I just started my summer reading with an interesting book my daughter gave me.  She's about to graduate with a BA in Economics, and she's interested in pursuing a graduate degree that combines the disciplines of Economics and Psychology, so it's no surprise she gave me the book "Predictably Irrational" by MIT Psycho-Economist Dan Ariely.  The book, which was a New York Times bestseller, consists of descriptions of Ariely's psycho-economic experiments with students at various universities - the exact one depending on who his collaborators were for that experiment (and he has many collaborators) - and his extrapolations of their observed behavior to players in the American economic system, which is to say, every American.

I'm somewhat familiar with the kind of experiments Ariely has been conducting, having participated in some similar ones as an undergraduate.  The participants generally play a game, usually on a computer (or, in my day, a computer terminal) and usually with some actual small monetary payoff, which then records their responses and enables the researchers to draw conclusions about their behavior as it relates to economics.  The payoff, which one can be sure the participants are trying to maximize even if it is small, ensures that their behavior is responding to economic incentives.

Although I'm not finished with it, I'm finding the book quite interesting.  Probably the most interesting part is the author's attempt to generalize the conclusions from his experiments,  because these experiments, although the results are driven by the subjects' attempt to optimize payoffs, just like economic behavior in real life, are far more simplistic than the problems one actually encounters in trying to optimize real-life decisions.  For example, the second chapter, entitled "The Fallacy of Supply and Demand" ("fallacy" - there's a loaded word if I ever heard one) deals with what the author calls "arbitrary coherence," by which he means that companies can essentially create demand for their goods and even ensure elevated prices by associating them high-priced and/or other desirable features.  One of the examples he uses is a dealer who had the market in black pearls cornered - in that he had the only supply of them - in the early 1970s, except that there was no demand for black pearls, only white ones.  This businessman therefore ensured that pricey Manhattan jewelers displayed the black pearls in their stores, thereby associating them with high-priced jewelry and creating a "must-have" item for the Manhattan jet set, a crowd well-known to have a lot more money than brains.

This idea isn't new.  In fact, over 50 years ago, the well-known Keynesian John Kenneth Galbraith first wrote about dastardly corporations creating demand for unnecessary items in his book "The Affluent Society."  Galbraith reasoned that Americans in the post-war world were so affluent that they were trying to find ways to spend money, and conniving corporate marketeers were finding ways to help them spend it, on "useless" products for which demand was contrived by marketing wizards.  Ariely takes this notion one step further by saying that while traditional economic theory asserts that price is determined when "informed" consumers enter the marketplace to bid for goods and services produced by "competitive" suppliers, this assertion is a fallacy.  He claims that consumers are influenced by psychological factors that trick them into overbidding for goods and services, but unfortunately, the examples he provides to demonstrate this fall a little short.  In none of the cases he presents is there any true market in the sense that enough consumers and suppliers are interacting to drive an equilibrium price, a condition necessary for economic theory to operate.  In the case of the black pearls, for example, there is only one monopoly supplier, so that he can charge whatever people with more money than they can spend will pay.

However, Ariely's biggest leap comes at the end of Chapter 2, when he states, "If we can't rely on the market forces of supply and demand to set optimal market prices, and we can't count of free-market mechanisms to help us maximize our utility, then we may need...the government (we hope a reasonable and thoughtful government) must play a larger role in regulating some market activities, even if this limits free enterprise."  Actually, this is two big leaps.  The first leap is the one I alluded to above; Ariely's examples and experiments have in no way, shape, or form demonstrated that free market equilibrium can't be reached through intelligent, or at least thoughtful, decision making.  But the second leap is even bigger, at least to anyone who's ever worked for or with any government agency - a reasonable and thoughtful government!  Does such a thing even exist in real world?  If it does, I've never seen it.

Government isn't "reasonable and thoughtful" because it doesn't have to be.  When consumers make the wrong choices, who pays?  They do!  When government makes wrong choices, everyone pays, which is the same as saying no one pays.  So, Professor Ariely, the real issue isn't one of thoughtful or intelligent decision making.  The real issue is accountability.  The great advantage of the free market system is that decision makers - individual consumers - are the ones who pay the price for mistakes.  That provides a tremendous incentive to not make mistakes.  When government inserts itself into the free market to "regulate" it, that incentive is gone.  Ariely has unwittingly provided a blueprint for the Obama administration's economic policies, and the next few years should provide a good look at what a fallacy "The Fallacy of Supply and Demand" really is.  Liberals are so irrationally predictable.