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The Marketplace of Perceptions

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For a modern view of economics an interesting article was published called The Marketplace of Perceptions.

Like all revolutions in thought, this one began with anomalies, strange facts, odd observations that the prevailing wisdom could not explain. Casino gamblers, for instance, are willing to keep betting even while expecting to lose. People say they want to save for retirement, eat better, start exercising, quit smoking—and they mean it—but they do no such things. Victims who feel they’ve been treated poorly exact their revenge, though doing so hurts their own interests.

Such perverse facts are a direct affront to the standard model of the human actor—Economic Man—that classical and neoclassical economics have used as a foundation for decades, if not centuries. Economic Man makes logical, rational, self-interested decisions that weigh costs against benefits and maximize value and profit to himself. Economic Man is an intelligent, analytic, selfish creature who has perfect self-regulation in pursuit of his future goals and is unswayed by bodily states and feelings. And Economic Man is a marvelously convenient pawn for building academic theories. But Economic Man has one fatal flaw: he does not exist.

When we turn to actual human beings, we find, instead of robot-like logic, all manner of irrational, self-sabotaging, and even altruistic behavior. This is such a routine observation that it has been made for centuries; indeed, Adam Smith “saw psychology as a part of decision-making,” says assistant professor of business administration Nava Ashraf. “He saw a conflict between the passions and the impartial spectator.”

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As with most movements, there were early adopters. “In the 1980s the best economists in the world were seeing the evidence and adopting it [behavioral economics],” Bazerman says. “Mediocre economists follow slowly—they continued to ignore it so they could continue doing their work undisturbed.”

To be fair, the naysayers would have agreed that the rational model only approximates human cognition—“just as Newtonian physics is an approximation to Einstein’s physics,” Laibson explains. “Although there are differences, when walking along the surface of this planet, you’ll never encounter them. If I want to build a bridge, pass a car, or hit a baseball, Newtonian physics will suffice. But the psychologists said, ‘No, it’s not sufficient, we’re not just playing around at the margins, making small change. There are big behavioral regularities that include things like imperfect self-control and social preferences, as opposed to pure selfishness. We care about people outside our families and give up resources to help them—those affected by Hurricane Katrina, for example.”

The article concludes

“Then, the model of the market is not simply buyers and sellers coming together for mutually beneficial exchange,” Wanner continues. “Instead, the exchange between buyers and sellers has aspects of a zero-sum game. The seller can do even better if he sells you something you don’t need, or gets you to buy more than you need, and pay a higher price for it.” The classical welfare theorem of Vilfredo Pareto was that markets will make everyone as well off as they can be, that the market distribution will be an efficient distribution that maximizes welfare. “But once you introduce framing, all bets are off,” Wanner says. A zero-sum game between buyer and seller clearly does not maximize everyone’s welfare, and hence suggests a different model of the marketplace.

There are many political implications. We have had 30 years of deregulation in the United States, freeing up markets to work their magic. “Is that generally welfare-enhancing, or not?” Wanner asks. “Framing can call that into question. Everyone agrees that there’s informational asymmetry—so we have laws that ensure drugs are tested, and truth-in-advertising laws. Still, there are subtle things about framing choices that are deceptive, though not inaccurate. We have the power of markets, but they are places where naive participants lose money. How do we manage markets so that the framing problem can be acknowledged and controlled? It’s an essential question in a time of rising inequality, when the well-educated are doing better and the poorly educated doing worse.”

It’s a question that behavioral economics raises, and, with luck, may also be able to address. The eclipse of hyper-rational Economic Man opens the way for a richer and more realistic model of the human being in the marketplace, where the brain, with all its ancient instincts and vulnerabilities, can be both predator and prey. Our irrationalities, our emotional hot-buttons, are likely to persist, but knowing what they are may allow us to account for them and even, like Odysseus, outwit temptation. The models of behavioral economics could help design a society with more compassion for creatures whose strengths and weaknesses evolved in much simpler conditions. After all, “The world we live in,” Laibson says, “is an institutional response to our biology.”

If this is how modern economics theory is developing, is it any wonder that there is no understanding of free market economics in our society.

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If this is how modern economics theory is developing, is it any wonder that there is no understanding of free market economics in our society.

