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The relevance of the irrelevant

By Justin Peterson
web posted November 20, 2017

Things that are irrelevant are, to state the obvious, irrelevant. Richard Thaler, the winner of the 2017 Nobel Prize in economics, would disagree. In a column that he wrote for The New York Times, he argues that the irrelevant may in fact be quite relevant. He says that there are things that, to a rational being, would mean nothing. However, humans, being ever so fond of their logical fallacies and natural biases, do not always make the best decisions.

Early in his teaching career, Thaler had his students take a test to assess the capabilities of his class. It was a very difficult test, and the average grade was 72 out of 100. Even though it was graded on a curve, the students (along with their parents) were angered by the "low" scores. To a rational mind, the number would not matter. All that would matter is what percentage of the class that a student would be in. Students were getting upset over irrelevant details. Obviously, Thaler didn’t like the large amount of complaints that he got, so he decided to grade the next test out of 137 instead of 100. It was actually a more difficult test, and the average score was a 70%. However, since 137 was the maximum amount of points possible, students were getting 90 points and, on occasion, scores exceeding 100. Thaler never got another complaint.

No rational being would be happier with a 70% score than a 72%. Humans, in contrast, were getting excited over nothing. It really is quite ridiculous. Similarly, what rational person would be happier with an 18/20 than a 9/10? None would. However, humans do! Thaler notes that a detail, seemingly irrelevant, has single-handedly ended the complaints from his class.

Could there be bigger, more, one could say, relevant applications of manipulating irrational behavior? Besides making students happy, perhaps consumption and retirement saving could be increased. Consider retirement plans. All the retirement plan is doing is taking a certain amount of one’s income and saving it for retirement. A rational person could simply calculate how much they need to save and set it aside on their own. However, people using retirement plans often benefit from them. Why? Simply put, it makes it so that the person using the plan cannot be irrational by spending the money too soon.

One example that Thaler used in his article is from the time of the last recession. Taxpayers were to be given a tax cut, but how should it be given? For example, should a $1,200 tax cut be given in one payment or broken into 12 monthly payments? Since people are likely to spend all of their wages from month to month, giving the money in increments would likely result in the money being spent. However, one might think twice before spending 1,200 more than last month. People may save some of the money, or pay off a debt. Since the idea of the tax cut was to increase consumption, the tax cut was given in increments. Once again, to a rational mind, how fast you get the money would not affect your spending as long as you know how much you will get.

Clearly, humans are not rational. The unimportant may, at times, be of the utmost importance in a human’s decision-making process. Economics sometimes overlooks how unintelligent we, as humans, really are. Considering the relevance of the irrelevant is not only fascinating, but also applicable. ESR

This is Justin Peterson’s first contribution to Enter Stage Right. © Justin Peterson 2017

 

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