Rationality and scope in economics

Whenever someone is busy attempting to have a heart-to-heart with me, I have one catch all statement I always pull out:

Hold yourself to a high standard that you can feel proud of, but never base your expectations or judgments of others on that standard

The usual resp0nse to this is “that’s f’ing obvious”, “no shit, do you think you’re adding anything”, and “congratulations you’ve made the obvious sound pretentious”.

Now this is fine, I agree that the point is obvious and not particularly exciting.  But at the same time this is one of the key reasons why economic theory builds up from basic rational expectations – and yet many of the same people that would call my advice overtly simply when looking at their daily life, would turn around and imply that this sort of assumption is inappropriate when trying to understand the tendencies in the world around us.

What are you saying?

When we assume people act “rationally”, we are assuming that individuals make choices based on the costs and benefits put in front of them.  As an individual I know I make choices, and those choices are on the back of my implied view on the costs and benefits of my actions, so using this view of the individual makes sense to me as a firm prior.

Now, when I look within myself I can see issues with my choices – but given that they are my choices I also know that I have the ability to change them.  Furthermore, my ability to recognise my own faults and poor choices, and still not change my choices, seems to imply that the cost of making “better choices” is seen as too high in my own eyes.  As a result, the policy I enforce often just lets me make my own choices.

In this context, when we look at other individuals we should be LESS judgmental of their choices.  We cannot observe the costs and benefits they face, we cannot determine their inner monologue for justifying and discussing choice, we have only a biased external view of how they think and feel.  Presuming that we can tell them what their choices should be is the height of arrogance, a belief in the supreme superiority of us above them – and assuming the direct irrationality (that they do not make choices based on costs and benefits) of people in this context just has no basis.

This is not to say that we can’t identify areas where individuals have biases, or may want help with choices.  We can look inside ourselves and observe present biases, addictions, and areas where we are short on information – however, this is no irrationality, but merely constraints to our own decision making.  Providing institutions that help individuals move past these biases is the right sort of solution – rather than prescribing choice.


Irrationality is the rally call of people who have a policy they want to put in place, and they need to find “a reason” to do it.  Everyone thinks that people around them are irrational, but a mere moment of introversion suggests that we are too quick to judge the actions of others – given our inability to look through their eyes, or feel the desires that drive their action.

Economic theory is based off the idea that individuals have the best understanding of their own minds, and that policy must be based off a clear market/institutional failure.

Calling for policy based on irrationality just plays on our prejudice against other people based on their “intelligence”, a perception that relies on poor information  is biased by our own desire to make ourselves feel more important in our own lives.

  • Kimble

    Lets see a +1 if you often get into unnecessary arguments with people because, when presented with a case of “obviously irrational” behaviour, you try to describe a reason why that behaviour might actually be rational!


  • Joe

    Just to test Kimble’s theory – how about ‘consensual cannibilism’? Are you prepared to concieve of that as rational?

    More broadly, I like the sentiment that we should be less judgemental of other’s choices than our own. It may be that rationality is the best default proxy for thinking about how people behave. But what of the (growing) litertature that suggests that individuals will be predictably irrational in a variety of ways? We struggle with inertia, loss aversion and all sorts of forms of cognitive biases, not to mention that our rationality is surely bounded at best?

    • Hi Joe,

      “Just to test Kimble’s theory – how about ‘consensual cannibilism’? Are you prepared to conceive of that as rational?”

      On the face of it yes.  Of course, it may be the case that the few people who do agree to this extreme transaction or in emotional or mental distress – if we can relate to that I can understand why we would prevent it.  However, the burden of proof is on the prevention.

      I think I covered similar sorts of issues when talking about Sweeny Todd and welfare principals.


      “But what of the (growing) litertature that suggests that individuals will be predictably irrational in a variety of ways? We struggle with inertia, loss aversion and all sorts of forms of cognitive biases, not to mention that our rationality is surely bounded at best?”

      Excellent point, and now I will be a bit more serious 😉

      I think that a lot of this literature, and introspection by individuals, illustrates that we are biased in certain ways – and that we recognise this, and try to come up with mechanisms to deal with it.

      In so far as policy is based upon these mechanisms, and can be viewed as a “social contract” to help us improve outcomes, it is fine.  However, to me this view fits into the scope of rationality – it just involves coming up with a fuller representation of what individual decision making entails.

      This is in contrast to how many people use irrationality – which is just to presume stupidity.  I am not convinced there is a basis for this type of assumption 😉


    • Kimble

      Hmm, I do think consensual cannibalism is rational when you know you are going to die anyway, and your meat could save lives (giggity).

      Perhaps you mean the arms length consensual cannibalism that was practised in the last few years by some Russian, German, or Skandi?

      More on topic; I reckon one of the best things to come from my tertiary education was a greater tendency to ask “what are my biases?” and to admit (at least to myself, outside the heat of prattle) “maybe I could be wrong”.

      I like to pay my lecturers the honour of having played some small, but not insignificant, role in making me the most awesomely humble person I am today.

      I think irrationality can exist, and I dont read the OP as saying any different. Only that very often when you see people (or politicians) assert the irrationality of others, they arent likely to be supported by reality.

      • Irrationality is such a weakly defined term, and I suspect the definition of “rationality” I use when describing economic models is a LOT more broad than the rationality definition people use when criticising said models 😀

  • Once we abandon rationality, cost benefit analysis anywhere becomes a nonsense – all economic notions of cost and benefit are grounded in subjective individual utility assessment. Doing cost-benefit analysis where benefits are based on how much the analyst thinks the subject should enjoy something, where the subject demonstrably behaves in ways inconsistent with the analyst’s assertion, is utter nonsense. 

    • It is assuming your own conclusion – it isn’t any sort of objective analysis.  100% agree with you here.

      • Exactly. It begs the question, in the proper usage of the term. Like BERL and Collins & Lapsley did. :>

        • As you know, I’m not going to blame the organisations for doing what they were asked to do – the issue stems from the fact that people felt these costs were policy relevant in of themselves in the first place.

          Economics in primary schools IMO.