Thomas Russell and Richard Thaler

Abstract

In this paper we start to explore the implications of irrationality for economics. We begin by defining what we mean by rational, and what departures from rationality we think are most likely. We then consider what happens if rational and less than fully rational agents (whom we call quasi rational) interact in competitive markets. We show that the knee-jerk reaction of some economists that competition will render irrationality irrelevent is apt only in very special cases, probably rarely observed in the real world. Our analysis highlights the important roles played by arbitrageurs and entrepreneurs. We find that, perhaps counter to intuition, more competition can actually make things worse by leaving no possibility of a profit to an entrepreneur who offers education or information.