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The Winner's Curse

Richard H. Thaler

Princeton UP, 1994
First Edition: 1991

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getAbstract.com highly recommends this classic of economic literature, one of the first (more or less) accessible presentations of the evidence against economic rationality. Economists have assumed, conventionally, that economic choice rests on a foundation of rationality. For instance, economists tend to think that people will put the same value on two mathematically identical offers. Yet laboratory experiments have proven what everyday experience suggests: people are not quite rational. Author Richard H. Thaler, a founding father of behavioral economics, presents convincing exhibits to make the case that the assumption of economic rationality is an awfully big pill to swallow. Stylistically, his book strikes a neat balance between accessibility and obscurity. A reader will need a certain amount of schooling in economics and a great deal of patience with academic prose to wade through every word of every chapter, although the payoff is substantial. However, it is possible for the impatient reader to get the gist by reading the introduction, the first page or two of each chapter and the epilogue. And even that is eminently worthwhile.

Summary

Rational Advantages

As commonly understood, economic theory postulates the investor as a rational actor intent on maximizing his or her advantage. This rational actor, it seems, has an instinctive understanding of complex mathematical utility functions that take economists months or years of work to put on paper. Basic economics assumes that individuals seek their selfish best interests and work with unperturbed rationality to identify and pursue those interests, yet this position is very difficult to prove. In fact, many experimental attempts to determine how people really behave call the assumption of rationality into question.

Consider, for example, the well-known case of the prisoner’s dilemma. In this case, two people have committed some crime, and face a choice. If each person refuses to talk, both can expect to receive a one-year sentence. If one person talks, and the other does not talk, the one who talks goes free, while the person who does not talk receives a 10-year sentence. If both people talk, both receive five-year sentences. It does not take a great deal of analytical acumen to see that talking is the best strategy. Yet experiments show that people ...

About the Author

Richard H. Thaler is a professor of behavioral science and economics at the Graduate School of Business at the University of Chicago.

The Winner's Curse

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