Irrational Economic Behaviour

In what can be described as irrational economic behaviour, people do not always follow their own self-interest in their decisions.

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 behaviour – upsetting the mathematical models used by economists.  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.

People can get carried away with ‘irrational exuberance’, the feeling that they can defy economic gravity, when they see other people getting rich quickly.  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 (, these price bubbles destabilise the financial system.

People are sometimes prepared to apply moral criteria to their choices.  This qualifies as irrational economic behaviour because it is driven by broader considerations than short-term profit and loss.  This has caused conflicts between activist shareholders and those who believe that companies should be solely focused on maximising returns on investment, as described in an article It’s Conservative David vs. the Woke Corporate Green Giant:

“Republican legislators and attorneys general across several states have recently launched inquiries into or introduced bills opposing the wide embrace of three initials profoundly transforming capitalism: ESG, short for Environmental, Social, and Governance. That’s an approach increasingly driven by Wall Street and endorsed by regulators to judging companies based on their devotion to achieving environmental and social goals that go beyond maximizing profits on behalf of shareholders.”

The article identified the following moral issues that affect economic behaviour:

“The anti-woke backlash comes in response to a years-long surge in progressive activism in corporate America, regarding issues ranging from guns and abortion to immigrationelection integrity, and criminal justice. Companies have bowed to the prevailing winds by, for example, pledging to reduce greenhouse gas emissions, embracing “diversity, equity and inclusion” in employee hiring and training, or tying executive compensation to ESG performance. One survey from consulting firm KPMG shows 82% of large U.S. corporations devoting space in regulatory filings to demonstrate their ESG bona fides.”

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.



This page is intended to form part of Edition 4 of the Patterns of Power series of books.  An archived copy of it is held at https://www.patternsofpower.org/edition04/3351.htm.