Friday, June 26, 2009

You can't use the word in the definition

I am reading this book called "The Origin of Wealth" and in it the author traces through the history of traditional economics. He criticizes traditional economics because he thinks that the model of a rational actor is flawed. He says that the agents in that model (us) are assumed to think about every possible scenario before making a decision and one would always make the economically optimal decision.

I think the above is intuitively obvious but, to belabor the point, I will reiterate an example he cites. Let's say you were on a plane seated next to a banker and a rich woman. The woman, being a fan of behavioral economics, decides to conduct a study on human rationality and proposes a deal. She will give both you and the banker $10,000 under the following conditions: the banker decides how to split up the money and you decide whether to take the deal. If you refuse, then both of you get nothing. So the banker, being the greedy banker, proposes that you get $10 and he gets the rest. What should you do? Well, in purely economic terms you should take the money because $10 is more than you had before. Low and behold, people don't take the money. Why? Because they are irrational agents.

What is rationality? If rationality is something that exists outside of human beings then we can say in absolute terms that we are irrational. But, if rationality is a quality of human beings then how can you say that the exercise of that quality is irrational? You can't. I believe rationality is an inherent human quality. To say that the universe, or a dog, is rational is nonsense for precisely this reason. Only people can be rational or irrational.

It is a mistake to translate economic optimality with human optimality and to call the difference irrational. Economics, is about the latter not the former.


Phillip said...

I would say that given the example, the metaphorical finger to that banker would be worth more than 10$ in terms of emotional satisfaction -- for me anyway. The economical optimality, at least as I understand it from your post and citation, only concern money. Happiness (not pleasure) makes more sense to use as the yardstick. After some point, there are severely diminished returns on the the benefits of wealth -- which probably explains why not all of us are cut-throat corporate crazies.

I agree that premise of the rational actor is false -- whether for financial or happiness gains. I have known several very smart people who display this trait quite well. I probably do it every day.

Good post.

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