[Book] Predictably Irrational

1.      The truth about relativity

Relativity helps us make decisions in life. But it can also make us downright miserable. Why? Because jealousy and envy spring from comparing our lot in life with that of others.

It was for good reason, after all, that the Ten Comandments admonished, “Neither shall you desire your neighbor’s house nor field, or male or female slave, or donkey or anything that belongs to your neighbor.” This might just be the toughest commandment to follow, considering that by our very nature we are wired to compare.
(Level of salary doesn’t relate to our happiness. We find satisfaction is dependent on relative salary)

Can we do anything about this problem?

The good news is that we can sometimes control the “circles” around us, moving toward smaller circles that boost our relative happiness. (If we are thinking of buying a new car, we can focus on the models that we can afford)

We can also change our focus from narrow to broad. (2 errands to run today: buying a new pen and buying a suit. At an office supply store, you see a nice pen for $25. But it’s on sale for $18 at another store 15 min away. Do you decide to take the trip to save $7? Most people faced with this dilemma say that would take the trip to save $7. Then you’re shopping for your suit. You find a luxurious gray pinstripe suit for $455 and decide to buy it before someone whispers in your ear that exact suit cost $448 at another store 15 min away. Most people in this case wouldn’t bother travelling to save $7!)

This is the problem of relativity – we look at our decisions in a relative way and compare them locally to the available alternative. We compare the relative advantage of a cheap pen with expensive one, and this contrast makes it obvious we should spend extra time to save up $7. The relative advantage of cheaper suit is very small, so we spend the extra $7. Think of whether you can spend that marginal amount of money spent on somewhere else (perhaps spending on a book?). 

[Link] Money Money Money

http://www.bbc.co.uk/news/magazine-11443564

[Link] LiveLeak.com - CNN Hero Narayanan Krishnan

LiveLeak.com - CNN Hero Narayanan Krishnan

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[Learn] Decision-Decision

Here is this young kid, put in a situation where he has 50 cents to spend on candies in a candy shop. She knows candies do not grow on trees, and the 50 cents is all she has and she knows whatever decision she makes has to be a good one. Surrounded by dozens of choices, she considered a lot of factors: how many candies are there in one bag? How big is each candy? How much would she enjoy eating that particular flavour? After narrowing down to a few options, it is even harder to choose amongst the remaining few. This would be a tortuous decision for a 6-year-old girl, and you would have imagined it's never going to be a problem a grown up adult.


In fact, kids are not the only ones having hard time choosing between options with equal perceived quality. Budian's ass illustrates a similar problem: 
It refers to a hypothetical situation wherein an ass is placed precisely midway between a stack of hay and a pail of water. Since the paradox assumes the ass will always go to whichever is closer, it will die of both hunger and thirst since it cannot make any rational decision to choose one over the other.
We often find ourselves making informed decisions, whether it is about choosing to have rice or noodles for dinner, or getting up early and exercise or having a lie in. We are capable of doing various analysis like pros & cons and cost & benefit. At the end of the day, it is the decision that we have to make matter. If you completely neglect the amount of time spent on the thought process itself, you're probably better off to just flip a coin. Afterall, the reality could be more unpredictable. And the decision might not have been as 'informed' as you might have thought it was. 

[Learn] Mistakes

Experience is the name everyone gives to their mistakes.

The greatest mistake you can make in life is to be continually fearing you will make one.

[Economics] Horizontal Product Differentiation

Interaction
When we assess a market, we could analyse it by using static determination of prices. When firms optimally set endogenous variable(s) in order to maximise profit under a static competitive environment. This would help us understand why firms would set higher price in monopolistic market, earning positive profit, or setting price equals marginal cost in perfectly competitive market, earning zero profit.

However it is inadequate in explaining competitive interactions: which is why we should also consider strategic moves and firm's interactions. When we model the situation as an extensive game, where firms choose various settings in different stages of the game, it might help us understand what would happen in an ideal world.

Here, firms do not just simultaneously maximise profit by setting price or quantity, they would also pick a location as we assume products are differentiated. Product differentiation means that consumers do not view products as perfect substitutes, so that the product that is priced higher would not have zero demand.

In a horizontal differentiated industry, the market is scattered of consumers with different tastes. For example, in the carbonated drink industry, some would prefer Cola to Fanta, or Sprite taste to Red Bull taste. Firms would then have to locate themselves in the market before competing with other firms. For instance, in an industry with 2 firms (duopoly market), each of 2 firms in the industry would have to pick a location along consumer's preference set before competing against each other.

The game
So we split the entire game into 2 stages, firstly firms set to locate a point in the consumer's preference set. Then they would compete in the market by setting price.

To find out what firms would do, we have to see firstly what price they would set when they compete in the final stage, then work out how they would locate themselves in the market (using backward induction).

To set price, there are two effects that might affect their decisions. Firstly, the ability for each firm to extract consumer surplus from consumers depend on the market power each firm possess. Consumers would be more sensitive to price if they have elastic price elasticity of demand. Therefore, in this set-up, we can link this to consumer's preference. Assuming consumers in the market have the option to choose only between the 2 firms, if they derive huge dis-utility to a different 'taste' product, then firms would be equipped with market power, so that consumers are less tempted to switch from one firm to another. This would allow firms to extract more surplus by pricing higher with less compromise in quantity demand lost. Therefore, the stronger consumer's taste is, the higher prices firms would set.
Secondly, the decisions of pricing would also depend largely on the locations they have set in the initial stage of the game. The closer they are located within consumer's preference set, the more similar are their products, hence price competition is fiercer. Hence, they would undercut each other more aggressively.

To set locations, they would have to take into account 2 factors. Firstly, there is a market share effect, which states that if firm A locate closer, they would capture more of the market. Therefore making firm A wanting to set a location in the consumer's preference set in a closer proximity to firm B.
Secondly, there is the market power effect, which acts as a countervailing force to market share effect. It states that if firms are closer to each other, the price competition is greater, and they would have less market power (less ability to set high price and capture consumer surplus, and hence they would make less profit if they are located close to each other).
If market power effect dominate, such that it is best for firms to have maximal differentiation, they would select location furthest away from each other in equilibrium. If market share effect dominate, they would be close to each other and price would be lower in that case, keeping consumer's taste unchanged.

Under geographical constraint, if firms are constrained in a small geographical area, they would have to locate at close proximity to each other. Hence, there is greater price competition effect, and less market power of each firm as consumers can readily switch to rival firm. Whereas in larger markets, firms can obtain more market power, price would be higher and it could be exaggerated by consumers with higher taste (two products are not ready substitutes of each other). Therefore, changing geographic location would weaken the amount of market power each firm has in setting price, and this could explain the fierce price competition (result of the second stage) in places where firms are restrained (in the location setting stage) of this particular strategic game model.