When most economists talk about the economy, they start from the assumption that people are calculators. If you want to understand how the economy works, they say, pretend that people are rational and that they have all the info they need to make a decision. Take a gazillion people making decisions in their rational self-interest, and you can put together a pretty decent picture of how the economy operates.
All models have to make assumptions to simplify the world. But when you start from an assumption that is obviously flat-out wrong, that’s a problem.
For example, how do you explain the multibillion-dollar industry of advertising? Does Budweiser spend millions on advertising filled with hot models and/or silly men because they think it’s a rational argument for buying their beer? Or maybe people buy Bud because they enjoy the commercials and are drinking Bud to subsidize making more commercials — sort of like supporting the arts.
And then there’s the financial world. After last year, does anyone really need convincing that what goes on in Wall Street isn’t entirely rational?
In the last few years, a small but growing band of researchers have argued we should stop pretending people are always rational and study how they actually make economic decisions. Go to a bookstore these days and you can find plenty of titles in the burgeoning field of “behavioral economics” — Predictably Irrational, How We Decide, and Nudge to name a few. These books are filled with real-world examples of how people make decisions using a mix of of rational calculations, unconscious cognitive biases, habit, and emotion. It seems like a hell of a better assumption on which to build a useful model of the economy.
