ESSA

ESSA

Slacking Off


Hungy Ye

By

June 24th, 2012


If you were rational, you’d do it too: Applying finance theory to decision making


Ever feel like putting things off and not doing them until the last minute? Feel like doing things in advance requires too much effort and that getting things done just before it’s due gives you that distinct sense of satisfaction? It’s probably common knowledge that you’re not alone and many people (yours truly included) tend to be serial procrastinators – leaving everything to the last possible minute before getting it done.

Of course there’s probably a variety of good reasons as to why people are lazy, but to answer this question as an economist I can’t just make unsubstantiated claims.  To make things more interesting I’ll be borrowing a concept from finance called an ‘option’ to help. Those of you familiar with options can skip this introduction: an option is a type of security, which is an agreement or contract between two parties. Its defining characteristic is that the buyer of the option, pays the seller a fixed fee for the right, but not the obligation to enforce the contract within a fixed time period.

Usually this means one person ‘buys’ the option to buy something (apples for example) at an agreed price from the seller at some point of time in the future, the point being to protect the buyer against unfavourable movements in price of apples. Say today apples cost you $1 each and you need apples for fresh juice in a week’s time, but the weatherman says that a cyclone is on the way to Queensland and you suspect the price of apples is going to be $10 by the time you want your juice. A friend of yours thinks you’re crazy because only bananas are ever grown in Queensland so he offers to sell you 10 apples for $1 each in a week, as long as you pay him $5 upfront now.

If you agreed to your friend’s deal you have just bought an option on apples for $1 expiring in one week, whereas your friend has sold the same option. There are a few basic types of these securities but on the whole they behave similarly to each other. What’s interesting about them is that the value of the option changes over time, depending on the value of whatever the option was taken out on (e.g. price of apples) and how long left before the option expires, known as the intrinsic value and time value respectively.

In finance there is a concept known as a ‘real option’ which refers to the application of option pricing to a decision making process.  Whereas actual financiers might be concerned with the intrinsic value of an option contract, with ‘real’ options the time value is more relevant. This is largely because real life events don’t always vary constantly in value the same way apples in a shop might from day to day – doing an assignment now or next week will probably take you the same amount of time regardless of the cyclones in Queensland. (Different story if you happen to live up there though) The time value, on the other hand, changes as time passes: it decreases continuously until the option expires.

How does this work? Intuitively, the time value of an option depends on how likely the value of that something will change and how much time there is left on it. An example would be one of those pesky group assignments you’ve been handed to do, especially if you know someone in your group is very smart and is likely to solo the project. By not doing the assignment, what you’re effectively doing is getting an option to not do the project, and holding on to it by not working. If you did the assignment, the option is void because you can’t not do something you already did (I suppose you could by throwing it out but we like to assume people are rational).

Right now the option you have isn’t worth much, because you’ll still have to do the homework when it expires if no one else does. The benefit of having the option to not do work comes in when your very good friend decides they’d rather take one for the team than fail, and goes ahead and finishes it. Now you can use (exercise, in finance parlance) your option to do nothing, and enjoy  the free time gained from handing in an assignment that you contributed absolutely nothing to. Of course being an ‘option’ means you always have a choice: you have a right to do nothing, but not the obligation. You can always do the assignment yourself if you don’t like what you see.

So now that we have this example, we can extrapolate from it as to why big assignment groups tend to have lots of people slacking off, and beyond homework why laziness exists: we’re all waiting for each other to do the work. And why not? One of the maxims of microeconomics is ‘more is better’; people want to get the most out of their limited time and resources. What’s a better way to maximize that besides waiting to see which problems will be solved by other people before they require our own precious time and attention to deal with?

In case you didn’t notice, this is all common sense. Of course there will always be irrational people who like to throw a wrench into the most well constructed of arguments and do the exact opposite for the heck of it, but you always have the right but not the obligation to decide for yourself. Economics might seem to be a complex discipline but it’s built from simple, logical axioms and its applications are all around us. Now if only someone would go find them for me.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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