Goods, marketing, preferences and the Genius

I’ve gotten used to ignoring iTunes pining for one upgrade or another – seems to happen every other time I start it up – but, this time, the promise of the Genius was too tempting to ignore. 

The Genius is a new gadget attached to iTunes that is designed to create “smart” playlists at the touch of a button; pick a song from your library and it’ll create a playlist made up of songs that fit well with the one you picked. If that sounds familiar, it’s because it’s precisely the same idea that personalized internet radio (my favorite is Pandora) has been trading on for a few years, with the obvious difference that Pandora and its cousins are capable of creating playlists built on more than one song or genre and that they can play you songs you don’t own. Both Genius and Pandora are working on a collective wisdom principle – learning what to recommend based on what you like and on what people like you like, and so on. Actually, that even sounds a bit like the supposed basis for Goggle’s search algorithm, right?
Anyway, I’ve been crying out for this: shuffle in iTunes is precisely useless, and I’m pleasantly encouraged by early returns from Genius. What’s all that got to do with economics?
Well, what do we assume about preferences? We’ve always tried to be agnostic about what people like, which was neat for keeping us honest but made us a little fuzzy on where they come from or how they might change. Genius and Pandora are, arguably, operating on a person with malleable preferences, who’s persuadable that she likes what’s being connected. For these to be valuable products, there must exist preference for convenience (having playlists made for you rather than doing it yourself) or surprise (for hearing unexpected songs). 
Or could it be as simple as information? Perhaps these things are most valuable as informers, letting us know what goes well with our music or showing us new music that we might like. Again, slightly non-traditional consumer theory, although imperfectly informed consumers isn’t a new idea in economics or in life. Strangely, iTunes seems to be at a distinct disadvantage here; sure, this new gadget is designed to recommend things to you to buy at the iTunes store, but it’s not a pure free-preview model like Pandora. Nevertheless, we’re in the territory of deterministic preferences, and in particular the role of advertising.
The most commonly asked question about advertising in economics has been ‘informative or not?’, and there’s the balance between these two functions: am I being coerced or informed when Genius tells me what songs I’m missing that would go well with one I own? The strict segregation of preferences and the tangible world of goods and budgets that is used in consumer theory is violated a little by this kind of thing; we get into nice philosophical questions like how to define a good. Are my preferences changing when I learn about these awesome songs I’m missing out on?

What is a ‘good’?

One very important concept in economics is ‘goods’. They’re one of the most fundamental building blocks of the tangible side of economics. If economics is about resource allocation, ‘goods’ are what the resources are being allocated towards. What is a ‘good’?

It’s not quite so simple as just a thing, like a TV or a sandwich; ‘goods’ are anything – any thing – that one can allocate resources towards that contains value for that allocator (rather confusingly, ‘services’ are ‘goods’ too, by this definition; so is something like ‘charitable contributions’). Yes, we’re going to have to plunge into the pool of abstraction. First of all, we have to think about time and space: is a hot coffee in the morning in winter in New England the same as a hot coffee in the afternoon at a swim-up bar in the summer in the Caribbean? Doubtful.

We have two broad strategies, as economists, for dealing with that problem. One might be to say, well, people have different preferences at different places, at different times. That’s difficult to work with because we have to try and hit a moving target, so to speak, and since we can’t know preferences for sure anyway we sure can’t know changes in them either. A second might be to say, those two coffees are different goods. That’s also difficult to work with because then it’s difficult to compare things at all.

In fact, in either case it will be very difficult to generalize. On the individual level, knowing how you allocated your resources in this situation at that time doesn’t help me describe what you did or predict what you’ll do in the future: if I see what you did at 11a.m. on Thursday when faced with the decision of coffee versus tea, how can that help me figure out what you might do at 10a.m. on Friday when faced with the same decision. These aren’t necessarily the same ‘goods’ at both times, and in any case, the difference might not just be the time or something else that I can measure; it might be your mood or whether you’re especially tired or just feel like a nice cup of tea for some mystical reason.

Seems trivial, but raise that to the level of the market for coffee, or the global coffee industry, or the impact of consumer decisions on the American economy, and the difficulty of defining a ‘good’ has snowballed into modeling chaos. For example, it’s impossible to properly think about the current climate in the market for oil without thinking of the market for oil in the future. Of course, in the real world, the financial world, it’s well understood that things vary in space and time: that’s why we have things like futures markets, which let you buy ‘thing X at time Y’ (which is just a special case of ‘good X now’, really). These things are considered separate (though connected) markets, with separate prices.

And that’s just how they were treated by economists as we developed microeconomics. The definition of a good was allowed to be very, very flexible and abstract, so that these ‘things’ don’t just vary in physicality but in time, space, functionality, and so on and so forth.

It’s not just time and space, though. An example: think of a college education. Is the good being sold by universities a ‘college education’? Is it a ‘degree from college X’? Is it a ‘college education of quality Y from college X’? The signaling model by Michael Spence wondered (and I obviously paraphrase wildly) if people would still pay for a college education if it the education was intrinsically worthless but had the value of ‘signaling’ that you were willing to give up four years to prove that you were great.

Should it be surprising that the cost of a college education has been rising despite there being a bigger supply of colleges? Maybe not, if our definition of the ‘good’ includes ‘quality’, perceived or actual; it’s easy to build a new college, but impossible to build a new college with a reputation to rival Oxbridge or the Ivy League. The supply of that good, whatever it is, is fairly well fixed. Econ 101 is obsessed with ‘supply and demand’ analysis; the fact is, supply and demand analysis takes you very, very far if you’re prepared to speculate properly on what a ‘good’ is.

This is all quite similar to the corporate strategy mantra of identifying your ‘core competencies’ and defining the industry. For example: railroads and train companies aren’t ‘the railroad industry’, but ‘the transport industry’, competing with airlines and buses, and maybe even ‘the food industry’ if they serve food, etc etc. That leads us dangerously close to the kind of ‘provider of transport services’ corporate-speak euphemisms that plague so many firms, but it’s pretty much the same question as how to define a good in economics.