Saturday, September 5, 2009

Rationality and Economics

John Kay of the Financial Times has a good piece on economics and rationality. Economists tend to think of rationality as consistent decision making - although that is not the only way rationality is defined, but if you asked an typical economist, that is the answer you would most likely get. (Remember - we're talking about economists).

What Kay argues is that rationality should be defined such that it leads to wise decision making, or as an economist rationality should lead to making people better off. I am not opposed to such an idea. Yet one must remember that economics is really about market behavior and not exactly about individual behavior. Yes, individuals act in markets, but some of the bizarre individual behavior may be washed out when looking at market behavior. So if I value shiny pennies more than shiny nickels, someone will be willing to trade me a shiny penny for a shiny nickel. I will be unable to keep this up indefinitely, and thus drop out of the market - with some shiny pennies.

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