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> convince otherwise rational people to make an irrational decision This is a myth that economics will not let go of. Almost all human decisions are influenced

> convince otherwise rational people to make an irrational decision This is a myth that economics will not let go of. Almost all human decisions are influenced by emotions. Here's two examples: [A] Would you rather receive $49 or have a 50% of receiving $100? - The rational decision would be to choose the 50% chance since your expected value would be $50. Most people go for the $49, humans are irrationally risk-averse in terms of gains. [B] 1)You have $1,000 and you must pick one of the following choices: Choice A: You have a 50% chance of gaining $1,000, and a 50% chance of gaining $0. Choice B: You have a 100% chance of gaining $500. 2)You have $2,000 and you must pick one of the following choices: Choice A: You have a 50% chance of losing $1,000, and 50% of losing $0. Choice B: You have a 100% chance of losing $500. Time after time, when presented with this problem, people chose B for question 1 and A for question 2. A rational person would choose either A or B for both questions. The expected value is the same for both questions, but it shows that people are risk averse in gains and risk seeking in mitigating losses. Couple this with the number of people who actually understand the concept of compounded interest rates and yikes. Just nitpicking, but people are not otherwise rational. Study after study has shown that emotions are involved in nearly every,if not all, decisions that we make.

ericd 10y ago
Reducing variance is worth real money to people, since the marginal utility of the first dollar is much higher than the 1000th.
- incongruity 10y ago
  Adding to that - it's the flaw of averages at work in many of those examples. The listed "expected value" in some of those examples could never actually be a real outcome of the examples - it is completely rational to opt to take a 500 loss rather than risk a 1000 loss if you have, say, only 750 to your name and cannot be overdrawn (see debtors prison or whatever incentive one would like to imagine). The expected value of the $500 loss only happens in one option. In the $0 or $1000 loss, if you had repeated draws over time it would indeed trend towards an average of a $500 loss but in a single draw situation, you can never achieve the average so you absolutely must view it as different from the flat $500 loss and compare that to your imagined circumstances in this thought exercise.
- geomark 10y ago
  Yes. There are many cases where a lower expected value is a rational trade off for reduced variance.
- FullMtlAlcoholc 10y ago
  I completely agree. A bird in hand is worth 2 in the bush and all that. However, even today economic theories do not take this into account and assume rationality === choosing the highest expected payoff. I.E. we're all statistical savants
  - ericd 10y ago
    Yep, your main point that economics' rational man is a complete fiction is absolutely correct.
    - HarryHirsch 10y ago
      He's a convenient fiction though. Since to homo oeconomicus a certain expense of USD 500 and the 50 % chance of a USD 1000 expense are the same, expect him to be rolled out to sell you high-deductible health insurance and health savings accounts. H. oeconomicus is the model human, consequently he isn't cashflow constrained, and the fact that HSAs double as tax shelters for the wealthy doesn't concern the Ideal Man either. University economics is a religion, not a science, it offers up myths instead of testable predictions on observable reality. High finance is a different deal, but they surely don't build their models on university textbooks.
      - slededit 10y ago
        > University economics is a religion, not a science That's a bit harsh. Is every field that employs simplified approximations of complex systems a religion as well? With that definition even physics is out and that's one of the more concrete sciences.
        FullMtlAlcoholc 10y ago
        At times it does appear to be a religion because of the cult of personality that proliferates (remember the Greenspan years?) and, most significantly, the blind faith and slavish devotion to free markets being a solution to everything. What I find most off-putting are those who advocate for wholesale changes in our society on little more than hypothesis and faith instead of running experiments starting at the smallest reasonable scale and then successively working your way up from that. It should at least pretend to try to applying basic scientific methodologies to its practice.Psychology has evolved to being a rigorous, evidence based social science. That psychology is not one of the foundations of studying economics is also problematic too.
- kirrent 10y ago
  For a real world example, consider government bonds which have relatively low returns but are almost guaranteed.
deleted 10y ago
[deleted]
coliveira 10y ago
You answer to question A is true only if this is a repeatable event. If you have only a one-time decision to make, the logical answer is to take the money and run.
fixxer 10y ago
You are defining rational behavior as ignoring variance and accepting expectation as a gauranteed outcome for a trial. I don't want to be a jerk, but you are wrong to a phenomenal degree.
- FullMtlAlcoholc 10y ago
  You're not being a jerk. I should've put quotes around rational to highlight that this was the common thinking at the time in the field. That was just a extremely example of Prospect Theory. Before this was presented as a better model to understand human behavior, the prevailing theory didn't take into account that humans are even risk averse with gains and more likely to take risks with losses. My main point was that it took psychologists to present a model of man that resembled reality Cumulative Prospect Theory takes this into account and states that people tend to overweight extreme, but unlikely events, but underweight "average" events, but I digress I was just trying to show the base irrationality of the human mind. Here's another example. Consider you have two offers for the New York Times: [A] $59 – Internet Only Subscription $125 – Internet and Print Subscription [B] $59 – Internet Only Subscription $125 – Print Only Subscription $125 – Internet and Print Subscription Both offers are the same, with the exception of including the “print only” subscription in Offer A. Despite the fact that not a single person chose that unattractive offer, its impact was dramatic – In a study, 62% more subjects chose the combined print and Internet offer, and predicted revenue jumped 43%. The print-only offer was the decoy, and served to make the combined offer look like a better value. This is called decoy marketing and is only one of an arsenal of tools that is used to take advantage of the irrational mind. You'll see this everywhere so it pays to identify it.
CPLX 10y ago
Your argument is nonsensical. Your scenarios have differences in risk. Transferring risk from one party to another is the entire basis of our financial system. To assume risk is irrelevant in step one is to fundamentally misunderstand how economic decision making works.
- FullMtlAlcoholc 10y ago
  You are missing the greater point. I agree with you. Before Prospect Theory, economists did assume risk was irrelevant and that one would choose either A or B for both. That even a layman would find it nonsensical is exactly my point. I should've put rational in quotes to show sarcasm or followed rational with "defined by economists at that time"
  - CPLX 10y ago
    > That even a layman would find it nonsensical is exactly my point. I have a degree in economics and both my parents are professors of economics, so I have some perspective on this. Economics as a discipline has never really been confused about risk in the way you describe.
    - FullMtlAlcoholc 10y ago
      Let's look at it another way and the so-called "sunk cost" fallacy. I have somewhat expensive tickets to an NBA game. On the night of the game, I'm sick and there's a blizzard. If I paid for those tickets, I'm damn well going to that game. If they were given to me, I'm staying in. Study after study shows that most people also would act in this matter. That this type of behavior was considered irrational made me think that a lot of economists in the past didn't try to understand actual human behavior. BTW - this is not comparable to an investment situation I have a degree in economics too and my main complaint is that I wish those in the field treated it with more rigor, more like a scientific or engineering field... explicitly state the simplified assumptions and limits on the models. And don't proclaim that your model is correct without experimenting. It's not as much a problem as it was in the past, but people like Hayek advocated for whole changes in society based upon ideology and philosophy without any experimental evidence. I understand it is difficult to conduct experiments, but if that is the case, stop being so certain and adamant in your position without evidence
closeparen 10y ago
Nit: observed values converge on expected values over many trials. If you asked me which strategy I'd like to play 100,000 times, I'd take the 50% chance. Just once, I'll take the $49.

