My last post raised a lot of questions about rationality. Rather than reply to them individually, I decided to devote this column to the topic.
I talk to the public a lot about economic discoveries that violate assumptions of rationality. And one thing that always surprises me is just how pleased people are to hear about these violations of rationality. Gleeful even. Relieved to not be the only dummy out there.
It's surprising that people are so excited because, when it comes to economics, violations of rationality are pretty darn recondite.
An economically rational individual is someone whose preferences obey certain formal rules that insulate them from economists' bugbear: intransitive preferences. Intransitive preferences means I prefer an apple to an orange, an orange to a pear, and a pear to an apple. This pattern of preferences is distressing to economists because some opportunistic evildoer could come along and offer to trade me an apple for my orange plus a small fee, and then offer me a pear for that same apple plus an additional fee, and then offer me an orange for the pear plus another small fee. Then that evildoer winds up with a free lunch from me. And there's nothing economists hate more than a free lunch. (Economists would say that this evildoer has turned me into a ‘money pump').
But the real reason this bothers economists goes much deeper than their annoying perennial reminders about free lunches. In the early 20th century, economics struggled to establish itself as a formal and rigorous science. Economists craved respect. (Anyone who has heard economics called the dismal science knows it's been an uphill battle). Many brilliant economists built the field a solid foundation that was axiomatic - based on a few simple and obvious rules - the same way Euclid did with geometry and Peano did with arithmetic. And to make these axioms, economists had to come up with an economist's equivalent of mathematically true and false. And they chose the terms rational and irrational.
These words were not intended to describe what people do. Humans are not robots; most (but not all) economists know that. Even if we were, our brains are finite. We have to take mental shortcuts. We are approximately rational and even that only sometimes. We economic psychologists love the phase ‘bounded rationality'.
Economics 101 is one of the most popular undergraduate courses in the United States, and it often gives rationality a central place. But we all have money anxieties, so we are predisposed to hear personal judgment coming from our economics professors. Every year, a new crop of students thinks their teachers are criticizing them about how they manage their personal finances.
But that's not it at all.
Violations of rationality are nothing to be ashamed of. They are like optical illusions in vision: they are universal and they provide clues to how the visual system works. We study irrationality because it gives us essential clues to help us learn how the brain makes economic decisions. And we do that because it leads us to solutions for the real irrationalities: depression, addiction, schizophrenia, and so on.
Invite your local economists to the bar, buy them a round of beer and ask them about it. They'll admit (in my experience, cheerfully) that when they go to the store, they make the exact same mistakes as the rest of us do. Because we are all human. We are all irrational.