Rational Choice Theory

Posted by PITHOCRATES - June 10th, 2013

Economics 101

Trying to Predict which Choice People will Choose is Difficult

People.  They’re the worst.  A joke on Seinfeld.  But so true in economics.

People look out for their best interests.  Everything they do that they have power to do they do to improve their station in life.  When they buy gas they choose the station with the lowest price.  When they get a mortgage they go to the lender with the lowest borrowing costs.  When they go shopping they go to the store with the best sales.  Most of the time.

Some nights people may stop at a pizzeria on the way home from work.  Take the food home.  And scarf it down in front of the television.  Sometimes people may go out to dinner at an expensive restaurant.  Enjoying a fine dining experience.  At a fancy restaurant.  Taking their time.  Savoring every course.  A fine wine.  A decadent dessert.  Two very different choices.  Takeout pizza.  And a fine dining experience.  Trying to predict which choice people will choose is difficult.  Especially when the same people may choose one option one night.  Then the other option on another night.

You can’t reduce People’s Decision-Making Process down to a Mathematical Equation

Choice.  What will we choose when given choice?  That is the million dollar question.  For being able to predict how human beings will choose will make the one who can predict choice very wealthy.  Stores would know exactly what to sell.  Investors would always know what stocks to buy.  And television executives would only put television shows on air the people will love.  But stores often have huge sales to unload merchandise that isn’t selling.  Investors lose money in the stock market.  And every fall television executives bring a slew of new shows to air.  Most of which will be off the air by next season.

Yes, people are rational.  And they typically choose to maximize their utility.  That is, getting the most bang for their buck.  But they are human.  They think.  A lot.  And when they consider everything before making a choice they may choose what to others is irrational.  Even if it’s not to them.  That’s the problem with people.  You can’t reduce their decision-making process down to a mathematical equation.  But economists try.  As do politicians.

But their efforts rarely get the people to do what they want.  During a recession they will implement policy to change people’s decision-making process.  They’ll expand the money supply to lower interest rates.  To encourage people to borrow money and buy things.  Like houses.  And cars.  Even if they weren’t even thinking about buying a house or a car.  The hope is that if these people start buying things they weren’t previously going to buy it will generate economic activity.  And pull the country out of recession.

Left to their own Devices the People will make the Best Decisions

But it rarely works.  If it ever works.  A recession is like a cold.  You can take a lot of over-the-counter cold medicine to ease your discomforts.  But you can’t cure it.  You just have to let it run its course.  So it is with a recession.  A recession is a correction.  Prices correct to market values.  And supply corrects to match demand.  Suppliers cut back on production.  And lay people off.  This is the painful part of a recession.  People losing their jobs.  But they have to.  Because there are too many people producing more than others are buying.  But once the recession runs its course the economy can start growing again.  And business will start hiring again.

Trying to prevent this correction with low interest rates will only delay the correction.  Worse, it will encourage people into irrational behavior.  Such as borrowing money to buy a house during a correction.  Getting a mortgage that will soon be worth more than the value of the house.  Once the correction resets housing prices to market values.  While some people make these irrational decisions others make rational decisions.  Refusing to increase production or to hire more people when the government floods the market with cheap money.  Because they know that it will at best delay the correction.  So they won’t act as the government hoped they would.  Leaving the economy in recession.  So it can run its course.  Like the common cold.

Because recessions must run their course the government should not intervene.  They should not try to influence the decision-making process of the people.  For left to their own devices the people will make the best decisions.  Which is why countries with free market economies have healthier economies than countries with managed economies.  And why when the government does not intervene in the economy recessions are shorter and less painful.  Because the correction that must happen happens.  In the shortest time possible.  But when government intervenes we get things like the Great Depression.  And the Great Recession.

