FYI here's one example of the sort of things Steve Reed is discussing, coming
from experimental studies.

The simple model (utility maximization) of rational choice predicts that we will
be risk averse. In general, we are, and that can be observed in financial
markets (and start-up businesses) by a higher average return for assets viewed
ex ante as riskier. At the same time, lots of people buy lottery tickets, which
are not even a "fair" gamble -- but the model predicts that a "rational"
individual will reject an offer to play even a fair gamble.

Part of the answer is that one is buying a piece of a dream by purchasing a
lottery ticket -- not doing it purely for its (negative) financial return. But
other variations of this same anamoly are found in controlled experiments. There
are lots of other anamolies as well, of other flavors. But often, as with
lotteries (or more generally, behaving "properly" when odds are long), they deal
with behavior that is frequently observed but not central to core questions.

---------------
Date: Mon, 11 Sep 1995
From: msmitka[atx]liberty.uc.wlu.edu (Michael J. Smitka)

>Economic rationality has been researched at length and serves as a good
starting point. I think most agree and experiments have shown that many
individuals don't act rationally in certain economic situations. We also know,
however, that savings rates go up given economic incentives such as a 401K or
IRA plan, from which one can conclude that there is at least some rationality in
the aggregate.

One minor correction: empirically, IRA's cause a shift in the instruments in
which savings are placed, but do _not_ appear to increase overall savings. They
do, however, result in less tax revenue. I therefore personally think IRA's are
bad policy.

This fits well with a large body of studies which do not find savings responsive
to modest changes in real interest rates. Changing the tax treatment of savings
ought to be interpreted by savers as a change in the real rate of return, and so
if the response to an IRA is consistent--as it seems to be--it ought not change
total savings.

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