A Blog About Nothing » Signals and Incentives

The opportunity not to be a price taker!

The Homo Economicus — Sun, 28 Mar 2010 14:43:41 +0000

In economics a “price taker” is defined as a small individual or firm that is not able to affect the prices of goods individually.

We are price takers. Even if we go now to the local grocery store and one million tomatoes, the price of tomatoes in the market won’t be affected.

Not being a price taker though makes you feel powerful, like a monopoly. On the other hand, drinking also makes you feel powerful. What if we put both of them together in one place? A bar in NYC will start selling drinks with a variable price that will change according to the demand in the pub. You can look at http://www.reuters.com/article/idUSTRE62N51X20100325?feedType=RSS&feedName=oddlyEnoughNews&rpc=69 (courtesy of my friend Roy).

In this setting people will be affecting the price of the beer, scotch, vodka, etc. Prices going down would mean that there is no demand for that drink, creating incentives for people to drink more of those. I think this modus operantis is highly profitable for two reasons:

1) Depending on the elasticities of demand of people for some drinks, the bar can make a lot of money. Even if the most popular drink is, say, a mojito, and prices keep going up, some people might still decide to buy it because it is the most popular drink in the bar that night, and a marginal increase in price would not decrease demand as much.

2) This could solve the inventory problem! As soon as the unpopular drinks become cheaper, some people will drink those and then these extra bottles hanging around will be emptied at some point of the night.

It is worth to check out this place!

The Marginal Productivity of an Additional Line in your Resume

The Homo Economicus — Mon, 11 May 2009 05:37:34 +0000

One of the assumptions that economists use very often is the “diminishing returns to scale” assumption, which means that each additional worker in your factory (keeping constant the number of machines) helps to increase your output but in a smaller amount that the worker that joined before him. For instance, if you have a guitar factory with 1 machine, your first worker will be able to produce 10 guitars. When you hire an additional worker, you will be able to produce in total 18 guitars, and when you hire a 3rd one, in total you’ll be able to produce 25 guitars. this means that each worker contributes to the total output, but the contribution gets smaller and smaller (the first worker contributed with 10 guitars, the second with 8 and the third with 7). This is, labor has diminishing returns to scale.

The fact is that many other things in life behave like this. For example, your curriculum vitae (CV). We all agree that your resume is a signaling device. You send your resume to many places when you are searching for a job, to convince the people to call you and to invite you to an interview. Clearly, they cannot get to know you through your CV, but if you are able to draw their attention such that they will call you for an interview, the signal accomplished its goal. Why is it a signal? Well, you generally know better than your prospective employer what kind of worker are you: if you are a bit lazy, or if you are really hard-worker. In any case, the way that you reveal them your “type” or personality is through signals, which is your CV: the education you acquired, the awards you received, previous experience, and so on. In addition, you also don’t know what is the exact kind of worker that the employer is looking for, so you want to give the appropriate signals.

The big question is, what to write? So, the first thing you should understand is that you are constrained in space. You cannot hand in a CV that has every little thing you did in your life, but you must choose the best signals to fit one page, maximum!

So let’s assume that you are applying for a position which you believe diversity is welcomed – which means that they want to see your education, some work experience, some awards maybe, some publications, some voluntary activities… in other words: everything is valuable you think! How do you put all that in one page?

Here it were the diminishing marginal productivity story comes. Let’s say you were very successful in your previous job, and you want to emphasize at least 10 different projects you were managing in a leadership position. On the other hand, you want to write on your education all the courses you took on math, because you believe they are relevant to the position. If you do that, then you are already above the one page constraint. So your formula to solve this problem is the following:

The marginal productivity of an additional line of one section (say education) must be equal to the opportunity cost of not adding another line in another section (say, work experience). This means that you keep adding lines in education, until you realize that the “cost” of not using that same line on another category of your life is higher than the marginal contribution of the additional education line. This will always happen at some point, because the marginal contribution of each line is decreasing within each section. You don’t have to write all your math classes, but you will write the most relevant one, or the top 3, because each additional course is not saying something very different about you, and you would prefer to use that line to signal about another skill which is not math.

It would be a shame if the employer doesn’t know about your leadership skills because you wanted to write 10 math courses, instead of the most important one. If you leave your leadership experiences aside, so then your prospective employers won’t know anything about your leadership skills and your ability to teamwork which are far more important for the employer than your 5th or 6th math course in the list.The bottom line is that, once you write down your top three courses of math, the employer will understand that you are good at it. Don’t waste an additional line on that, when you can use that very same space to accentuate another skill that will make your curriculum more attractive.

Employers usually don’t have time to read all the CVs, so one should be very strategic on signaling correctly, and not to use two lines for signaling the same skill. The opportunity cost of that line is higher than the marginal contribution of repeating a skill.

Signs and Signals…

The Homo Economicus — Thu, 19 Mar 2009 03:08:21 +0000

I’m not a native English speaker (as many of you that read my grammatical mistakes in this blog from time to time might notice), but I think I can explain the difference between Signs and Signals and what do I mean when I mention those in this post.

While Signs is what you probably already know – a Sign – such as a road signs or sign languages or localization signs, etc. Well, you get the idea.

But when I refer about Signals I mean the economic sense of the word. Signals is what individuals (or firms) can broadcasting to the world, in general to *signal* that they belong to a specific type of person or they will take a certain decision or they will make some kind of action. The big question up to this point is: why to signal instead of saying what type of person are you or what decision are you going to take?

Sometimes there is incomplete information and you want to take advantage that other people don’t see what is in your mind, so either you can signal to confuse them and make them thing that you are a different type of what you really are or simply there is not enough space to say all the relevant information so you have to signal the most important things that will hint what kind of individual are you without just saying everything.

For instance, let’s start with the second explanation – when you just cannot say everything about you. A Curriculum Vitae is a signal. In one page you cannot write everything you would like the potential employers to know. So you signal the more important things to transmit that you are responsible, skilled, etc etc. You cannot come and say: “I’m skilled and smart, give me a job”. You have to signal in a proper and credible way. (There is a post coming soon on the rational about writing a CV).

Another example is when you buy a used car. You don’t know the buyer, and you don’t know the car. So he will always signal that the car is good and make the signal as credible as possible. Graduate school applicants will signal in their application to the admision committee on why should they choose them before other candidates. Anyway, people signal all the time.

I just found some interesting signs lately which I believe are also there to signal. I am sure you saw adds like this. The first one I’m sure you all saw it somewhere. I found it inside of the Men’s restroom:

Is this a sign, or also a signal? Well, maybe the owners of this restaurant are signaling to the customers that it is a clean restaurant, and the customers don’t have to worry about cleanliness and the food not complying with the minimum hygienic requirements . (for Seinfeld fans: remember what happened when Jerry saw Poppie going out of the bathroom without washing his hands). But, do you really think that the employees in that restaurant go to that bathroom?

Another sign/signal is the following:

It says: “Please leave all unpaid merchandise outside restrooms, Thank you.”

This belongs to the Harvard Coop in Harvard Sq. Apparently people were taking books to read in the bathroom. Would you buy a book that was taken to the bathroom by other? Well, maybe you won’t. But there is no way to know about that. This sign is not an enforcement of the rule, but more a signal for you to be sure that your book wasn’t taken to the bathroom by some stranger and that your book is free of stranger’s germs!

Signals are all around us: marketing, people talking or simple signs. In fact, some of the (weird) signs that we see around are – in part – meant to be signals – specially when those signs are not enforced.

This is it for now!