And Now For the Reality of an "America First" Economy

http://www.msn.com/en-us/money/markets/economic-growth-expectations-are-quietly-falling-through-the-floor/ar-AAo28Zj?ocid=spartanntp

Saving Doesn’t Mean What You Think It Does

Learn the savings-related errors you’re making and how to correct them.

Jacqueline Verrilli

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Saving money is a hot topic these days, whether related to how to pay for health insurance in a fast-changing marketplace or how to ensure a comfortable retirement on a moderate income.

But do you understand what “savings” really means, and how to best go about it?

More than likely, your concept of "saving" is inaccurate, influenced by cognitive errors based on misinformation and media messaging. These errors lead to dangerous misconceptions and logical gaps related to your decision making about saving money.

The good news is that such errors can be identified and corrected, resulting in a better understanding of savings—and more money genuinely saved.

Words Matter

Many of us gain some satisfaction from finding grocery or other items on sale, or using coupons and rebates to reduce their cost. We’re saving money, we tell ourselves.

That’s not the case.

Shopping, by definition, involves spending, not saving. Spending less is still not saving.

An informal online survey I conducted revealed that over two-thirds of respondents believe “taking advantage of sales, coupons, and discounts” is a good way to save money. Even when the disconnect was pointed out to them, the majority of respondents felt that the common usage of the word “saving” made it “fair” for them to conflate spending less with saving (even as you’re reading this, it’s likely hard to dissociate those terms).

Part of the problem is a cognitive error called an “availability bias”: the use of some form of the word “save” in advertising is ubiquitous, making it easy for us to erroneously think of spending less on discounted goods and services as truly saving; the easy availability of that association makes us believe it.
 

But the idea that purchasing anything could be considered saving money is, by economic principles, preposterous. And it gets worse, as we’ll discuss next.

The Discount/Overspending Paradox

It doesn’t hurt to spend less money on items you would have bought at a higher price otherwise. But spending less only translates into savings if the amount you didn’t spend is placed into a financial savings vehicle such as a bank CD or retirement account. What actually happens, though, is the money you don’t spend on, say, a box of cereal or a new TV remains in an account accessible for discretionary spending and is typically spent on more of that item or some other item, often in the same store! 

Research from the University of Pennsylvania shows that people who go into a store armed with a mental budget have “slack” built into that budget, enabling them to make additional purchases at their discretion. So, if they find a planned purchase is discounted, they often buy more of it, thus spending more than intended on that trip, with the rationale that they will spend less on that item longer term. On its face, such “stockpiling” is rational behavior that reduces the effective cost per unit of an item. But it can ultimately be harmful when consumers amass too much of a given item and waste it due to changing tastes or spoilage. It’s fair to guess that too many of us have untouched discount-club store purchases collecting dust in our basements.

The second problem is more insidious: shoppers often purchase unplanned items while in a store, whether because they believe they’ve “saved” money through discounts/stockpiling or merely because they see desirable items, discounted or not. Research from Notre Dame University shows that making even one unplanned purchase opens the door to additional ones.

These behavioral patterns mean that taking advantage of discounts in any form may actually result in spending more, or what I have dubbed the “Discount/Overspending Paradox.”

The Bother of Budgets

Dissociating the concept of saving from spending less is a big step toward better savings-related decision-making.

But let’s pull even further back to think about budgets.

According to Gallup, no more than a third of Americans uses any kind of household budget. That’s a major problem as there’s no way to save money systematically, or to save “more” money—as most of us would like to—without an understanding of, and goals related to, how much we spend on  expenses. We do recognize this connection: many of my survey respondents listed budgeting as an important savings-related tool.

So the first step is being willing to budget. If you don’t use an online financial-management program such as Mint.com already, consider signing up, or check out these free budget templates. A household budget helps you determine your fixed expenses (such as mortgage, car payments, food staples, and insurance), understand your historical discretionary expenses (dining out, clothes, entertainment), and identify savings opportunities. Of course, any amount “saved” isn’t truly considered savings until you’ve placed it into a savings vehicle, as I hope I've made clear above.

