Marketing Thought

Confusion About Individual Rationality and Market Outcomes

Amongst marketing scholars there is a lot of confusion regarding individual rationality and market outcomes. There is also plenty of blame to go around for the confusion.

Marketing’s Two Groups Who Politely Ignore One Another

In marketing we have bifurcated into two groups. Psychologically trained scholars often suggest that economically trained scholars all believe in the cult of humans as perfect decision-makers. Psychologically trained scholars should know better. Those trained in economics aren’t all complete idiots. (Nearly) all know that human decision making is flawed. Thus, Vernon Smith describes the quest to show that decision making as flawed. It is a “cottage industry” engaged in “a search that can only succeed” (Smith, 2003, footnote 8, page 467).

Strange Behavior

Economically trained scholars are also to blame. Economists know that people aren’t perfect decision-makers. Still they often give psychologically trained scholars plenty of reason to doubt this through their language. Economically trained scholars often treat assumptions made because they are useful to their models as laws of nature that cannot be questioned.

Questioning Assumptions About Individual Rationality And Market Outcomes

The economist Vernon Smith is refreshing as he seeks to justify market rationality as a product of the market not the brilliance of the people within it. The basic idea is that markets can, theoretically, work well from a wisdom of the crowds perspective. This is despite the fact that any given decision-maker is a flawed decision maker.

The lesson from Smith isn’t that economic models assuming market efficiency always work despite flawed decision making. The lesson is that the models sometimes can work relatively well. Thus, those showing that decision making is flawed are proving things that are widely know. That said, psychologically informed findings don’t necessarily matter in markets unless the flaws are shown to impact the results of a given market (model).

Fair Criticism Is Good

To my mind the relevant criticism of economically trained scholars is not that their models can never work. It is that the models often don’t work. Markets don’t magically always compensate for flawed decision making. This is true even if sometimes markets can do so. The big task for business decision making scholars is to find when exactly a given market does work well and when it doesn’t. It is a massive job. This is still much better than psychologically trained scholars showing even more evidence of flawed decision making and economically trained scholars simply yawning.

For more on rationality see here.

Read: Vernon Smith, 2003, Constructivist and Ecological Rationality in Economics, The American Economic Review, 93 (3), pages 465-508.

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