3.3.5.1 Irrational Behaviour

(This is a current page, from the Patterns of Power Edition 3 book contents.  An archived copy of this page is held at http://www.patternsofpower.org/edition03/3351.htm)

Classical economic theory assumes that people will behave as rational individuals: a model sometimes known as ‘homo economicus’.  In practice there are many situations where people do not conform to this model.  Recently some economists have examined the effects of irrational decision-making, describing what is now called ‘behavioural economics’; Sendhil Mullainathan and Richard H. Thaler have explained How Behavioral Economics Differs from Traditional Economics, citing several examples.

Irrational exuberance can also be a factor.  For example as Kalen Smith observed in his History of the Dot-Com Bubble Burst and How to Avoid Another, “[m]any investors foolishly ignored the fundamental rules of investing in the stock market, such as analyzing P/E ratios, studying market trends, and reviewing business plans”.  As already noted (3.3.4.3), these price bubbles destabilise the financial system.

People are sometimes prepared to apply moral criteria to their choices, as described previously (3.1.2.3).  Such choices might conflict with a narrow definition of their self-interest.

In an essay entitled Networks and the need for a new approach to policymaking, Paul Ormerod defined network effects as “[t]he fact that a person can and often does decide to change his or her preferences simply on the basis of what others do”.  Fashion is an obvious example: individuals are affected by each other, rather than making autonomous decisions in accordance with classical economics.

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