The Right Decision? It all depends if you’re up or down…

Why are taxis hard to find on rainy days? Now that is a question that traditional economics struggles to answer. Economists tell us that on rainy days when taxis are in demand more drivers will work and increase the supply. The taxi driver disagrees…

The majority of New York taxi drivers do not own the cabs they drive. They rent them in twelve hour blocks for a fixed price. They can then keep all of the fares and tips, making a good living when the demand is high, but risk losing money, by failing to cover the rental cost, when demand is low. What a study has shown is that on slow days, when the fare-paying passengers are hard to come by, taxi drivers work longer hours than average. In contrast, when the business is brisk they work for less hours and quit early. This doesn’t seem very rational, the drivers aren’t maximising their hourly earnings. You would expect the drivers to put in more hours when it is raining and business is good, but give up early on a sunny spring day when people are happy to walk. But all humans have a built in aversion to making a loss. Every driver has a reference point - the cost of the cab and a profit that they expect or need to make every day. On a slow day, quitting early would mean accepting a loss so they keep working, taking a gamble that business will pick up so that they don’t have to crystallise the loss. On good days they move into profit quickly, the reference point is passed and the lure of the additional gains from working longer hours seems less attractive. Each day is seen in isolation. Each day the driver is reluctant to accept a loss and will work long hours to avoid it. The unintended consequence is that there are fewer cabs on the street when the demand is high than when demand is low - now you know why you can’t get a taxi when you need one most.

You can use the same aspect of human psychology to make a profit. Most people who go for a day’s racing will lose money. This of course is how the betting industry survives. Towards the end of the day the majority of people have lost more than they have won. There is one last race. Seeking to avoid a loss for the day, a high proportion of people will be drawn to one last gamble, a chance to recover their losses. Putting a bet on the favourite on the last race with its short odds and consequently low return is unlikely to earn enough to recover the accumulated losses. Consequently, the high priced long-shots get heavily backed in the final race as risk-seeking punters gamble to recover their losses. The favourite, seeing less money than expected, will have a more attractive price. Because of the loss aversion of the majority of punters that are trying to get back to break-even, the best odds at the race track are for the favourite on the last race. It may not win but a strategy that bets only on the favourite in the final race will have the best long-term return of any other on-course strategy.

- Chris Blake

One Response to “The Right Decision? It all depends if you’re up or down…”

Heated Towel Rail on June 7th, 2009 2:39 pm

You are so right i can never find a taxi when it is raining, but when it is sunny and i dont need one i see loads. They are like buses, you dont see one for ages and then they all turn up at once

Geoff

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