Freakonomics Radio - 140. How to Think About Money, Choose Your Hometown, and Buy an Electric Toothbrush

Episode Date: October 3, 2013

Dubner and Levitt field your queries in this latest installment of our FREAK-quently Asked Questions.

Hey, Levitt, what are your very favorite three letters in the English alphabet? I have no idea. What do you mean you have no idea? You must have three favorite letters. You mean like in a row that spell a word? Yeah, maybe. How do you like F? F's good. Give me an A.

A. Give me a Q. Oh, F-A-Q. I didn't know what you were talking about. What's it spell? F-A-Q. And what's it mean? It means I'm heavily confused right now.

From WNYC, this is Freakonomics Radio, the podcast that explores the hidden side of everything. Here's your host, Stephen Dupner. Every now and again, Steve Levitt and I ask you, our listeners and readers, to send us questions and then we try to answer them on this podcast. It is called Frequently Asked Questions. Okay, so Levitt, let's take some questions from readers and listeners of this fine Freakonomics Radio podcast. Okay, you ready for a couple? Sure. Okay.

This is from a fellow named Steve Rita, or Rita, Rita, I guess. He says, this morning I was reading an article on how credit card spending is making us, quote, irresponsible, end quote, because it removes the, quote, pain of paying with cold, hard cash. I found this assertion to be untrue for those of my age group. I'm 22 years old, Steve writes, full-time quality assurance analyst at a government contractor outside Washington, D.C. For me and my colleagues, we've found that on the rare occasion we actually have cold, hard cash, it actually feels almost like spare money. It doesn't come up in our bank accounts since we've already either withdrawn it some time ago or accepted it as repayment for something else.

It seems to be a widely accepted concept that credit cards are causing us to be poor spenders, but could it be that this so-called irresponsibility of credit cards is simply an issue for those who grew up using hard cash instead of hard plastic? Leva, I love this question. This is exactly the kind of question that got me interested in economics long ago, the work of Richard Thaler and before that, Kahneman and Tversky and mental accounting and all this stuff.

So what do you say? First of all, let's address Steve's assumption about is it true that people spend credit and cash differently? And maybe has the paradigm shifted for the younger generation now? So look, what do I know? I don't know anything, but it sounds completely and totally wrong to me. It just seems completely off. I mean, I believe firmly in this idea of mental accounting that people don't think of a dollar as a dollar. They allocate money differently.

But everything we know about the intersection of psychology and economics says that if you delay pain, it doesn't hurt you as much. And clearly the paying would be seen as the painful part. The consumption is the reward and the paying is the punishment. I mean, take paying for gas as a good example. People talk incessantly about the price of gas and how expensive gas is. And the reason is because they have to go to the pump every couple weeks and actually watch $60 roll up on the gas pump. Whereas other things which are more invisible, which might be much more like your cell phone bill, which might be $50 or $100 per person,

but it's invisible because you automatically directly pay it, don't seem like anything. So I just think it's completely backwards. I think that if you actually have to pull the money out of your pocket and you have to dole out those bills, it's just got to Home Without It, a further investigation of the credit card effect on willingness to pay. Willingness to pay being a phrase that you economists use a lot, which nobody else does. It says, in studies involving genuine transactions of potentially high value, we show that willingness to pay can be increased when customers are instructed to use a credit card rather than cash. The effect may be large, up to 100 percent, and it appears unlikely that it arises due solely to liquidity constraints. Can you translate that a little bit from Economist Speak to us? What does that mean, appears unlikely that it arises due solely to liquidity constraints?

Well, the first part in English means that if you try to get somebody to buy something with a credit card or cash, they'll pay you a lot more with the credit card than cash. And by liquidity constraints, I think what they're implying is that sometimes you just run out of money and you can't buy something even if you want to. And they're saying the way they designed this experiment, it wasn't that you just ran out of money so you couldn't buy it. It was this other psychological factor about the deferring of the pain. Let me hear an anecdote, let's say. Show me the way in which you do mental accounting, and let's analyze that a little bit. So one example of mental accounting that I do for sure is if I buy a big object, say a computer, a nice laptop computer, versus an electric toothbrush, which costs me $20.

