Is wanting less money irrational?
Posted February 14, 2008
on:The Standard links to an interesting LA times article on loss aversion. Now loss aversion in itself is a very interesting issue, something Rauparaha may like to write about ;). However, my focus is going to fall on the same result that The Standard was interested in namely that people would rather earn $50k when everyone else earns $25k than earn $100k when everyone else earns $250k. The article calls people ‘irrational’ for doing this – but is this the case?
According to the Austrian economists at http://www.mises.org, rationality is “the use of the peculiarly human mental processes by which man strives to connect his ideas as consciously, coherently and purposively as possible in order to plan the attainment of ends sought”.
I’m happy with this definition, as it gets the idea across, and also illustrates how well those Austrian economists can write!
Sticking with this, I can see three ways that a ‘rational’ person will make this choice, even if they value ‘goods and services’ positively.
- If prices fully adjust, then your claim on goods and services depends on your relative income, not your absolute income,
- If prices are not different between the two cases, it is possible that you may value your relative position highly enough to allow the sacrifice in terms of goods and services – there is a trade-off here. Economics (in theory) does not presuppose what people value!
- Even if it would be the ex-post ‘best choice’ to pick the $100k, because for some wild reason prices have become unfathomably sticky, you may follow a rule of thumb that states ‘choose the income distribution that offers you the best wealth position’, as the prior probability of being in a position where prices are that sticky is so low.
In all three cases, the individuals choice is rational. I find the first one the most appealing – remember people don’t value ‘money’ they value the goods and services that they can purchase with money.
23 Responses to "Is wanting less money irrational?"
I remembered the other rebuttal: those large migrant flows from poor countries to rich countries (but not vice versa) suggests that absolute income is preferential to relative income.
Matt, I agree with about you the consumption externality (I think Robert Frank is the most famous exponent). But if you don’t believe in it, how do think people get added value out of relative status gains (since you’ve also assumed that prices are unchanged in case 2)?
Some people are stupid, they make dumb decisions. I think this survey illustrates there are more stupid people than not.
As I said on the standard:
“Would you rather earn $50,000 a year while other people make $25,000, or would you rather earn $100,000 a year while other people get $250,000?”
It makes sense to want to earn $50k if everyone else earns 25k as you would be earning 2x as much as the average person.
If you earnt $100k, while everyone else earned $250k you’d only be earning 40% of the average wage. In this case it would suggest that there was a situation where there was rampant inflation and your wages haven’t kept up with everyone else.
It makes a big difference to your spending power what your wage is compared to everyone else.
Of course all of this is meaningless unless one knows how much say $50k or $100k would buy in each scenario.
Let’s not forget that the question is supposed to state “all things being equal.” Unfortunately, all things are never equal, and the human brain cannot make decisions as if they were. Specifically, we still have an evolutionary drive that causes us to care about rank, meaning that option #2 is probably the explanation. The reason we care about rank, of course, is the many other benefits of being at the top of the pile. Evolutionarily, that would have been the best females for men. Today, it’s the prestige and other ancillary benefits of being the richest man in town, such as political power etc. It’s actually quite rational to care about rank in addition to absolute levels.
It’s not clear what sort of prices remain the same in this scenario.
If the prices at McDonalds stay the same, and the prices at the fancy restaurant stay the same, but your friends all start eating at the fancy restaurant cos of their $250k salaries, the the price of “dinner with your friends” has increased.
With $100k, you can do more stuff, but you might be doing it alone. Humans are social creatures, so it makes sense that they have other-regarding preferences.
A dinner with friends at a fancy restaurant is a different product to a dinner with friends at McDonalds.
And a dinner with friends at McDonalds is a different product to a dinner without friends at McDonalds.
I think the problem is with asking people to imagine ceteris paribus counterfactuals in cases where ceteris paribus is implausible.
Researchers have the same problem with the one-shot prisoners’ dilemma — it’s really hard to stop subjects from playing it as though it’s embedded in a larger repeated game.
When I first heard this experiment described, I think the survey group was MBA students and the income parameters related solely to their classmates. This doesn’t rule out misinterpretations, but it makes it less likely that price level was expected to adjust.
Has anyone actually tracked down the study being referenced?
From an economist article:
In one striking example, students at Harvard University were asked whether they would prefer (a) $50,000 a year while others got half that or (b) $100,000 a year while others got twice as much. A majority chose (a)….
Although people value their income in relation to that of others, this does not seem to be true of their leisure time. The same Harvard students were also asked to choose between (c) two weeks’ holiday, while others have only one week and (d) four weeks’ holiday while others get eight. This time a clear majority preferred (d). In other words, people’s rivalry over income does not extend to leisure. The result of this, suggests Lord Layard, is that developed societies may tend to work too hard in order to consume more material goods, and so consume too little leisure.
I think the leisure result would also be consistent with confusion about the price level explaining the income result. Surely the original survey, if well designed, would have asked follow up questions to the students about why they chose a).
Warning: acecdotal “evidence” follows.
Australia has a movement of “sea changers” and “tree changers” as well-off people semi-retire to live on the coast or in small communities inland. They’ll either telecommute or start a small business that they can run part-time. Selling a million dollar home in Sydney (there are lots of them) and buying something for $200k is quite practical and becoming more common (and house prices in popular areas are rising as a result). To me that’s a clear case of people choosing lower pay and more leisure.
I’ve chosen a variant of that – for quite a while was working as a contract programmer and earning $50k each year before stopping and doing other things. So I worked 4-8 months and had 4-8 months off. Then I got sucked into a salaried job for lots more money. Some days I’m not sure it was a change for the better…
Individuals are more likely to choose $50k because individuals think in terms of relative deprivation. While $100k is clearly greater than $50k, choosing $100k means being relatively deprived in comparison to your peer group. If you choose $50k, you are at the top of the peer group and others will aspire to earn as much as you do.
It is more common for individuals to complain about wages if they are lower in comparison to their peer group. If I was earning $50k in a group of individuals earning $100k, I’d feel relatively deprived. However, if there was an individual earning $30k outside my peer group, I would not feel grateful for earning more than them.
Everyone lives in a state of mild deprivation, however depressing that is. Few people stop and appreciate that most Americans are better off than those living in third-world countries. Instead, they compare themselves to Americans within their own social strata, or at their workplace, or academic institution. This emphasizes the importance of peer groups..
Also, another comment: a dinner at McDonald’s is almost always an inferior good. As income level increases, people are more likely to branch out to upper-end restaurants that fit their social status.
Though I agree that the price of the dinner at McDonald’s increases if your friends are all going to a higher-end restaurant. There are some interesting social incentives at play.
1 | CPW
February 14, 2008 at 11:25 am
I think the question states that 1. is not the case. Of course, I doubt that many people can fully comprehend a world in which they have greater purchasing power but a smaller claim on total goods and services. Would I be closer or further away from buying a Picasso? Would girls be more or less impressed with my greater purchasing power (if less, then are “prices” really the same) 🙂
Of course, I’d take the larger amount of money, so I guess I’m homo economicus. I always wonder whether these survey results actually have any backing in real world decisions. I think I heard the point somewhere that we don’t actually observe middle-class families moving to poor neighborhoods so they can have the largest house on the street.
You can always posit that your expenditure has an externality for me. You buy a porsche, I feel worse about my ford falcon. But this could be rational too if we think there is imperfect information about how hard it is to find porsches, your porsche might cause me to update my estimate of the cost of obtaining a porsche.