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Are we human, or are we rational?

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When you hear the word “economics,” what’s the first thing that comes to mind? Supply and demand? Interest rates? Maybe just complex graphs and configurations? You’re not to blame, but there’s a more approachable branch that we can explore: welfare economics. It’s how we evaluate the aggregate well-being of all of society, and how it can be improved or, yes, maximized. It’s the examination of efficiency versus equity (See “The Big Tradeoff”) and the study of how our government might have an opportunity (and an obligation) to step in and champion social welfare.

I’m sure the term “pareto optimal” also comes to mind. The idea that it’s impossible to improve the conditions of one group without making another group worse off. Remember, there’s always a tradeoff. And it makes public policy decisions tough because not everyone is going to get what they want.

But, let’s pause. With this above model, we assume that every human makes rational decisions. I’d be surprised if there wasn’t a time one of us spent that grocery money on a Starbucks caramel macchiato with chocolate drizzle instead. And if we’re going there, we should also consider:

This version of economics that immediately comes to our minds has been the dominant economic theory and the rigid models that have long been based on mathematics and the idea that the economic [wo]man is rational. It assumes there is perfect competition in the market, we have access to perfect information, and we have the same preferences for all things in life. Perhaps Milton Friedman’s faith in a free market and limited government regulation holds up if we were to put efficiency on a pedestal and throw equity in the trash—and if we were to believe that we are all perfect, rational beings. What this leaves out is us, our flaws, our unique preferences, and our imperfections as humans. It also leaves out the nuances and external forces that govern how we live and how the world works.

Fortunately, economics is evolving to be more human-centered. And this, in turn, helps policymakers understand welfare economics in regard to the people, and not just the numbers. A round of applause goes to Richard Thaler, who was chosen as the Nobel Prize laureate in economics this year. The American economist blends psychology with economics and recognizes that we are imperfect. Sometimes we lack self-control; sometimes we have limited rationality when making decisions; sometimes we choose what’s easiest or most convenient at the time. We might opt for fast food despite knowing that making a healthful dinner at home is better for us in the long run. We also might opt for a vacation when it’s beyond our budget and we know we have bills to pay. Thaler shines a light on these imperfections:

“In order to do good economics, you have to keep in mind that people are human.”

And humans are anything but perfect. Thus, our capitalist system, which assumes perfection, is inherently flawed. But as we begin to acknowledge humanity for what it is, and infuse economics with these values, economists and policymakers alike have a better chance at improving social welfare. And we, as humans, have a better chance at equity—equity that is optimal for all.

Published On: October 17, 2017 |
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