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Irrationality

• Evan Davis
• 12 Feb 07, 11:45 AM

Evan's reading list

Irrationality by .

This is a classic book, and it鈥檚 great to see it is being re-published this month, nine years after the author himself died.

The book simply documents some of the common quirks of human behaviour that can be described as 鈥渋rrational鈥�.

It鈥檚 full of short examples of psychological tests and their implications, and it is an especially good read for economists who tend to assume that people behave according to some simple precepts of rationality.

So here鈥檚 an interesting but familiar example: the sunk cost error (outlined on page 71).

You visit the theatre but have forgotten your 拢15 ticket. The box office refuses to replace your ticket, but as the theatre isn鈥檛 full, offers to sell you another one for 拢15. Should you buy it?

The rational answer is probably yes. If the play was worth 拢15 before you visited the theatre, it is surely still worth 拢15 and so if the choice is whether you watch the play for a 拢15 sacrifice, consistency demands you should choose to watch the play and thus buy the second ticket.

You should treat the forgotten ticket as a sunk cost - it鈥檚 gone whatever action you take now, and so is irrelevant to the choice of how much you pay and whether you see the play.

But - as has commonly been observed - people don鈥檛 always follow this logic. They reason that the play is costing them 拢30, the price of two tickets, and if it isn鈥檛 worth that much, they choose not to buy the second ticket.

As the Sutherland book notes, this kind of mistaken thinking has far more significant consequences than missed theatre plays. Generals persist in following failing strategies, investors hang on to falling shares, waiting to recoup their losses.

Sutherland鈥檚 book is packed with many, many different types of irrationality, and by alerting us to common forms of misguided reasoning, it arms with some protection against our own predictable errors.

But if the book persuasively demonstrates that we do make systematic mistakes, does it debunk the whole subject of economics, a science that seems to rely on rational economic man?

The answer of course is no. The point of the assumption of rationality in economics is not that it is accurate. Of course not. The reason we make the assumption is that it makes life easier鈥� it simplifies our understanding of the choices we make.

The assumption of rationality in economics is like the map of the London Underground: it strips out the complexity of the system, to illuminate the essence of it.

Of course, in practice we err, but it鈥檚 still useful to know what we would do if we were rational.

And then we can read books like Stuart Sutherland鈥檚 to understand some of the ways life is in truth more complicated. Just we look at proper street maps once we鈥檝e navigated our way round the Tube system.

Irrationality, Stuart Sutherland.
Pinter&Martin 拢8.99

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