Monday, August 23, 2004

Once again: are choices rational?

Am I betraying my students? I have to teach a matriculation course for new students. It is supposed to make economics attractive, less dismal, and ... well, easy. So, should tell them that all choices are assumed rational. (To make it more jocular, I borrow David Friedman's -- or is it Steve Landsburg's? -- "Economists assume everybody as rational, except... themselves"). Almost simultaneously I also teach this course on how "irrational" choices can be. This is challenging, but more realistic. Take for example, a recent paper by Thaler and Sunstein (AEA Papers and Proceedings, May 2003 -- subscription required), "Liberal Paternalism". I quote, "... Research by psychologists and economists over the past three decades has raised questions about the rationality of the judgments and decisions that individuals make. People do not exhibit rational expectations, fail to make forecasts that are consistent with Bayes' rule, use heuristics that lead them to make systematic blunders, exhibit preference reversals,...". I remember we discussed this in Carl Nelson's class on Risk and Uncertainty (e.g. Kahneman-Tversky fanning-out utility function). Yet, he never mentioned the word "irrationality", as far as I recall. I am worried, that our problem is on how we define rational (or lack thereof). Who are we to call somebody acting differently with what we think he would, irrational? Who says I am irrational just because I refuse to do something known as my hobby so far? Assumptions? The failure to define rationality (or, the mistake of calling their models "rational") has caused economists to call the opposite "irrational". While what they mean is in fact the deviation from the models they use. They (oops, "we") fail to model complicated behaviors. So we just call them irrational. Nice.

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