ericd 10y ago

Reducing variance is worth real money to people, since the marginal utility of the first dollar is much higher than the 1000th.

incongruity 10y ago
Adding to that - it's the flaw of averages at work in many of those examples. The listed "expected value" in some of those examples could never actually be a real outcome of the examples - it is completely rational to opt to take a 500 loss rather than risk a 1000 loss if you have, say, only 750 to your name and cannot be overdrawn (see debtors prison or whatever incentive one would like to imagine). The expected value of the $500 loss only happens in one option. In the $0 or $1000 loss, if you had repeated draws over time it would indeed trend towards an average of a $500 loss but in a single draw situation, you can never achieve the average so you absolutely must view it as different from the flat $500 loss and compare that to your imagined circumstances in this thought exercise.
geomark 10y ago
Yes. There are many cases where a lower expected value is a rational trade off for reduced variance.
FullMtlAlcoholc 10y ago
I completely agree. A bird in hand is worth 2 in the bush and all that. However, even today economic theories do not take this into account and assume rationality === choosing the highest expected payoff. I.E. we're all statistical savants
- ericd 10y ago
  Yep, your main point that economics' rational man is a complete fiction is absolutely correct.
  - HarryHirsch 10y ago
    He's a convenient fiction though. Since to homo oeconomicus a certain expense of USD 500 and the 50 % chance of a USD 1000 expense are the same, expect him to be rolled out to sell you high-deductible health insurance and health savings accounts. H. oeconomicus is the model human, consequently he isn't cashflow constrained, and the fact that HSAs double as tax shelters for the wealthy doesn't concern the Ideal Man either. University economics is a religion, not a science, it offers up myths instead of testable predictions on observable reality. High finance is a different deal, but they surely don't build their models on university textbooks.
    - slededit 10y ago
      > University economics is a religion, not a science That's a bit harsh. Is every field that employs simplified approximations of complex systems a religion as well? With that definition even physics is out and that's one of the more concrete sciences.
      - FullMtlAlcoholc 10y ago
        At times it does appear to be a religion because of the cult of personality that proliferates (remember the Greenspan years?) and, most significantly, the blind faith and slavish devotion to free markets being a solution to everything. What I find most off-putting are those who advocate for wholesale changes in our society on little more than hypothesis and faith instead of running experiments starting at the smallest reasonable scale and then successively working your way up from that. It should at least pretend to try to applying basic scientific methodologies to its practice.Psychology has evolved to being a rigorous, evidence based social science. That psychology is not one of the foundations of studying economics is also problematic too.
kirrent 10y ago
For a real world example, consider government bonds which have relatively low returns but are almost guaranteed.