Unfortunately, there’s often a large mental gap between having a budget and actually following it faithfully. One issue is that your official budget may be in annual or monthly terms, but you need to make spending decisions on a weekly or even daily basis. For example, in financial terms, the “pro rata” amount you could spend for the week on groceries would be your annual budget divided by 52 weeks; so if you budgeted, say, $7,800/year for groceries, that would equate to $150/week. But your mental budget upon reaching a store may be very different, depending more on how flush you happen to feel at the time (did you just receive a paycheck or bonus?), your mood, or other factors. And, of course, you have the Discount/Overspending Paradox discussed earlier to contend with, as well, which can be more pronounced for middle and upper-income shoppers.

In short, you have to be willing to keep a budget in the first place, then do your best to align your official budget with your mental one by figuring in smaller time increments (weekly or daily instead of annually), and identifying factors that may throw you off. Any additional money not spent, then, can be placed in a savings or investment instrument.

Lifestyle 2.0

The more we earn, the more we spend—and thus the less we save, proportionately.

My survey respondents, mostly from middle and upper-middle income levels, almost unanimously agreed they needed to improve their saving habits. But the reality is that as our incomes rise, we tend to purchase larger homes and more luxurious cars, meals, goods, and vacations.

To save, many of us target spending less on discretionary items—maybe we will go out to eat less often or to less expensive restaurants, or stream a movie instead of going to the theater. This may make a difference if you’re consistent, but there’s a potentially much more powerful approach: reducing your fixed expenses.

Fixed expenses are generally larger and easier to identify than smaller, more frequent, discretionary expenditures. A typical household’s most common fixed expenses are in housing (including real estate taxes), insurance (health, auto, home), and transportation, which together compose a substantial portion of the budget. So just cut down on one or more of these, right?

The problem is that almost no one is willing to downgrade on lifestyle. Psychologists call the taste for increased luxury “hedonic adaptation”—once we’ve been to a ritzy hotel we tend to prefer such accommodations. The research of renowned cognitive scientists Daniel Kahneman and Amos Tversky shows that once people have something (or even anticipate having something), it becomes a “set point,” or a new baseline expectation, such that anything less is considered a loss. Similarly, they found that we tend to feel losses more strongly than gains, helping to explain why so few of us are willing to downsize our houses—or most anything else—to save money.

Let’s use housing costs as part of a fuller example of savings-related trade-offs. If, like most people, you purchase a home using a mortgage, then the larger the mortgage the greater the total payment —including interest. Less costly homes also tend to have lower insurance rates, lower real estate taxes, and lower maintenance costs. But if these were the only considerations, most of us should opt for a smaller home. In reality, owning a home is not just an expense but an investment that pays returns beyond financial: location, comfort, space, community, and others. That means the “utility”, that is, the total economic enjoyment, of owning a particular home may outweigh some post-retirement perks like frequent tropical vacations.

Moreover, since society still values home-ownership highly, there’s a strong availability bias, such that few consider renting a permanent solution for housing. Making the same lifestyle choices as others is known as "herding" and it can take a great deal of self-reflection to overcome.

You can see how analysis of choices/trade-offs for even one major budget line item can get complicated quickly. But thinking things through can produce important information to guide your savings decisions.

Death and Savings

Many of my survey respondents take advantage of direct deposit and other automated money-transfer tools to build long-term savings vehicles.

While that’s a good habit, the problem is that people who “pay themselves first” in this way tend to feel that the amount they’re saving, whatever it may be, is sufficient for the post-work lifestyle they desire. Many retirement savings calculators suggest otherwise: living on just 15% to 30% of your current income, even with decades of compounded interest, is not feasible for all but the most frugal among us.

