Dan Ariely is professor of Behavioral Economics at Duke University. Behavioral economics examines market trends like traditional economics, but distinguishes itself by not assuming that humans always act rationally. The research relies on observing how people behave rather than using traditional economics methods such as cost-benefit analysis.
What is the behavioral economics perspective of the recent stock market crash?
DA: You can think about the recent stock market crash as a good example of the differences between standard and behavioral economics. In standard economics you let people run loose, and because people can optimize and be rational and they do only what’s best for themselves, the whole system works very well. In behavioral economics we don’t think this is the case. We think that there’s a lot of reasons why people make mistakes, and as a consequence they can’t be let loose on everything. The free market is not the right approach.
Define “irrational.”
DA: When we act in ways that we don’t understand or predict. This matters because it gives us an opportunity to get into trouble. If I think that I will have safe sex when the time comes but when I get aroused I don’t, it’s an opportunity to get into trouble. If I think that I will save for a long time but then I get tempted to buy certain things, that’s a problem. If we think that people can compute what is the right amount of mortgage for them to take out that’s a problem. If we think like Greenspan said when he testifi ed in front of congress that he thought that people would work in the best interest of their companies, which is clearly not the case, we get into trouble.
