Are People Rational?

 

    

Let’s ignore the snarky answer to the title question …

 

People are rational when they agree with you and irrational when they don’t agree with you.

    

The italicized sentence is obviously nonsense.

    

However, people live and act as if the italicized sentence was true.

    

Let’s move to a deeper level of consideration without assuming that anyone whose religion or politics is different than our own must be a fool.

    

There is a whole field of study called behavioral economics that tests the degree to which people make rational decisions. That literature finds that people make the same sort of systematic mistakes over and over again.

   

One example is that they are loss averse. Consider the following lab experiment:

Scenario A:

The Experimenter Gives the Subject a Dollar.

The Experimenter Offers the Subject The Following Deal:

We Flip a Coin.

Heads - You Double Your Money and Get an Extra Dollar.

Tails - I Take Your Dollar Away.

    

Scenario B:

The Experimenter Takes a Dollar Away from the Subject..

The Experimenter Offers the Subject the Following Deal:

We Flip a Coin.

Heads – You Get Your Dollar Back.

Tails - I Take An Extra Dollar Away From You.

    

The two bets are mathematically exactly the same. The experimenter is offering you a $2 bet on a 50-50 coin flip. However, most subjects choose not to take the bet in Scenario A but do take the bet in Scenario B.

    

They have just won a dollar in Scenario A and don’t want to lose it. They have just lost a dollar in Scenario B and want to regain what they have lost.

There is a similar phenomenon that occurs with auctions. In the heat of bidding to “win” an auction, many people end up paying more than the prize is worth. The thrill of victory obscures rational thinking about the actual value of the object they are trying to obtain.

   

Mistakes like these can be called calculating errors. The person knows exactly what they want to accomplish. They have all the information they need to do the job. However, even with everything they need at their disposal to make a rational decision, emotion pushes them to miscalculate the value of their choices and to choose something of questionable worth.

    

Calculating errors receive most of the attention in the behavioral economics literature. But these are not the primary causes of people behaving irrationally. There are two even larger forces that produce most of the whopper mistakes that we see in real life. The two larger forces are

1. Being Confused by Multiple Motives and

2. Choosing to Work with Incomplete Information

Let’s consider each in turn.

 

Multiple Motives

    

Rationality is easiest to achieve when there is one and only one thing that a person wants. In economics, this is generally money. In that world, people are profit maximizing.

    

(Actually, in the real world, people are profit maximizing too.)

   

But in the real world, people also want sex.

   

They also want love and respect.

    

They are also lazy and prefer not to work too hard. (Neoclassical economics actually allows for that one.)

    

If they are religious, they want a deep spiritual experience or the joy of following ritual.

    

If they are politically committed, they want their side to win.

   

The trouble is that many of these things are mutually inconsistent. You can’t go to religious services and have sex at the same time. You can’t make the maximum amount of money at work and also be out in the neighborhood leafleting.

    

Theoretically, the totally rational human is supposed to take all of the things they want into account and figure out the action that produces the highest benefit for all of them. Nobody really does this. It is almost impossible to weigh any decision simultaneously on its impact on your economic well-being, your personal life well-being, your religious well-being, etc., etc., etc.

    

So what people tend to do is “sequence” their pursuit of goals. They think of one goal at a time and act on it. They do that until some other goal is in such bad shape that it approaches crisis status. Then they work on correcting their situation with the second goal until some third goal is in such a mess that it requires attention. Then they move to the third goal, all the while blithely ignoring goals one, two, four and five. Most people manage multiple priorities not by being super organized but by running from crisis to crisis on particular goals without balancing their entire situation. You work at the office, until your spouse has a huge argument with you about how he or she is being ignored. So you spend more family time until you get on the scale and notice how fat you have gotten. So just for your health, you spend more time working out. Then you get the email from your boss about the coming evaluation on your next project. You realize how far behind you are and now it is back to fourteen hours a day at the office.

    

People are unable to multitask or even multi-think effectively. They can only deal with one thing at a time.  While they deal with that one thing, everything else gets neglected and is treated irrationally.

 

Incomplete Information

    

To act rationally, you have to have nearly perfect information. Are you going to buy a house? Well, does it have wood rot or not? How good is the wiring? What is going to happen to real estate prices in the neighborhood over time? And is there a better deal on a better house in a neighborhood where you forgot to look?

    

You met someone fantastic on a dating site? Well, is this person going to have weird ideas about child raising that are ultimately going to destroy your marriage? And is there someone else living in another building in your date’s apartment complex who actually would have been the perfect person for you?

   

Of course, you can’t live your life in analysis paralysis. There will always be something in the future that could affect the decision you make that you could have found with more researching but you didn’t. And there will always be more choices out there than the ones you are looking at now.

   

Finding out the information you need is time consuming and expensive. You can’t read every book on every subject, check every review on every website, or talk to every person you know about every subject. Imagine if every time you wanted to buy toilet paper, you went to every supermarket in a fifty mile radius to see who was offering your brand of toilet paper at what price. You would never have time to live the rest of your life.

   

You will never have full information on anything before you make any of your decisions in life. You will always stop researching before you learn everything you need to know.

    

But worse, your information search is biased. If you were just getting information randomly, the subsample of facts you get would roughly reflect the population of facts that are out there. So, you might not know “everything”, but what you know might be a good reflection of whatever information there is out there that you need to know.

    

If your search is biased rather than random, however, what you know is likely to be highly deceiving, because you are systematically missing a whole particular kind of fact.

    

What are the biases in people’s information searches?

a) People don’t like change. They try to make the same choice today that they made in the past. You drive a Mazda 3, but you need a new car? The first car you check out is another Mazda 3. You need a bigger house in Waltham, Massachusetts? Your first search is other houses in Waltham, Massachusetts. People miss improvements that would come if they chose to explore the more exotic options.

b) If they can’t match what they already had, then they copy the behavior of someone with high status who seems to be smart and successful.  A lot of behavior is mindless imitation. Everyone else is wearing blue jeans. So you wear blue jeans. Your company needs to upgrade its marketing? The top firm in your business advertises on game sites. So you advertise on game sites. Sometimes this makes a lot of sense, if the role models you are following have situations similar to yours. The decision is not so smart if your role model is different from you. Going to Paris on vacation seems to make sense if you like wine and the people you socialize with go to Paris. But Dublin might have been a better bet if you prefer a good pub crawl and Irish ales. 

c) Search is done sequentially. So the option you find out about first is disproportionately likely to be what you choose. You can’t consider all of the choices in the world at the same time. So you consider each option one at a time, only looking at Option Two if you reject Option One, only looking at Option Three if you reject Option Two. So if you are lucky, the best option just happens to be Option One. If not, you may have made your decision and gone off the market before you even got a better option

 

d) Given that search is done sequentially, people with agendas try to cut in line to have you consider their option first. You don’t think of buying a paper shredder until you bump into a saleswoman selling paper shredders. Because she is selling Brand Z paper shredders, you make a decision on Brand Z paper shredders before you consider any other viable option. Another example from the office: at the big meeting where the boss is introduced to Issue X for the first time, the speakers giving the PowerPoint presentation on Issue X, by going first, have completely framed the agenda in their favor. This puts them at a huge advantage relative to anyone else who has an alternative solution to the problem.

*  *  *

    

Does any of this mean people are totally irrational?

    

No, it does not.

    

Sometimes people do manage to balance alternative priorities and somehow get most of what they want.

    

Sometimes early options are good options and a degenerate information search is good enough.

    

More significantly, people are not terrible at fixing things when things go wrong. A bad first decision is not an absolute final decision. People take second spouses if the first one did not work out. They move houses if their first house choice had all sorts of non-obvious problems. People’s first version of many decisions is suboptimal. But by fixing things and adjusting things and letting practice make perfect, they stumble their way to an almost rational choice.

   

Of course, some decisions are one-way and you don’t get to take a mulligan. If you choose the wrong surgeon, you don’t get to undo the operation that leaves you facing years and years of permanent pain. The idiot teenager who does something flagrantly illegal in front of an undercover cop still has to spend the rest of his life covering up for eighteen months in juvenile detention.

    

So why do people choose stupid political opinions even when you can see clearly these are inconsistent with the facts?

1. They may have one motive to “be correct” but another motive to keep their friends happy.

 

2. The clearly “wrong” opinion was given to them early in their search process. They have come to their opinion and made up their mind. Your brilliant better approach simply came too late in the sequence to get accepted.

    

But don’t think you are any more rational than they are, or that you are exempt from calculating errors, mangling multiple motives or making decisions before all the information is in.

    

The only person exempt from all of those problems is me. 😈 😈 😈

For More Information

The framework of mixed motives and inadequate information given here is an adaptation of a similar scheme in Richard Cyert and James March’s Behavioral Theory of the Firm. They refer to motives as utilities or goals; they refer to the searching for information problem as the setting of expectations. Differences of jargon aside, my model is their model.

Richard Thaler’s Winner’s Curse is a wonderful review of some of the most important findings in behavioral economics, particularly in regard to calculation errors. Dan Ariely’s Predictably Irrational is another entertaining book of the same genre.