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Journal of Economic Perspectives: Vol. 19 No. 4 (Fall 2005)

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Individual Irrationality and Aggregate Outcomes

Article Citation

Fehr, Ernst, and Jean-Robert Tyran. 2005. "Individual Irrationality and Aggregate Outcomes." Journal of Economic Perspectives, 19(4): 43-66.

DOI: 10.1257/089533005775196651

Abstract

In their personal lives, many economists recognize that they are surrounded by individuals who are less than fully rational. In their professional lives, however, economists often use models that examine the interactions of fully rational agents. To reduce the cognitive dissonance of this situation, many economists believe that interactions in markets will correct or offset individually anomalous behaviors—although the reasons for this belief are often not clearly spelled out. This paper presents evidence indicating that "strategic complementarity" and "strategic substitutability" are important determinants of aggregate outcomes. Under strategic complementarity, a small amount of individual irrationality may lead to large deviations from the aggregate predictions of rational models; under strategic substitutability, a minority of rational agents may suffice to generate aggregate outcomes consistent with the predictions of rational models. Thus, the presence of strategic substitutability or complementarity seems to be a key condition in determining when a population that is heterogeneous with regard to rationality reaches either a "rational" or an "irrational" outcome.

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Authors

Fehr, Ernst
Tyran, Jean-Robert

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