Two thousand years ago Aristotle stated, “Man is a rational animal”, to differentiate him from other animals who relied on instincts. In my college days, for a while I was hooked on rationality under the influence of Ayn Rand. I used to think that every action and every opinion should be rationally evaluated and life should be conducted with reason as the measure of virtue.
But are we really that rational? Vishal Khandelwal (of Safal Niveshak fame) states: “…[W]e are rationalizing beings. We make emotional decisions and then try to rationalize the same with logic”.
Dan Ariely, a behavioral economist at Duke University, in his book Predictably Irrational (2008) goes a step further. He says we are all inherently irrational. Not only that, this irrationality can be consistently and systematically brought out in controlled experiments. That is, our irrationality is predictable.
Ariely states in the Introduction: “In conventional economics, the assumption that we are all rational implies that, in everyday life, we compute the values of all options we face and then follow the best possible route.” But that is not the way real life works.
Consider an example countering the classical notion of supply and demand. Ariely narrates how an Italian diamond dealer, James Assael, created a new market for Tahitian black pearls. Initially there was very little demand for black pearls. Solely by clever marketing and positioning the black pearls in prestigious storefronts, the pearls “were soon parading through Manhattan on the arched necks of the city’s most prosperous divas.” This was because Assael had “anchored” his pearls to the finest gems in the world with prices following after. A similar case is made for Starbucks coffee – which is far more expensive than Dunkin’ Donuts coffee. Clearly these examples strike at the heart of the argument that prices are established by striking an equilibrium between supply and demand.
Ariely gives several examples of controlled experiments were irrational behavior was discovered and established. As he writes, "Our irrational behaviors are neither random nor senseless – they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. So wouldn’t it make sense to modify standard economics and move away from naïve psychology, which often fails the tests of reason, introspection, and – most important – empirical scrutiny?"
Ariely serves as a good starting point to initiate the study and accentuate the need for the field of behavioral economics. Clearly we can expect some interesting developments in this field which will change classical economics. But my question is: hasn’t all this been anticipated in the texts of Austrian economics, such as Human Action?
But are we really that rational? Vishal Khandelwal (of Safal Niveshak fame) states: “…[W]e are rationalizing beings. We make emotional decisions and then try to rationalize the same with logic”.
Dan Ariely, a behavioral economist at Duke University, in his book Predictably Irrational (2008) goes a step further. He says we are all inherently irrational. Not only that, this irrationality can be consistently and systematically brought out in controlled experiments. That is, our irrationality is predictable.
Ariely states in the Introduction: “In conventional economics, the assumption that we are all rational implies that, in everyday life, we compute the values of all options we face and then follow the best possible route.” But that is not the way real life works.
Consider an example countering the classical notion of supply and demand. Ariely narrates how an Italian diamond dealer, James Assael, created a new market for Tahitian black pearls. Initially there was very little demand for black pearls. Solely by clever marketing and positioning the black pearls in prestigious storefronts, the pearls “were soon parading through Manhattan on the arched necks of the city’s most prosperous divas.” This was because Assael had “anchored” his pearls to the finest gems in the world with prices following after. A similar case is made for Starbucks coffee – which is far more expensive than Dunkin’ Donuts coffee. Clearly these examples strike at the heart of the argument that prices are established by striking an equilibrium between supply and demand.
Ariely gives several examples of controlled experiments were irrational behavior was discovered and established. As he writes, "Our irrational behaviors are neither random nor senseless – they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains. So wouldn’t it make sense to modify standard economics and move away from naïve psychology, which often fails the tests of reason, introspection, and – most important – empirical scrutiny?"
Ariely serves as a good starting point to initiate the study and accentuate the need for the field of behavioral economics. Clearly we can expect some interesting developments in this field which will change classical economics. But my question is: hasn’t all this been anticipated in the texts of Austrian economics, such as Human Action?
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