Betting Markets as Insurance Against Psychic Losses

The existence of insurance, which dates back to at least 1000 BC, is one of the great arguments for the enriching power of markets.  Insurance allows people to transfer wealth from their hypothetical future self who is not in a car accident to their alternative hypothetical future self who is in a car accident, which is mind boggling to think about.  Still, as I think about the topic more, the puzzle isn’t why insurance exists in the first place, but why there isn’t insurance for more types of losses.

Take this 2017 The Atlantic article discussing some people’s reactions to Donald Trump’s presidential victory:

…as state after state flipped to red, her friends left quietly, one by one. Caffrey yelled at her husband for being too confident Hillary Clinton would win. She blamed herself for not volunteering more. Then she cried herself to sleep, “thinking about all the people who would die and suffer and become fearful and hated and hateful unnecessarily under a Trump presidency…”

…Tony Doran, a married gay man from New Jersey, was on a tropical vacation when he heard the news. “I left the luau and went back to our room and cried,” he said. “I was physically sick with terror…”

…It’s easy to mock reactions like these, but for liberals and conservatives alike, losing at the polls can produce an all-encompassing sense of despair. Conservatives experienced something similar after the election of Obama, whose socially liberal platform was anathema, for example, to many religious people.

These extreme psychic loss events aren’t just limited to politics.  One paper shows a drop in France’s suicide rate following a World Cup win, an effect that would presumably work in reverse too.  Another finds higher risk of stress-related deaths in cities whose team just lost a Super Bowl, and vice versa.

If the stakes of events like elections or sporting competitions are so high for bystanders, why not insure against these psychic losses in the event that your team or candidate loses?  We don’t even need to imagine what such a market might look like, as betting markets already exist.

The solution is simple- if you know you will be devastated if Trump wins in 2020, place bets on Trump to win until the payout you receive upon his victory is enough to offset your psychic loss.  The less likely that Trump is to win, the less you have to bet to get a given payout.

The question for another day: why aren’t people already doing this in droves?

Funemployment

When a great thinker like Scott Alexander designates the strongest argument for a policy you oppose, you should certainly pay attention:

This strikes me as the strongest argument for the minimum wage and other job-killing labor regulations: that they are turning otherwise-miserably-employed people into unemployed welfare recipients.

It’s rare, and refreshing, to read arguments for the minimum wage that acknowledge even the potential for disemployment effects, let alone acknowledge them as a feature rather than a bug.  The problem with Alexander’s analysis is that, ceterus parabus, we would expect the minimum wage to disemploy workers in less miserable jobs.

Imagine an economy with two jobs for low skilled workers: elevator attendant and fry cook.  Let’s assume for simplicity that demand for fry cooks and elevator attendants is roughly equal.  However, since fry cooks have to slave over a hot grill rather than in an air-conditioned elevator, the supply of fry cooks is much lower than the supply of elevator attendants.  If employers are to induce a worker to become a fry cook, they’ll have to pay her a higher wage, or a compensating differential.  Graphically, both markets clear, with some low skilled workers choosing to have a fun job at lower wages and other choosing to have a more difficult job at higher wages:

 

Now, let’s say that the government institutes a minimum wage somewhere between the wages of both jobs, which creates a surplus of workers in the market for elevator attendants but not in the market for fry cooks:

 

Using Alexander’s terminology, the only jobs that weren’t destroyed were the miserable ones!  It’s then possible that some unemployed elevator attendants, rather than waiting for a fun job to free up, will decide to enter the fry cook market…

 

…which lowers the premium for being a fry cook in the first place!

This is obviously a very simple world we’ve built, but, even in this model, it’s possible for a wage subsidy or even just a cash transfer to boost low skilled workers’ earnings without creating involuntary unemployment or forcing workers to consume a different bundle of wages and job enjoyability.