And it comes time to decide how to have it shipped. I might want the electric toothbrush just as much the next day as I want the laptop the next day, but I'm much more likely to pay an extra $30 or $50 in shipping to get the laptop sent to me, and I would never agree to have a $50 shipping charge put on top of a $20 toothbrush. But technically, in economics, if I really do want that toothbrush the next day, if the utility I'm going to get out of the toothbrush the next day is as high as the utility I'm going to get out of that laptop, I should be willing to pay the shipping charge equally on the two different purchases. And almost everybody does this, and it's really a violation of a simple basic economic principle and one that fits in very well with the idea of mental accounting. We've talked on this program before about Danny

Kahneman. Yes, a wonderful human and brilliant guy. And a lot of this mental accounting was popularized by Richard Thaler, your colleague at the University of Chicago, really grew out of Kahneman and Tversky work. I think one thing that makes Danny so appealing as a scholar is that he identifies these flaws in himself as much as in other people. He doesn't pretend to be the guy who's smarter than everybody else. He was saying a great example of this was when you buy a new house. Let's say you spend $700,000 on this house, and the house doesn't have furniture or curtains and you have to buy that stuff and you look at the total bill under one scenario and it's a hundred thousand dollars for all that stuff and you say well that's not so much i just paid 700 grand for the house

whereas if you were actually to buy it maybe piece by piece or not right after you bought the house or if it came furnished and you were buying the furniture separately, you'd consider $100,000 exorbitant, but you're much more likely to do it when it's proportionally relatively small to what you just bought. So I asked Danny, you know, have you ever known anybody who's really done that? He said, oh, yeah, I did. So it's obviously easy even for smart people to make that kind of mistake, but is it a mistake or is there some way in which that kind of mental accounting

is, you know, good for us, helpful, fruitful in some way? You know, that's a great question. And I don't know the answer to that. Many of the, quote, defects people have, where people deviate from rational behavior, you can attribute to either the complexity of the problem or simple rules of thumb, which usually work but occasionally backfire. And, you know, that's probably true of mental accounting. There probably are situations where, in general, I can save a lot of time and effort and heartache by following rules of thumb, which are consistent with mental accounting. But I've never really seen the problem talked about in that way. So I got to say, that's just one of those good questions that off the top of my head, I don't know the answer to. Coming up on Freakonomics Radio, what kind of economist will tell you that young people should be spending more money and saving less?

I think so often young people don't consume as much as they should. And they end up, you know, really scrimping and saving and wasting tons of time. Also, some of the questions we didn't get to. Do cardboard cutouts of policemen really deter theft?

How many sexual predators still have their foreskins. From WNYC, this is Freakonomics Radio. Here's your host, Stephen Dubner. Welcome back to Frequently Asked Questions, in which my economist friend Steve Levitt and I answer your questions. Sometimes we'll ask each other a question. So, Levitt, let me ask you this. Your oldest kids and mine are about the same age. So in five, six, seven years, we're going to be sending them off to college, hopefully. What's the financial or spending advice you give your kids going out in the world for the first

time with maybe you give them a debit card, a credit card, you load them up with cash? How do you teach them about money in the real world? You know, I care so little about money and I've always cared so little about money and I've never really wanted anything that I've certainly started as a parent to basically tell kids that nothing's really worth anything and you don't really need anything. And so hopefully my kids will go into the world putting almost no value on material possessions. Okay, but maybe I failed at that. But if I succeed at that, then there's really no lesson about anything. You give them the credit card, they don't want anything. If they're in a jam, they use it. Now on the flip side, I've also probably spoiled my kids by giving them what

they want because they don't really want anything. And so my kids probably have almost no understanding of the meaning of a dollar and what hard work entails. So I don't know. I think my kids might be in trouble. One of the best pieces of financial advice I ever got was from a senior economist at Chicago when I got here named Jose Shankman. What he told me is actually something that he said Milton Friedman told him. And what he said was you should spend more and save less. Because I think what happens to young people is young people are always told to be thrifty, to save, save, save. But Jose's point was this, look, you're never going to be poorer than you are today. I mean, this was when I was a first year professor at

the University of Chicago. Your salary will only go up, your earning power will only go up. And so you shouldn't be saving now, you should be borrowing. You should be living today in much the way you'll be living in 10 or 15 years. It's crazy to actually be sc an airport out of the sense that it was too expensive, that it was frivolous to buy a soda in the airport for $3. And then eventually I said, well, no, that's crazy. I'm going to give myself the freedom to anything below $5. I'm just not going to worry about it. If something is below $5 and I want it, I'm just going to buy it. And over time, that number has going up and up and up. And, I mean, obviously, you and I had some success with the books and stuff, so we have more money than we thought we would have.

