Neoclassical Theory Strikes Out, Again

by Will on November 8, 2010

Today I had to go do something in San Francisco. I rode BART to the Embarcadero, and planned to catch a streetcar from there to where I was going. But I only had a $5 bill, and the streetcars only take $1 bills or change. So I was walking around trying to change the $5. The shops all had long lines, so I turned to the street vendors. I made the following offer: “I will trade you this $5 bill for four $1 bills. Deal?”

Neoclassical economic theory would say that every individual vendor would take me up on this offer. I’m offering a return of 20 percent, just for their having cash! And it is well known that people will toil away to achieve a much lower return — the average is somewhere around 5 percent in business. Every vendor ought to have the necessary liquid cash, and ought to recognize the virtue of the free money I’m offering. I should have no problem whatsoever trading one portrait of Lincoln for four portraits of Washington.

And yet, that analysis in no way resembles what actually occurred. Most vendors simply claimed not to have the $1 bills — a strange lie, as best as I can tell. They see themselves, I think, as needing to prove their seriousness as legitimate businesspeople, and the trade I’m offering does not seem serious or legitimate. When I finally found a taker, the guy refused to short me the fifth dollar, giving me five $1 bills in trade for my $5. These people are all, indeed, pursuing rational self-interest. But the way that they calculate their self-interest is, I’m afraid, not nearly so straightforward and logical as the neoclassical economists of the world would have us believe.

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