Wanted: equilibrium mass psychology theory

Results from psychology or experimental economics don’t (as in DO NOT) translate directly into equilibrium behavior. This is because one person’s psychological bias may cancel out another person’s bias. Or even if people have anomalies that systematically bias behavior, the presence of a few non-biased actors may reverse the bias of the rest.

Psychologists usually report the systematic sorts of biases, so there’s not very many examples of the first kind of equilibrium outcome in that literature. That said, examples of human impreciseness are apparent. As individuals, for example, we’re imprecise estimators of value. For every potential widget buyer that overestimates the value to him of a widget, there’s a potential widget buyer that underestimates its value to her. The price will be set somewhere in between and would be equal to the price set if the buyers didn’t make mistakes ((needs cite… I’m sure I’ve seen results like this somewhere)).

On the other hand, psychologists and experimental economists love to report systematic biases, so-called anomalies. The examples of these are numerous. Just today, The Economist cited evidence of the money illusion ((BTW, guys, the relevant parts of economics, i.e. macro, know all about money illusion and don’t deny its existence. I’m not sure why this one finding “refutes” anything.)) and here they are talking about regret. It turns out people feel buyers remorse soon after buying, but after a while they start to think they should have consumed more.

In the case of money illusion, we know — in, like, an empirical sense — that money is neutral in the long run; doubling money will double prices. In other words, there’s some mechanism at play that corrects for this psychological bias. In the case of the finding about regret, its not clear at all if this would have systematic effects. Does the long term effect swamp out the short term effect? Does either effect have real affects on consumption decisions?

One way to assume these anomalies have macro effects is to assume all agents have perfectly coordinated states of mind (e.g. every last investor becomes chicken little). This isn’t exactly a bleedingly obvious assumption, so my theory of equilibrium mass psychology sucks. Can you do better?

We can’t just assume individual instances of “irrationality” aggregate up into systematic irrationality. Given our general ignorance of these individual psychological effects, their aggregate properties and the mechanisms underlying this aggregation, a theory like rational expectations that assumes anomalies wash out seems prudent to me.

Now excuse me, I need to go read Vernon Smith.

11 thoughts on “Wanted: equilibrium mass psychology theory”

  1. I don’t see how brain scans inform about… anything.

    Also, yes we do deny “money illusion” in macro written in the last 40 years. We don’t deny nonneutrality for various, valid, and pretty much rational reasons in the short-run.

  2. How do you reconcile that with things like sticky prices? If the “noise” of human irrationality auto-cancels, wouldn’t that eliminate all psychological explanations for stickiness?

    Also – it sounds like you need to hang out with some good marketing people.

  3. The discovery of money illusion in individuals gives a mechanism for short term price stickiness, but it doesn’t help understand macro dynamics (i.e. the return to neutrality in the long run). The result just isn’t that interesting for understanding macroeconomics.

  4. I don’t think “money illusion” is necessary for price stickiness and I wouldn’t bet that it’s sufficient either.

  5. Yeah- I’m thinking about stuff like this. Just take away the bit where there’s a clear answer to the problem and apply it to value of, say, designer shoes.

    Of course, that’s all micro. I’m just curious about how you get systemic effects (macro) without local effects (micro). Maybe I misunderstand the distinction – isn’t macro the aggregate of micro? Lots of tiny transactions accumulating into broad trends?

    Chemistry emerges from physics; atoms don’t consult the periodic table to figure out what to do next.

  6. Suddenly I realized that I might not have a large enough window in mind when you say “in the long run.” All else being equal, in a long enough run, I, too, would expect the manics and the depressives in the market to cancel out.

  7. “Chemistry emerges from physics; atoms don’t consult the periodic table to figure out what to do next.”

    No, but its “as-if” they did and that’s all that’s needed to do chemistry.

  8. Gabriel, exactly. Chemistry doesn’t depend on the particular mechanisms involved in nuclear physics. Whether or not electrons are waves or particles, Na will combine with Cl to produce salt. Money illusion may be what’s going on sub-atomically, but the specific mechanism doesn’t matter in the more macro picture. People that insist that every little finding in behavioral psychology or experimental economics need to be accounted for in our economic models are committing a category error. The effects created by aggregating psychologies overwhelm the individual psychological effects so it doesn’t make sense (or rather it makes things way too complicated) to use the language of psychology to do economics.

    That said, if I were a psychologist, I’d be totally interested in the underlying psychological mechanisms of how policy gets translated into expectations. And if I were a sociologist I’d be interested in how information about policy works its way through social networks (from government to high finance to main street to firms and workers setting prices and wages).

  9. Yes, chemistry does depend on the particular mechanisms. Chemistry *is* the particular mechanisms; the field itself is just a handy conceptual shortcut that humans use to describe sets of particle interactions like electron bonds. It’s just that the wave/particle distinction is too fine to make a noticeable difference at the granularity we’re generally working at when we do chemistry.

    Like you said, the specific mechanism doesn’t really matter because the granularity of the field isn’t high enough. Sort of like how astronomers don’t really worry about accounting for weather.

    Your question is interesting, though – cancellation requires that all of the agents are more or less equal, in the aggregate. What happens when many agents tend to follow a few agents? Is this the case in the real world?

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