(Ir)rational Economics

(Ir)rational economics

Most branches of the field of economics presume that people are rational actors in the marketplace. Homo economicus, the “economic person” that is dear to so many concepts we have covered, has full knowledge of all of the facts, is completely capable of analyzing all options, and always makes rational, self-interested decisions that maximize his (or her) utility.

But how well does that assumption hold up in reality? Do people really always make utility-maximizing, rational decisions?

In truth, we can probably all recall situations in which we did not make a “rational” decision (at least from the perspective of classical or neoclassical economics). For example, how many hours has the average customer spent in line waiting for free giveaways? (Think of Black Friday lines at the mall, the annual free cone day at Ben & Jerry’s, and the KFC debacle in 2009 to name just a few examples.) The product might be free, but that time spent in line has a value. So if we spend one hour waiting in line to get a $3 cup of coffee for “free,” that implies that we value our time at less than $3 per hour. Otherwise we would have gone to the coffee shop next door, waited only a minute or two, paid $3 for the beverage, and used the other 58 minutes to do something more productive, right? Homo economicus would not wait in line, so why do we?

The relatively new field of Behavioral Economics is trying to untangle these concepts to understand why and how psychological reactions influence our economic behavior. Rather than relying on simplified models and assumptions to understand the economic world, Behavioral Economics uses research techniques from psychology and sociology to study what people actually do. The results are sometimes astounding, and help answer questions like:
• Why do people gamble, when they know the odds are that they will lose money, not win?
• Why are black pearls more expensive than white ones?
• Why is it so hard to save money today, when we know it will make us better off in the long run?
• Why do we pay so much to avoid risk (rental car insurance and flat-rate phone plans, for example)?

We will explore these fascinating topics in a series of discussions in coming weeks. Stay tuned!