I have somewhat of an amateur interest in economics and have my own ideas about that article and the things it discusses. But I'd like to know specifically what about it you find discouraging, if you care to share. :)

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If this is how modern economics theory is developing, is it any wonder that there is no understanding of free market economics in our society.

Like Aurelia, I'm not sure what you find unattractive about this article. I have my own opinions about the article.

The economists who developed this so-called "behavioural economics" did notice a legitamate complaint about the standard line that economists may predict the behaviour of a man as rational. Where they went wrong is in identifying the correct perscription to the problem. Instead of saying "wait a second, maybe we can't predict humans, after all they do have free will" they took this as all statisticians would take it: a lack of information. So, now we have some even more complicated mathematical model that supposedly tells anybody with the ability to decipher the runes how man will act.

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Here's my brief analysis of the article.

The article in general leaves undefined what it considers the problem that economics is supposed to solve. It jumps immediately in with an array of examples (gambling, eating disorders, difficulty saving, victims seeking revenge) setting the stage for its thesis: that man acts irrationally and standard economics does not explain these things.

The article then talks about "Economic Man makes logical, rational, self-interested decisions that weigh costs against benefits and maximize value and profit to himself. Economic Man is an intelligent, analytic, selfish creature who has perfect self-regulation in pursuit of his future goals and is unswayed by bodily states and feelings." Which economists have ever held this view? Why no citations? "And Economic Man is a marvelously convenient pawn for building academic theories. But Economic Man has one fatal flaw: he does not exist." This simply means that they haven’t defined the concept properly, i.e., it’s a straw man. The article continues, "When we turn to actual human beings, we find, instead of robot-like logic, all manner of irrational, self-sabotaging, and even altruistic behavior." So, using logic is for robots?

"Nonetheless, neoclassical economics sidelined … psychological insights." And who held this view? No answer. "Two non-economists have won Nobel Prizes in economics. As early as the 1940s, Herbert Simon of Carnegie Mellon University put forward the concept of 'bounded rationality,' arguing that rational thought alone did not explain human decision-making." Which economists held only rational thought explain human decision-making?

Skipping down to Marketing Prudence, "insights can also be writ large. Laibson’s former student Nava Ashraf, who has worked extensively with non-governmental organizations, is now applying behavioral economics to interventions in developing countries." In other words, she’s manipulating people to act in a way that she prefers as indicated here. "She lived for a year in Ivory Coast and Cameroon, where she 'noticed that farmers and small-business owners were often not doing the things that a development policymaker or economist thinks they should do,' she says. 'They wouldn’t take up technologies that would increase agricultural yield, for example. They wouldn’t get vaccines, even though they were free!" Oh my! In other words, - they won’t listen to me!! "They also had a lot of trouble saving. In January they had a lot of money and would spend it on feasts and special clothes, but in June their children would be starving." In other words, their values were different than hers and Ashraf wants to change that. She finally admits the goals of behavioral economics: “ 'We can use what marketing people have known all along,' Ashraf says. 'There are ways of manipulating people’s psychological frameworks to get them to buy things.' "

Later, Mullainathan states "we tend to think people are driven by purposeful choices," [hmmm, I wonder what was driving this investigator] "he explains. 'We think big things drive big behaviors: if people don’t go to school, we think they don’t like school. Instead, most behaviors are driven by the moment. They aren’t purposeful, thought-out choices. That’s an illusion we have about others.' " Is this article an example?

Finally, the leitmotif of the article concludes, "There are many political implications. We have had 30 years of deregulation in the United States, freeing up markets to work their magic. 'Is that generally welfare-enhancing, or not?' Wanner asks. 'Framing can call that into question. [Which means if we just put in a context that fits where we want to go.] Everyone agrees that there’s informational asymmetry—so we have laws that ensure drugs are tested, and truth-in-advertising laws. Still, there are subtle things about framing choices that are deceptive, though not inaccurate. We have the power of markets, but they are places where naive participants lose money. How do we manage markets so that the framing problem can be acknowledged and controlled? [by whom, blank out] It’s an essential question in a time of rising inequality, when the well-educated are doing better and the poorly educated doing worse.'

