All They Gotta Do Is Act Rationally

Behavioral economics is a hot field these days. It’s also a very cool field, since behavioral economists get to do actual experiments.

Experiments are a relatively new thing in economics. You can’t very well run a random, controlled experiment on an entire economy, after all. “Let’s raise interest rates in 25 randomly-selected states and see how many people lose their jobs.” That sort of thing doesn’t go over too well, even when it’s not an election year.

But behavioral economists can get away with this sort of thing, since they’re only messing with individuals. They can give two groups of people $25 and expose them to different situations in a controlled environment and see what they do. It’s fun.

That’s the kind of stuff behavioral economist Dan Ariely does. In one experiment, he auctioned off bottles of wine and other products, but with a twist. Before making their bids, participants were asked to write down the last two digits of their social security numbers.

You might ask, “What do social security numbers have to do with bidding on a bottle of wine?” And you’d be right. They shouldn’t have anything to do with it. That was the whole point.

What Ariely found, however, is that people with higher digits bid more for the products, and people with lower numbers bid less.

Those with the last two digits in the 80s and 90s bid an average of $37 for a bottle of 1996 Hermitage Jaboulet La Chapelle wine. Those with last two digits from 00 to 19 bid an average of less than $12. Those with numbers in the 40s and 50s bid an average of $18. The same patterns emerged on bids for computer trackballs, chocolates, and other products.

Just writing down and thinking about a completely irrelevant number changed how much money people were willing to pay for things. People don’t always rationally evaluate the costs and benefits of goods, selecting the ones that will provide them with the greatest utility at the lowest cost. The values that people give things are relative, and malleable, and at times arbitrary.

So what? Why should we care about some obscure economics experiment? What difference does it make that consumers’ values can be easily manipulated?

Actually, it makes a big difference. Much of modern economics is founded on assumptions that people on average make rational decisions about what to buy – or least act like they do. That they don’t consistently make biased choices. If consumers do behave rationally – and if a number of other assumptions hold – then free markets normally will work best by themselves, without any interference from governments or other outside entities.

On the other hand, if consumers consistently make biased choices then a lot of modern economics is up for grabs. Violating the fundamental bases of economics could invalidate lots of free market theory, and open up the lots of potential for government policies that can improve economic outcomes.

I still believe that most of the time, most people do behave (mostly) rationally without regard to economic decisions. That is, they don’t intentionally do things that make them worse off.

But more and more, behavioral economists and others are finding exceptions, cases where people do things that just don’t make sense. Situations in which people consistently do things that aren’t best for themselves.

Government interference in otherwise efficient and competitive markets is almost always a bad idea. And government involvement even in distorted markets has lots of costs and risks, and should not be undertaken lightly.

But the more evidence we have that human are predictably irrational, the more potential there is that the right kind of government policies can make them better off.

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