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Individual Irrationality and Aggregate Outcomes

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Author Info
Ernst Fehr (University of Zurich)
Jean-Robert Tyran (Department of Economics, University of Copenhagen)

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Abstract

There is abundant evidence that many individuals violate the rationality assumptions routinely made in economics. However, powerful evidence also indicates that violations of individual rationality do not necessarily refute the aggregate predictions of standard economic models that assume full rationality of all agents. Thus, a key question is how the interactions between rational and irrational people shape the aggregate outcome in markets and other institutions. We discuss evidence indicating that strategic complementarity and strategic substitutability are decisive 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, whereas a minority of rational agents may suffice to generate aggregate outcomes consistent with the predictions of rational models under strategic substitutability.

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Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 05-09.

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Length: 22 pages
Date of creation: Jul 2005
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Handle: RePEc:kud:kuiedp:0509

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Related research
Keywords: bounded rationality; strategic interaction; strategic complementarity;

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Find related papers by JEL classification:
D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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  1. Mattos, Fabio & Garcia, Philip & Pennings, Joost M.E., 2008. "Dynamic Decision Making in Agricultural Futures and Options Markets," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37605, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management. [Downloadable!]
  2. Bruno Contini, 2008. "Testing Bounded Rationality Against Full Rationality in Job Changing Behavior," LABORatorio R. Revelli Working Papers Series 81, LABORatorio R. Revelli, Centre for Employment Studies. [Downloadable!]
  3. Miettinen, Topi, 2008. "Contracts and Promises - An Approach to Pre-play Agreements," Working Paper Series in Economics and Finance 707, Stockholm School of Economics. [Downloadable!]
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  4. Bruno Contini & Matteo Morini, 2007. "Testing Bounded Rationality against Full Rationality in Job Changing Behavior," IZA Discussion Papers 3148, Institute for the Study of Labor (IZA). [Downloadable!]
  5. Burnham, Terence C. & Cesarini, David & Wallace, Björn & Johannesson, Magnus & Lichtenstein, Paul, 2007. "Billiards and Brains: Cognitive Ability and Behavior in a p-Beauty Contest," Working Paper Series in Economics and Finance 684, Stockholm School of Economics. [Downloadable!]
  6. Sjögren Lindquist, Gabriella & Säve-Söderbergh, Jenny, 2006. "Testing the rationality assumption using a design difference in the TV game show 'Jeopardy'," Working Paper Series 9/2006, Swedish Institute for Social Research. [Downloadable!]
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