In Which An Economist Proves That I’m Irrational

by Mary Martialay on November 22, 2010

The proof - literally.

The proof - literally.

Greg DeAngelo, a recently appointed assistant professor of economics at Rensselaer, specializes in a new breed of economics that draws on cognitive science, neurology, and psychology to get at the science behind our economic choices.

DeAngelo and other “behavioral economists” find that, contrary to the assumption underlying most traditional economics, people do not always behave rationally for their greatest good. In reality, their choices are irrational and inconsistent.

I met DeAngelo recently, and it didn’t take him long to show me how irrational I am using something called “the Allais Paradox.” Care to try your luck against DeAngelo’s methods?

Scribbling on a scrap of paper, DeAngelo explained that the Allais Paradox first asks people to choose between two lotteries:

  • L1 is 10% chance at $5 million and an 89% chance at $1 million and
  • L2 is a 100% chance at $1 million.

Don’t move on until you make a choice.

Okay. Got your choice? Remember it.

Now chose between these two lotteries:

  • L3 is a 10% chance at $5 million and
  • L4 is an 11% chance at $1 million.

DeAngelo said most people (myself included) will choose L2 and L3.

“Economists tend to view this decision making as inconsistent,” DeAngelo said. “With a little math this can be shown. Let me explain below:

If an individual prefers L2 to L1, then they are saying that:

1 X $5 million + .89 X $1 million < 1 X $1 million

 And by subtracting .89 X $1 million from each side of the inequality, they are saying that:

.1 X $5 million < .11 X $1 million

“Or, written differently, L3<L4, which is, of course, the opposite of what we observe,” DeAngelo said. “So, to recap, if lottery 2 is preferred to lottery 1, then we should expect lottery 4 to be preferred to lottery 3. This rarely occurs, however. Most subjects like L2 to L1 and L3 to L4.”

DeAngelo said behavioral economists want to get at the root of these choices by applying advances in neuroscience, cognitive science and psychology to the time-honored models of the discipline.

“Neuroscience has enabled us to understand what part of the brain is firing at what time. And technology is at a point where I, as an economist, have access to EEG and FMRI machines,” DeAngelo said. “Now we’re in a place where we can disentangle how you make your decision – is it with the reasoning prefrontal cortex, or the reactionary part of the brain?”

DeAngelo joined the faculty at Rensselaer in the fall of 2010, after a year as a visiting professor at the University of Colorado-Denver. He completed his Ph.D. in Economics from University of California-Santa Barbara in 2009.

Since arriving at Rensselaer, DeAngelo has been actively presenting his work. He presented “Recidivism under Uncertainty – New York State Economics Association” at Cornell University’s Judgment by Numbers on October 4 and at the University of Colorado Youth Crime Working Group Oct. 14-16, and he presented a proposal on “Consistency in Decision Making” to the Russell Sage Small Grants in Behavioral Economics Group on Sept. 25.