Rational Actors

In economics (as well as a few other sciences of people) one of the critical assumptions is “rational actors”. There’s a minor flaw in the assumption, yet it works most of the time. Because it works most of the time people forget about the flaw.

A rational actor is someone who chooses in their own best interest. The choice is based on long-term best interest, and it assume “perfect knowledge”. No, perfect knowledge isn’t the flaw, though it’s also been the source of more than a few errors. The flaw that really messes things up when it appears is that best interest is long-term interest.

We see this in lotteries and in World of Warcraft. People take the “now” instead of waiting for the better they can see down the road. There are many reasons why this happens. It’s worth noting that when examined some of those reasons are actually highly rational as well. Let’s take lotteries first as an example. Large lotteries can pay off in a lump sum right now or a series of payments over the next 20 or 30 years. The payments will add up to much more than the lump sum; frequently larger than the recipient could get by putting it in an investment and leaving it to grow. So, why choose the lump besides simple gimme-now greed? Well…

Consider that most lotteries go to the winner and not the winner’s estate. If I win, for example, it pays me. If I die in five years, the remainder stays with the lottery and does not go to my wife or child. I’m pushing 50 now, and so have a reasonable life expectancy of somewhere between 20 and 30 more years — but I”ve some risk indicators that say I could go in a decade. The choice for me just on that basis becomes a coinflip. If I were 60 or older the rational choice is all or some, whereupon taking the lump now is much wiser.

At the same time the more common reality is short-term greed. For this we’ll take World of Warcraft. In the long run a cooperative player who doesn’t gank and doesn’t ninja will do better – will have more opportunities to get to advanced content, will get better deals for trades, will not have an “enemy” flag that has players hunting for him every time he comes online… Yet more than a few players will still ninja loot (grab all the goodies and disappear) and will gank (ambush significantly weaker players) happily.

When you build your model – your game, your examination of economic principles, whatever – you will be much better served if you remember that flaw. I recall a Smithsonian article from some years ago – I think it was “We’re in a Jam” in the April 2001 issue – where the traffic engineers of Atlanta were trying to model that mess so they could work on fixing it. Everything they added seemed to be ‘almost’ right but kept missing. Finally and almost in frustration, they added a “sometimes an idiot will stop for no reason whatsoever” element – just a tiny bit of irrational actor – and it worked.

I expect the next big thing in economics will be modeling the irrational actor effect. Economists got a wakeup call when their models failed, and some of them actually appear to be paying attention.

Oh, about that “perfect knowledge” assumption? That’s already incorporated in several places. The problem there is that WHAT information is not available is critical – and it’s hard to create general models when that specific is so variable. Even so, it’s happening.

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