Proof Econ is Dumb

Our group of thirty-some college-aged Westerners just returned from the second open market we’ve been to this tour of Beijing (open market = haggle time!). This one was the famous silk market. In addition to having all kinds of silk clothing, the hundreds of vendors sold paintings, trinkets, games, musical instruments, cameras, jewelry, and almost anything else you could imagine.

Our guides told us that if we see something we want, we should never pay more than a third of the quoted price. This turned out to be generous towards the vendors; Lucas, for example, walked away with a $60 camera shortly after being asked about $300 for it.

The existence of the organized chaos that makes up these open markets could cause a sort of crisis of faith for an economics student. This is because if the real world truly was bustling with perfectly rational consumers and producers, open markets of this kind should never exist.

Here is why: say I’m at the Beijing open market and would like to purchase a pair of knockoff Beats headphones. I have a whole lot of options; there are at least ten different vendors carrying this item. It seems that the dominant strategy is quite simple: go to one vendor, and haggle him down until he refuses to budge any lower. Then you walk to the next one, and ask if she can beat the first vendor’s price. If she can, then walk to a third, and fourth, and so on until you know you are getting some quality knockoff Beats for the smallest possible markup.

In anticipation of this, the first vendor should simply quote you the lowest price he can afford; that way he doesn’t lose the sale to one of his peers. He might even write that number on a tag, and attach it to the box, making it clear he cannot go below this price. Of course at that point, it is no longer an open market.

So why does this not happen?

I believe an example will serve well to illustrate: as we were walking through an area decked out in purses, wallets, suitcases and the like, a small Chinese girl was suddenly ecstatic to see me “again,” grabbed a hold of my wrist and did her best to tug me into her bag stall. And she was by no means gentle—despite her petite build I had to dig my feet in to keep my ground.  It was both awkward and hilarious.

My only explanation for this shameless behavior is that it must work. After all, we humans are not conditioned to blatantly ignore everyone who starts yelling at us, much less firmly shake off small, pretty girls pulling us by the wrist. The first few times you ignore a salesman, you kind of feel like a jerk, and it’s easy to see how one might accept a higher price simply to escape that feeling. More than one member of our group told a war story along these lines: “I just wanted to get out of there, but the lady wouldn’t let me leave, so I had to buy a coat.”

This is not the story of a Spock—it is one of a human being driven at least in part by instincts and emotions. In this case, rationality takes a backseat and irrational emotions determine the transaction.

This doesn’t mean rationality isn’t important—many in the group walked out of the market completely empty handed, as they stuck by their decision that they didn’t need anything. But it does have this implication: just because one can prove that people have a self-interested material incentive to behave a certain way, it doesn’t mean they will, or even that people in general will.  As the growing number of behavioral economists knows, psychological factors must be considered if economics is to offer a relevant and illuminating picture of our world.