The myth as such: people will act in a perfectly rational manner, and the economy will respond in reaction to that.
So... the idea here is that emotions will never influence someone's actions in making economic choices.
Which is, as we can guess, bullshit.
To quote Medium,
Mainstream (neo-classical) economics idealizes human beings as perfectly rational actors when it comes to making decisions. This concept, known as rational choice theory, is based on three assumptions:
1. People have complete and consistent preferences (which can be assigned quantitative values called utilities) among a set of decision outcomes
2. People act independently based on full and relevant information
3. People always select the decision option that maximizes their utility.
So. That's absurd. Let's start from the bottom, utility.
One of the first things you learn in any marketing class is that half the industry is run on an appeal to emotion.
(The other half of it actually is an appeal to logic, like 'you can use this tool to compare your insurance costs,' which is the aforementioned rational action.)
The most obvious example of that utility element being wrong is: Food.
For a completely rational actor, the food purchased would be the most nutrition for the least cost. Taste is irrelevant. Ambience is irrelevant. Occasion is irrelevant. You fill out the food pyramid for whatever you can pay the least amount of cash. Buy a fifty pound bag of rice, wholesale canned tuna, and frozen veggie mixes that you only need five minutes to heat up and consume.
Chocolate? No. Salt or sugar? Only enough to fulfill your need for water absorption. Spices? Waste of money!
This sounds extreme, because a complete lack of emotional impact on your purchasing habits is extreme. You seek things that make you happy or pleased. You search for sweet tastes that cheer you up, for fatty tastes that satisfy you, for spicy flavors that you can eat in a competition with your friends to prove who's the manliest.
That's not rational! But we do it! Food is an inherently irrational thing to purchase, unless you are so strapped for cash that you cannot afford to be anything other than fully dedicated to the highest calorie:dollar ratio that you can find.
The other thing that the utility factor disregards is charity. On the standard 'rational' definition used in economics, charity is completely irrational for anyone who doesn't get a tax cut from it.
But people engage in charitable actions and donations anyway.
Full and relevant information: Uhhhhh no
I think we can all agree that full and relevant information is not actually a reality for most people.
Manufacturers bend the truth. Marketers omit things. Word of mouth is unreliable. Influencers lie. Online reviews are fake.
Some don't! But you don't know who is or isn't lying unless there is a law that controls what information they can put out. Researching takes time, and figuring out which lies are actually lies is difficult.
There are a lot of videos all over YouTube talking about scams, both the obvious, and the more subtle. There's a reason that misinformation is such a huge industry these days, and hey! A lot of misinformation relies on those aforementioned appeals to emotion that are both a marketing device and a rhetorical one.
Complete and consistent preferences: Sometimes?
I mean, some people have complete and consistent preferences. I have a favorite Starbucks drink that I get most times (technically I have four and it depends on the weather). I have stylistic preferences for my clothing. I have musical preferences.
But it still takes me time to make decisions when at a restaurant, you know? My little sister likes a lot of foods, sure, but if you ask her to pick a place to eat it can take literal hours. Hell, there are entire phenomenons named after the fact that people don't have preferences and have trouble making decisions!
And on top of all that, you have people whose 'preference' is spontaneity. They pick whatever they haven't tried before, because it's new, and exciting, and that's cool!
Which really harshes the mellow on that whole "clear and consistent preferences" thing.
Where does that leave us?
Well, the rational actor is clearly a majorly inaccurate standard to hold individual consumers and the market to. That said, I don't think more than a handful of very extreme people would ever claim that the rational actor is an absolutely perfect predictor for the market.
Rather, it's used as a starting point. If the market reacts to forces in a completely rational manner, here is what we would be expecting. Then, upon projecting the actions of the market under the most rational and perfect conditions, we can apply other possible factors. The possible success of a marketing campaign. The risks of weather or politics impacting supply lines. An unexpected trend rising up from a comedic social media moment among teens and young people.
Imagine you have a catapult. Imagine you know what the catapult will do under perfect conditions, with consistent rope length and artillery weight and weather conditions. The numbers you run your basic physics class formulas with are the rational actor.
The market trends that cause that rational prediction to have error margins is the equivalent of "the wind's been varying between 3mph and 9mph, and from NW to SWW."
I'm not sure how safely I can get away with embedding images that I don't personally have the rights to when they're actually relevant to the education portion of this, and not just a silly joke like the TGP inclusion up there, so I'll just tell you to go look at the first graph at this link, and you'll see what I mean about the 'best, most predictable case' line vs the 'actual possibilities' forecast.
Hope that helps!
(If you wanted me to go more into the history of this concept than its actual uses, uh... whoops?)
page 350 - From an early age Economian children learn the dangers of applying short-run price elasticity of supply solutions to long-run price elasticity of supply problems. A policymaker who looks only at the short-run price elasticity of supply, will incorrectly predict changes in supply in the future, and therefore might make improper policy decisions.
Although such lessons have become codified in recent times, misuse of short-run data has been taboo in Economian society for generations. Folklorists can point to old stories where price elasticity of supply curves were applied incorrectly over and over again until a magic pattern formed, making dimensional walls elastic then fluid. With no barriers to entry, rational actors from beyond would enter our world to consume and kidnap children back to theirs.
Thatcherism didn’t teach people that greed is good nor did it teach people about charity, that they should decide what should be done through the allocation of the resources which they control. What Thatcherism did was create the conditions where this was the rational thing to do as self interested actor.
The problem is most selfish pricks think that they are the resources they control are spent on satisfying short term, easily definable in monetary terms desires as other larger desires are much harder to qualify and the satisfaction they afford is brief, dubious and unreliable. As anyone who has every tried to organise a threesome should know.
Then they asked these people who brought up to be selfish pricks whether or not they wanted to be in Europe. And guess what? Just because you can read the FT, doesn’t mean you can’t enjoy a pickle and marmite sandwich, with a pint a scorcher of a day looking out from the shores of Brighton, thinking this is heaven who wants to eat frogs legs on black pumpernickel bread with beetroot jam! Why would Thatchers children do as they were told; decide what you want and go out and get it. This is what Britain is all about.
The most central open question in economic theory, as I see it, is how to model realistic economic agents. Traditionally, economists have relied on the rational-actor model, but it is clear that it is just a rough caricature. It has been greatly enriched by behavioral economics in the past 30 years. Still, we are far from a unified, versatile, believable alternative to the rational-actor model. I am hopeful, though, that this might be overcome—in part because of progress in the sister disciplines (psychology and neuroscience) and basic modeling, and also because empirical anomalies are forcing the economic profession to be more open-minded. Contributions by computer scientists and physicists will help inject new perspectives into economics.
YES. The Rational Actor is not a proper model for the way humans actually behave. You have to create theories to patch up the holes in the way real humans behave in comparison to the Rational Actor. As more and more transactions are made online, it will be interesting to see if an economist can get access to some data from Square or Paypal and really fine tune that model.
We are players in a game we don’t understand. Most of our own thinking is below awareness. Fifty years ago, people may have assumed we are captains of our own ships, but, in fact, our behavior is often aroused by context in ways we can’t see. Our biases frequently cause us to want the wrong things. Our perceptions and memories are slippery, especially about our own mental states. Our free will is bounded. We have much less control over ourselves than we thought.
