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The Myth Of Irrationality In Economics

I hear very often from intelligent people that economics cannot be applied to certain problems because people behave irrationally and economic theory is based upon the expectation of a rational behavior. This is an incredibly powerful misconception that keeps persisting over generations and acts as a kind of an excuse for all sorts of attacks against the free market ideas. I'd like to explain why it's false to the core.

The first thing we have to do is look up the definition of irrationality. It's important, because by not using the same language we basically put ourselves in a position from which it is impossible to argue at all. I will address other possible definitions of this word, but for now, let me use this one from Wikipedia:

Irrationality is cognition, thinking, talking or acting without inclusion of rationality. It is more specifically described as an action or opinion given through inadequate use of reason, emotional distress, or cognitive deficiency. The term is used, usually pejoratively, to describe thinking and actions that are, or appear to be, less useful, or more illogical than other more rational alternatives (source: Wikipedia).

One thing we can take from this definition is that there is no objective irrationality. Rather it is measured against other actions that may be more or less rational. But how do we tell if one action is more rational than another? Well, the definition mentions reason and logic. That is, if there is a lot less logic in one action than in another, then it might be considered irrational. However, the problem is, people usually confuse logic with judgement. THAT is at the core of this misconception. Let's take an abstract example first.

If a = b, b = c then a = c. That's logic. This cannot be false simply because you or I decide it to be false. Regardless of what I tell other people about this relation, regardless of whether they believe me or not, a will always be equal to c. If I say that a != c, then I'm being illogical objectively. Now let's say I believe x = 1 and y = 2. I now am being logical in believing that x + y = 3. However, if another person believes x = 2 and y = 3 then he would be just as logical in believing that x + y = 5. The logic here is represented by a mathematical operation, whereas the judgement is me believing that x and y have certain values.

Now let's look at a less abstract example. Let's say I believe that knocking on a door exactly three times will prevent bad things from happening (a classic example of OCD). Is there no logic to what I'm doing and am I being irrational? Not at all. My brain does a very dirty trick on me. Some people don't even know it does this trick, because they know nothing about OCD. I know about OCD, yet I still keep knocking three times. Why? Because there's a very specific reason why I do that: my brain thinks it's important and this perception of importance overrides other factors. Now you may think I'm being stupid and my judgement is impaired. But dare you not say there's no logic to my actions.

Another very simple (and related) example would be people who go to church. You may think they are being irrational, yet it's their judgement that is impaired, not logic. The logic is still there. It is perfectly rational to go to church if you believe your sins will be forgiven. It would only be irrational to do this if I didn't believe in god.

Let's take another, more commerce-related example now. Let's say I decided to build a private airport. Building an airport is, by all measures, an expensive enterprise. But hey, I have money and I love aviation. So I'm in. Let's say after a year I realize that I dumped a huge amount of money into it, yet we don't even have half a runway built and nothing's working out. Worse still, I realize that because most airports are government owned, it would be a rather harsh competition against a monopoly. Yet I keep spending money and keep building, even though it's obvious this isn't going to be profitable. I keep doing it because I already dumped large summs of money into this project and because I love aviation. This behavior is known as escalation of commitment. Note, in this description on Wikipedia there are 4 drivers to such behavior: social (peer pressure), psychological (gambling), project (past commitments), structural (cultural and environmental factors). By no means my behavior is irrational; in my particular example at least two of these drivers are present: pshychological (I've already spent so much money!) and project (I love aviation!). Again, my judgement is impaired, but the logic is still there.

An example of irrational human behavior is extremely hard to find in the real world. A contrived example would sound like this: I don't like coffee, I'm not addicted to it, it's not really "cool" to drink coffee and it makes me feel sick - yet I drink it for no reason. That behavior can be called irrational. At least until the logic behind it is discovered. For instance, it may turn out that I simply needed something to get my mouth busy with and there's nothing else around, but coffee. Silly? Yes. Irrational - not at all.

Thus, most people don't act irrationally most of the time. Often we just don't know true reasons behind their behavior. Yet we hear time and again that people are irrational creatures who must be controlled and restrained. This way of thinking sounds more like a failure to try and discover true reasons for human action and inability to see through what appears to be irrationality, but really is just a different set of priorities and judgements.

Economics doesn't concern itself with people's judgement. It only concerns itself with scarcity. It doesn't matter why people want more bitcoins or why they love drinking beer. Different people may want those things for completely different reasons. The only important thing is that when people want things that are limited, there's a scarcity. You can't beat that.

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