From Individual Biases to Organizational Errors

Abstract

In economics the use of psychological assumptions other than rationality to make predictions about organizational or system behaviour is rare, although the company is quite good (Keynes, 1936; Nelson and Winter, 1982; Simon, 1982; Williamson, 1975, 1985). From an empiricist’s view-point the dearth of research using alternative psychological assumptions is disappointing since there is massive evidence that individuals deviate from rationality. Furthermore, these deviations are systematic — the errors tend to be in the same direction — which implies that non-rational behaviour is often not random but predictable. However, to be fair, incorporating assumptions other than rationality has its costs. Rational models tend to be mathematically elegant and yield precise predictions, while behavioural models tend to be more complicated and yield vague predictions. Richard Thaler (1992, p. 198) sums up the tradeoff succinctly: ‘Would you rather be elegant and precisely wrong, or messy and vaguely right?’