Saturday, February 23, 2019

Will Algorithms Cause Mischief for Consumers?

By Robert Wenzel

Financial Times columnist Tim Harford is out with a worst case artificial intelligence scenario. But I believe the scenario is the result of some extremely limited modelling.
He writes:
If you do not like the price you’re being offered when you shop, do not take it personally: many of the prices we see online are being set by algorithms that respond to demand and may also try to guess your personal willingness to pay.

What’s next? A logical next step is that computers will start conspiring against us. That may sound paranoid, but a new study by four economists at the University of Bologna shows how this can happen. The researchers allowed two simple artificial intelligence algorithms to compete against each other in a setting where they simultaneously set prices and reaped profits accordingly. The algorithms taught themselves to collude, raising prices from the cut-throat competitive level towards what a monopolist would choose. Price cuts were met with price wars, after which collusion would return. Just because you’re paranoid, it doesn’t mean the computers are not out to get you.
Here is the abstract from the paper:
Pricing algorithms are increasingly replacing human decision making in real marketplaces. To inform the competition policy debate on possible consequences, we run experiments with pricing algorithms powered by Artificial Intelligence in controlled environments (computer simulations).
In particular, we study the interaction among a number of Q-learning algorithms in the context of a workhorse oligopoly model of price competition with Logit demand and constant marginal costs. We show that the algorithms consistently learn to charge supra-competitive prices, without communicating with each other. The high prices are sustained by classical collusive strategies with a finite punishment phase followed by a gradual return to cooperation. This finding is robust to asymmetries in cost or demand and to changes in the number of players.
There is no doubt there is a role for artificial intelligence in helping corporations understand supply and demand. But AI is used in a much more sophisticated manner on Wall Street today, and yet the idea that all of Wall Street can, therefore, be gamed is absurd--never mind all of commerce.

Do I really need to point out that Long Term Capital Management, the 2008 financial crisis, the housing bubble and the mortgage-backed securities collapse all occurred, just for starters, with algos spinning in the background?

The fact of the matter is that the world is much too complex to model the entire thing. These are basic observations of the great Austrian school economists Ludwig von Mises and Friedrich Hayek.

Artificial intelligence may make markets more efficient but the very nature of the changing world teaches us that they can't possibly structure all prices for the benefit of some mystical oligarchies.

Robert Wenzel is Editor & Publisher of and Target Liberty. He also writes EPJ Daily Alert and is author of The Fed Flunks: My Speech at the New York Federal Reserve Bank and most recently Foundations of Private Property Society Theory: Anarchism for the Civilized Person Follow him on twitter:@wenzeleconomics and on LinkedIn. His youtube series is here: Robert Wenzel Talks Economics. More about Wenzel here.

1 comment:

  1. "The algorithms taught themselves to collude, raising prices from the cut-throat competitive level towards what a monopolist would choose."

    Right, but can the algorithms compel you to buy at that price? And if you don't, then what will the algorithms do? This shows a very Keynesian view of monopoly theory, which overlooks the point that an alleged monopolist has no real power, because consumers can always choose not to buy. Never mind that this would stimulate new suppliers to enter the market to try to satisfy the unmet demand.