Behavioral Economics

Behavioral Economics and Financial Choices

Behavioral economics is concerned with people’s financial choices. It focuses on how people make choices using means rather than rational reasoning. These options include whether to purchase a particular product or brand, as well as the price at which those items can be purchased. Individuals make financial choices depending on a variety of considerations, according to behavioral economics. Some people buy brands to achieve their instant gratification, and others do so because they have already bought a similar brand and considered it satisfactory. In certain situations, people make purchases when they think the most costly goods are the greatest. Tulip Mania arose as a result of such logic. In the 1600s in Netherlands, one of the most catastrophic economic bubbles occurred wiping away the wealth of thousands of citizens (Dowd, 2017). The price of one bulb of tulip flowers skyrocketed in two years to an all-time high, making it more expensive than gold and silver. However, after the unprecedented rise in the prices bulb of tulip, they later fell to an all-time low, and this marked a period known as the tulip mania.

The Origins of Tulips

Tulip was first made famous by a botanist called Conrad Gesner. Gesner claims that he first saw the flower in 1559 in a garden in Augsburg that belonged to prominent learned councilor by the name Herwart. He was known in those days for his collection of rare flowers (Mackay, 1841). Conrad received the bulbs and planted them in his garden at the University of Leiden pioneering the cultivation of Tulips in the Netherlands. From that time onwards, he dedicated the rest of his life studying them. (Dowd, 2017).

The Demand for Tulips

The demand for tulips originated from wealthy Dutch merchants who had made a lot of money from exploiting the European – Asian trade routes and wanted an avenue to show off their wealth. Their desire to show how much money they possessed led to purchase tulips and in no time, everyone who was wealthy scrambled for the available tulips. The result was the rise in the demand of this bulb tulips in the market (Sooke, 2016).

The Rise and Popularity of Tulips

Over the next eleven years, the flower had gained so much popularity, especially among the rich and powerful people in Holland and Germany, that they were willing to pay any price to have it (Van der Veen, 2012). By this time, the tulip had become a must have type of decoration for the rich and mighty and as a result, the prices for the flowers started to rise. The rise in prices continued to attract more demand for this commodity that had now become scarce.

Tulips and Their Extraordinary Nature

It is imperative to note that although the tulips were so famous and in demand, there was nothing exceptional about them apart from their beauty. They had no medicinal value whatsoever which makes one wonder why they became so expensive. Cowley created a poem about tulips to express his misunderstanding of the fuss about tulips. He says tulips were exceptional because they could change color. Cowley state that the tulips changed color from one form to other such as from purple to gold. He goes on to say that the only thing that made tulips stand out than the rest was their unique ability to please the eye. (Mackay, 1841)

Perception of Tulips in Poems

Beckmann was yet another poet who failed to understand the popularity of tulips. In his poem about tulips, Beckmann begins by praising the extraordinary ability of tulips to change color depending on the environment. He poetically narrates that a cultivated tulip is not similar to an uncultivated one. When it exists in the natural environment, it has an extraordinary large stem and broad leaves. Beckmann observes that tulip is not so pleasing to the eye but when it is ‘weakened by cultivation,’ it becomes more and more beautiful. However, the more it becomes attractive, the more difficult it is to transfer them. (Mackay 1841).

Tulip Mania and Overvaluation

From the poems above, it is clear that tulips were overrated. They had no extra value apart from their beauty, and therefore, there is no justifiable explanation whatsoever as to why the Dutch were obsessed with them. Tulip mania is a typical behavioral economics case study where people paid a high price for a commodity that did not match its value.

The Unimaginable Prices

In 1633, the price of a single bulb of a rearrests species of tulips called Semper Augustus doubled in just a matter of months. The prices went from an initial cost of 5500 guilders each to an astonishing 10000 guilders for the same quantity. To get a clear picture of just how expensive tulips were, it is imperative to understand that the amount of money paid for them was enough to feed an ordinary Dutch family for half their lifetime. Moreover, 10000 guilders were also enough to buy some of the most exotic houses in Amsterdam complete with a vast garden which could extend up to 25 meters in length and a couch house. It is vital to note that the prices of homes in Amsterdam were equally high as those in well-developed cities around the world (Dowd, 2017).

The Tulip Trade and Exchanges

As the demand for tulip continued to rise, the situation grew from bad to worse. In 1634 particularly, the rush and desire to have them increased so much that the Dutch neglected their key industries. Everyone, whether rich or poor embarked on this new-found trade and the prices continued to skyrocket. In 1635, some people were known to pay up to 100,000 florins for forty roots. One bulb of an Admiral Liefken, a rarer species of tulips, cost 44 florins and 400 perits of this kind of tulips, was worth roughly around 4400 florins (Mackay, 1841).

Future Contracts and Trading

As time went by, the tulips trade grew so much that the Dutch started trading the sales regular marts at stock exchanges around the country, in particular, Amsterdam’s Stock exchange, and Rotterdam’s stock exchange. Naturally, tulip bulb takes seven to twelve years to bloom, and this only happens between April and May. Bulbs appear between June and September, and this meant that the Dutch could trade in tulips only during June and September. To remedy this limitation, they came up with future contracts which could sell in the stock exchanges throughout the year (Colombo, 2012). This kind of trade soon spread to Haarlem, Leyden, Alkmaar, Hoorn and other neighboring towns. The tulip – jobbers, benefitted the most from this business. They were not interested in owning the tulips themselves. Instead, they bought the marts when prices were low and sold them when the prices were high. Mackay paints the picture of the tulip trade in a rather funny way. He likens people’s rush to trade in tulips to how flies flock around a honeypot (Mackay, 1841). They all thought the hype would last forever.