deleted 10y ago

[deleted]

coliveira 10y ago

You answer to question A is true only if this is a repeatable event. If you have only a one-time decision to make, the logical answer is to take the money and run.

fixxer 10y ago

You are defining rational behavior as ignoring variance and accepting expectation as a gauranteed outcome for a trial. I don't want to be a jerk, but you are wrong to a phenomenal degree.

FullMtlAlcoholc 10y ago
You're not being a jerk. I should've put quotes around rational to highlight that this was the common thinking at the time in the field. That was just a extremely example of Prospect Theory. Before this was presented as a better model to understand human behavior, the prevailing theory didn't take into account that humans are even risk averse with gains and more likely to take risks with losses. My main point was that it took psychologists to present a model of man that resembled reality Cumulative Prospect Theory takes this into account and states that people tend to overweight extreme, but unlikely events, but underweight "average" events, but I digress I was just trying to show the base irrationality of the human mind. Here's another example. Consider you have two offers for the New York Times: [A] $59 – Internet Only Subscription $125 – Internet and Print Subscription [B] $59 – Internet Only Subscription $125 – Print Only Subscription $125 – Internet and Print Subscription Both offers are the same, with the exception of including the “print only” subscription in Offer A. Despite the fact that not a single person chose that unattractive offer, its impact was dramatic – In a study, 62% more subjects chose the combined print and Internet offer, and predicted revenue jumped 43%. The print-only offer was the decoy, and served to make the combined offer look like a better value. This is called decoy marketing and is only one of an arsenal of tools that is used to take advantage of the irrational mind. You'll see this everywhere so it pays to identify it.

CPLX 10y ago

Your argument is nonsensical. Your scenarios have differences in risk. Transferring risk from one party to another is the entire basis of our financial system. To assume risk is irrelevant in step one is to fundamentally misunderstand how economic decision making works.

FullMtlAlcoholc 10y ago
You are missing the greater point. I agree with you. Before Prospect Theory, economists did assume risk was irrelevant and that one would choose either A or B for both. That even a layman would find it nonsensical is exactly my point. I should've put rational in quotes to show sarcasm or followed rational with "defined by economists at that time"
- CPLX 10y ago
  > That even a layman would find it nonsensical is exactly my point. I have a degree in economics and both my parents are professors of economics, so I have some perspective on this. Economics as a discipline has never really been confused about risk in the way you describe.
  - FullMtlAlcoholc 10y ago
    Let's look at it another way and the so-called "sunk cost" fallacy. I have somewhat expensive tickets to an NBA game. On the night of the game, I'm sick and there's a blizzard. If I paid for those tickets, I'm damn well going to that game. If they were given to me, I'm staying in. Study after study shows that most people also would act in this matter. That this type of behavior was considered irrational made me think that a lot of economists in the past didn't try to understand actual human behavior. BTW - this is not comparable to an investment situation I have a degree in economics too and my main complaint is that I wish those in the field treated it with more rigor, more like a scientific or engineering field... explicitly state the simplified assumptions and limits on the models. And don't proclaim that your model is correct without experimenting. It's not as much a problem as it was in the past, but people like Hayek advocated for whole changes in society based upon ideology and philosophy without any experimental evidence. I understand it is difficult to conduct experiments, but if that is the case, stop being so certain and adamant in your position without evidence

closeparen 10y ago

Nit: observed values converge on expected values over many trials. If you asked me which strategy I'd like to play 100,000 times, I'd take the 50% chance. Just once, I'll take the $49.