Is Experimental Economics Irrational?

Everybody knows there’s no such thing as money. So how come everybody acts like it’s real?

In particular, why do economists and other similar creatures find the lack of “rationality” curious when reviewing the transactions, and game-theory simulations of transactions, between real people?

There do exist bits of shiny metal, certain organic byproducts, and slips of paper that are called “money.” But these objects have no intrinsic value. Money is a concept, not a thing. It is a proxy for agreements between people, a mechanism to ease the trading of things that do have value.

Like I said, everybody knows this. So why has it been so difficult—why did it take so long—to see the logical consequences of this truth? Why, that is, is there the consternation over the lack of “rationality” when it comes to theories of money.

Use an example of buying a six-pack of beer from a bodega in New York City. Not some homeopathic brew like Coors Light. Real beer, like Brooklyn Brewery’s IPA.

The Korean lady in charge can announce that the beer is “Regular price $10; Today 10% off” or she can say “Regular price $8, plus New York City health tax surcharge of $1.” (This example is not fictional: NYC is always pegging up its sin taxes.)

Which would you prefer? According to classic economic and game theories, you’re not supposed to have a preference. Any deviation from indifference is considered “irrational” because, either way, you’re out nine bucks. Either way gets you the six-pack.

But nobody buys just a six-pack. You don’t “buy” anything, actually. You make an agreement between you and the shopkeeper; or, more realistically, between you and your crew of family and friends against the shopkeeper and her organization.

Your contract negotiations are short; much is agreed upon before you walk into the store. When our lady offers the beer for $1 less than usual, there is at least the appearance that she is giving a gift. What I receive is the beer, plus the good feeling that I am being treated nicely.

As all marketers know, I am negotiating for both the beer and the experience of buying it. Management with experience in negotiating with unions know experience counts. What often becomes a sticking point in these, obviously more formal, negotiations is not money but respect.

A union will sometimes accept fewer dollars in return for more autonomy, or better toilets, or anything that awards its members more esteem from the suits. This makes sense—it is rational—because the non-economist union members know that money isn’t everything.

Lack of respect—between me and my rapacious government—is why I would be in a bad mood after shelling out eight bucks for beer plus yet another one for tax.

That extra dollar might be so irksome that I am willing to take a car to Jersey—New Jersey!—to give my $8 to a different family-owned organization. I’d pay more money for this, but I’d receive the additional experience of being able to shop for beer and wine simultaneously; an experience New York State forbids. (Oh, yes.)

Over the past decade, the field of “experimental economics” has grown fat. It’s the same old economics, but married to the more practical mathematics of game theory, with the addition of college students corralled into prisoner’s dilemmas.

It was from these fields that economists are finally accepting that money isn’t real. Only they don’t put it that way. The say, in wonderment, that “man is not rational”—by which they mean that we don’t function as if money were real.

They carry out various simulations and discover, like our example above, that the “optimal” solution is often neglected for an “irrational” one. But “optimal” means quantitatively optimal given that money is real.

We’ll have to talk more about this, but these experiments suffer from an irremovable fault. Since money is not real, and since our economic transactions are really just negotiations and agreements, then the experimenters can never remove themselves from the experiment. They are just as much a part of it as the volunteers are.

Those volunteers will, of course, react differently to different experimenters. The hope is that the differences in oddities, irascibilities, quirks, and other weirdnesses of these volunteer-experimenter interactions will even out somehow. This is a matter of faith, and misplaced faith at that.

Even when they recognize this, it will difficult to shake economists loose from money. It’s so quantitative! It can be p-valued, plotted and pie-charted, set into percentages. Mostly, it can be modeled with soothing mathematics.

But how do you quantify my willingness to drive to Jersey to avoid a tax, or a student’s distraction due to the “teacher pants” the experimental economist wears to the game?

You cannot. So—once more: everybody all together now—in the end, the conclusions will be too certain, too sure.

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The idea of this post came from Karl Sigmund’s interesting review of Herbert Gintis’s The Bounds of Reason: Game Theory and the Unification of the Behavioral Sciences. Linked on—where else?—Arts & Letters Daily.

15 Comments

  1. It seems this type of commentary recurs with swiss clockwork precision in a variety of academic & other formums.

    Its not that humans are or are not “rational” — economists choose such forensically stale models because they are quantifiable and repeatable per the assumtions & conditions made.

    But its what humans ARE that matters — emotional, social animals that weigh & value personal feelings (disguised as likes, tastes, etc) to a significant degree, but seldom consistently over time. Which is to say that rewards/payment/rents [economist’s term] need to include certain emotional factors.

    Modeling psychiatry or psychiatry, which describe human nature, is very difficult [extraordinarily so] and not at all intuitive unless one has studied the underlying factors in depth. That’s also stuff from an entirely different, independent, academic discipline (and we know how poorly academia collaborates across disciplines).

    So what is really going on is that economists make the easiest assumptions, fabricate a model that fails to capture real-world human nature decision-making processes, then blame people (the real world) for being “irrational” for not behaving like their model.