Moral Blameworthiness and Elasticity

Bryan Caplan’s next big project is entitled Poverty: Who to Blame, a cornerstone topic of which will be “moral blameworthiness“.  Caplan discusses the concept in short in a recent exchange with Robin Hanson:

Unlike Robin, I should add, I’m a big believer in moral blameworthiness.  Whether we’re discussing poverty or involuntary celibacy, I think we should always start by investigating whether the sufferer is culpable for his own woes.  And empirically, I think the sufferer usually is highly culpable…At the same time, though, I freely admit that a sizable minority of people suffer blamelessly. A severe congenital handicap could easily lead to both severe poverty and isolation despite exemplary behavior. Should government do anything about this? I don’t know…

This analysis, and the forthcoming book, relies on deontological moral philosophy that is pretty alien to economic analysis, which almost presoposes consequentialism.  While Caplan would reply that even the most deterministic and consequentialist person would still likely be angry at a close friend for committing a morally blameworthy action, I think that moral blameworthiness actually squares quite nicely with a topic covered in every ECON-101 class: elasticity.

To review: elasticity can be thought of as a measure of a person’s responsiveness to incentives for a certain action.  An activity with low elasticity- like buying food- is not very responsive to changes in incentives.  If the price of food were to double, for example, I wouldn’t reduce my consumption of food by nearly that much, so we say that food is an “inelastic” good.  On the flip side, activities with high elasticity- such as buying tickets to a concert- are very responsive to changing incentives.  If the price concert tickets doubled, I would reduce my consumption of concerts by more than 50%, so we call them “elastic” goods.

What’s the connection to moral blameworthiness?  It seems to me that actions considered morally blameworthy are also actions with very high elasticities, and vice versa.   We can see this apply to some of Caplan’s examples of morally blameworthy and non blameworthy behavior:

If your girlfriend misses your birthday, “My car and phone both broke down” is a better reason than “I forgot.”

Maintenance of your car and phone is much less elastic than maintenance of your memory.  The promise of a hundred dollar payout would likely be enough for you to remember even an incredibly arbitrary fact for a year, but an equivalent promise for a year without car or phone trouble probably wouldn’t change your behavior at all.

If a co-worker goes home early and asks you to cover for him, “I have the flu” is a better reason than “I want to play Skyrim.”

Again, if I were to pay a group of volunteers a large sum to go a month without videogames, most, if not all, would likely follow through.  A similar group paid to go a month without getting sick would probably see only a small reduction in the rate of flu cases compared to the general population.

In a future post we’ll cover why the similarity between moral blameworthiness and elasticity strengthens the case for means-testing- a case typically made using moral philosophy rather than economics.

“Choice Agony”

Previously, I discussed behavioral challenges to the cornerstone economic assumption that adding more choices can’t make people worse off, and posed the idea that the real driver behind the “paradox of choice” was the mathematical tendency for more choices to reduce consumer surplus.  Today, I’d like to examine a related, but I think more empirically relevant concept that, surprisingly, I first heard about in this talk on role-playing game design of all things.

The basic idea behind what is termed “choice agony” is that, in certain situations, the calculus of choice-making can itself induce disutility.

Sophie’s Choice might be the best example of this phenomenon, where (spoilers for a 39 year old book), the titular character’s trauma stems from her experience in Auschwitz, where a guard forced her to choose one of her children to die in order to save the other.  If the title isn’t evidence enough, it’s clear that Sophie’s misery isn’t primarily, or even mostly, about the loss of her child, it’s about the horror of the choice-making process itself.

Unlike the paradox of choice, however, surplus or opportunity costs don’t seem to be a driver here.  Indeed, we would expect Sophie to have higher surplus after making her choice as opposed to if the guard were to pick one of her children randomly.  After all, her choice, essentially, saved one of her children, while losing a child at random has no such negative opportunity cost (opportunity benefit?).  But readers of the book are supposed to be more horrified at the guard’s behavior for inducing choice agony.

