“The ultimate aim of economics is, as of every science, to clarify the relationships between elements which have been thought in isolation.” Lionel Robbins, economist, 1898 -1984
Let me tell you a story that might just get you laughing. Two guys walk into a bar… Okay, I know it sounds like the beginning of a joke, but bear with me. This story is actually about the concept of artificial scarcity, and it’s one my economics professor shared with me during my first year at Columbia University.
Recently, I had the pleasure of sharing it with a group of aspiring economists at a secondary school in Padawan as part of a special conversation in our “A Day In The Life Of An Economist” series. Trust me, it’s a true account that will show you just how powerful this idea can be.
Imagine you’re at a bar and a guy approaches the first woman he sees, offering to buy her a drink. Unfortunately, she turns him down. Unfazed, he tries his luck further down the bar, but each woman he approaches turns him down, leaving him empty-handed.
Desperate for success, he turns to Cupid.com and uses the same technique, but with no luck. The women he messages also turn him down, leaving him frustrated and Cupid.com with a problem.
The dating platform is struggling because women are being bombarded with date offers from men, leading to burnout and eventually causing them to quit the platform. And if women quit, men will also quit, posing a significant challenge for Cupid.com.
So, who can help solve this issue? The answer is economists. Don’t laugh, yes, economists! In fact, Cupid.com decides to call in not one, but two economists to assist them with the trouble; Muriel Niederle from Stanford and Dan Ariely from Duke.
Their idea is simple yet profound: to set a limit on the number of date offers that men can make to women each month, creating an artificial scarcity. This technique would manage the overwhelming number of messages women were receiving and prevent them from feeling burnt out.
The economists suggested that by implementing this technique, men would take their offers more seriously, leading them to read women’s profiles thoroughly. As a result, women would be more likely to accept date proposals, knowing that the men had shown a genuine interest in getting to know them.
Thanks to the artificial scarcity technique, Cupid.com solved its problem, and other dating sites followed suit. The impact of this technique can be seen in the global online dating market, which was worth US$9.65 billion in 2022.
Now, let’s take a closer look at the search page on Google. The company’s ad auction system has revolutionised online advertising, but its success is not solely attributable to the company’s engineers. In fact, economists played a significant role in developing the system that has made Google and other web retailers so successful.
Initially, Google had to rely on a laborious process of door-to-door advertising to convince advertisers to place ads alongside search terms. This approach was not scalable, given the explosive growth of the search engine’s popularity. To solve this problem, the company’s engineers developed an automatic system based on auctions. However, they were worried that the auction process could lead to never-ending auctions and crashes.
The engineers then developed a second-price auction system, where the winning bid was the second-highest bid plus one penny. This elegant solution simplified the process, eliminated never-ending auctions, and solved the problem of the winner’s curse.
Many people who have participated in auctions might have experienced “the winner’s curse,” where the winning bid feels like it’s too high, and the bidder regrets having won. The technique devised by the Google engineers helped address this issue by ensuring that the winning bid was not necessarily the highest bid, but rather, the second-highest bid, which prevented advertisers from overpaying for ad placements.
Google’s CEO at the time, Eric Schmidt, was initially sceptical of the auction system until he met Hal Varian, an expert in auctions and the internet. Varian convinced Schmidt that the second-price auction system was the ideal solution, as it was proposed by Columbia University’s economist William Vickrey. This insight led to the hiring of Varian as Google’s first chief economist and the development of an army of statisticians and economists to refine the auction system.
Microsoft also took notice of the success of Google’s auction system and hired Susan Athey, a renowned economist at Stanford, to develop a similar system. This move highlights the critical role that economists have played in the development of the internet economy.
Throughout my career, I have met many businessmen and bureaucrats who don’t respect economists. They doubt our ability to make payroll or understand the realities of running an economy. But the truth is, economists have played a crucial role in shaping the world economy.
We’ve helped develop the system of online advertising, including online auctions. We’ve made luxury travel more affordable, allowing people to enjoy five-star hotels at three-star prices. And, we may have even helped you find a date or your spouse.
So the next time you hear someone doubt the value of economics, remind them of the impact that economists have had on our world.
