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Irrationality

  • Evan Davis
  • 12 Feb 07, 11:45 AM

Evan's reading list

Irrationality by Stuart Sutherland.

This is a classic book, and it’s 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 “irrational”.

It’s 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’s an interesting but familiar example: the sunk cost error (outlined on page 71).

You visit the theatre but have forgotten your £15 ticket. The box office refuses to replace your ticket, but as the theatre isn’t full, offers to sell you another one for £15. Should you buy it?

The rational answer is probably yes. If the play was worth £15 before you visited the theatre, it is surely still worth £15 and so if the choice is whether you watch the play for a £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’s 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’t always follow this logic. They reason that the play is costing them £30, the price of two tickets, and if it isn’t 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’s 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… 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’s still useful to know what we would do if we were rational.

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

Irrationality, Stuart Sutherland.
Pinter&Martin £8.99

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