© Dmitry Eliuseev
Behavioural Economics is a term that means many things to many people.
There is the “why people do stupid things” school of thought that has popularised the field, that we can be predictably irrational, examples of which we can laugh at in hindsight.
On the other hand there is the school of thought that behavioural economics is just a bit of nifty PR rebranding of social psychology, with Prospect Theory just a label conjured out of thin air as it sounded good.
For me, modern humans are capable of doing incredibly stupid things, but we aren’t irrational.
We might not understand why we have done something that appears irrational in hindsight but this is due to us not understanding the rationale hardwired into us by evolution.
Examples of our apparent irrationality are (to me) evidence of our creation of an environment we haven’t evolved for.
There are (as I see it) at least three ways in which our regularly chosen preferred response to the environment (U) may not provide the greatest benefits of those available.
Estimation: the probability or quantity involved is too great or too small for us to reasonably estimate. In the environment we evolved for we didn’t have the need to estimate large quantities any more precisely that “a lot” or “many” or more accurately than “hundreds” or “millions”. We don’t for example say there were “1,250s of them”. We see, practically, the limits of our ability to estimate magnitudes in national and state lotteries. The chance of hitting the jackpot runs into millions-to-one but we can’t fathom the remoteness of it occurring so it remains practical for people to play (when they’d be better off keeping their money in their pocket).
The Introduction of Additional Lotteries: We are not privy to the machinations of our brains derivation of U. We don’t have cognitive access to our brain’s own internal exchange rate – it might be doing something for an evolutionary good reason that we don’t understand. If I offer you the choice between $10 or $12 you are going to take the latter. If I offer you the choice between $10 now or $12 next week you are probably going to take the former. The traditional behavioural economics standpoint is that this is an irrational thing to do. I would argue that it is an incredibly rational thing to do and I’m grateful for my ancestors for possessing this trait/bias/sense. Underpinning the change in choice is the introduction of another lottery. We now have to deduce value from time and price instead of price alone.
Rapid Recomposition of U: Traditionally in behavioural economics this is called reframing. We sample the environment to produce U. In our production of U we look for the largest relative advantage over the environment. When circumstances change suddenly and we have to recompose U our choices may appear “off” in absolute terms. Avoiding relative losses to the environment is more important to us than absolute losses, as, in our evolutionary history, this prevented us from becoming dominated by our competitors. We seek to minimise any relative loss to the environment while maximising any relative gain. This may appear odd in absolute terms and is exacerbated and highlighted by rapidly changing the lotteries in the environment, but again is sensible when you realise the consequences of being repeatedly relatively outperformed.
The Standard Interpretation of Behavioural Economics