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Market Forces and Health Care

Posted by PITHOCRATES - March 4th, 2013

Economics 101

Keynesians try to reduce Human Behavior down to Complex and Confusing Math

We hear a lot about introducing market forces into health care.  But what does that mean?  What exactly are market forces?  Are they like magnetic forces?  Electric forces?  Hydraulic forces?  No.  Market forces are not forces that conform to the laws of science.  Rather, they belong in the realm of the social sciences.  That are less science.  And more opinion.  Where there are a lot of theories.  And politicians massage the data to fit their theory.  As Mark Twain said, facts don’t lie but liars figure.  And politicians figure.  A lot.

So there are no hard rules when it comes to the social sciences.  Just a lot of theorizing.  And a lot of drawing conclusions.  Based on the data.  And how some massage the data.  Something to keep in mind whenever anyone discusses economic numbers.  For the accepted school of economics most politicians adhere to is the Keynesian school.  The dirty little whore of economics.  For there is a whole lot of massaging going on with Keynesians.  With the data.  Not each other.  Politicians love Keynesian economics because this school of economic thought calls for governments to tax, borrow, print and spend.  Empowering government.  Making government grow.  And become more intrusive in our personal lives.  All things politicians love.  Which is why they massage the economic data.  They have to.  Because this school of economic thought doesn’t work.

Keynesians make economics very complex.  Open a text book and you will find a lot of graphs and formulas.  Where they try to reduce human behavior down to math.  Very complex and confusing math.  And you can’t do that.  Humans have free will.  They make decisions based on any number of things.  One influencing factor more or less could change the way they decide.  And there’s no way we can quantify all the variables in our lives.  Therefore, there’s no way to reduce human decision-making down to math.  Which is what drives market forces.  Our decision-making process.  That point in time that triggers the free exchange of money for goods and/or services.

When it comes to the All-You-Can-Eat Buffet Customers think more in Terms of Quantity than Quality

Consider an all-you-can-eat buffet.  And how it changes your decision-making process.  But first let’s look at some typical behavior at a normal restaurant.  Where you may spend $15 for a 4-course meal and drink.  Soup, salad, entrée and dessert.  Which you enjoy with a friend.  You have pleasant conversation as you enjoy each of your 4 courses.  Taking your time.  Enjoying each course.  Slowly getting full.  And satisfied.  The portion sizes are just right.  Leaving just enough room for dessert.  You’re full.  But not too full.  Comfortable.  You’re able to go for an after-dinner walk.  Even take in a movie.

Now let’s consider the all-you-can-eat buffet.  Where you may pay $20 for unlimited access to the buffet.  You’re paying more than for a sit-down service.  Why?  Because you plan to eat more.  You will maximize the value you get for your $20.  Which means you’ll probably skip the soup and salad.  And start loading your plate with the expensive entrées.  You’ll probably go back once or twice.  Making sure you get a taste of everything.  And a lot of anything that is expensive.  Again, to maximize your value.  In fact you maximize so much that you become uncomfortably full.  Too full to sit through a movie without nodding off.  And too full for a walk.  All you want to do is go home and nap.

The restaurant sees this from a slightly different perspective.  The all-you-can-eat buffet is simple to serve.  You mass produce food to load up the buffet so it’s ready at the beginning of the buffet hours.  You replace the items people eat most.  While the less popular items sit longer in the buffet.  Becoming less fresh.  Also, the buffet is a good way to get rid of things approaching their ‘serve by’ dates.  Saving the freshest food for the made-to-order sit-down service.  And putting the older food in the buffet.  Because when it comes to the buffet you know customers are thinking more in terms of quantity than quality.  The food is good in the buffet.  But not as good as the food for the sit-down clientele.

If you Pay Cash at the Pharmacy you are more likely to Ask for the Less Expensive Generic Drugs

These are market forces.  People have come together to make voluntary exchanges.  The quantity of food available makes some people opt for the more expensive all-you-can-eat buffet.  Others may opt for the less expensive but higher quality made-to-order sit down service.  For the person who places the greatest value on eating mass quantities of food will choose the buffet.  The person who places the greatest value on the dining experience (quality of food, made-to-order, conversation, after-dinner walk or movie, etc.) will choose the sit-down service.  If more people are choosing the buffet the owner may extend the buffet hours.  If fewer people are choosing the buffet and leave a lot a food to throw away the owner may end the buffet service.  These are market forces.  Buyer and sellers coming together in the marketplace.  Seeing what each has to offer.  If they come to a mutual agreement they make an economic exchange.  The buyer willingly exchanges his or her money for goods and/or services.  The seller willingly accepts an amount of money in exchange for his or her goods and/or services.

