The Telegraph
Since 1st March, 1999
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- Actual behaviour diverges systematically from the economist’s model

The author teaches economics at the University of New South Wales, Sydney, Australia

For over a hundred years, economists have analysed human behaviour using a particular model of rationality. It says that, in any given situation, a person takes that course of action out of all feasible ones which best furthers his well-being. This sounds quite reasonable, but has implications which are often hard to match with observed behaviour. Other social scientists have been consistently critical of economic theory on this ground. The Bank of Sweden agreed this year, awarding the Nobel in economics to two pioneers in experimental economics. This subject has in recent decades thrown up substantial evidence that actual behaviour diverges systematically from the economist’s model.

Now economists are turning increasingly to biology for explanations. Here is an example. Suppose you have decided that you want to watch a movie, A. There is another movie, B, also showing in town, which you definitely do not want to watch. Tickets are ten rupees each. Your decision means that movie A is worth at least ten rupees to you, while movie B is not. Having bought a ticket in advance, you arrive at the cinema.

Now things go wrong in one of two ways. You find that you have lost your ticket. The ticket window is still open, and you can buy another if you still wish. Will you' Many experimental subjects put in such a situation decide not to. Having spent ten rupees already, they are not willing to spend another ten to watch the movie. Alternatively, you discover that the movie actually showing is B. There are people around who will buy your ticket from you. Do you sell your ticket and leave, or do you go in anyway' Many subjects decide on the latter—having come all the way they are unwilling to leave without watching a movie.

Observe that the valuation of the movie is here being affected by an event which is now irreversible. “Having spent ten rupees” or “having come all the way” are conditions that are not going to be changed by a decision at this point. The question remains whether the movie is worth the ten rupees, which is what must be now spent for it. The subjects’ actions do not tally with the valuations that were made earlier. These subjects are acting irrationally.

A cost which has already been incurred and cannot be undone by future actions is called a “sunk cost” in the economist’s parlance. Traditional economic theory tells us that such costs should be ignored in rational decision-making. The relevant considerations involve the further costs that will follow as a consequence of the decision, which must be balanced against additional benefits which will be generated. For the overwhelming majority of people the problem with this excellent principle is that we have been judiciously and systematically taught to violate it, ever since we were children. We have instead been held responsible for our past choices, even when the unfolding of events show that those choices were ill-founded.

Take the case of the drain-pipe trousers which my classmate, Probal, once acquired. (Some older Calcuttans may remember those excruciating pants, nary twelve inches around at the ankles, which had become fashionable here at the turn of the Seventies. Elders mused whether they had been stitched before or after the act of wearing.) Probal had pleaded with his parents for a year before he was allowed three whole pairs, all at once. Unfortunately, they turned out to be too many and too late, since within a few weeks his small world was overwhelmed by bell-bottoms.

The sheer and hopeless contrast only accentuated the daily agony of pulling the drain-pipes on. In those days, one did not throw away new pants. Probal’s well-intentioned parents ruled that he must live with his decision — which he duly did for two humiliating years. The reader may note that the parents enforced a decision rule which utterly contravenes the eco- nomist’s rules. However it may be, the incident must have left a deep mark on Probal’s psyche — to this day he cannot buy even a screwdriver without long consideration of potential consequences.

This is not an isolated example, as is confirmed by the episode of the tin suitcases, which were marketed as primary school bookbags. When they first appeared in the market in pre-drainpipe Calcutta, the sheer novelty caused an immense stir among the potential target demographic. The young son of the Maharaja of Goleswar got one immediately, as did many of his humbler classmates. Within weeks, however, it became clear that the suitcases were not right. On closer inspection they looked ridiculous, their sharp corners scratched unsuspecting knees, they were cumbersome to carry, and they fell open in the most inconvenient of circumstances. The rank and file had to suffer their suitcases for an average of three years, but the young prince of Goleswar tossed his on the scrap heap and promptly acquired a Duckback back-pack.

Probal had been more characteristically circumspect in this instance — which reflects better his middle-class upbringing, much as the indiscretion of the young prince sits comfortably with the practices of royalty. Surely the prince later acquired drain-pipes as well, and discarded them unused when bell-bottoms arrived on stage. The prince to this day undoubtedly buys many a screwdriver which are utterly inadequate for screwing the specific screws that he intends to screw, if a prince indeed buys his own screwdrivers, or screws any of his screws himself.

The divergence in the predispositions of the commoner and the prince is more likely to be a matter of upbringing than of wealth. I have later encountered the sons and daughters of business tycoons who command resources far greater than did the Maharaja, who nevertheless consider it an imperative to live by their decisions. My friend Dinesh — from a successful business family — stuck out his first full-time job for a year even though he hated it, because his father would disapprove of quitting. “If I tell him I want to quit, he’ll say I shouldn’t have taken the job in the first place.”

If Dinesh had ever had a tin suitcase, he certainly carried it for a while. One suspects that in later life he made employment decisions with better judgement, not in anticipation of paternal wrath, but because that is how he had been schooled. I am also sure Dinesh has the perfect set of screwdrivers for his screwing needs.

The moral is clear. It may be advisable to throw out bad decisions once they turn out to be bad. But to make this a habit invites more bad decisions, since one does not then expect to bear the full consequences. Our parents made us suffer for our actions to induce a habit of thinking in advance. Those who do so will prosper in the long run, the others will perish. If you can disown your leap, you are not likely to look before. Indeed, we do not see people blithely ignoring sunk costs because those that did so have, by and large, perished as a result of their misjudgments. If their descedants prospered, it is by emulating success instead, and acquiring the art of well-considered action.

In time, this circumspection has become encoded in our behaviour as a component of morality. The action which seemed irrational in a single instance is actually part of a larger pattern which makes the individual fitter for survival in the longer term. It is as if Probal and Dinesh inherited a good mutation that made them ultimately prevail over those who did not — the mutation “invaded” the population. This is a theoretical position imported directly from evolutionary biology. Evolution is providing the explanation for behaviour which experimental economics uncovered. Watch out for such thinking, because it is about to sweep social science.

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