Later On

A blog written for those whose interests more or less match mine.

Psychology and the economy

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Interesting Scientific American article:

Peter Ubel is professor of medicine and psychology at the University of Michigan, where he directs the Center for Behavioral and Decision Sciences in Medicine. He’s the author of the forthcoming book, Free Market Madness (Harvard Business, 2008), which investigates the irrational tics that lead people to overbid on eBay, eat too much ice cream and take out mortgages they can’t afford. Mind Matters editor Jonah Lehrer chats with Ubel about his research.

LEHRER: Your new book, Free Market Madness, argues that conventional economics, which assumes that humans are rational agents acting in  their own self-interest, is deeply naive and scientifically  unrealistic. Instead, you describe a brain brimming with biases and flaws. Do you think these flaws are responsible for the latest economic turmoil? If so, how?

UBEL: Irrationality is responsible for the economic mess we find ourselves in right now.  Irrationality plus greed, of course, and a substantial dose of ignorance.

Let’s start with ignorance. I’m sad to say that many Americans have a difficult time with even simple math—around a third of American adults cannot calculate 10 percent of 1,000. People who struggle with concepts such as percents have an extremely difficult time with more complicated ideas, such as compounding of savings and, very relevant to our current crisis, adjustable rate mortgages.

To make matters worse, most of us are hard-wired for optimism. Ask us how we rate as drivers, and the vast majority of us are convinced we are above average, even those of us who have gotten into multiple car accidents. As a result of our unrealistic optimism, we are convinced that our incomes will rise fast enough to keep up with our outsized mortgage, or that our adjustable rate won’t rise, or that our house’s value will indefinitely outpace inflation.

We are social beings, too, and frequently judge our own decisions by seeing what other people are doing. If my neighbor added on a new kitchen through a home equity loan, I might assume that is a good idea for me, even if a more rational weighing of my finances would suggest otherwise.

Even savvy financiers can get caught up in irrational impulses. If a competitor’s firm makes huge profits on risky loans, it is easy for me to push aside my fears about such risks: if he took those risks and was rewarded, maybe I overestimated the risks!

LEHRER: What can eBay teach us about human irrationality? …

Continue reading.

Written by LeisureGuy

21 December 2008 at 2:35 pm

Posted in Daily life, Science

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