Particularly, what we know about cognitive biases precisely is “theory of irrational behavior” — we just don’t have a, complete, theory of irrational behavior.
Friedman continues, but I shortened the quote to make it punchier. Essentially he says that, (1) given a large number of individuals irrationality will average out in the aggregate, (2) In most cases that an economist would be interested in (eg. investors, CEOs) the individuals have been selected to be good at the task they are performing, i.e. not irrational in that domain.
In some contexts it makes sense to talk about errors in opposite directions canceling out but in others it does not as errors only accumulate. Suppose one person overestimates how much they’ll enjoy having an iPad and buys one when they’d be better off without one, and another person underestimates how much they’ll enjoy having an iPad and doesn’t buy one when they’d be better off with one. Looking at the total number of iPads sold, these errors cancel out. But looking at total human welfare, the errors just add up—two people are each less happy than they could be, which is doubly bad. Similarly, if one person gets too much medical care and another gets too little, then they both lose, one from being overtreated and the other from being undertreated.
If you look at the market as a means of aggregating information (as in prediction markets) then errors can cancel out, but when you evaluate the market as a means of distributing products to people then errors just accumulate.
Friedman continues, but I shortened the quote to make it punchier. Essentially he says that, (1) given a large number of individuals irrationality will average out in the aggregate,
This is the part that sounds (and is) wrong. It would perhaps be correct if it was “given a large number of individuals selected from mind space via a carefully crafted distribution of deviations about some mind the irrationality will average out in the aggregate”. The irrationality of a large number of human individuals will not average out.
This seems to be an argument about definitions. To me, Friedman’s “average out” means a measurable change in a consistent direction, e.g. significant numbers of random individuals investing in gold. So, given some agents acting in random directions mixed with other agents acting in the same (rational) direction, you can safely ignore the random ones. (He argued.) I don’t think he meant to imply that in the aggregate people are rational. But even in the simplified problem-space in which it appears to make sense, Friedman’s basic conclusion, that markets are rational (or ‘efficient’), has been largely abandoned since the mid 1980s. Reality is more complex.
This sounds wrong. Biases have predictable direction, that’s why they’re called biases and not variance (ahem).
Particularly, what we know about cognitive biases precisely is “theory of irrational behavior” — we just don’t have a, complete, theory of irrational behavior.
Friedman continues, but I shortened the quote to make it punchier. Essentially he says that, (1) given a large number of individuals irrationality will average out in the aggregate, (2) In most cases that an economist would be interested in (eg. investors, CEOs) the individuals have been selected to be good at the task they are performing, i.e. not irrational in that domain.
In some contexts it makes sense to talk about errors in opposite directions canceling out but in others it does not as errors only accumulate. Suppose one person overestimates how much they’ll enjoy having an iPad and buys one when they’d be better off without one, and another person underestimates how much they’ll enjoy having an iPad and doesn’t buy one when they’d be better off with one. Looking at the total number of iPads sold, these errors cancel out. But looking at total human welfare, the errors just add up—two people are each less happy than they could be, which is doubly bad. Similarly, if one person gets too much medical care and another gets too little, then they both lose, one from being overtreated and the other from being undertreated.
If you look at the market as a means of aggregating information (as in prediction markets) then errors can cancel out, but when you evaluate the market as a means of distributing products to people then errors just accumulate.
This is the part that sounds (and is) wrong. It would perhaps be correct if it was “given a large number of individuals selected from mind space via a carefully crafted distribution of deviations about some mind the irrationality will average out in the aggregate”. The irrationality of a large number of human individuals will not average out.
This seems to be an argument about definitions. To me, Friedman’s “average out” means a measurable change in a consistent direction, e.g. significant numbers of random individuals investing in gold. So, given some agents acting in random directions mixed with other agents acting in the same (rational) direction, you can safely ignore the random ones. (He argued.) I don’t think he meant to imply that in the aggregate people are rational. But even in the simplified problem-space in which it appears to make sense, Friedman’s basic conclusion, that markets are rational (or ‘efficient’), has been largely abandoned since the mid 1980s. Reality is more complex.
Both claims are implausible. Is there some kind of substantiation?