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He may also fall prey to quasi-magical thinking— behaving as if he believes his thoughts can influence events, even though he knows that they can't. Most people, say psychologists, are also vulnerable to hindsight bias : once something happens, they overestimate the extent to which they could have predicted it. Closely related to this is memory bias : when something happens people often persuade themselves that they actually predicted it, even when they didn't. Finally, who can deny that people often become emotional , cutting off their noses to spite their faces.

The responder can either accept the offer, in which case he gets the sum offered and the proposer gets the rest, or reject the offer in which case both players get nothing. And yet responders seem to reject offers out of sheer indignation at being made to accept such a small proportion of the whole sum, and they seem to get more satisfaction from taking revenge on the proposer than in maximising their own financial gain.

Mr Spock would be appalled if a Vulcan made this mistake.

It brings together several aspects of psychological research and differs in crucial respects from expected-utility theory—although, equally crucially, it shares its advantage of being able to be modelled mathematically. It is based on the results of hundreds of experiments in which people have been asked to choose between pairs of gambles. But those suffering from loss aversion do not measure risk consistently.

They take fewer risks that might result in suffering losses than if they were acting as rational utility maximisers. Prospect theory also claims that people regularly miscalculate probabilities: they assume that outcomes which are very probable are less likely than they really are, that outcomes which are quite unlikely are more likely than they are, and that extremely improbable, but still possible, outcomes have no chance at all of happening.

They also tend to view decisions in isolation, rather than as part of a bigger picture. Many New York taxi drivers, points out Mr Camerer, decide when to finish work each day by setting themselves a daily income target, and on reaching it they stop.

Is Behavioral Economics Doomed?

This means that they typically work fewer hours on a busy day than on a slow day. Rational labour-market theory predicts that they will do the opposite, working longer on the busy day when their effective hourly wage-rate is higher, and less on the slow day when their wage-rate is lower. Prospect theory can explain this irrational behaviour: failing to achieve the daily income target feels like incurring a loss, so drivers put in longer hours to avoid it, and beating the target feels like a win, so once they have done that, there is less incentive to keep working.

People betting on horse races back long-shots over favourites far more often than they should. Prospect theory suggests this is because they attach too low a probability to likely outcomes and too high a probability to quite unlikely ones. Gamblers also tend to shift their bets away from favourites towards long-shots as the day's racing nears its end. Because of the cut taken by the bookies, by the time later races are run most racegoers have lost some money.

For many of them, a successful bet on an outsider would probably turn a losing day into a winning one. Mathematically, and rationally, this should not matter. The last race of the day is no different from the first race of the next day. In America, shares have long delivered much higher returns to investors relative to bonds than seems justified by the difference in riskiness of shares and bonds.

Orthodox economists have ascribed this simply to the fact that people have less appetite for risk than expected. But prospect theory suggests that if investors, rather like racegoers, are averse to losses during any given year, this might justify such a high equity premium. Annual losses on shares are much more frequent than annual losses on bonds, so investors demand a much higher premium for holding shares to compensate them for the greater risk of suffering a loss in any given year.

A common response of believers in homo economicus is to claim that apparently irrational behaviour is in fact rational. Gary Becker, of the University of Chicago, was doing this long before behavioural economics came along to challenge rationality.

The Upside of Irrationality

He has won a Nobel prize for his work, which has often shed light on topics from education and family life to suicide, drug addiction and religion. Rationalists such as Mr Becker often accuse behaviouralists of picking whichever psychological explanation happens to suit the particular alleged irrationality they are explaining, rather than using a rigorous, consistent scientific approach.

Caltech's Mr Camerer argues that rationalists are guilty of exactly the same error. For instance, rationalists explain away people's fondness for betting on long-shots in horse races by claiming that most are simply more risk-loving than expected, and then claim precisely the opposite about investors to explain the equity premium. Both are possible, but as explanations they leave something to be desired. Being irrational may even be rational, according to some rationalists. Irrationality can be a good to be consumed like any other, argues Bryan Caplan, an economist at George Mason University—in the sense that the less it costs a person, the more of it they buy.

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In fact, the battle between rationalists and behaviouralists may be largely in the past. Those who believe in homo economicus no longer routinely ignore his emotional and spiritual dimensions. Nor do behaviouralists any longer assume people are wholly irrational. In recent years, he has demonstrated that random digits can influence bids in an auction, that sexual arousal leads to reckless decisions at least in college males and that brand-name aspirin is more effective at treating headaches than generic aspirin, even when the pills are identical.

Mind Matters editor Jonah Lehrer chats with Ariely about his research. What led you to become interested in behavioral economics? The interesting thing about economics is that it has become the main guiding principle for policymakers, lawmakers and businesses. My hope for the kind of work I do, and for behavioral economics in general, is that by augmenting standard economics it could help design better policies that actually work with what people can compute and the ways they reason.

In particular, I think that this approach in behavioral economics can have a substantial impact on savings, health care and a tendency to engage in risky behaviors. Do you get the ideas for these experiments from your own life? Most of my experiments begin as a way for me to investigate and gain a better understanding of my own behavior or the behavior that I observe around me.

I also get many ideas from talking to people and from current events. Instead, we see a flash of yellow, the rough shape rough shape, our brain completes the pattern and we run.

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Bias, as Eliezer says, is not something we layer on top of a purely rational mind, it is our whole decision-making process. So, why is AI irrational? Theoretically, AI has the potential for rational decision making.

Be rational about irrationality

Pragmatically though, AI is quite unlikely to be rational. That complete, accurate and unbiased dataset that rationality requires?

That vast processing power to ingest and make decisions based on that dataset, or the best dataset we can come up with? The only way that we would achieve anything close to a rational AI or automated system is through brute force, and brute force is going to be slow and very expensive. Businesses are motivated first and foremost by profit. If AI or automation is being considered to replace a historically human run process the business case made to adopt the technology will fundamentally be about how it improves profit.

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I would not be surprised to find out that there are businesses in the world who willingly break the law because their unlawful conduct makes them more profit than it costs them in fines. Either way, an argument towards profitability is only going to increase the chance of success for a rational or unbiased product. If we begin to look beyond more standard automation, towards Artificial General Intelligence, we know that the project ahead of us will be challenging and expensive.

Something which might be better or at the very least more cost-effective than a human at one specific task. Rinse and repeat until you have yourself an AGI. The trouble here is that we will be encouraged to make irrational AIs at these stages.

Irrational Labs | Behavioral Economics

As we are limited in resources, data and intelligence at the early stages developers will need to cut corners, finding sometimes elegant, sometimes less-so ways of generalizing problems to get to their next iteration. A simple solution to this would be for the business to slow down, but this issue is similar to a prisoners dilemma, particularly if we are beginning to look at artificial general intelligence. The most beneficial outcome for society is to develop safe, and value aligned AI.

What do you mean by the term irrational?