“Proof” that people are rational
March 10th, 2009 | Published in Economics idea, Uncategorized
The economics definition of rationality says that if you prefer good A to good B and good B to good C, then you must prefer good A to good C. Your preferences need to be transitive, to use the mathematical term. A > B and B > C implies A > C.
If this isn’t the case, one of my economics profs argued when I was in school, you could be fleeced in the following way. Suppose good A is an apple, good B is an orange, and good C is a banana. Suppose that you would be willing to pay 5 cents to trade the fruit you have for the one you like better. If you prefer apples to oranges, oranges to bananas, and bananas to apples, I could keep trading fruit with you in a cycle that goes on forever extracting 5 cents each trade.
You have an apple? I’ll trade my banana for it and 5 cents.
Ah, now you have a banana. Would you like to trade it for my orange at a cost of 5 cents?
Now you have an orange. Here’s a nice apple. I’ll trade for 5 cents.
Now you have your original apple back and I am 15 cents richer. Let’s do it again.
My prof’s argument is that people can’t be irrational because they would be quickly wiped out financially. It’s a good argument except for one problem. There is a simple way for irrational people not to get fleeced in this way. Don’t make trades where the difference in value is small or uncertain.
In the real world, nobody is going to trade an orange for an apple at a cost of 5 cents even if they slightly prefer the apple. They would just eat the orange they have and perhaps buy apples next time. They certainly aren’t going to go swapping fruit endlessly.
Most people get the things they need in a two step process. They trade their labour for money and then money for the things they intend to use. A little bit of irrationality in their preferences just means they won’t always buy what will make them happiest. The fleecing scenario rarely if ever materializes.
In my opinion, it’s safe to be irrational. While it certainly isn’t optimal to make daft decisions, If you aren’t omniscient, you have to do the best with the brain you have.
