Diffusion and Stability

I just mentioned my Google Desktop Search regarding Steven Lansburg….

Well, among the search results was this article by Fabio Rojas, frequent guest blogger at Marginal Revolution. He points to an article in which Mr. Lansburg argues that, economically speaking, authors of computer virus cause significantly more damage than a murderer. Thus, that we execute murderers implies that we should execute such hackers.

Of course this is ridiculous, but why should it be? Prof. Rojas makes the point that people must be “hard wired to care about concentrated damages rather than diffuse damages,” a psychological argument to explain away ‘irrational’ behavior.

This reminded me of an article today by Prof. Delong about price gouging. Economically, price gouging in times of spiked demand makes sense because it incents suppliers to prepare for such a shortage.

“Ridiculous!” crys the non-economists. As Prof. DeLong points out:

Now out in the real world it is fair to say that nobody who has not been brainwashed by the graduate economics core would look upon such a pattern of prices with equanimity–not in electricity, not in airline tickets, not in railraod freight traffic, not in port charges, not in cargo shipping, not in vaccines, not in plywood in the week after a hurricane.

Prof. DeLong goes on to say:

…people seem to value a stable environment, or a smoothness of prices, or something even when the result is substantial allocative inefficiencies when the shortage comes and we then ration haphazardly by luck rather than efficiently by price. People strike long-term contracts that are clearly inefficient–that specify price but leave quantities to be delivered at the discretion of the purchaser.

…another psychological argument to dispense with otherwise sound economic argument. It seems to me that a psychological preference (are these preferences?) for diffuse costs (i.e. smooth prices in space) must be related to the psychological preference for stable prices (i.e. smooth prices over time).

Why would shocks in price (in space or time) ‘override’ otherwise rational decision making?

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