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PRESENTER:
- Hello to all you listeners out there and a big welcome to the "Talking economics" show. We've got Bernard on the line. Go ahead and ask your question …
BERNARD:
- Er, hello. Your guest mentioned the theory of rationality earlier. Could she tell us more about what she meant exactly?
PRESENTER:
- Of course, of course… Sarah Smart, let's just remind people that you are head of the E2IE, European Institute for the Invincible Economy, what do you have to say in reply?…
SARAH SMART:
- Firstly, the theory of rationality is one of the starting points for the so-called "classical economic thought" put forward by Adam Smith…
PRESENTER: [addressing listeners]
- Adam Smith, the late-18th-century Scottish philosopher and economist…
SARAH SMART:
- So, for Adam Smith, the wealth of nations increases because, quite rationally, individuals become specialised in tasks at which they are the most efficient and which allow them to gain the most from.
BERNARD : [Bernard, in an irritated tone]
- So, that means I don't always act rationally then… !
SARAH SMART :
- You know, like all theories, the rationality theory is an oversimplification. For Milton Friedman, Nobel Prize winner in 1976, it's a simplification that makes it possible to predict people's decisions. It is assumed that we are rational, even if it is not entirely the case. Bernard, if the price of fish goes up, you buy less, which means you're rational…
PRESENTER : (in the tone of a follow-up question)
- But if Bernard knows that fish prices are about to rise again, maybe he'll fill his freezer up with fish?
SARAH SMART:
- In this case, he will be anticipating according to information and in a quite rational manner, won't he? This type of behaviour has been expertly analysed by Robert Lucas, another Nobel Prize winner in 1995.
PRESENTER: [in an amused, defiant tone– and immediately picked up by the guest]
- Sarah Smart, do you really think that rationality is still relevant when share prices in a particular sector reach astronomical levels and then suddenly plummet ?
SARAH SMART:
- When a speculative bubble bursts? In that case, we're dealing with players who all want to sell at a higher price than they paid. Everyone tries to second guess what others are thinking about a given company and not its true potential. They imitate each other and lose all rationality. John Maynard Keynes identified this phenomenon in the 1930s...
BERNARD:
- Oh come on!
PRESENTER:
- Yes Bernard?
BERNARD:
- What's the point of taking such risks?
SARAH SMART:
- Because the truth is that many investors take decisions without always taking the time to inform themselves and weigh everything up. Herbert Simon, Nobel Prize winner in 1978, described this process very well.
PRESENTER:
- So, homo-economicus is just another human being, capable of being totally irrational? [presenter, in a conciliatory summing-up tone]
SARAH SMART:
- Absolutely. Experiments by Daniel Kahneman, the psychologist/economist and even Nobel Prize winner in 2002, clearly highlighted the extent to which our rationality may be far more complex than the theory would suggest…
PRESENTER:
- Bernard, I hope that has cleared things up for you, Talking economics continues. Time for a new caller and today's three experts…
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