Rational Agent – Theory Of Economic Behavior

Mike Russo 4/2/13 "rational agent" theory of economic behavior, the one that says that people, in their economic lives, behave like calculating robots, making rational decisions when they buy a stock, take out a mortgage, or go to the track. These scholars have offered a trove of evidence that people, far from being the rational agents of textbook lore, are often inconsistent, emotional, and biased.

Perhaps tellingly, the pioneers of his field were not economists. Daniel Keenan and Amos Taverns were Israeli psychologists who noticed that real people often do not make decisions as economists say they do. Taverns died in 1996; six years later, Keenan won the Nobel Prize for economics. Thinking, Fast and Slow, Kinsman's new and most accessible book, contains much that Is familiar to those who have followed this debate within the world of economics, but it also has a lot to say about how we think, react, and reach?rather, jump to?conclusions in all spheres.

What most interests Keenan are the predictable ways that errors of Judgment occur. Synthesizing decades of his research, as well as that of colleagues, Keenan lays out architecture of human decision-making?a map of the mind that resembles a feely tuned machine with, alas, some notable trapdoors and faulty wiring. Behaviorist's, Keenan included, have been cataloging people's systematic mistakes and analogical patterns for years. A few of the examples he cites: 1 -Framing.

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Test subjects are more likely to opt for surgery If told that the "survival" rate Is 90 percent, rather Han that the mortality rate is 10 percent. 2. The sunk-cost fallacy. People seek to avoid feelings of regret; thus, they invest more money and time in a project with dubious results rather than give It up and admit they were wrong. 3. Loss aversion. In experiments, most subjects would prefer to receive a sure $46 than have a 50 percent chance of making $100. A rational agent would take the bet. Remarkably, and for similar reasons, golfers putt better when missing would leave them a stroke behind.

As compelling as these examples are?repeatedly, we recognize our own eases?Kinsman's greater achievement Is to build a framework for how. Or why, the mind reasons as it does. You may feel a spasm of doubt, as I did, when first introduced to his central contrivance, using two fictional "characters," which he refers to as System 1 and System 2. Suspend your doubts for Just a moment. System 2 is your conscious, thinking mind. We conceive of this active consciousness as the principal actor, the "decider" in our lives. System 2 thinks slowly; it considers, evaluates, and reasons.

Its work requires mental effort?multiplying 24 by 17 or ruining left at a busy intersection. We attribute most of our opinions and decisions to this thinking, reasonable fellow. For Keenan, however, the main protagonist Is System 1 . This is the agent of our automatic and effortless mental responses. System 1 can add single-digit numbers and fill in the phrase "bread and ?. " It is equipped 1 OFF patterns of association ("Florida/old people") that enable it to spew out a stream of reactions, Judgments, and opinions.

System 1 can detect a note of anger in a voice on he telephone; it forms snap Judgments about those we meet, Presidential candidates, investments that we might be considering. The flaw in this remarkable machine is that System 1 works with as little or as much information as it has. If it can't answer the question, "Is Ford (F) stock a good investment? " it supplies an answer based on related but not really relevant data, such as whether you like Ford's cars. System 1 simplifies, confirms, it looks for, and believes it sees, narrative coherence in an often-random world.

It does not perform complicated feats of logic or statistical evaluations. You hear about a terrorist incident and want to avoid all buses and trains; only if you slow down employ the tools of System 2, do you realize that the risks of terrorism affecting you are very slight. Willpower requires effort; it is a feature of System 2. In an experiment, 4-year-olds who were able to delay eating an Ore scored higher, a decade later, on IQ tests. Keenan suggests that the ability to switch to System 2 is a sign of an "active mind" and a predictor of success.

Keenan s perhaps least persuasive in his treatment of the business world. Noting that even top performers in business?also sports?tend eventually to revert to the mean, he attributes success largely to luck. This confuses events that may not be predictable with those that are determined by chance. A high-achieving retail store, to cite one of his examples, is not lucky, it is well situated. And if its sales later decline, that is not necessarily a sign that its prior success was random. Business has a self-correcting cycle that fosters mean reversion. Success attracts competitors.

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