The Fallacy of Irrational Action from Richard Thaler

It’s been dry lately, and busy. It’s been a combination of being super busy, a string of shows that aren’t particularly controversial, and a bit of writer’s block. It’s been one of these constantly, every time I sit down to write. Well, one of the latter two when I do sit down to write, and then for the days where I don’t get that far it’s from being so busy and exhausted.

I’m here now and I have found time to read quite a bit lately. I looked into behavioral economics, a school of thought that Jason talked about a long long time ago. It’s interesting. I’m not sure all of it is really economics, either by Sowell’s definition or by the Misessian definition, but much of it does seem plausible. There are some very basic and fundamental problems with behavioral economics. Since the show hasn’t been giving me a lot of material lately- or what material there is, is either out dated or purely political- I’m going to take on Richard Thaler.

In his book, “Misbehaving” Thaler attacks one of the fundamentals of economics, as it has been known since the late 1800s. Thaler takes pride in demolishing “homo-economicus.” That is the “old” notion that men base all their actions according to calculations regarding their own value scale, opportunity costs, values, costs vs profits, and their time preferences, and assessments of the probability of varying unknown future events. In other words, men act rationally and are self-interested.

The Austrian School teaches that all men act, and that the purpose of each act is to relieve a felt sense of uneasiness. Or, to put it another way, each act aims at exchanging the actor’s current condition for a better condition. It is purposeful action that employs means to attain ends.

Furthermore, there is a logical structure of the mind, so that individuals prefer some things to others, our limitations of time and resources create the necessity for us to prioritize how we spend our time and resources. This leads to what is referred to as a value scale.

Individuals organize their desires in a linear sort of way, a man prefers A to B, and B to C, and C to D, and so on. Not that every person writes all this out in long hand, but merely that this is how we operate, this is how we must operate. We must act and each act precludes other acts. So that on a given afternoon you must make a choice between taking a walk or going to a movie, or going fishing. If you choose to do any of those, it is proof you prefer that activity more than the other possible activities.

Thaler presents some challenges to this notion, one being how people would respond to the different scenarios. For instance if given two choices: A, where you are guaranteed to win $100, and B, where you have a 50% chance of winning $200 and a 50% chance of winning nothing, most folks chose the sure thing. When presented with a second choice: A, a sure loss of $100, or B, a 50% chance of losing $200 and a 50% chance of losing nothing, most people take the gamble.

In each case it was just about 2 to 1.  But this isn’t really the realm of economics at all. The main point of this study is trying to understand how people make their choices, not a study of human action.

Somewhere in that book he presents a problem that actually had me questioning the whole notion of a value scale for about 5 minutes. He mentioned two guys who won tickets to a game. One man sold the tickets for $1,000. The other man went to the game. Neither could understand the logic of what the other was doing. Clearly an example of subjective value theory at work.

Consider this: suppose “YOUR TEAM” is going to the Super Bowl. You enter a raffle at work or at the local chamber of commerce or whatever and you win! Now you have two choices: you go or you don’t go and you sell the tickets for $2,000. For the sake of argument, let’s pretend there is no travel expenses, just suppose the Super Bowl is in your home town… Now, what do you do? If you go, it clearly demonstrates you prefer attending the game over $2,000. But suppose you don’t win any tickets. You can either buy the tickets for $2,000 and go, or you can not spend the money and watch it on T.V. In this case, if you don’t go it is because you prefer $2,000 to attending the game.

It seems plausible that this could happen, but how could this fit into that neat Misessian/Rothbardian value scale?  I put the book down and began to question how this could be. How can a person prefer A to B and at the same time prefer B to A? I considered if this were my situation, If I could go to the Super Bowl for free, why I would go, and why I wouldn’t go if my team did go to the Super Bowl but I had to buy the ticket.

I began to think over the fundamental premises of economics. Men use means to attain ends. Each act is intended to exchange one’s current condition for a more desirable condition. And that was it, in a flash, it made perfect sense.

Before the tickets are acquired, my condition is $X in the bank. After the tickets are acquired, I either have $X in the bank and the tickets. If I won the tickets, or $X-$2,000 if I had to buy the tickets. And, of course, $X+$2,000 if I decide to sell the tickets. Depending on what that $X is, my choice would be different. If $X=$500, I’m selling the tickets if I win them and I will not buy them if I don’t win them, obviously.  If $X=$1500 I may go to the game if I win the tickets, but I will not buy them if I don’t win them. And if $X=$6,000 I  will buy the tickets if I do not win them.

Now that’s perfectly logical and reasonable. There are actually 3 sets of value scales, not one.

1. $6,000 and tickets
2. $4,000 and tickets

1. $1,500 and tickets
2. $1,500 and no tickets

1. $2,500 (after selling tickets that were won)
2. $500 and no tickets.

Maybe the Austrians do have some cracks somewhere, but not here. Men do use reason (many times flawed). Men plan, quite imperfectly sometimes, and men do act in order to better their condition, even if they regret their actions later and their condition is actually worsened.

I do think we are homo economicus, but that doesn’t mean we are always right, or that we don’t make gross errors in our calculations. But, all the theory of homo economicus states is that we do make calculations.