Do You Even Act Rationally Bro?

If you have taken an introductory economics class, you learn that the world is made up of rational human beings trying to allocate scarce resources. In essence, people demand goods that have a limited supply. Where demand meets price is where we get the equilibrium quantity and price. What this classic model fails to notice is that people are fucked. It also fails to recognize that people are sometimes irrationally good. In the three sections of this article, I will discuss the areas where the classic view of economics is not sufficient. In essence, this article is a quick overview of some basic concepts in behavioral economics.

That’s Not Ethical, Man

If you solely accept the simple principle of supply and demand as your over-arching market compass, you may be a giant dick. Under this view, you would be okay with a hardware store increasing the price of snow shovels the morning after a large snowstorm. In that, the snowstorm increased demand and due to that increase, price should shift upward. Behavioral economists Daniel Kahneman, Jack Knetch, and Richard Thaler proposed this scenario in a survey to individuals asking if it was fair. 82% of respondents answered that the price hike was unfair. So although theoretically the storm increased demand for snow it did not increase peoples willingness to pay because they see the price increase as unjustified and therefore unfair.

So, if it isn’t just simple supply and demand that dictates price and profit, then what does? The answer involves a little sociology my friends, in that social norms dictate community standards of fairness. Ernst Fehr believes a social norm has three parts:

• It is a behavioral regularity; that is
• Based on a socially shared belief of how one ought to behave; which triggers
• The enforcement of the prescribed behavior by informal social sanctions.

So what have us wealth thirsty capitalists defined as fairness in the application to price, rent and wage setting? “A relevant precedent that is characterized by reference price or wage.” Da Fuq?!?!? No, it really is quite simple and is known as the principle of dual entitlement. The basic idea is that, transactors have an entitlement to the terms of the reference transaction and firms are entitled to their reference profit. This means a firm is not allowed to increase its profits by arbitrarily violating the entitlement of its transactors to the reference price, rent, or wage. So raising the price of snow shovels after a storm is arbitrary, but raising the price of snow shovels because of an increase in cost for the firm would be fair. What are the possible sources of reference transactions? Price, posted price, and previous transactions between a firm and a transactor.

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