But just in general, I think so often young people don't consume as much as they should. And they end up, you know, really scrimping and saving and wasting tons of time. I mean, if you think about how people will spend hours and hours to save a few dollars, it makes no sense, right? And if you have any value on your time, you shouldn't go across town. Can I just say, so this advice sounds like some of the worst advice I've ever heard, except maybe in your very narrow situation, because what you're leaving out there is that you've already made a massive investment in your education. And now your investment is starting to pay off returns and dividends and basically an annuity. But not everybody's in that situation.

In fact, most people are not in that situation, right? So you had basically turned yourself into a walking human annuity by the time you were, whatever, 27, 28 years old. Unless you totally screwed up. And knowing that, I can see why you might want to consume more than you had been conditioned to do so. But absent those facts, you don't want to do what you're describing or do you? In other words, a lot of people now, they get a first good job at, let's say, 24, 25, 28, 30. Did they have the sense that you would have had as a young academic of that age that they're just going to be on an upward trend? I think most people don't feel that. So the actual question you asked had to do with your kid going off to college. So college students,

people who are going to graduate from college are never poorer than they are in college, assuming their parents aren't helping them much. And if you look at the overall earnings trajectory of college graduates, it goes up for 25, 30 years before it starts going down. Yeah. So in general, what I'm saying is true, that people get richer over the life cycle. And so what we expect they should do is that they should not save when they're young. They should start saving in their 30s and 40s, and they should dis-save when they're in their 60s and 70s. They should run down the savings. So I stand by what I'm saying. I think people are too thrifty, not thrifty enough.

Here's a question from Joe Westhead. The subject line is the economics of choosing a hometown. He writes, hi, chaps. I don't know if anybody's ever called us chaps before. I like that. Do you feel chappy? He must not be American. Is he American?

Oh, I can't tell from any of his identifiers. Let's read the email. All right. So here's a question I've been pondering, he writes. Perhaps you'll find it interesting. I'm one of the growing number of people who can work remotely from a laptop as long as I have internet. I'm free to live in any city I like, presumably any non-city too. How would an economist go about choosing a place to live, attempting not to be biased by prejudice?

How should you quantifiably choose a hometown? Joe, attempting not to be biased by prejudice. How should you quantifiably choose a hometown? Joe, what do you say, Lemon? If you were starting from scratch, you didn't have to be in any particular place, what are the dimensions and the metrics and the yardsticks that you begin to assemble to figure out the kind of place and the actual place you want to live? So when economists talk about location, they use the word amenities to mean the kinds of things that people are willing to pay for. So access to theater or to nature or to a good bar scene or things like that. And the thing about amenities in cities is that it's a market, right? So that the places that have lots of amenities like San Francisco and New York City also tend to be extremely expensive because space is scarce and people will pay to be where to live is to figure out how do you find your way to a city or a location that has a lot of the amenities you like, but not a lot of the amenities you don't really care about. So an interesting example is that couples who have no children don't want typically

to live in places that spend a lot of money on education, that have very good school systems. And so consequently, there's a lot of self-selection away from fancy suburbs by people who are childless. I mean, maybe also in addition, fancy suburbs don't have a lot of the fun things to do that childless couples are looking for. There's been some interesting research done on homosexual couples and where they tend to live. They tend to be more affluent than the typical person. And they tend to like different sets of amenities and not have as many kids. And it turns out that if you want to figure out where all the nice places in the country are, you just go to the places where the homosexual couples end up.

Because they tend to be concentrated in the places that everyone else is willing to pay a whole lot of money to go live in. So I think that's what, uh, was Joe the name of the fellow? Yeah, Joe. So he should look for where there are a lot of gay couples living. Well, you know, but not so clear because a lot of what you're buying in the city is proximity to places to work. So I was actually, like you, I was surprised to use the word city. So let me ask you this. You live in a city in Chicago. It's probably not the place you would have picked absent the job at the University of Chicago though, right? Right. So I wouldn't live in Chicago probably if I didn't teach at the University of Chicago and I wouldn't

live in Hyde Park. You probably wouldn't live in a city even, would you? Or would you? No, I would be, I would live in a suburb for sure. Cause pretty much everything I like is in suburbs. You know, I like fast food. I like golf courses. I like big houses and big yards and stuff like that. So yeah, pretty much that's what I like. You like making U-turns across six lane highways. You like Dairy Queens, right? But, you know, I'm not big into culture. You're not. You've never been in a museum in your life, have you? Not very often, no. Not usually willingly.

