Econ434handout6

Econ434handout6 - Exuberance Is Rational Or at least human...

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1 The New York Times Magazine February 11, 2001 Exuberance Is Rational Or at least human Richard Thaler has led a revolution in the study of economics by understanding the strange ways people behave with their money. By Roger Lowenstein 1 It is possible that Richard Thaler changed his mind about economic theory and went on to challenge what had become a hopelessly dry and out-of-touch discipline because, one day, when a few of his supposedly rational colleagues were over at his house, he noticed that they were unable to stop gorging themselves on cashew nuts he'd put out. Then again, maybe it was because a friend admitted to Thaler that, although Thaler he mowed his own lawn to save $10, he would never agree to cut the lawn next door for $10, or even more. But the moment that sticks in Thaler’s mind occurred back in the 1970s when he and another friend, a computer maven named Jeff Lasky, decided to skip a basketball game because of a swirling snowstorm. "But if we had bought the tickets already, we’d go.” Lasky noted. “True – and interesting,” Thaler replied. Thaler began to make note of these episodes – anomalies, he called them – and to chalk them up on his blackboard at the University of Rochester, where he was a young, unheralded, and untenured assistant professor. Each of these stories was at odds with neoclassical economics as it is taught in graduate schools. Indeed, each was a tiny subversion of the prevailing orthodoxy. According to accepted economic theory, for instance, a person is always better off with more than with fewer choices. So why had Thaler’s colleagues roundly thanked him for removing the tempting cashews from his ling room? The lawn example was even more troubling. Perhaps you dimly remember from Economics 101 that unlovely term, “opportunity cost.” The idea, as your pointy-headed prof vainly tried to persuade you, is that forgoing a gain of $10 to mow your neighbor’s lawn “costs” just as much as paying somebody else to mow your own. According to theory, you either prefer the extra time or the extra money – it can’t be both. And the basketball tickets refer to “sunk costs.” No sense going to the health club just because we’ve paid our dues, right? After all, the money is already paid – sunk. And yet, Thaler observed, we do. People do not behave like the pointy-heads say they should. In the ordered world of economics, this rated as heresy on the scale of Galileo. According to the standard or neoclassical school (essentially a 20 th century updating of Adam Smith), people, in their economic lives, are everywhere and always rational decision makers; those who aren’t either learn quickly or are punished by markets and go broke. Among the implications of this view are that market prices are always right, and that people choose the right stocks, the right level of savings – indeed, they coolly adjust their rates of spending with each fluctuation in their portfolios, as though every consumer
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Econ434handout6 - Exuberance Is Rational Or at least human...

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