To really determine how much you need to save for the future lifestyle you want, you’d have to reasonably estimate the entirety of your future earnings, create rational approximations of your post-retirement living expenses, account for inflation, investment income, and compounding, and then base your current spending on the present-day budgets you’ve made using those forecasts. It’s safe to say that the vast majority of people haven’t completed that exercise, including economists and financial planners!

Part of the challenge is uncertainty. We know that people are generally living longer than before, but it’s hard to say how long any particular person will live, complicating long-term financial planning. But using the average age of death and adjusting for your family history and health habits should get you in the ballpark.

Still, few of us like to think about our mortality. Economists “get” that it’s an evolutionary advantage to fear death. But to save strategically, you need to overcome that fear. That means you should have a spreadsheet or some other budgeting tool that extends through your best-guess life expectancy, with scenarios for exceeding that target. And you should revisit this document at least annually to adjust for any unexpected events, such as a substantial period of unemployment (pro tip: everyone should plan for at least two years of unemployment in their lifetime, and for decreased income after age 60).

Define “Saving” for Yourself

To be clear, I’m not advocating that you need to downsize your home or give up ownership to rent. I’m not asking you to reject coupons, sales, and discounts. The point here is to carefully consider the now, the future, your preferences, and how you came to have those preferences, because most people are not making rational choices by economists’ standards.

In even simpler terms, you might later discover that you would like to have pursued saving differently, had you thought more about the bigger picture and the choices you made within it.

Remember: strategies to achieve your savings goals will likely not come from the first ideas that come to mind. Availability biases, social norms, cognitive set points, and behavioral paradoxes like the Discount/Overspending Paradox will likely affect your choices and undermine your savings goals.

The first step is understanding that “saving money” may not mean what you think it does, but you can learn the right definition and take strategic steps to define the right savings goals for you. The ideas here are a good start.

Savings-related Resources

The Only Budgeting Book You’ll Ever Need

Mint.com

Link to Savings Survey

Jokes for Economists. No... really...

That's Nash.

A traditional economist, a game theorist, and a behavioral economist are about to walk into a bar.  The behavioral economist says, “Since we all know that we are going to drink too much and get into an argument, we should not all go in.” The traditional economist says, “Since my rational inter-temporal preference is not to have a hangover tomorrow morning, I agree.” Then the game theorist says, “Well then you two should give me the expected value of the drinks you would have drunk and I’ll go in and have a beer and the quiche and find myself the Nash girl in the bar.” The traditional and behavioral economists hand over their money to the game theorist, they all agree that it was a lovely evening, and part ways.

Kill Joy - The Economic Fall Out of The Cubs' Win

By Jacqueline Verrilli

Economics is known as the dismal science. This is because the law of supply and demand suggests that economic profits will always fall to zero in the long run, which sucks for capitalists, and businesses tend to find a way to exploit or create an inefficiency, which sucks for consumers. In keeping with the idea of economics being dismal thematically, I decided to do a back-of-the-envelope estimate of the productivity lost due to the Cubs winning the World Series. Now... rather than put this disclaimer in small print where everybody would neglect to see it or choose to ignore it. I am stating in bold face print here that: THIS AND ALL OTHER BACK-OF-THE-ENVOLOPE ESTIMATES SHOULD NOT BE CONSTRUED AS FACTS. IN ORDER TO GENERATE A SCIENTIFIC FACT ABOUT LOST PRODUCTIVTY A REASONABLE SAMPLE OF HEAVILY VETTED DATA WOULD NEED TO BE COLLECTED AND RUN THROUGH A RIGOROUS STATISTICAL PROCEDURE. THIS IS NOT THAT. Great.  Now that no one will mistake this for a fact, let's see if I can have some fun with this.