So I'm not really the kind of person who would pay a lot of money to be close to a central city. So let me ask you this. So to me, one of the great – look, I live in New York. I never planned to live in New York City, but I do now and have lived here a long time and I've come to love it. To me, one of the unexpected benefits – unexpected to me only because I was naive – of living in a city, especially New York, is propinquity, like the density of people and ideas and stuff. Now, I don't really like being around people that much or being in, you know, around a lot of people.

But I like being in a place where you've got that density and propinquity because the spillover effects are massive. So I wonder if you might feel the same, even though you think you don't like cities too. I think you make a good point, which is that location really matters. And think about it in terms of academics. So who do I write my papers with? Right, the people in your building. I tend to write my papers with the people that I go to lunch with.

And I go to lunch with the people whose offices are right by me. And you can see how much distance matters. I mean, even one floor or certainly a building has an enormous impact on who you interact with. And it's interesting that this somehow persists even in a world in which so much occurs virtually just because any social interaction that takes work tends not to happen. Getting back to Joe's question about, you know, how you pick the place to live,

what's, like, if you're going to look for a place to live, what's one thing that you have to have in that place, let's say, or one thing, maybe not that you have to have, but one thing that to you is a really good signpost or arbiter that this is a place that I can live. You're saying about me personally? Yeah. Yeah. Well, for me right now, it's all about the kids' schools. I mean, I care more about the kids' schools than anything else. All right, that's kind of a standard middle-class parent answer, no offense. So let's pretend you're a different you. Let's say you have your preferences that you do have as Steve Levitt, but you're not thinking about a family right now. You're just thinking about you. What's the opposite of the canary in the coal mine?

I'll tell you what mine is. Here's the thing. I could never live in a place that doesn't have a good diner because I feel like even if I don't want to go to the diner, I like what a diner – a diner is like all things to all people. It kind of – it democratizes the whole idea of eating. So you have like – in your neighborhood, your Salonica, your Greek diner where you like to get your steak and eggs and bring home your bone for the dog, right? That's the kind of thing that has to exist for me in a place where I want to live. I like the idea that there's a place where people of all different kinds can get together. And if you've got to have

breakfast at five in the afternoon, we understand. If you have to have moussaka for breakfast, we can arrange that. So what about for you? Wow, you're much more multilayered than I am. I think, I mean, because I think about of all the things I do, the only thing that I really would be nuts about, you want to move to a place that has a lot of gay couples, enough wealth that you can handle it, golf, and a good diner. Can Joe just move into your extra spare bedroom? I don't know. If I had a spare bedroom, you'd put a putting green in. But yeah, we could offer that. So that does it for this edition of Frequently Asked Questions. Thanks for listening. Thanks especially for sending in your questions. Here are some of your questions that we didn't get to. And in some cases, I'm sure you will understand why. mafia dress themselves in expensive suits. Are people who care about the environment more or

less likely to use a toilet cover? Does being able to swim increase your likelihood of dying due to drowning? Why is it that runners of East African descent tend to dominate distance running, but runners in the U.S. and Jamaica of West African descent tend to dominate sprints. Do cardboard cutouts of policemen really deter theft? How about traffic violations? How many sexual predators still have their foreskins? Hey, podcast listeners. America is one of the most generous nations in the world, maybe in the history of the world. On next week's show, what really makes people give?

And how can we get them to give more? Beautiful women ended up raising the most money of all the solicitors that we had. This entire physical attractiveness result is driven by men answering the door. They say, oh, tell me more about this relief fund. Tell me how I can help. Oh, I'd love to help. You just can't beat a beautiful blonde who's going door to door to raise money for your cause. The science of fundraising.

That's next time on Freakonomics Radio. Freakonomics Radio is produced by WNYC and Dubner Productions. Our staff includes David Herman, Greg Rosalski, Beret Lamb, Susie Lechtenberg, and Chris Bannon. If you want more Freakonomics Radio, you can subscribe to our podcast on iTunes or go to Freakonomics.com, where you'll find lots of radio, a blog, the books, and more.