Yardstick Competition: is it bad to compare ourselves to others?

 You might hear, in many cases, the well-known phrase "the grass is always greener on the other side," which suggests that people often believe other people always seem to be in a better situation than you, although they may not be. In other words, we are always tempted by and envious of what other people have, and we always compare ourselves to others, our neighbors, for example. Is it a good idea to do so?

Firstly, it’s natural to compare your situation or other situations with others, especially when it feels like they have a better one, especially in finance.  However, it's important to remember that everyone's financial circumstances are unique, and what might seem better on the surface might not actually be so. On the other hand, it is not such a bad idea, and in any case, cases might result in competition with a favorable outcome.

 This form of competition, known as a Yardstick Competition, refers to a regulatory approach where the performance of one firm is evaluated relative to others in the same industry. This is common in industries where natural monopolies exist, like utilities. Instead of directly controlling prices or profits, regulators use the performance of other firms as a benchmark (a "yardstick") to set standards or incentives for the firm being regulated.

Yardstick competition is primarily used in industries where firms operate under similar conditions, making it easier for regulators to compare their performance. It’s particularly prevalent in regulated industries such as utilities (electricity, water, gas), where competition is either limited or nonexistent due to the nature of the industry.

The first to analyze this approach was Andrei Shleifer. His theory of yardstick competition, introduced in his 1985 paper (link), is an influential concept in economics, particularly in the context of regulated industries or public sector performance. The basic idea is that in markets where direct competition is limited or nonexistent (such as monopolies or oligopolies), regulators or policymakers can use the performance of similar firms as a benchmark or "yardstick" to judge the efficiency and pricing of a given firm.

Key Concepts:

1. Benchmarking Performance: Regulators compare the performance of a regulated firm (like a utility company) against similar firms in other regions or countries. The idea is to use the performance of other firms as a standard or "yardstick" to assess whether the regulated firm is operating efficiently.
2. Incentives for Efficiency: Since the firm knows that its performance will be compared to others, it has an incentive to operate efficiently. If it doesn't, it risks penalties or stricter regulations, or it might lose its favorable standing with the regulator.
3. Asymmetric Information: One of the challenges in regulation is that the firm typically has more information about its costs and operations than the regulator does. Yardstick competition helps mitigate this problem by using external comparisons as a way to infer whether a firm’s reported costs are reasonable.
4. Application in Regulation: This theory is particularly useful in industries like utilities (electricity, water, etc.), where direct competition is not feasible. By using yardstick competition, regulators can simulate competitive pressures and encourage efficiency, even in the absence of actual competition.

Practical Implications:

• Utility Regulation: Regulators might compare the cost structures and service quality of electricity providers in different regions to set appropriate tariffs.
• Public Sector Performance: Governments could compare the performance of public hospitals or schools across regions to identify inefficiencies and promote best practices.

The main question is how we can apply Shleifer’s theory of yardstick competition in everyday life.

Applying the theory of yardstick competition to an individual in everyday life can be thought of as using comparative analysis to make better decisions, whether it’s in financial matters, purchasing goods, or evaluating services. Here's how you can use this concept practically:

1. Comparison Shopping

• What It Is: Just like regulators compare companies to assess efficiency, you can compare different products or services to ensure you’re getting the best deal.
• How to Apply: Before making a purchase, look at multiple options. For example, if you're buying a car, compare the price, features, and reliability of similar models across different brands. This will help you identify which option offers the best value.

2. Assessing Financial Products

• What It Is: When considering loans, insurance, or investment products, compare the terms and conditions offered by different providers.
• How to Apply: If you’re looking at getting a mortgage or a loan, don’t just go with the first offer. Instead, compare interest rates, fees, and terms from multiple lenders. This helps ensure you’re getting a competitive rate, similar to how a regulator would benchmark a utility company’s rates.

3. Evaluating Service Providers

• What It Is: Just as regulators evaluate service quality across firms, you can assess different service providers (e.g., contractors, doctors, tutors) based on their performance.
• How to Apply: When hiring a service provider, check reviews, ask for recommendations, and compare their rates and quality of work against others. This helps ensure that you’re choosing someone who provides good value for the cost.

