People are not irrational-at least not as much as we are led to believe. This is because the brain is economic. That is, brains have a limited amount of energy to achieve necessary goals like survival and reproduction. As a result, brains have evolved ways to make decisions in an efficient way. Professor Richard McKenzie at UC Irvine and I call this "rational rationality" (for more details, see McKenzie's forthcoming book In Search of a Defense of Rational Behavior in Economics).
All biological systems are economic because physical resources are inevitably scarce. Think of a cow that is happily munching grass on a small hill. It moves slowly to extract all the grass near it and eventually the hill is nearly denuded. The cow must make a decision to continue to graze the increasingly bare hill, or move to the lush hill nearby. Because the cow's energy is limited and walking to the new hill takes energy, it uses a simple algorithm to decide when to move: do so when the additional energy gained by moving to the new hill exceeds the additional cost of energy spent moving to it.
It turns out that many animals do this comparison of costs and benefits when acquiring resources. Ecologists call this the "explore versus exploit" (EvE) problem; should you exploit the stuff near you, or explore for new stuff. The brain appears to have evolved a similar EvE algorithm when using its limited resources to make decisions.
This can be seen in many ways, but a most interesting example can be found in an experiment you can do with me right now. Click on the link I'll give you in a minute and count the number of times the players dressed in white pass the basketball to each other. This is tough so please concentrate. Here's the link
How many passes did you count? Did you see anything else interesting in the video? If you did not, play it again and this time don't count the number of passes, just watch the action.
Yup, a guy in a gorilla suit walked through, beat his chest, and walked out. Why didn't you see it the first time? (Don't feel bad, about 50 percent of those who see this video miss the gorilla the first time). This has been called "inattentional blindness." We have a limited amount of attention because attention rapidly burns up neural resources.
So when do we marshal our rational resources to make a decision? The EvE model predicts that we'll do this when the return we expect from our effort is high. Buying a house and buying a car are obvious examples. What about choosing a spouse? Huum, that's a tougher one. Obviously an important decision, but what does love have to do with it? Numerous studies have shown that most people "positively assortatively mate." In human-speak, this means that we typically find spouses that have similar education, beauty, and socio-economic status to ourselves, suggesting that finding a mate involves more than just love. We integrate our cognitive and emotional resources to choose compatible spouses (well, compatible at least 50 percent of the time).
How about other hard decisions? Those that involve a lot of resources, like how to invest your retirement money, are doubly difficult as the information needed for a rational decision are often hard to find and understand without specialized training. To help us save cognitive resources and improve decisions, humans have devised institutions, or sets of rules, as cognitive prosthetics. Continuing the saving-for-retirement example, institutional fixes include compulsory contribution programs like Social Security, voluntary employer matching of retirement funds, and optional tax-deferred savings in IRAs.
Rational rationality also means that crises are inevitable. We need more than a nudge to invest the cognitive resources needed to improve our decisions, we need a shove off a cliff. We are only compelled to change when our decisions fail our expectations by a wide margin. Otherwise, rational rationality means that we make decisions on autopilot: if the current situation is similar to previous situations, then we decide the same way.
Crises that we survive give us an opportunity to improve our decision-rules and even the institutions that help us make decisions. The recent mortgage market bailout and associated additional regulation is an example of this. So, embrace your crises!
Rational rationality also means that we will continue to be blind to many aspects of our decisions. Nobel laureate Herbert Simon (1916-2001) called this kind of decision-making "satisificing", or making good-enough decisions. Evolution is frugal, and this just fine most of the time. We are predictably rationally rational.
Dan Ariely, author of the recent and very interesting book Predictably Irrational, has a different view, so I've asked him to respond to this. Find his video reply at http://www.predictablyirrational.com/ and on YouTube here.