How and Why the Economy Works in 3 Minutes: Behavioral Economics, Ep. 1

Behavioral Economics (playlist): Heuristics, cognitive biases, public choice– oh my! Watch the entire series to learn more about behavioral economics at http://hayekandchill.com/economics/
Predictably Irrational (book): From drinking coffee to losing weight, from buying a car to choosing a romantic partner, we consistently overpay, underestimate, and procrastinate. Yet these misguided behaviors are neither random nor senseless. They’re systematic and predictable—making us predictably irrational.  

>> I’m Anthony Davies.
>> I’m Erika Davies.
>> And this is Behavioral Economics.
>> At some point in our distant past, a human who had food met another who had a spear. The two exchanged, and departed better off than when they met.
>> Early in their lives, children learn the importance of exchange.
We call it sharing, but we teach it as a quid pro quo. You share your toys with your friend, and your friend shares his toys with you. That’s exchange.
>> The discovery of exchange led to the discovery of specialization. Humans learned that they had more to exchange when each person concentrated his time and energy doing what he did best.
Those with manual dexterity, spent more time making spears, those with strength, spent more time hunting. They traded spears for meat, and both were better off.
>> This dance of specialization in exchange was the birth of the economy. Fast forward tens of thousands of years, the economy has grown in size and complexity.
Humans are now so specialized that many don’t know how to hunt or to grow food. They rely on others to obtain food for them. In exchange, they spend years of their lives developing complex skills that make other people’s lives better, in ways that were impossible before.
>> As these exchanges grew, humans formed questions about the economy itself.
What is the nature of property and prices? How is it that the economy appears to work without anyone guiding it?
>> From these questions, economists developed a body of theory to explain how humans behave when their unlimited desires collide with their limited abilities. This body of theory is economics.
>> One of the principles underlying economics is that humans behave rationally That they make choices they believe will bring them happiness now or in the future.
>> But if we look around, it appears that humans aren’t that rational. People smoke, and then suffer ill health. Students put off studying, and then regret it.
All people behave irrationally sometimes. And that raises the question of whether economics itself is built on a false premise? Is it possible that human irrationality nullifies economic theory?
>> To understand what economist mean when they say that humans are rational, let’s examine molecules. Fluid mechanics explain how fluids behave.
Our understanding of fluid mechanics enables us to design ship hulls with minimal drag, and airplane wings with maximum lift.
>> While individual molecules behave unpredictably, the behavior of a group of molecules is so predictable that we bet our lives on the predictability every time we step on a plane or a boat.
>> And this is where our irrational humans come in. Unlike individual molecules, individual humans are at least sometimes predictable because they are at least sometimes rational. And that means that when they are in groups, they become highly predictable.
>> People do make irrational decisions, but we tend to learn from our mistakes, and from the mistakes of people around us.
Meanwhile, many apparently irrational choices people make can be, in fact, quite rational. Take for example a student, who chooses to party now and study later. This choice appears irrational to the professor.
>> But is the student really making an irrational choice? Possibly not. When the student chooses to party instead of studying, she’s making a rational choice to take leisure time from her future self and enjoy it now.
In exchange, her future self will have to study.
>> The professor might consider this folly, but he has different preferences and abilities, and so might be less willing to make that exchange for himself.
>> This difference in preferences and abilities is what makes our modern economy possible. People who are more willing to put off consuming, tend to save their money which is then borrowed by people who are less willing to put off consuming.
Among them, entrepreneurs who want to try out new ideas.
>> And when those entrepreneurs ideas succeed, we get the automobile, the plane, the computer, the Internet, and all sorts of other things we wouldn’t have but for the fact that a couple of cavemen once traded spears for food, setting in motion the wondrous cooperative venture we call the economy.