I have a post on rules of thumb written in one of my notebooks (The problems of only being able to write in using pen and paper, is you have to type it later, argh).

One of my points is that Rules Of Thumbs are incomplete if they are not accompanied with the bounds that they are effective.

Rationality is a Property of Equilibrium

Some thoughts on rationality and economics, perhaps for a future paper, motivated by the financial panic:

Rationality is a property of equilibrium. By this I mean that rationality is habitual and experience-based and it becomes effective as it becomes embedded in the rules of thumb and collective wisdom of market participants. Rules of thumb approximate rational decision rules as market participants become familiar with an economic environment. Individuals per se are not very rational; shift the equilibrium enough so that the old rules of thumb no longer apply and we are likely to see bubbles, manias, panics and crashes. Significant innovation is thus almost always going to come accompanied with a wave of irrationality. When we shift to a significant, new equilibrium rationality itself is not strong enough to tie down behavior and unmoored by either reason or experience individuals flail about liked naked apes – this is the realm of behavioral economics. Given time, however, new rules of thumb evolve and rationality once again rules but only until the next big innovation arrives.

Posted by Alex Tabarrok on January 13, 2009 at 07:20 AM | Permalink

Marginal Revolution: Rationality is a Property of Equilibrium.