1586 THE AMERICAN ECONOMIC REVIEW JULY 2016
Obviously the typical monthly
members have an arbitrage opportunity
(arbitrage is
the purchase and sale of an asset in order to profit from a difference in the asset's
price between markets. It is a trade that profits by exploiting the price
differences of identical or similar financial instruments on different markets
or in different forms, is basically buying a security in one market and
simultaneously selling it in another market at a higher price, thereby
profiting from the temporary difference in prices) available. Why
pay $17 a visit when they could be paying $10? One possible explanation for
this behavior is that customers understand that they are affected by sunk costs
(whether or not they realize it is a fallacy
( mistake in an
argument or idea that makes it false, https://www.youtube.com/watch?v=EJp4bZhhYfw )
and are strategically using the membership fee as a (rather ineffective)
commitment device to try to induce more frequent gym usage. Let’s suppose that
explanation is correct. What could a competing gym do to both make more money
and reduce or eliminate the less than fully rational behavior of their clients?
It would certainly not be a great strategy to explain to customers that they
could save a lot of money by switching to the 10-ticket package. Not only would
the gym be losing money on a per visit basis, but they would also forego (to decide not to do or not to have something)
the payments from infrequent gym users who procrastinate
(delay or
postpone action; put off doing something, https://www.youtube.com/watch?v=xu3-BrhQrzo )
about quitting. The average person who quits has not been to the gym in 2.3
months. So if competing gyms can’t make money by turning them into Econs, who
can? I suppose DellaVigna and Malmendier could have started a service
convincing people to switch to paying by the visit, but I think they made a
wise career choice in selecting academia over personal finance consulting. The
same analysis applies to the recent financial crisis. Many homeowners took out
mortgages with initial low “teaser rates
(a teaser
rate is a low, adjustable introductory interest rate advertised
for a loan, credit card, or deposit account in order to attract potential
customers to obtain the service. The teaser rates are normally too
good to be true for the long term, and are far below the common
realistic rate for the service https://www.youtube.com/watch?v=JftsNJKA2NY ).”
Once the rates reset, some homeowners found they were unable to pay their
mortgage payments unless home prices continued to go up and mortgage
refinancing remained available at low interest. The mortgage lenders who
initiated such mortgages and then immediately sold the loans to be securitized
made lots of money while it lasted, but the subsequent financial crisis was
painful to nearly everyone. Let’s assume that at least some of these mortgage
borrowers were fooled by fast-talking mortgage brokers. [4]
How would the market solve
this problem? No one has ever gotten rich convincing people not to take out
unwise mortgages. Similarly if people fail to follow the dictates of the
life-cycle hypothesis and fail to save adequately for retirement, how is the
market going to help them? Yes, there are firms selling mutual funds but they
are competing with other firms selling fast cars, big screen televisions, and
exotic vacations. Who is going to win that battle? The bottom line is there is
no magic market potion (a medicine, especially
one that seems strange or old-fashioned) that miraculously turns
Humans into Econs (Econ usually
refers to economics, the social
science that analyzes the production, distribution, and consumption of goods
and services); in fact, the opposite pattern is more likely to
occur, namely that markets will exacerbate
(to make a problem become worse) behavioral biases by
catering to those preferences. The conclusion one should reach from this
section is that the explainawaytions are not a good excuse to presume that
agents will behave as if they were Econs. Instead we need to follow Milton
Friedman’s advice and evaluate theories based on the quality of their
predictions, and, if necessary, modify some of our theories.
[4] Of
course some borrowers might have been planning all along to default and live
rent free for as long as possible before walking away. They were then acting
like Econs.
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