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Markets and Rationality

One of the few quotations that I have posted on my office door is from Will Durant's 1939 book The Life of Greece:

The crossroads of trade are the meeting place of ideas, the attrition
ground of rival customs and beliefs; diversities beget conflict,
comparison, thought; superstitions cancel one another, and reason

I'm pretty sure — a la the important research of Leda Cosmides and John Tooby –  that the human mind is not naturally reasonable or rational in any general sense.  We are evolved to survive, and then evolved to survive in environments drastically different from the expansive commercial society that today spans the globe.  Evolved from apes and hunters-gatherers, there's simply no reason to flatter ourselves that we, as a species, are as "rational" and as dispassionate and as enlightened and as aware and as educable as some economic models are sometimes interpreted to make us out to be.

But not to worry too terribly much: competitive, decentralized markets — commerce — generally manage to produce results that make us seem to be more rational and smarter than we really are.  This interesting paper by John List and Daniel Millimet, winner of the 2008 Arrow Prize for Senior Economists, uses experiments to make this point.  Here's the abstract of "The Market: Catalyst for Rationality and Filter of Irrationality":

Assumptions of individual rationality and preference stability provide
the foundation for a convenient and tractable modeling approach. While
both of these assumptions have come under scrutiny in distinct
literatures, the two lines of research remain disjointed. This study
begins by explicitly linking the two literatures while providing
insights into whether market experience mitigates one specific form of
individual rationality—consistent preferences. Using field experimental
data gathered from more than 800 experimental subjects, we find
evidence that the market is a catalyst for this type of rationality.
The study then focuses on aggregate market outcomes by examining
empirically whether individual rationality of this sort is a
prerequisite for market efficiency. Using a complementary field
experiment, we gathered data from more than 380 subjects of age 6-18 in
multi-lateral bargaining markets at a shopping mall. We find that our
chosen market institution is a filter of irrationality: even when
markets are populated solely by irrational buyers, aggregate market
outcomes converge to the intersection of the supply and demand

(Here's Steve Horwitz's blog post, over at The Austrian Economists, on the List & Millimet paper.)

Now in light of current events, there are at least two takes on the List-Millimet findings.  One take is that these findings cast doubt on the widespread belief that irrationality and excessive exuberance are root causes of today's economic woes.  A second, and very different take, is that today's economic woes cast doubt on List's and Millimet's findings.  (A note for those persons sympathetic to the latter take: List's and Millimet's findings are not the product of armchair theorizing; they are the result of controlled experiments with real people.  So it would be illegitimate to assert that the real-world event that we call today's financial meltdown automatically disproves these scholars' findings and arguments.)