Anecdotal Evidence - Take 1: The Random Walk

It is now 11:00 am and I am sitting in a Starbucks on Fullerton Avenue in Chicago. In the last hour I have seen multitudes of people walking by in Cubs gear, presumably on their way to the officially sanctioned parade and celebration. Many of them looked like they should be at work. So I asked several people who appeared of employable age if they skipped work today. Everybody enthusiastically said "Yes!" Even a woman who was a freelance writer and so was self-employed, thereby, directly hitting her own bottom line more than anyone else's, said she was on her way to the parade. Out of twenty people only one woman who had a toddler in tow hadn't taken the day off work. The City of Chicago has estimated that 4 million people will come downtown today to celebrate the ending of the curse of the goat. If we extrapolate by assuming that 19 out of 20 adults attending the festivities have taken off work, and that 50% of the people who attend are an active part of the labor force (this is a WAG for eliminating children, college students, stay at home parents, etc.), then 1.9 million people attending the festivities are skipping work today.

Anecdotal Evidence - Take 2: Whack-a-mole

At about 10:00 am today, I texted several friends asking if they were going into work today and, if they were, I asked them to do a quick head count and estimate the percentage of people that would normally be there that are not at their desks. I got some wild guesses that ranged from between 30% and 50%. I asked one respondent to yell "Go Cubs!" in her office and see how many heads popped up. She decided to take a walk around instead and said that it appeared to her that people had come in and dropped off their personal items but had then headed out to the parade. Taking a truly wild guess, I would estimate (conservatively) that the workers in the downtown area who attend the festivities would not be at their desks for at least 3 hours today. I am assuming that 100% of people working in the suburbs that are attending are taking the whole day off.  

Anecdotal Evidence - Take 3: The Virtual Commuters

One respondent to my mad texting poll said that 5/6 of his team decided to work from home today. In his text to me, however, he felt that his team might be more productive because of it.  Since this event is special and would have served as a distraction, I am inclined to agree. The question is whether or not they would be equally productive at home as they would have been on a normal day at work and this is difficult to answer. Studies show that people who attempt to work from home regularly are actually generally less productive on those days. There are also studies, however, that show that, since it takes time to regain concentration, taking time away from one's assigned duties at work in order to attend a meeting can, if fact, make people less productive, so people who stay home today would not have those issues. I would argue, however, that going to meetings at work is production even with the re-focusing time. Lost concentration time is simply a part of the work day and meetings are productive for the overall company if not for the individual employee. So I'm calling people working from home today (and today only) a wash. By the way... the 6th employee...?  Yeah, he gone.

Let's Calculate, Shall We?

Okay... So here it is Chicago. Making a crazy, wild guess about the mix of the 1.9 million people lost at least partially from the world's productivity today, let's assume that 500,000 are suburban workers and 1.4 million are downtown workers, and, using an average wage of $50,000, this would bring us to a loss in productivity of about 8.2 million hours of production resulting in over $197 million of lost productivity. Now, I can't begin to calculate the additional revenue the downtown restaurants will have to today or the dollars of additional gear that will be sold today. And, as an officially official economist pointed out, there are ancillary productivity benefits that result from the relationship-building due to shared experiences. But I didn't say I was looking for a net number, did I?

It would have been interesting to see what the corresponding loss might have been if Cleveland had instead won the series. Perhaps this would console some hurt feelings about Cleveland fans' continued struggle for a pennant. Sorry, Ohio. The burden falls to you to drive the economy today. And the economists in Chicago thank you.

Wealth-Debt-Income-Invesment-Wealth

http://www.forbes.com/sites/investopedia/2014/01/28/a-study-on-the-wealth-effect-and-the-economy/2/#154cbef468a4

The above links to a Forbes article from 2014 regarding the "wealth" effect.  This article and the economic theory behind it imply that people convert some of their wealth to income and spend it in times of increases in asset prices. The research can be interpreted to be conflicting, but it appears that the wealth effect is more pronounced for wealth associated with housing price increases than with stock price increases. The suggestion in the article is that this may be due to the perception that stock wealth increases are considered more ephemeral (or risky, in economic terms).  The writer ultimately derides using your home as an "ATM" for current consumption at the expense of future consumption.

