There have been several interesting articles and discussions online recently about economics. On the freakonomics blog there was chatter about the Sunk Cost Fallacy(SCF) (which Eric discussed on his blog). Then there is the Yahoo Finance article on income inequality.
Both articles, and Eric’s post, talk about rationality in economics (for Sunk Cost, read the 3rd paragraph of Eric’s post it’s a nice summation). SCF is a no-brainer, if recovery is not possible, get out and don’t throw good money after bad. Easy peasy. (I would add, that there are reasons to pursue a dying project outside of economics, such as one’s self image as successful/unsuccessful. Seeing a project through, even one that is ultimately an economic loss, could have value to the person).
The Yahoo article talks about a different emotional/economic connection, that is, relative wealth.
From the article:
In other words, we care less about how much money we have than we do about how much money we have relative to everyone else. In a fascinating survey, Cornell economist Robert Frank found that a majority of Americans would prefer to earn $100,000 while everyone else earns $85,000, rather than earning $110,000 while everyone else earns $200,000.
The author then goes on to posit:
Think about it: People would prefer to have less stuff, as long as they have more stuff than the neighbors.
I think he’s drawing the wrong conclusion personally. Let’s think of the question this way:
Would you rather make 100K while everyone else made 110K, or would you rather make 110K while everyone made 200K. You can have either, but only one, and no chance to change it afterward.
Personally I would choose 100K, and it’s not to be benevolent to the rest of the world. Even from the perspective of self interest, choosing a smaller income gap between you and the rest of society will (in my opinion) work out better for you.
It seems to be a simple market problem. If everyone else makes 200K, the market can bear higher prices for goods and services than it could if everyone made 110K. So, if you choose 110K, the market will bear higher prices and as a result you’d actually have less wealth than had you picked the smaller gap, that nets less real income.
Maybe I am being reductionistic, I’d like to hear what you have to say on the issue.
Have to a bit careful with the “everyone else makes $200k” part, as it needs to be “your coworkers all make $200k” because people do care about inflation in at least two ways:
1) if everyone in the world made $200k and I made $110k, I’d have ~1/2 the purchasing power.
2) if your friends all made $200k, you’d have ~1/2 the purchasing power and would be excluded from some of the things they could do.
This assumes your sets of coworkers and friends are not equal.
I agree with your choice of income, Nathan. I think that considering the amount of dollars someone makes or has all by itself is utterly meaningless. Wealth can only be meaningfully measured when compared with others’ incomes and the general conditions of the economy. Then you can determine purchasing power which is a lot more meaningful than the floating point number on one’s paycheck.
Now…who are these people that are making all this money :)
You are being a bit reductionist I think. If you could decrease income inequality while keeping production at the same level the results would be as you describe. However, at some point decreasing inequality would likely result in a decrease in production since the producers would have less incentive to produce. It’s a trade off I think. Too much inequality and you get social problems. Too little and production declines.
David…good point, I hadn’t thought of that.