14th
A few thoughts on economics and rationality
References in popular media to “irrationality” in human behavior seem to have increased in frequency in the last several years - a noticeable start to the rise coinciding with Kahneman’s Nobel Prize in 2002, and a flurry of squawking generated by the financial turmoil of the past several months. There seems to be some general tacit implication that the traditional (economic) perspective of human behavior as rational is simply misguided, and that we need new mindsets for analyzing (and approaches for reacting to/managing/sterring) said behavior.
I get that Homo economicus isn’t totally real. I took classes from Amos Tversky (Kahneman’s collaborator, who surely would have shared his Nobel had he still been alive), and their work is elegant and, more to the point, empirically validated to some degree. There are certainly adjustments to be made to “standard” economic theories about how people deal with risk and uncertainty and time preferences and so on.
In general, though, I tend to think people are more rational than they’re usually given credit for. Note, among other things, that the bar for “rationality” is actually pretty low: it doesn’t mean intelligent, or wise, or prescient. In fact, the “axioms of rationality” are pretty darned innocuous. (See end of post if you actually care what they are.)
One semi-celebrated piece of evidence I’ve heard in the last year or so for “irrationality” is the notion that people’s experience/sense of happiness/etc. of something varies depending on the price associated with that something. For instance, when people pay more money for a bottle of wine, the wine tastes better.
Despite the fact that I’m not sure whether I’d call this irrational in the first place - after all, placebos are medically real; why not accept them economically? - I was pleased to see a study a few weeks ago suggesting that the effect was, perhaps, not terribly widespread. (Part of the criticism of the original study on wine was that the effect was seen in a somewhat-contrived laboratory setting, in a context - wine-tasting - where people may be particularly psychologically primed to associate cost with better taste.)
The experiment was rather elegant: the economists observed diners in a restaurant who were choosing which entree to select from a prix-fixe menu. The a la carte prices of the entree selections were varied - for instance, on one menu, the fish, the steak, and the chicken would all cost $20, whereas on another menu, the fish would cost $25 whereas the steak and the chicken would still cost $20.
The economists found that varying the a la carte prices created no significant difference in the diners’ choices: people didn’t choose the fish simply because it was more expensive, instead (presumably) choosing according to their own tastes.
People surely do things that are stupid, or unwise, or shortsighted. People may be unable to figure out the exact implications of their actions in complex situations, or they may act in conditions of uncertainty. … but I tend to believe that they rarely act in a way that is purely and bizarrely irrational.
(Axioms of rationality, stated verbally and somewhat imprecisely:
- Given two choices, either you prefer one, prefer the other, or are indifferent.
- Preferences are transitive. If you prefer A to B and you prefer B to C, you prefer A to C. (Some people don’t think this is innocuous - I think it’s completely so.)
- Your preference between A and B isn’t affected by the possibility that some random event might preempt both choices.
- Nothing is infinitely desirable or infinitely horrible.
Don’t come up with an argument based on variety or complementarity in cases 2 or 3 - that’s not what they’re talking about. These are one-shot, static, non-synergistic choices.)
