When is acting irrational the rational thing to do? | Economics in Plain English

Nov 02 2009

When is acting irrational the rational thing to do?

FT.com / Comment / Opinion – Magic and the myth of the rational market.

Imagine you’re a poor farmer who has always had just enough to feed your family, with no surplus left over to sell. Then one day the government decides to grant your family and your neighbors enough land to grow your own food and plenty more to sell on the market. The government’s intention, of course, is for you to cultivate all your land, sell your surplus, generate income for your family to improve your quality of life, send your children to school and save for the future.

You’re the farmer. You’ve just been given land. What would you do?

1. Plant crops on all your land, harvest the crops, sell the surplus and enjoy the profits from your surplus?

OR

2. Plant crops on only part of your land, grow enough food to feed your family, and let the rest of the land lie uncultivated. You have no surplus, nothing to sell, and continue to live the way you always have lived: poorly.

The science of economics assumes that individuals always act rationally in their own self-interest. Self-interest is the ultimate motive of economic actors: firms are profit-maximizers, individuals are utility-maximizers. The theory of rational behavior would lead one to assume that the farmer would pursue option 1 above. But in Papua New Guinea, where the government recently relocated thousands of displaced farmers to new plots of land, it is more common for farmers to chose option 2:

“If they see me planting too much cocoa, they’ll do things to my land and my family, and they won’t bear fruit; really bad things; puripuri and other witchcraft.”

Such an avoidance of profit maximisation might have appeared economically irrational. But from the perspective of those villagers, putting in extra work just to make oneself a target for the jealousy of one’s neighbours would be highly irrational behaviour.

Economists need to re-think their assumptions on rational behavior. What appears irrational to one person may be perfectly rational to someone else, as in the case of the Papuan farmers who only plant half their land. Humans, it seems, are a bit more complicated than the cold, calculating arithmeticians economists have long assumed them to be.

In the wake of the largest economic crisis since the great depression, the assumption of rational actors interacting in rational markets has come into question. A new field of economics blending the traditional study of resource allocation in the market place and human psychology has arisen to tackle the challenge of better understaning the seemingly irrational behaviors of investors, buyers and sellers in today’s global economy:

One response to the current crisis has been a rise in the popularity of behavioural economics, which examines the psychological and emotional factors behind transactions. These models drop the assumption of the rational actor yet implicitly keep the same model of economic rationality at their heart. We may diverge from the path of rationality for all sorts of psychological reasons but only because emotion, Keynes’s famous “animal spirits”, clouds our judgment.

To break human behavior down to the basic pursuit of profits by producers and utility by consumers neglects to acknowledge the “animal spirits” within us all. Economics is entering a new era, in which psychology and markets are intertwined. Rational behavior will remain a basic assumption of the science, but a re-defining of what it means to be rational will allow economists to better understand the behaviors of individuals, investors and firms as the economy emerges from a slump Alan Greenspan might say was ushered in on a wave of irrational exuberance.

Discussion Questions:

  1. Are economists wrong to assume that individuals always act rationally? Why do the Papuan farmers only use half their land? Are they stupid or lazy?
  2. Can you think of any examples in which you or someone you know has done something that was not in his best economic self interest?
  3. Is charity irrational? What about gift giving? If you calculated that the chance of getting caught steeling something you REALLY wanted was 0%, wouldn’t it be irrational NOT to steal? What would keep you from stealing that thing if you deemed it rational to do so?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

2 responses so far

2 Responses to “When is acting irrational the rational thing to do?”

  1. Gavin Steinhublon 26 Aug 2009 at 6:00 am

    1) I dont believe economists are wrong to assume that people make decisions rationally, i do however believe that it should just be an assumption, and not stated as a fact. In the example given, most people would still be rational and cultivate all the land, like most economists would expect, however there will always be outliers. With the land example, its just one small country, Papua New Guinea, that is used. So in most cases the economists would be correct and the farmer would be rational to maximize profit, but in some special circumstances there will be the exceptions. As for the people of New Guinea, i don't think they are stupid or lazy, because they are doing it for reasons we wouldnt understand. Because Switzerland isnt the same culture, we wouldnt have the same problem as the farmers of Papua, so we cant really say they are stupid or lazy for their choice not to fully cultivate.

  2. Pilar Mulleron 08 Nov 2010 at 7:01 am

    1. To a certain extent, economists are wrong to just assume that consumers always act rationally. In most of the cases, they do not because the human being is also irrational at times. Nevertheless, there are also consumers who act just rationally in order to maximize their total utility. In the end, if e.g I have 10 dollars to spend on popcorn, the rational thing for me to do would be to spend all of my income until my total utility reaches its peak.

    In the case of the Papuan farmers, they do not use all of their land (rational way), not because they are lazy but because they have superstitions. Because of the irrationality of humans to belive in superstition and evil, the Papuan farmers acted in an economically speaking irrational way, in order to ensure their own well-being.

    2. I have experienced many times where, when I was really thirst, I just went buy a soda to the next best shop. However, most of the times you get to a store where they are selling their sodas for a too high price, which means that my total utility of consuming a soda does not correspond with the very high price. In that situation, however, the irrational consumer might just buy the soda, because he/she is so thirsty and cannot wait to get to another store (irrational behavior).

    3. I would say that charity might be seen as irrational because the consumer does not spend that money for himself/herself. Nevertheless, most consumers give money to a charity when they have earned a big profit or are just having a sort of "surplus" concerning money, which does not make them worse off, and does not really lower their purchasing power, since they mostly already have enough money to spend.

    Yes, it might be irrational not to steal when there is a 0% chance of getting caught. However, since we are human beings, we are taught from very young on that stealing is bad, which would be seen as economically irrational and thus we mainly do not steal, if possible.