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The Economics of Confirmation Bias
How do we see the world? Is it purely factual, or is it how we want to see it ourselves? We exaggerate facts that we already know, which is why we read the newspapers we like, subscribe to YouTube channels that suit us and watch TV shows that are compatible with our beliefs. We also tend to seek friends who are like-minded.
Because of this, we don’t always make the wisest economic decisions. We tend not to look at the evidence and make decisions accordingly. Instead, we look for simple rules that we can apply to novel situations.
For example, an environmental NGO (non-governmental organisation) intercepts a consignment of ivory tusks. What should it do? Should the ivory tusks be destroyed, or should the NGO sell the ivory to make revenue to keep it running.
Morally, it would be wrong to do that latter, but economically speaking, it is the right answer. The NGO should sell the ivory. This would keep the organisation running and better equip it to suppress the threat of poaching. Selling the ivory would also increase supply in the ivory markets, which would depress prices, making ivory less profitable. Economics is about cold rationality. Sometimes this is not compatible with the human psyche.
This is why we have markets. Free markets were thought to be the ultimate method of allocating scarce resources. According to Adam Smith’s theory, the ‘invisible hand’ will guide the market towards an equilibrium which would naturally maximise welfare in society.
Another example; imagine a market for trading babies between biological parents and those wanting to adopt. Both sides could reach a mutually beneficial agreement if there were a free market for this. However, why does this market fail? It fails to recognise the interests of a third party: the baby. This is an example of an externality, and it is why free markets tend to fail without some sort of regulation. The external cost is the exchange borne by a third party who can’t consent to the exchange.
This is why regulation is necessary as an attempt to guard the interest of all affected parties.
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