Misbehaving: The Making of Behavioral Economics by Richard H. Thaler Read Free Book Online Page A

the situation . . . [and] would ‘just know’ in a vague and rough way, whether or not it would pay him to hire more men.” Machlup was highly critical of Lester’s data, but presented none of his own.
    It is in the context of this debate that Milton Friedman, a young economist headed for fame, weighed in. In an influential essay called “The Methodology of Positive Economics,” Friedman argued that it was silly to evaluate a theory based on the realism of its assumptions. What mattered was the accuracy of the theory’s predictions. (He is using the word “positive” in his title here the way I use “descriptive” in this book, that is, as a contrast to normative.)
    To illustrate his point, he traded Machlup’s driver for an expert billiard player. He notes that:
    excellent predictions would be yielded by the hypothesis that the billiard player made his shots as if he knew the complicated mathematical formulas that would give the optimum direction of travel, could estimate by eye the angles etc., describing the location of the balls, could make lightning calculations from the formulas, and could then make the balls travel in the direction indicated by the formulas. Our confidence in this hypothesis is not based on the belief that billiard players, even expert ones, can or do go through the process described; it derives rather from the belief that, unless in some way or other they were capable of reaching essentially the same result, they would not in fact be expert billiard players.
    Friedman was a brilliant debater and his argument certainly seemed compelling. For many economists at the time this settled the issue. The AER stopped publishing any more rounds of the debate it had been running, and economists returned to their models free from worry about whether their assumptions were “realistic.” A good theory, it seemed, could not be defeated using just survey data, even if the defenders of the theory presented no data of their own. This remained the state of play some thirty years later, when I began to have my deviant thoughts. Even today, grunts of “as if” crop up in economics workshops to dismiss results that do not support standard theoretical predictions.
    Fortunately, Kahneman and Tversky had provided an answer to the “as if” question. Both their work on heuristics and biases as well as that on prospect theory clearly showed that people did not act “as if” they were choosing in accordance with the rational economic model. When the subjects in one of Kahneman and Tversky’s experiments choose an alternative that is dominated by another one—that is, chosen in lieu of an alternative that is better in every way—there is no way they can be said to be acting as if they were making a correct judgment. There was also no way Professor Rosett’s wine-buying habits could be declared rational.
    In homage to Friedman, whom I genuinely admired, I titled my first behavioral economics paper “Toward a Positive Theory of Consumer Choice.” The last section contained a detailed answer to the inevitable “as if” question. I too began with billiards. My main point was that economics is supposed to be a theory of everyone, not only experts. An expert billiard player might play as if he knows all the relevant geometry and physics, but the typical bar player usually aims at the ball closest to a pocket and shoots, often missing. If we are going to have useful theories about how typical people shop, save for retirement, search for a job, or cook dinner, those theories had better not assume that people behave as if they were experts. We don’t play chess like a grandmaster, invest like Warren Buffett, or cook like an Iron Chef. Not even “as if.” It’s more likely that we cook like Warren Buffett (who loves to eat at Dairy Queen). But a snappy retort to the “as if” critique was far from sufficient; to win the argument I would need hard empirical evidence that would convince economists.
    To this