The private economy works because it is buyers and sellers meeting and making exchanges they both freely agree to.  This is the key of market forces.  It’s what makes people with money go to the marketplace.  And it’s what makes people bring goods and/or services to the marketplace.  Because they will seek each other out and make these exchanges.  After which both buyer and seller will come away with something they value more.  This is what is missing in health care.  Buyer and sellers aren’t meeting to make exchanges.  In fact, the buyer and seller do not even meet.  Patients never ask for any prices.  Because they aren’t paying for anything.  Their insurer is.  And the medical provider will always provide the most expensive treatment billing guidelines will allow.  For that’s who they must please.  The people paying them.  Not the patient.  And they have to charge as much as they can to cover all the things they won’t get paid for.  People they treat without insurance who can’t pay.  And for the billings the insurers deny.

So this changes the decision making process.  For everyone.  Introducing a third party into the equation removes market forces.  If you pay cash at the pharmacy you are more likely to ask for the less expensive generic drugs.  If you get free prescription coverage you will ask for the most expensive name-brand medicine they have.  For when you’re not paying price is no object.  But when you are paying price is a very important object.  Because when it’s our money getting value for our money is very important.  So we’ll ask if the name-brand has any more value than the generic.  For who would spend more for something that doesn’t give you any more value than something you can get for less?

When it comes to medical tests and procedures patients aren’t going to ask for more than they absolutely need.  And doctors aren’t going to prescribe any more than a patient needs.  Because they aren’t billing a faceless bureaucrat.  They’re billing someone they have a close and personal relationship with.  And they sure aren’t going to try and bill someone they have a close and personal relationship with for someone else’s unpaid bill.  Not if they want to keep them as a patient.  Because a doctor-patient relationship is a long-term relationship.  A doctor could lose a lot of business by mistreating a patient to make an extra buck.  These are market forces.  Which makes the private sector work so well.  And why their absence makes the health care system not work so well.  Transforming our health care from a moderately priced, high quality, custom, sit-down service to a higher priced, mass-produced, lower quality, all-you-can-eat buffet.

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FUNDAMENTAL TRUTH #29: “The problem with doing what is best for the common good is that few can agree on what the common good is.” -Old Pithy

Posted by PITHOCRATES - August 31st, 2010

CHOOSING IS EASY WHEN ONLY ONE IS CHOOSING

Lunch groups can be a pain in the you-know-what.  Ass.  I mean, if you’re hungry, you can go and eat whatever you want.  If you want pasta you can eat pasta.  But if you’re dragging 3 others with you, there’s a chance at least one of them doesn’t want pasta.  He or she may want Thai.  And be the only one who wants Thai.  Another may be trying to lose weight and wants a healthy vegetable sub.  Which may be the last thing someone wants if they have their heart set on a good, juicy piece of dead cow.

So you know what happens.  You don’t have pasta, Thai, the sub shop or the steakhouse.  You end up going to that greasy diner that smells like an old, unwashed ashtray.  The food’s not that bad and they have a huge menu.  Which never ceases to amaze you.  And worries you.  Just a little.  (You know they’re not selling broiled haddock every day and you wonder just how long it’s been in the freezer.)  There’s something for everyone.  It may not be the best.  No one is particularly happy with the choice.   But it was the best compromise everyone could agree to. 

Picking a movie can be just as fun.  “What do you want to see?”  “I don’t care.  What do you want to see?”  And this can go on and on.  And on.  An action thriller?  Too violent.  A romantic comedy?  Too sappy.  That r-rated comedy?  Too many boobs.  That 3-hour movie that’s like Steel Magnolias only sadder?  I can sleep at home for a hell of a lot less. 