"It’s a question that behavioral economics raises, and, with luck, may also be able to address. The eclipse of hyper-rational Economic Man opens the way for a richer and more realistic model of the human being in the marketplace, where the brain, with all its ancient instincts and vulnerabilities, can be both predator and prey." [Their view of man’s nature is finally stated.] "Our irrationalities, our emotional hot-buttons, are likely to persist, but knowing what they are may allow us to account for them and even, like Odysseus, outwit temptation. The models of behavioral economics could help design a society with more compassion for creatures whose strengths and weaknesses evolved in much simpler conditions. After all, 'The world we live in,' Laibson says, 'is an institutional response to our biology.' "

So, to summarize, it is our irrationalities that work in the marketplace where reason is impotent. We are all weak creatures that evolved for simpler conditions. There is no difference between the metaphyical and the man-made: our institutions reflect our biology. Why? Because Kant and Marx said so.

All [brackets] and bold are mine.

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Thank you, Paul's Here, for sharing your analysis. It helped me to identify something about my own understanding of economics.

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Thank you, Paul's Here, for sharing your analysis. It helped me to identify something about my own understanding of economics.

Care to share what that "something" is?

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Care to share what that "something" is?

Sure! :)

It's that I actually know very little of what traditional economists say. Most of what I know is based on discussion with friends and my own observation, and thinking; but I hadn't realized before how very ignorant I am of standard economic theory.

I understand very easily why Economic Man is a Ptolemaic fallacy [that is, constructing a self-sufficient system that has nothing to do with reality]. Humans are volitional and as such aren't automatically rational. But you're right, he doesn't give any evidence, cite any economists, that this is the basis for their theories. Either way, it's bad writing on the author's part.

Mostly I take issue with where behavioural economists go with that observation. Like being rational or irrational are both in man's nature so if they can just figure out the right proportions they can predict what men will decide and how to exploit those decisions; without recognizing that it is an individual choice and statistics only tell you what has been decided.

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Most of what I know is based on discussion with friends and my own observation, and thinking; but I hadn't realized before how very ignorant I am of standard economic theory.

I always recommend an old classic, Henry Hazlett's Economics in One Lesson, brief but illuminating, especially at explaining some commonly held economic fallacies.

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I always recommend an old classic, Henry Hazlett's Economics in One Lesson, brief but illuminating, especially at explaining some commonly held economic fallacies.

I second this recommendation. Too bad it's not a MUST for high school graduation!

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Sure! :)

It's that I actually know very little of what traditional economists say. Most of what I know is based on discussion with friends and my own observation, and thinking; but I hadn't realized before how very ignorant I am of standard economic theory.

I'm not sure what 'standard economic theory' means. I'd suggest you begin your study of economics by studying free market economics. The books below are short, easy to read, and are classics when it comes to explaining how the market works and why government intervention doesn't.

These are the best introductions to economics, read Hazlitt's Economics in One Lesson, and von Mises' Planned Chaos and Planning for Freedom.

I understand very easily why Economic Man is a Ptolemaic fallacy [that is, constructing a self-sufficient system that has nothing to do with reality]. Humans are volitional and as such aren't automatically rational. But you're right, he doesn't give any evidence, cite any economists, that this is the basis for their theories. Either way, it's bad writing on the author's part.

Mostly I take issue with where behavioural economists go with that observation. Like being rational or irrational are both in man's nature so if they can just figure out the right proportions they can predict what men will decide and how to exploit those decisions; without recognizing that it is an individual choice and statistics only tell you what has been decided.

I don't want to take issue with behavioral economics as a subject, since I'm not familiar with it. There may be some values in some observations, but the article above was really poor, in my opinion.

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Thanks a bunch, Philip and Paul's Here. Now that school's out I have lots of time to plan intellectual projects that have been on the back-burner, like learning a little economics. I'm building myself a little liber legendus [books to be studied] and this helps.

I'm not sure what 'standard economic theory' means.

I meant it in the sense of the type of things one learns in an economics course; the general consensus among economists and to whom/where those theories are attributed.

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Thanks a bunch, Philip and Paul's Here. Now that school's out I have lots of time to plan intellectual projects that have been on the back-burner, like learning a little economics. I'm building myself a little liber legendus [books to be studied] and this helps.

Your welcome.

I meant it in the sense of the type of things one learns in an economics course; the general consensus among economists and to whom/where those theories are attributed.

Well, the first thing to learn is that the consensus of modern economics in universities is almost all of the statist / mixed economy / status quo persuation. You really have to self-study in economics to learn how the free market works.

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