The Standard links to an interesting LA times article on loss aversion. Now loss aversion in itself is a very interesting issue, something Rauparaha may like to write about ;). However, my focus is going to fall on the same result that The Standard was interested in namely that people would rather earn $50k when everyone else earns $25k than earn $100k when everyone else earns $250k. The article calls people ‘irrational’ for doing this – but is this the case?
According to the Austrian economists at www.mises.org, rationality is “the use of the peculiarly human mental processes by which man strives to connect his ideas as consciously, coherently and purposively as possible in order to plan the attainment of ends sought”.
I’m happy with this definition, as it gets the idea across, and also illustrates how well those Austrian economists can write!
Sticking with this, I can see three ways that a ‘rational’ person will make this choice, even if they value ‘goods and services’ positively.
- If prices fully adjust, then your claim on goods and services depends on your relative income, not your absolute income,
- If prices are not different between the two cases, it is possible that you may value your relative position highly enough to allow the sacrifice in terms of goods and services – there is a trade-off here. Economics (in theory) does not presuppose what people value!
- Even if it would be the ex-post ‘best choice’ to pick the $100k, because for some wild reason prices have become unfathomably sticky, you may follow a rule of thumb that states ‘choose the income distribution that offers you the best wealth position’, as the prior probability of being in a position where prices are that sticky is so low.
In all three cases, the individuals choice is rational. I find the first one the most appealing – remember people don’t value ‘money’ they value the goods and services that they can purchase with money.