And round and round you go.  Finally, you settle on a compromise.  Great Moments in Opera History – a film of a live performance of Verdi’s Rigoletto that includes some nudity.  There’s singing, a sad story, some comedy, a tragic ending and, of course, boobs.  No one was bursting with anticipation to see this movie.   No one is particularly happy with the choice.   But it was the best compromise everyone could agree to. 

When you’re deciding for one, you only have to please yourself.  The more people involved with the decision-making process, the less you please yourself and the more you try to please others.  Key word being ‘try’.  Because the more people in the decision-making process, the less likely anyone is going to be pleased.

E PLURIBUS UNUM (OUT OF MANY, ONE)

They call America the melting pot.  Canada is a mosaic, but we’re a melting pot.  America became a mixture of the different immigrants that came to this country.  These people assimilated into being Americans.  People with different nationalities and religions melted together and made a singular national identity.  Out of many, one.  (In Canada, there’s no melting.  Hence the mosaic.  And no singular national identity.)

Many say our diversity is our strength.  We’re not conformists.  Just look at the explosion in television channels.  We’re so diverse that we can’t agree on what to watch on TV.  So there are hundreds of channels to choose from.  To satisfy our very different tastes and interests.

We like different things.  Television shows, restaurants, movies, books, newspapers and blogs.  To name just a few.  There is, in fact, little that we really agree about.  Other than agreeing we should be able to enjoy the things we wish to enjoy.  And not be forced to endure the things we don’t.  Mosaic or melting pot, however you want to look at it, individuals make up the whole.  Persons with individual tastes and interests.  With individual hopes and dreams.

WHO’S TO SAY WHAT’S BEST?

Now put the two together and what do you get?  A lot of people who don’t agree with each other trying to agree with each other.  It’s sort of like drawing a square circle.  You can’t do it.  Now take that group and ask them to make a decision for the common good.

Sounds easy, right?  Most are willing to sacrifice a little.  If it’s for the common good.  We just need to list the things that everyone would agree are important for the common good.  Like better fuel economy in our cars to reduce pollution and our dependence on foreign oil.  Or making cars safer so people get hurt less in accidents.  Both of these appear to be for the common good.  But they also conflict with each other.  More of one means less of the other.  Little boxes with sewing-machine engines will give great fuel economy.  But they can get blown off bridges (like that Yugo that blew off the Mackinac Bridge in 1989) and don’t fare well when struck by an 18-wheel truck. 

Which is the greater good?  It depends on your definition of the greater good.  Which is, must be, subjective.  Big, heavy cars are safe.  Light, little cars have good fuel economy.  Some people so hate the internal combustion engine that a rise in highway fatalities is acceptable to them.  Others would rather give up a few MPGs for a safer car for their family.  These people aren’t likely to agree.  They’re probably not all that willing to compromise either.  For, unlike the lunch group, there’s no real motivation to get along with each other.

Now multiply this by thousands of other issues.  More arts funding.  A stronger military.  Stem cell research.  Lower taxes.  The Decriminalization of drugs.  Better border security.  Abortion.  AIDS research.  High-speed rail.  Etc.  Each of these has strong proponents.  And hefty price tags.  Or provoke bitter social/moral/ethical debate.  Can we agree which of these is the greater good?  Ask 10 of your family, friends and coworkers and find out.

SHARED SACRIFICE

Getting people to agree that we should do what’s best for the common good is easy.  Getting those same people to agree on exactly what that common good is, well, is impossible.  We’re too many people with too many diverse interests.  I know what’s best for me.  But how does my neighbor know what’s best for me?  And how do I know what’s best for him?  We can’t.  And the more we try the more we must settle for something less. 

When we start deciding for others, some will have to sacrifice for the greater good.  But that’s okay.  Because everyone is for ‘shared’ sacrifice.  If it’s for the common good.  As long someone else’s share of sacrifice is bigger than yours, that is.

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