Healthcare might be one area where choice agony is relevant, as described in this article, or this quote from the great Robin Hanson:

Here’s one possibility: Maybe we are just terrified of thinking about death. Would imply that we just don’t want to think about not trusting our doctor. Want to push decision off on someone else. By buying health insurance, the vision is that someone else is responsible. This explains some of the puzzles, but not all. Explains apparent excess medical amount. If you were terrified of not getting enough food, you’d go only to all-you-can-eat restaurants. Wasteful-appearing care is not wasteful because it consoles you.

Hanson actually rejects this explanation in favor of a signalling-based approach,

If I were to attempt to steel man proposals for universal health care, I would probably begin from these foundations.

 

Labor Market Monopsony- “Widespread”?

Azar, Marinescu, and Steinbaum recently released a working paper through the Roosevelt Institute on Labor Market Monopsony.  In their words:

In short, we find that most labor markets (as defined by occupation and geography) are very concentrated, and that that concentration has a robust negative impact on posted wages for job openings. These findings are drawn from only one (large) dataset, so they are not the last word on the subject. The implication, along with the other papers cited above, is that the antitrust authorities should not operate under the assumption that labor markets are “naturally” competitive.

Their posted map of the concentration indices for each region is certainly striking:

widespread-labor-monopsony1 (1)

It seems that the entire nation is blanketed in a sea of exploitative employers!  Until, that is, we compare this map to a population density map of the United States…

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…in which “hotspots” of population are also “hotspots” of labor market competitiveness.  Colorado and Minnesota are especially striking examples of this.  This is especially relevant since the Census Bureau estimates that 80% of the US population lives in these urbanized areas, which are the same areas where Azar, Marinescu, and Steinbaum found pockets of competitive labor markets:

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US Urbanized Areas (80% of population) with AMS’ Labor Market Concentration Map

So, yes, labor market monopsony is widespread, except where there are people.

The Paradox of Surplus

Ben Schwartz’s Paradox of Choice (2009) coined the term “choice overload”, or the phenomenon by which “an increase in the number of options to choose from may lead to adverse consequences such as a decrease in the motivation to choose or the satisfaction with the finally chosen option” (Scheibehenne et. al (2010), p. 409).  While empirical evidence of choice overload has been mixed, and it seems odd that businesses that continue to expand the choices they offer continue to thrive in the real world, the idea seems like such a fundamental challenge to the foundations of economics that we shouldn’t ignore it.  However, one of the fundamental ideas behind choice overload: that increasing the number of options decreases the consumers satisfaction with the chosen option, is actually completely compatible with one of the basic tools of economic analysis.

Scheibehenne et. al describe one influential experiment that seems to point to choice overload:

In another study, Iyengar and Lepper (2000) offered participants a choice between an array of either six or 30 exotic chocolates. Participants who chose from the 30 options experienced the choice as more enjoyable but also as more difficult and frustrating. Most intriguingly, though, participants facing the large assortment reported less satisfaction with the chocolates they finally chose than those selecting from the small assortment. (p. 410, emphasis mine)

While satisfaction could have many definitions, if participants in the experiments were reporting their consumer surplus as their satisfaction, this isn’t necessarily surprising.

We can test this idea using this simple probability simulation.  We assume that a consumer’s value of all goods is uniformly distributed on the interval (0,100).  In the first sheet, we randomly present the consumer with five goods, and note the consumers highest and second-highest valued goods.  We then subtract the two to find the consumers surplus.  Running the experiment 30 times, we see that the average consumer surplus after being offered a choice of 1 out of 5 goods is 16.67 (σ=11.2).  When we increase the size of the choice set to 11 choices, the average surplus shrinks to 11.8 (σ=10.19).  Increasing the size again to 45, average surplus shrinks yet again to 2.17 (σ=2.05).  It’s not only possible, but highly likely that increasing the number of choices available to a consumer will reduce their total surplus.