Thursday, November 1, 2007

The Sense in Irrationality

There's a more cynical view of why it is relatively unusual for businesspeople to go back on their word than the one I posted about a couple of days ago. I mentioned that the cost of redress when treated unfairly often made it economically irrational to try to enforce a broken contract. I said that more contracts aren't broken because people are naturally trustworthy.

Another reason may be that people are often quite economically irrational.

There's an experiment in behavioural economics known as the Ultimatum Game. This game gives one person a certain amount of money and asks them to split it however they want with a second person. If that person accepts, then both people get the money as allocated by the first person. If the second person refuses, however, neither gets anything. The game is played once, anonymously.

The rational strategy for the second person is to accept any split that offers them anything. The alternative is to get nothing. Thus, the rational strategy for the first person is to offer the minimum amount to the second person.

This is not what happens. Although it varies from culture to culture, any split offering less than 20% to the second player is usually rejected. People are willing to act somewhat irrationally to enforce an idea of justice. Economists, who often base their theories on the idea that each person is an autonomous unit making only decisions that benefit themselves, can not explain this result. But it's easily explained as a group dynamic: if everyone was willing to personally accept some cost to punish the unjust, there would no longer be any injustice. It wouldn't pay.

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