The Behavioural Faultlines of Price Theory

In reply to my previous post, Tom was scpetical of the general approach I took to explaining the missing market. He said:

People aren't perfectly rational, but it shouldn't be our default explanation for every slightly perplexing feature of the market

Well...why not?

Of course this is a more general argument about why perfect competition doesn't exist. We can try and understand market failure by using the standard tools of the economist - assume homo economicus, look for transactions costs, point to an externality, find a public good problem and so on. All of these are valid to some extent. But if we know people are't rational in significant ways, then ignoring this fact trying to shoehorn human behaviour in some preordained way seems a bit odd.

This doesn't mean we have to argue that markets are always and everywhere a non-starter. It is merely an acknowledgment that the model proferred by neo-classical economics is not the final draft of economic explanation, but that it is akin to the Newtonian Physics awaiting its Einsteinian upheaval. For me this is tremendously exciting, as it opens up the study of economics and allows its foundations to be put under the experimental zoom lens. If people are predictably irrational, then it is something we need to be aware of as empirical scientists and integrate into our models of market behaviour.

I personally am quite enamoured with this approach, while Tom is less so I believe. This should make for much fruitful disagreement into the future, exactly what the discipline needs if we want to dispel the shrill pundits wailing about the death of capitalism and all that other nonsense.