The Desperation and Losses

In more desperate situations, some people made grave mistakes of converting their property, including large pieces of lands and houses, into cash, to be able to trade in tulips. No one was left out (Dowd, 2017), foreigners too were attracted to engage in the madness and moved to Holland to take part in the trade. By this time, money was pouring into the country from all directions. However, the booming business did not stay for long.

The Burst of the Tulip Bubble

Over time, the bubble burst. The rich no longer bought tulips. The fact that everybody was now trading in tulips, also altered the free market law of supply and demand resulting in the fall of prices. The drop in prices made many to flock the market to sell their tulips sell in an attempt to cut their losses (Gross, 2004). However, the move only worsened the situation because as the seller increased buyers reduced drastically. The increase in the number of tulip suppliers led to increasing fall in the prices of tulips. In no time, tulips were selling for just a small fraction of their original price. As a result, a lot of people, especially merchants, incurred heavy losses with a vast majority being reduced to complete poverty.

The Impact of the German-Swedish War

Another reason given for the fall of the trade is the Germans – Swedes war of 1636 that took place at Wittstock. In Germany, tulips were planted by peasant farmers and sold to the princess of Germany, but after the war, the farmers began to revolt, and this led to the decline in the number of tulips produced in the country. During the war, Germany also imported tulips from the mayors of Amsterdam. When production reduced in Germany, the princes began to plant tulips themselves, and this reduced the demand for tulips from Holland causing the prices to fall (Gross, 2004).

The Economic Fallout

The collapse of the tulips trade crushed the economy of Netherlands leaving most of the people in debt. As a result, those who had purchased tulip marts started defaulting on their payments. Therefore, Tulip Mania in the late 1630s was characterized by people having some of the most expensive and rarest kinds of tulips but were unable to pay for them. They held future contracts of tulips that they failed to honor (Goldgar, 2007).

Efforts to Resolve the Crisis

To find a solution, the people decided to send their delegates (deputies) to discuss with the government on how to solve the problem, but the government refused to interfere. Instead, the government advised them to talk among themselves and come up with a solution. The deputies held numerous meetings, but they all failed to come up with a meaningful settlement that benefited all of them (Mackay, 1841).

After a series of disagreements, bickering, and ill will, the deputies proposed a solution. They suggested at Amsterdam that all contracts held at the height of the tulip trade, or before November 1636, were to be declared null and void. They further proposed that, for those contracts created after the above date, buyers were not to pay a tenth of the total amount in the settlements. This decision, however, was not widely accepted. Those who held their tulips shortchanged while those that had promised to buy felt unfairly treated. Actions for breach of contract again accumulated in the courts, but the courts refused to provide remedies under the law (Mackay, 1841).

After failing to agree on the best way forward, they referred the matter to The Hague’s provincial council. The people expected that this body would finally come up with an answer to the issue, but that did not happen. The members of the board met on numerous occasions, but they did not arrive at an acceptable solution. In the meantime, the committee proposed that vendors should offer the tulips to the buyers in the presence of witnesses for the agreed prices. If the latter refused, the tulips were to be sold at a public auction, and the original contractor held responsible for the losses incurred if any. Since the resolution was similar to those proposed by the deputies, the people sought court intervention. However, the courts did not settle the cases citing grounds that debts contracted in gambling were not recognized under the law. The matter, therefore, was never resolved (Dowd, 2017). Those who still had piles and piles of tulips were left to bear their massive losses.

The Lessons of Tulipmania

In conclusion, tulipmania was a duration of an unprecedented rise in demand and prices of tulips in Netherlands. The tulips were not a precious and costly commodity as shown in this paper. The behavioral economic help to explain why the demand of tulip rose considerably in the 1600s. According to the behavioral economic model, the increase in demand and eventually prices of tulips was based on the belief that the prices of tulips would never fall and that having more of the tulips would lead to more wealth. It was based on the notion that those who owned tulips were wealthy and powerful and so many individuals decided to invest in them. The absence of logical thinking among most investors led the considerable loss to many people. Future generations should, therefore, learn from the Dutch and avoid future economic catastrophes.

Reference

Colombo, J. (2012, June 15). The Dutch “Tulip Mania” Bubble (aka ”Tulipomania”). Retrieved from http://www.thebubblebubble.com/tulip-mania/

Dowd, B. (2017, September 15).Tulip Mania: When Tulips Cost As Much As Houses. Retrieved from https://www.focus-economics.com/blog/tulip-mania-dutch-market-bubble

Goldgar, A. (2007). Tulipmania: Money, honor, and knowledge in the Dutch golden age. Chicago: University of Chicago Press.

Gross, D. (2004, July 16). Bulb Bubble Trouble. Retrieved from http://www.slate.com/articles/business/moneybox/2004/07/bulb_bubble_trouble.html

Mackay, C. (1841). Extraordinary Popular Delusions and The Madness of Crowds. S.L.: Dead Authors Society.

Sooke, A. (2016, May 3). Tulip mania: The flowers that cost more than houses. Retrieved from http://www.bbc.com/culture/story/20160419-tulip-mania-the-flowers-that-cost-more-than-houses

Van der Veen, A. M. (2012). The Dutch Tulip Mania: The Social Foundations of a Financial Bubble. Department of Government College of William & Mary.