Do individuals make more rational decisions when the stakes are higher?

Often yes, but this is a shibboleth of economics that doesn’t always fit the facts, as has been illustrated starkly by our behaviors during the pandemic.  Many people have taken too much risk, or been too risk-averse, even with high stakes on the line.  Here is one excerpt from my recent Bloomberg column:

You might wonder why we are getting these big, important decisions so wrong. I have at least two hypotheses. One is that anxiety causes people to make worse decisions. Facing the danger of a deadly pandemic, for example, the higher stakes might induce me to shift into denial, if only to protect my sanity and peace of mind. I might make worse decisions than if I were simply trying to avoid the common cold, for which the stakes are far lower.

My other hypothesis involves identity and the desire for belonging. It is no accident that red states in the U.S. are under-vaccinated relative to blue states; vaccine skepticism is in part an identity marker for Trump supporters. People tend to see big decisions as more important in shaping their identity than small ones. In essence, the significance of a decision induces all kinds of surrounding social forces to “infect” that decision with partisan influences, and that decision in turn becomes a truly credible signal of what we believe.

For most economic decisions, people do still make better choices when the stakes are higher — but this isn’t a universal principle. Are you so sure, for example, that decisions about who to marry are made more rationally than those about which TV show to watch? Maybe they are, but it’s not entirely obvious.

Note that it is now much easier to make good small stakes decisions, largely because of the internet:

An accompanying change is that low-stakes decisions are easier than ever, due largely to the internet, with one crucial caveat: The decision-maker must be relatively rational. Several decades ago, if you wanted to figure out the best paper towels to buy, you might have asked around and then collated a lot of information yourself. These days it is easy enough to search the internet for the answer. Or consider the example of credit-card rewards, which are far easier to collect, manipulate and use because of the internet.

The danger of course is that the sum of all these smaller triumphs convinces people that they are rational about big dilemmas too — despite the fact that they choose rather poorly on some of them. We are not used to a world where we are worse at big decisions than the small ones. But it has been hurtling our way for some while now.

Recommended.  I also cite this: “Bryan Caplan, a colleague who studies human rationality, has put the individual Covid response in only the second percentile of “my initially mediocre expectations.””

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