Monday, September 05, 2016

The rationality of economic behaviour

... After two hours I saw a direction sign to a camping site. I took a hotel. Was it rational? ...

Let me repeat an example from my last blog: Someone offers you a gamble on the toss of a coin. If the coin shows tails, you lose € 100,-, and if it shows heads you win € 150,-. Would you accept it? The expected value of the gamble is positive, for you can gain more than you can lose. Therefore the best you can do is accept the offer, or so the economic utility theory says. Nevertheless, most of us don’t, although we would do if we could win € 200,-, and probably we would also accept the gamble if we could repeat it hundred times, which is just as the utility tell us to do since it is rational, while refusing isn’t. Therefore we have a problem: Is it irrational to refuse the gamble since the utility theory tells us that we have to accept it? This is what I assumed in the last few blogs, but it is correct? I think that the difference between what the utility theory tells us to do and what we actually do says more about the limited view on rationality of the utility theory than about the rationality of man’s behaviour.
Let me give another example. Recently I have travelled round and camped in my tent in Austria. When I left the country on the last day of my holiday, it was late and the homeward drive was too long to do it yet the same day. Therefore I had to overnight in Germany. After two hours I saw a direction sign to a camping site. I took a hotel. Was it rational?
Let’s see what the utility theory tells me. I have my tent and everything I need for camping with me plus enough to eat for the breakfast. A night on the camping site costs €25,-. The night in the hotel with breakfast costs € 100,-. So, I save 75,- euros by camping. The expected value of going to the camping site is positive, which makes it rational to camp. However, I am tired after a long day, and to pitch my tent will take me an hour. Then I have to go to the restaurant, which is next to the hotel. Sleeping in the hotel will be more pleasant and I have a personal bathroom there. I don’t need to break up my tent next morning. I just leave, and the only thing I want to do is going home as soon as possible. Taking a hotel is simply more comfortable. However, what is the expected value of comfort? Well, if you ask me to give its money value, I must say that I cannot. For me it’s a value in itself. And here we are at the heart of the problem. Comfort is a subjective feeling and we cannot give at a money value, although I must admit that I wouldn’t have taken a hotel for € 250,- a night (but then I would have felt myself a bit unhappy at the camping site for this night; and even more tired). To keep it short, economic reasoning based on the utility theory has a limited idea of rationality. It can express rationality only in terms of figures, preferably in money values. But often much what makes life valuable can’t be expressed in money and much of what we do is not done by us because of a positive expected money value (utility), but because we enjoy it, because we like the style of a certain action, because, it pleases our wife or husband, or someone else; and so on. But if a theory can explain our actions only if and insofar as we can ascribe money values to them, it must fail, sometimes or in most cases. Generally, economic theories can explain what we do only if they can compute what we do in terms of money. However, that they can’t compute money values for many human actions, doesn’t mean these actions are not rational. It means only that they apply an idea of rationality that is too limited for most what man does. Man’s behaviour is not irrational if it doesn’t fit the utility theory but often it’s simply rational in another way.
And how about the first example of this blog? Why don’t most of us accept the gamble? The surest thing you can do is to refuse. Most people prefer certainty and why should you take a risk to lose money if the possible benefit is minimal? In most situations playing safe is the best choice, and it will spare you a big fuss. Certainty is what many people prefer, and tell me, why wouldn’t it be rational?

No comments: