rational.

Which brings me to this paper from last year, by Coren Apicella and  Eduardo Azevedo of the University of Pennsylvania, James Fowler of UC San Diego, and Nicholas A. Christakis of Harvard University. The paper is described in lay terms in some detail here, so I will forego a long explanation. Essentially, in this paper the researcher describe an experiment where they tested for the presence of the endowment effect among one of the few remaining hunter-gatherer societies in the world - the Hadza Bushmen of northern Tanzania. They exploited the fact that some Hadza live close to tourist trails and interact with tourists and guides, while others live further away and have fewer contacts with outsiders. Those who have had more interactions were hired as guides, sold bows and arrows, etc. In other words, they engaged in more market transactions. What the researchers found was that the Hadza who lived in the most isolated villages did not display endowment effects, while those who had engaged in more market transactions (because they lived closer to the tourist trails) did exhibit significant endowment effects. Based on these results then, exposure to markets makes us less rational.

How can markets make us simultaneously more rational and less rational? The apparent paradox is troubling, but consistent with the old proverb that a little knowledge is a dangerous thing - a little bit of market experience may reduce rationality, until we become experienced enough in market transactions to overcome the endowment effect. Alternatively, Apicella and friends give some potential explanations for their results, including exposure to "concepts of ownership, selling and purchasing of goods, and payment for labor, all of which could be driving the group’s preference for owned items". I'm left wondering if it's the concept of ownership that leads to the endowment effect. I imagine that hunter-gatherers have quite a different conception of ownership than we do in the western world (the Apicella and friends paper notes that "While the Hadza do own some items, such as knives, bows and arrows, and animal skins, ownership is limited to what can be carried"). Exposing the Hadza to markets may broaden their conception of ownership, and more importantly to the loss of ownership. I wonder if there are any plans to test whether loss aversion is present amongst this group?