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October 17, 2004

Behavioral Economics

I recently blogged on the Trust Game or Investment Game. J. O.N. refers me to this Newsweek article on it. Some people in "behavioral economics" like to say that people are not economically rational. What I think is more correct is to say that people do try to maximize utility but 1. People make a lot of dumb mistakes, and 2. People have moral preferences as well as material ones.

Why trust someone to whose material advantage it is to take your money and return you nothing? It could be a dumb mistake-- not realizing that they could take advantage of you. That's why investment scams work. Or it could be that you are relying on the fact that most people are moral, to at least a small extent, and would feel guilty if they did not return anything to you. Sometimes the gamble will work out, sometimes it won't.

There's nothing in economics that says all preferences have to be for material consumption. In fact, that would be a hard position to make coherent, since what we really consume are particular sensory outputs of material objects (think of the old Kelvin Lancaster idea of utility over characteristics, used in hedonic regressions of how valuable a car is in terms of speed, acceleration, roominess, etc.) It is no more objectively rational to pay a $100 to hear some music waft across a concert hall than to pay $100 to go to the concert hall to impress someone else with my good taste, or to pay the $100 to subsidize musicians because I like them. And, getting back to mistakes, I and everyone else might have paid the $100 thinking I'd hear nice melodies but we get Schoenberg instead, and regret it.

The biggest ideas in economics are, I think, markets, incentives, and efficiency. All these apply to situations where there are mistakes and nonmaterial preferences. Raise the price of an activity, and people will do less of it is the usual rule, and a very powerful idea. That applies to all the concert examples above-- if I have to pay $200 to get teh same effect (including to benefit musicians by $100), I may well decide not to go to the concert.

Posted by erasmuse at October 17, 2004 04:11 PM

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