Misbehaving: The Making of Behavioral Economics by Richard H. Thaler Page A

mortgage, or a job, we don’t get much practice or opportunities to learn. And when it comes to saving for retirement, barring reincarnation we do that exactly once. So Binmore had it backward. Because learning takes practice, we are more likely to get things right at small stakes than at large stakes. This means critics have to decide which argument they want to apply. If learning is crucial, then as the stakes go up, decision-making quality is likely to go down.
    Markets: the invisible handwave
    The most important counter-argument in the Gauntlet involves markets. I remember well the first time Amos was introduced to this argument. It came during dinner at a conference organized by the leading intellectual figure at the Rochester business school where I had been teaching, Michael Jensen. At that time Jensen was a firm believer in both rational choice models and the efficiency of financial markets. (He has changed his views in various ways since then.) I think he saw the conference as a chance to find out what all the fuss around Kahneman and Tversky was about, as well as an opportunity to straighten out two confused psychologists.
    In the course of conversation, Amos asked Jensen to assess the decision-making capabilities of his wife. Mike was soon regaling us with stories of the ridiculous economic decisions she made, like buying an expensive car and then refusing to drive it because she was afraid it would be dented. Amos then asked Jensen about his students, and Mike rattled off silly mistakes they made, complaining about how slow they were to understand the most basic economics concepts. As more wine was consumed, Mike’s stories got better.
    Then Amos went in for the kill. “Mike,” he said, “you seem to think that virtually everyone you know is incapable of correctly making even the simplest of economic decisions, but then you assume that all the agents in your models are geniuses. What gives?”
    Jensen was unfazed. “Amos,” he said, “you just don’t understand.” He then launched into a speech that I attribute to Milton Friedman. I have not been able to find such an argument in Friedman’s writings, but at Rochester at that time, people attributed it to Uncle Miltie, as he was lovingly called. The speech goes something like this. “Suppose there were people doing silly things like the subjects in your experiments, and those people had to interact in competitive markets, then . . .”
    I call this argument the invisible handwave because, in my experience, no one has ever finished that sentence with both hands remaining still, and it is thought to be somehow related to Adam Smith’s invisible hand, the workings of which are both overstated and mysterious. The vague argument is that markets somehow discipline people who are misbehaving. Handwaving is a must because there is no logical way to arrive at a conclusion that markets transform people into rational agents. Suppose you pay attention to sunk costs, and finish a rich dessert after a big dinner just because you paid for the dessert. What will happen to you? If you make this mistake often you might be a bit chubbier, but otherwise you are fine. What if you suffer from loss aversion? Is that fatal? No. Suppose you decide to start a new business because you are overconfident and put your chances of success at 90%, when in fact a majority of new businesses fail. Well, either you will be lucky and succeed in spite of your dumb decision, or you will muddle along barely making a living. Or perhaps you will give up, shut the business down, and go do something else. As cruel as the market may be, it cannot make you rational. And except in rare circumstances, failing to act in accordance with the rational agent model is not fatal.
    Sometimes the invisible handwave is combined with the incentives argument to suggest that when the stakes are high and the choices are difficult, people will go out and hire experts to help them. The problem with this argument is