4. Budgeting and Personal Finance

• What It Is: Compare your spending habits, savings, or investment returns against common benchmarks or averages.
• How to Apply: For example, compare your savings rate to the national average or to your peers. If others are saving a higher percentage of their income, this could motivate you to adjust your budget and increase your savings.

5. Job Market Decisions

• What It Is: In the job market, compare salaries, benefits, and job conditions across similar roles or industries.
• How to Apply: Before accepting a job offer, compare the salary and benefits to what’s typical in your industry. You can use resources like salary surveys, or job market reports to ensure you’re being offered a competitive package.

6. Home Maintenance and Repairs

• What It Is: Compare quotes from different contractors for home repairs or maintenance work.
• How to Apply: If you need a repair done, get quotes from several contractors. Compare not just the price but also the reputation, guarantees, and quality of materials used. This ensures you’re getting a fair deal.

7. Improving Personal Efficiency

• What It Is: Just as companies are encouraged to operate efficiently through yardstick competition, you can look for ways to improve your personal productivity.
• How to Apply: Compare your productivity or time management skills against others, or use tools like time-tracking apps to see how you can optimize your daily routines.

What teaches us about Yardstick Competition is that by regularly comparing your options and performance against relevant benchmarks, you can make more informed decisions and potentially improve your financial and personal outcomes, similar to how Yardstick Competition encourages efficiency in businesses. Since a person can not compete with themselves and a benchmark is needed, this approach could result in a profitable outcome.

The pictures in this post were taken from Unsplash.

 

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What can a simple person learn from a prisoner's dilemma?

 The Prisoner's Dilemma is a classic example of game theory that demonstrates why two rational individuals might not cooperate, even if it appears that it is in their best interest to do so. Here’s an in-depth look at the Prisoner's Dilemma and what it can teach us:

Scenario

Two individuals, A and B, are arrested for a crime. The police do not have enough evidence to convict them of the principal charge but can convict them of a lesser charge. The prisoners are separated and cannot communicate with each other. The police offer each prisoner a deal:

• If A betrays B (defects) and B remains silent (cooperates), A will be set free, and B will get a 10-year sentence (and vice versa).
• If both A and B betray each other, they will each get a 5-year sentence.
• If both A and B remain silent, they will each get a 1-year sentence on the lesser charge.

Payoff Matrix

The following payoff matrix can represent the situation:

	B Cooperates	B Defects
A Cooperates	(-1, -1)	(-10, 0)
A Defects	(0, -10)	(-5, -5)

There are many versions of the current scenario, but all have the same results (link to another scenario).

The predicted outcome of the game (Nash Equilibrium)  is when both prisoners choose to defect, resulting in a (-5, -5) outcome. Namely, five years in prison. This is a stable state where neither prisoner can improve their situation by changing their strategy unilaterally.

On the other hand, the (Pareto) optimal outcome is when both prisoners cooperate (-1, -1), which is better for both compared to the (-5, -5) outcome. However, reaching this outcome is challenging due to the lack of trust and inability to communicate.

 The dilemma highlights the importance of trust in cooperative scenarios. If prisoners could trust each other, they would both remain silent, achieving a better outcome. In real-world situations, building trust is essential for cooperation.

It is important to notice that if an equivalent interaction to the Prisoner's Dilemma repeats, the players might cooperate.

Merrill Flood and Melvin Dresher first raised the prisoner dilemma issue in the 1950s (for example, one of the articles in the field (link)). Since then, many works studied this issue in many variations. The main question is, what can a simple person study from it?

In a sense, a large proportion of social interactions can be thought of in terms of the Prisoner's Dilemma, which pits our self‐ish interests against the motivation to cooperate with and help others. A simple rule of the Prisoner's Dilemma is this: When we play against someone else in an iterated manner, expecting to have further interactions with that same person, we tend to be nicer than when we are playing against someone in a one-off capacity.

Interacting with strangers, which is now commonplace in some of the human experience, can be seen as a form of Prisoner's Dilemma. In modern conditions, we constantly find ourselves in situations where social interactions are between strangers who have no expectations of interacting with one another again. Perhaps this simple insight can help us create environments more conducive to helping, cooperation, and love.

The moral of the Prisoner’s Dilemma is that self-interest can sometimes lead to an optimal outcome beyond everyone's reach. And in that case, everybody loses.

 

 

The pictures in this post were taken from Unsplash.