8/13/2019 Behavioural Economics - Week 1
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BE101x: Behavioural Economics in ActionUnit 1.3.3 The Axioms of
Rational Choice
DILIP SOMAN: Now when you push through the math behind this
formulation-- andthe formulation behind something called the
expected utility theory, which is the
cornerstone of rational choice-- it turns out that there are a
number of what we callaxioms that actually underlie this theory.
I'm going to spend a few minutes goingthrough these axioms one by
one.
The first axiom is something called completeness. It says
something very simple. Itsays that if I give you the choice between
x and y, you should be able to do one ofthree things. You should be
able to choose x over y, or y over x, or you should be
perfectly indifferent between the two. But you cannot say, gee,
I don't know, becausethe moment you say that, you are unable to
compute a utility, and therefore you haveno basis for making a
choice. So, rational choice theory says people have the ability
tomaximize something called utility, and that completeness means
they can either prefer
x, or y, or both equally.
The second is perhaps one of the more important axioms of
choice, and it is calledtransitivity. It seems fairly obvious, but
let's think through this for a minute.Transitivity says if I like x
over y, and I like y over z, I should like x over z. It makes
perfect sense. If I'm going to give you $50 versus $100, you're
going to choose $100.If I'm going to give you $100 versus $200,
you're going to choose $200. If I give you$200 versus $50, you
should choose $200, no arguments.
But it turns out that there are many situations in which
transitivity is violated. Here'sone example. Let's imagine you're
recruiting for a job. You're looking for an assistant,you're
looking for a research assistant. Three people apply, Mr. A, Mr. B,
Mr. C.You've got information on to attributes, the IQ and the
number of years of experiencethey have in doing their job. What you
see in this chart is that you've got three peoplewith IQs of 120,
110, and 100, but the one who has the highest IQ has only one
year'sworth of experience, followed by two, followed by three.
Now you also know from all of your years of being a professor or
being a researcherthat, in fact, the IQ measure isn't very stable.
And in fact, there's very little to choose
between someone who has an IQ of 100 and 110 because the error
on the scale isabout 10 or 15 points. And so the idea is very
simple, is you really can't tell the
difference between 100 and 110, but you can tell the difference
between 100 and 120.So here's my rule. I want to choose the
smartest guy, but if they're equally smart, thenI'm going to choose
the one with the greater experience.
How do I handle this choice? Again, I'm going to look at A, B,
and C. If I look at Aversus B, A and B have about the same IQ. B
has more experience than A. I'll chooseB.
Likewise if I look at B versus C, about the same IQ. C has more
experience than B. Ichoose C.
So I choose B over A. I choose C over B. I should choose C over
A. But if I have Cand A in the same room, now I know that A is
smarter than C, and I will pick A.
