Arnold Kling  

Cognitive Ability and Decision-making

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Daniel J. Benjamin and Jesse M. Shapiro write,

Using data from the National Longitudinal Survey of Youth (NLSY), we show that individuals with greater cognitive skills make consumption and personal financial decisions that more closely resemble the predictions of economic theory. Individuals with greater cognitive ability are more likely to participate in financial markets, are more knowledgeable about their pension plans, accumulate more wealth, and are more likely to participate in tax-deferred savings programs.

Thanks to Tyler Cowen for the pointer.

The authors find evidence suggesting that people can learn to make choices relative to risk more rationally. The survey article on neuroeconomics to which I pointed recently also says that when people are made aware of better ways to make choices they choose more rationally.

For Discussion. If preferences (or at least choices) are influenced by knowledge and education, how serious a problem is this for standard economic analysis?

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The author at Financial Rounds in a related article titled Smart People Think More Like Economists - Part 2 writes:
    In a previous post, I referenced a study that indicates that smarter people think more like economists. Arnold Kling at Econolog links to yet another study that supports this notion: [Tracked on May 23, 2005 5:11 PM]
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Lancelot Finn writes:

Not much. Generally, it just takes a few clever arbitrageurs to make markets clear.

It might make you more cautious about policy that will result in economic disruptions, i.e. to prefer the gradualist approach to market reform, a la China, to the "shock therapy" approach, a la Russia.

Conchis writes:

Depends what you're analysing and what you care about. If it's stock markets, then sure, perhaps not much at an aggregate level, though more people may get burned, so it certainly affects the distribution of gains.

But if you're analsying consumer behaviour then potentially a hell of a lot. Particularly as you've got no competitive mechanism here weeding out the 'irrational' ones. I would have thought this sort of thing pretty much demolishes the standard welfare theorems.

Of course, it also suggests that even well-intentioned governments are likely to be less efficient at successfully mitigating any of these problems too.

NB: The authors take pains to stress that even though education and knowledge can improve decision-making, even the smart, educated knowledgeable ones don't do all that well against the standard of rationality. Moreover, it's likely that this is partially just about cognitive ability, so learning won't necessarily help.

Lawrance George Lux writes:

Not as great as Benjamin and Shapiro would assert (By the way, I agree with Tyler's assessment of Shapiro) Sustained access to both sides of the Mexican border assure myself that Wage and Price Knowledge sharing does not depend on cognitive ability, but associational protective devices. lgl

Ian Lewis writes:

One of the problems with "economic theory" is that it is developed by "individuals with greater cognitive skills" than the average idiot. Let's face it, most people are not as rational, nor have the same goals, as most intelligent economists.

John Ford writes:

So as cognitive skills rise, conclusions asymptotically approach economic theory. Does this mean that as we as a race evolve intellectually...we will all begin to think like professors Kling and Caplan? Yikes!


Tom West writes:

Since economists are busy trying to optimize the system for homo economis (the rational consumer), does this mean they might be working *against* the interests of the majority who will not take advantage of such an economy, or in fact may be taken advantage of in the freedoms provided by such an economy.

Shouldn't we be optimizing for the average citizen, rather than those with the greatest cognitive skill?

Hi, Tom.

You asked a wonderful and very sophisticated question:

Shouldn't we be optimizing for the average citizen, rather than those with the greatest cognitive skill?

Actually, whatever power economics has to make predictions lies not in optimizing for the average person, but for the extreme person. The extreme person--the person at the edge or "margin"--is demonstrably the one who has the most influence on economic variables such as prices, available quantities, variety of goods, and investment in future opportunities. The power of being at the margin applies not only to everyday purchases, but also to cognitive arenas, education, the stock market, marriage choices, and more.

As it turns out--nicely!--the average person takes advantage of and immensely benefits from what the marginal person drives to fruition.

Think of it this way: if you only aim for the average instead of the best, not only is the best not achieved or available now as an option, but future growth is also thwarted, not to mention the loss of compounded of future growth on top of that.

When I read your comment again, what stands out is the word "should", as in "Shouldn't we be optimizing...". It echoes caring concerns you express in your first paragraph:

...does this mean they might be working *against* the interests of the majority who will not take advantage of such an economy

Economics as a science has achieved its only actual successes when it has stood back from trying to figure out what "should" happen, or whether to work "for" or "against" any particular social goal, and instead focused on what can be predicted objectively. Objective prediction is not a matter of what economists should concentrate on, but what they can reliably offer to the discussion of what others promote as the social goals to aim for--such as the interests of the majority.

Regardless of what we as individuals should strive for, even if we were to agree on that, the reality is that we can only achieve certain goals: specifically, the ones consistent with marginal analysis. It's the job of the economist to think about the implications of marginal analysis: who gains, who loses, what happens in the long run; and perhaps whether there are enough gainers to, say, compensate the losers if we could find a way to accomplish that transfer, including what would be the short- and long-run repercussions of attempting such a transfer.

[Fleshing out the marginality concept, how it works, and what the consequences are was what is now called Marginalism, or the Marginal Revolution, in economic thought. The ideas, inherent but not explicit in much earlier economic thought, were only finally clarified in the late 1800s, somewhat simultaneously by Jevons in England, Walras in Switzerland, and Menger in Vienna. Bringing understanding of the concept of the margin to the classroom level took many others: Pareto, Edgeworth, J. B. Clark, Wicksteed, Marshall, Samuelson, Fisher, and the struggles of thousands of college and grad school teachers of economics every day.]

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