William Poundstone’s “Priceless” (2010) is an interesting and useful read for anyone who’s curious about the arcane science of behavioral decision theory. In application, this field of study is particularly useful in addressing questions regarding the both the psychology and, thus, the frequently debated “rationality of the market” (or lack thereof).
As a fundamental economic concept, the psychological underpinnings of market behavior remains one of the least understood and, yet, most critical factors driving the business cycle, and more often than not, public economic policy.
Adam Smith’s description of the “invisible hand”, we might recall, was among the earliest attempts to identify the mysterious forces that contribute to market behavior, specifically the self-interested motivations of buyers and sellers. For many, however, Smith’s notions of self-interest fell short in providing adequate explainations for what often appears to be irrational behavior. Perhaps, other motivations (or processes) are also at work.
The “self-interest” meme is central to the laissez-faire and libertarian principles of the free market. Milton Friedman, for instance, was an ardent proponent of the belief that “rational self-interest” laid the foundation for what he termed “the possibility of cooperation without coercion“. And, to be sure, while other motivations are surely at work in the market, virtually any economic decision we might make will reflect variations of the same theme, “which choice do we expect to maximize our happiness and/or minimize our pain”.
Notwithstanding rather lame attempts to qualify altruism – or other possible alternative motivations – as merely another form of self-interest, there are few “rational” explainations for perceived irrational market behavior. It is here that the study of behavioral descision theory shines. Perhaps, self-interest itself is a function of perceptual and contextual factors.
Of the findings presented in “Priceless”, the notion that human perception is largely geared to “relativistic”, rather than “absolute”, evaluation is, possibly, the most intriguing. In effect, humans – creatures well-integrated into and subject to the same natural laws as the physical universe in which they live – are naturally adept at relating to an environment that may be described as a construct of “power curves”.
The Power Law, as it is known, surrounds us in the physical world. More to the point, it rules the physical world. From Wikipedia: “A power law is a special kind of mathematical relationship between two quantities. When the number or frequency of an object or event varies as a power of some attribute of that object (e.g., its size), the number or frequency is said to follow a power law.” Prime examples of power laws include such trivialities as, say, the force of gravity and, say, Einstein’s Theory of Relativity.
And relativity, as it happens, is also the name of the game, when it comes to human perception. Big surprise: we find that humans, part and parcel of the universe in which they reside, relate to their environment in a manner that accounts and adjusts for non-linear power scaling. So attuned are we to this sort of “relativistic evaluation”, that we can easily estimate comparative values – be they physical or abstract properties, and, yet, fail miserably in the estimation of absolute values on the same scale. In effect, without the aid or benefit of useful comparative benchmarks, we’re generally clueless.
More significant, as Poundstone’s review of the subject illustrates, our perceptions are intrinsically linked to the comparative benchmarks provided. In this context, “rationality” becomes an almost purely subjective ideal. Seems sort of obvious, I suppose, to understand that what may be rational for one will be irrational for another, based on the perceptual bias and relative utility of the comparative benchmarks being relied upon.
Well, that explains EVERYTHING, doesn’t it? Of course, it does re-affirm – for me, at least – the critical nature of the comparative benchmarks that we rely upon. So much of our behavior, whether it be in the market, the political realm, or in our personal relationships, could easily be “irrational” manifestations of fallacious, irrelevant, or intentionally manipulative benchmarks. These, we must understand, are the tools not only of the huckster, but of the politician and mass media.
As one who believes in the existence of absolutes, even absolute truth, it is rather humbling to be reminded just how easily our own perceptions might be compromised. Still, as a source of insight to this all-too-human frailty, Pounstone’s book may well be “Priceless”.
When I was a child, I spake as a child, I understood as a child, I thought as a child: but when I became a man, I put away childish things. For now we see through a glass, darkly, but then face to face: now I know in part; but then shall I know even as also I am known. And now abideth faith, hope, charity, these three; but the greatest of these is charity. – I Corintians 13: 11-13