The Optimistic Post That Took Four Days To Write
My uncle recently emailed me this quote from economist Max Bazerman’s Smart Money Decisions:
To see the kind of money mistakes people make, consider the problem that I created for a group of executive students who were attending one of my lectures. I took a $100 bill from my wallet and announced the following:
‘I am auctioning this $100 bill to the highest bidder. All members of the audience are free to participate or watch the bidding of others. Participants are welcome to bid in multiples of $5 until no further bidding occurs. The highest bidder pays the amount he or she bids for the $100. This auction differs from traditional auctions in that the second-highest bidder must also pay the last amount that he or she bid, although he or she will obviously not win the $100. For example, if Warren bids $15 and Charlene bids $20, and then the bidding stops, Charlene will pay me $20 for the $100 bill (earning an $80 profit), and Warren, the second-highest bidder, will pay me $15 and get nothing in return. Who will bid $5 to start the auction?’
I have run this auction many times with undergraduate students, graduate students, and executives, and I have sold $1, $10, $20, and $100 bills. The pattern is always the same, regardless of how much money is at stake. The bidding starts out fast and furious until it reaches the $70-$80 range (on the $100 bill). Then, everyone except the two higest bidders drops out of the auction. The two bidders then begin to feel trapped. One bidder has bid $65 and the other $70. The $65 bidder must either bid $75 or give me $65 (and receive nothing in return). The uncertain option of bidding further (a choice that might produce a gain if the other bidder quits) seems more attractive than the sure loss, so the $65 bidder bids $75. This continues until the bids are $95 and $100.
Then, to everyone’s surprise, the decision to bid $105 is very similar to all previous decisions. The $95 bidder can accept a $95 loss or continue and reduce his or her loss if the other bidder quits. Of course the rest of the group roars with laughter when the bidding goes over $100, which it usually does.
Obviously, the bidders are making money mistakes. But which bids are the mistakes? Twenty-dollar auctions typically end between $20 and $70. However, I have sold a $20 bill for $407, and I have had eleven $20 auctions hit the $100 mark. I once sold a $100 bill for $505. In total, I have earned over $20,000 running these auctions in classes over the last decade.
Then the explanation:
The key to solving this problem lies in indentifying the auction as a trap and, therefore, choosing not to make even a very small bid. The bidders are making three mistakes: failure to consider the decisions of other parties, escalating their commitment rather than accepting a loss, and wanting to beat the other party no matter the cost (i.e. ego).
After a few queries on “The” Google, I found this is a variation of something called the dollar auction, which involves irrational escalation. (Side note: Why do I bother searching for anything else? It seems I always end up at Wikipedia.)
Unforseen losses in this game start off with simple and seemingly obvious decisions - “I’m gonna win $100 with a $5 investment!” Then there’s a simple decision based on mitigating risk or losses - “Well, if I continue further, at least I’ll probably win the $100.” Eventually hope for profit is lost, but the logic continues - “Damn! I was outbid. I’ll make a $120 bid and only lose $20 compared to having to lose my last $110 bid and go home with even less money.” When one of the bidders finally decides to stop the madness, it comes with a sense of relief - at the cost of a little pride and acceptance of bad decisions in the past, potentially endless future losses are averted.
The math nerd in me is excited by logic problems like this one. If you are always willing to make things a few percent worse, things seem manageable but can get out of hand rather quickly.
Take for example, Harry the Hiker. Harry is on a hiking trip, but is lost. He’s only a mile from camp. Since Harry can easily traverse a mile in a half hour, the situation isn’t a big deal. Plus with Harry’s unmatched foraging skills, he can find food and shelter. What Harry doesn’t know is that he really sucks at finding his way around, and he gets six percent more lost every day. After a day of wandering, Harry is just over 300 feet further from his destination, but who cares - I saw Michael Vick throw a football that far in a Gatorade commercial. After a week, Harry is half a mile further than he started. Not a big deal, if he finds a tall enough tree to climb his problems are over.
After a year goes by, Harry ends up 1.7 billion (yes, with a B) miles from camp, his car, and the nearest search & rescue team. He’s well on his way to Pluto, and the sun is now small enough to confuse with other nearby bright things. After taking a moment to reflect on how he traveled nearly a hundred million miles in the last twenty-four hours, Harry suddenly realizes he’s ill-equipped for space travel and explodes in the pressureless void. Harry should have read Max Bazerman’s book.
If Don Knotts was available, he’d have told Harry the Hiker to ‘nip it in the bud‘ before things got really bad.
Real-life situations like the dollar auction happen frequently and on different levels. Maybe you haven’t been to the dentist in a while, and after gradually increasing amounts of procrastination, you undoubtedly have an embarassing number of cavities. Maybe you need a haircut and have needed one for months, and everybody around you ponders whether your ‘do constitutes a mullet. Maybe the nation you cheer for commits to some impossible goals and gets mired in someone else’s civil war.
These real-life situations end often after some moment of clarity - some kind of eureka event - and you finally decide to do something about it. You notice half of your teeth are transparent. Your unkempt mane gets caught in an escalator. You check the paper and find that the army you’re so proud of has killed 655,000 people in order to prosecute someone for killing 148.
It’s not a simple realisation, and the eureka moment doesn’t instantly come with joy and rainbows and ticker-tape parades. It can actually be heart-wrenching, tear-jerking, and otherwise difficult. But the decision to do something about it comes with more than just a silver lining - it comes with a relief of conscience, an end to the downward spiral, a chance to fix things, and some pride in actually taking responsibility.
When I finally told my family I was an atheist after years of pretending otherwise, I could finally breathe easier. Suddenly each day was no longer shrouded in the dread of ‘how will I tell them?’ And I didn’t have to worry about the next white lie. That was easily one of the best decisions I’ve made.
As good as that decision was, I don’t think that relief would compare to the relief of once again having something as simple and crucial as checks and balances in government.
Picture such a world with me. When our troops are mired in harm’s way for a lie, the people would have a mechanism in place to say to the President “hey liar, get them out of there”. When your children get sick and need medical attention, it would be provided here just like it is in pretty much every other industrialized country in the world, and it wouldn’t completely bankrupt you. And when the president refers to the Constitution as “just a goddamned piece of paper” we’d have actual representation with the courage to show him exactly what that piece of paper can do.
I’d like to live in that world. And tomorrow, assuming there’s not enough tampering, we just may decide to live in it again. And we’ll all breathe easier.
I’ll end this rambling with a little George Michael and a reminder what Tuesdays after the first Monday of every other November are for.