Gary Becker's irrational agents still find an equilibrium, and so do property owners

We can put aside debates about whether market actors are rational or not. It doesn't matter!

A big idea in economics is that rational agents are a necessary input to rational markets.

This is wrong.

Market outcomes will be ‘rational’ even without rational agents, because the budgets of each interacting decision-maker will constrain their collective behaviour.

Think of two competing views on the process that makes markets rational.

• Process A: Rational agents choose optimally and profitably

• Process B: Irrational agents choose randomly and markets select for profitably

In Process A all agents are rational. No one goes bust. The future is well known in advance. But in Process B companies start and fail all the time and it doesn’t matter whether we can know the future because agents who survive in the market will be those that have so far successfully predicted the future (or well enough to survive).

These underlying assumptions about how markets work or don’t have a lot of relevance to many problems in economics, such as in my case how we think about housing supply and the rationality of waiting.

My answer to the challenges about whether property owners have deep pockets and know they can wait, or whether they want to rush, is that it doesn’t matter. The market will select patient property owners and the overall market outcome will be an equilibrium regardless. This means that a model of a single “rational” actor in a market can be a good way to represent the outcome of many “irrational” actors in a market where those who fail go broke and those that don’t survive.

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Check out this article for why property is always owned by the most patient owners (hint: they are willing to pay the most to buy it).

Patient property owners

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Although it is often convenient shorthand to say “a developer wants to do this”. The truth is it doesn’t matter. The market selects for behaviours and investments that make money via the trial-and-error of market participants.

Gary Becker knew rationality was not required

Back in 1962, Gary Becker tried to explain that most of the rational microeconomic results in economics could be derived from irrational agents subject to financial constraints.¹ Becker wrote that:

negatively sloped demand curves result not so much from rational behavior per se as from a general principle which includes a wide class of irrational behavior as well. Therefore, households can be said to behave not only "as if" they were rational but also "as if" they were irrational: the major piece of empirical evidence justifying the first statement can equally well justify the second.

I want to demonstrate his logic here.

I take the usual budget constraint for a household with two goods. Let’s say the household has $10 to spend and the price of Good A is $10 per item. If only Good A is purchased, then the maximum spending of any agent on Good A is $10. So the budget constraint, in blue, shows 10 of Good A with zero of Good B.