    There ARE some good economic models, or other means of accounting for, or at least observing pattterns regarding, human nature:

    http://www.amazon.com/Misbehavior-Markets-Fractal-Financial-Turbulence/dp/0465043577/ref=pd_sim_b_1

    http://www.amazon.com/Where-Customers-Yachts-Street-Marketplace/dp/0471119784

    The CLASSICs:

    http://www.amazon.com/Extraordinary-Popular-Delusions-Madness-Crowds/dp/051788433X

    http://www.amazon.com/Random-Walk-Down-Wall-Street/dp/0393315290

    And individual rewards & motives & how they affect larger issues:

    http://www.amazon.com/Blood-Street-Sensational-Generation-Investors/dp/0743250230

    http://www.amazon.com/Liars-Poker-Rising-Through-Wreckage/dp/0140143459

  2. When done right (and there are lots of examples of it not being done right) Marketing is about changing the nature of the transaction to include more “intangibles” in exchange for more “money”. Good marketing folks understand, at least at an instinct level, that money is not real. And that revelation is very empowering – if you can alter the nature of the transaction, even if it costs you “money” now, in a way that creates a deeper relationship then you will gain more in the long run.

    And that’s the other part about these economic views of rationality. They tend to view each transaction as distinct, rather than as part of a coherent and rational whole based on our desire to have relationships and not monetary transactions.

    Good stuff. Keep up the great work.

  3. Excellent piece, I would enjoy reading more on this from you Mr. Briggs.

    Economics has become increasingly mathematical in the last fifty years. This is not in and of itself bad, however it has led to a tendency for some to ignore non-pecuniary costs and benefits of a given transaction for the simple reason that they are very difficult to measure, much less squeeze into a differential equation. Unmeasurable and zero are not interchangeable terms, and when they are treated as such we “observe” irrationality, where in fact we are seeing the effects of something that cannot be directly measured. The assumption of rational individuals in economics is part of the foundation of the presumption of superiority that freedom enjoys over tyranny in western civilization. Once we show that people are systematically irrational, it is a small step to justify coercive supervision of individuals by an enlightened authority.

    An inherent problem with most of the experiments that I have seen is that they involve a trivial amount of money. As the size of the financial incentive approaches zero, more and more “irrational” behavior becomes evident. My strategy when playing penny-ante poker is very different than it is in a game where the ante is ten bucks. This is evidence of rationality not irrationality. I want to play in every hand if I am doing it for amusement.

  4. How much am I willing to pay for a six-pack of beer? That beer may have $20 dollars value to me, but I wouldn’t pay more than $8, if I thought I could get it elsewhere cheaper. So, is this economist, who is measuring my willingness to pay for beer, measuring my rational ability to judge if I want the beer, or is he measuring my skill of negotiation? If I am negotiating with limited information, that price anchor may be the only information I have. And, my decision to walk away, may have nothing to do with my rational efforts to satisfy my desires.

    Reading through the linked article, Sigmund discusses several flavors of the prisoner’s dilemma to point to “irrational behavior.” Classically, the prisoner’s dilemma gives the players the choice to rat-out their accomplice for a lighter sentence. Each player knows that his accomplice is in another room getting the same deal. The “rational” decision is to rat. However, this assumes that the game ends there, and there are no further repercussions to the players. If there is a possibility that a player will be in this situation again, then it makes sense to cooperate.

    I don’t think that any economic theory requires all actors to be rational. It is obvious that all people behave irrationally from time-to-time and some frequently. The theories hold if the marginal actor is rational.

  5. Economics is irrational in a society where the vast majority of consumption is based on wants rather then needs.

  6. Harrywr2,

    Quite the opposite, economics does quite well with elastic desires than inelastic needs, or, for that matter, rights.

  7. This planet has – or rather had – a problem, which was this:
    most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movements of small green pieces of paper, which is odd because on the whole it wasn’t the small green pieces of paper that were unhappy.’

    Douglas Adams.

  8. I wonder, did the economists that believed in ‘rational actors’ in the market never behave irrationally in a deal? Or were they so unselfconcious that they didn’t notice? Or perhaps they noticed, knew that all actors in a deal were likely to behave in strange ways, but daren’t point this out as a) It was against the ‘consensus’ and might cost them funding and tenure, and b) It would screw up all their pretty theories.

  9. I’m sure this is an interesting post – it started out with great promise – but I began daydreaming at “IPA”, and never really made it back. I’ll try again tomorrow.

    Happy Friday to everyone!

  10. Money might not be the best thing in the world but on the whole it beats whatever comes in first place.

  11. Chris Riley,

    Very well said. Reminds me of a lottery example, to show you how “expected values” are largely meaningless.

    Lottery has probability of a payout p. Winnings are w. Expected value is p * w, right? Now, wouldn’t any merchant be happy to take your ticket (before the drawing, of course) for an item that costs less then p * w? If he were “rational” in terms of money-as-real, then he should.

    The solution is to say that people’s utilities are non-linear in money. Ain’t that the truth. I say they are more than one-dimensional.

    Because I would guess that no matter how large w is, for small p (like all major lotteries like MegaBall), no merchant would accept the ticket unless the merchandise would be in the penny-ante range, as you suggested.

  12. Well, not really. The food emporium just started selling their version of Pommeroy’s Plonk next to the beer & chips.

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