But what about using your home to arbitrage investments? Miller-Modigliani proves that, in efficient markets, debt is simply negative cash and if an opportunity exists to create additional wealth or income by investing in another asset then you should jump at it. Many people leveraged their primary residences and bought second (and third) homes, investment real estate, and other assets like stocks and bonds during this period of time to increase wealth. These are seemingly rational responses to incentives. When it was discovered that markets not directly related to housing or stocks were inefficient (the CDO crash), many assets lost value due to the waterfall effects.  More research is needed here to uncover the vectors of inefficiency before drawing conclusions about what to do with wealth. Converting wealth to income is certainly not always a bad thing, even when the conversion is for consumption, if future income is rationally assessed to be greater. But, I would argue, the circumstances of the conversion and the ultimate use of the funds can have a chicken-and-egg effect on asset pricing.

Antidisestablishmentarianism

By: Jacqueline Verrilli, Evanston, Illinois, USA

Oh, yes, she did…! Yes, folks, I just used one of the longest words in the English language as the title of this blog post. I used it because it’s length is analogous to the seemingly interminable Presidential campaign season, upon which this blog is based. And I also used it because it is an appropriate description of two people who were running: Bernie Sanders and Donald Trump. “Old news” you say? “Bernie’s not in the race anymore” you point out? Hogwash! The forces that brought these two candidates to the forefront of politics are still hard at work and wholly relevant. They have simply gotten lost in the weirdly non-issues-based ether that is our media-driven political system - especially post-convention. So I’d like to address what it is that made Donald and Bernie so popular and break it down a bit. At the heart of it is a large swath of the populace feeling disenfranchised. The question is, WHY? Well, here’s my two cents.

Anti: A prefix meaning “against,” “opposite of,” “contrary to,” “in opposition of or to,” “not,”

Prior to the most recent crash, it was mostly rich people who were hurt when our economy tanked. People who held stocks, people who had invested in large commercial real estate projects, people who bought large amounts of derivative investment vehicles, you know, the solidly middle class and above. These are people who knew the risks and could afford to lose the money in hopes of the return commensurate with the risk. Sure, when the economy tanks, many people of all classes lose their jobs, and often people lose as much as a year’s worth of earnings (less any unemployment insurance they collect) while finding another one. And, yes, I understand that oftentimes when people lose their jobs they are unable to find a job that was paying as much as they were making prior to the loss, and this can impact the entirety of their future earnings. We dispassionate economists would argue, however, that, on average, those that lost their jobs were making excess wages prior to the crash. Don’t send me the hate mail, send it to Adam Smith or Merton Miller. Or better yet, write a love letter to Joseph Stiglitz. He’s still alive, and he’ll empathize with you.

This last crash was different in many ways, though, because it affected, not just rich people and business profits, not just the wildly effective money-making machine that is the US economy, but, everyone, everywhere, and all economies around the globe. And not just temporarily for a few people who worked in particular industries, but broadly, on a very long-term basis, for people of even very meager means. Only the Great Depression was worse and that was only because governments refused to intervene for so long thinking that it would all work itself out. In this last crash, hundreds of millions of people around the world lost a portion of their retirement fund. And there are still millions of homes in the US alone where the mortgage is technically “upside down”, meaning that the mortgage principal (the loan amount on the home) is more than the home is worth. But many people are still paying those mortgages because they need somewhere to live. I’d be pissed, too. But being pissed off about your own poor decisions to buy stocks and first or second homes (again, economists place all of the blame directly on you, dear reader, responding to incentives) is still no reason to endorse particular candidates, is it? This is technically, irrational behavior. Blaming the government for your own poor judgment has now become an international pastime. I personally blame Facebook and network television for fueling the ability to sit around and be entertained by finger-pointing and so allowing it to become a part of the social zeitgeist.

Those of us who do actually think for ourselves and question the information we receive from all sources recognize that we have a big choice to make in this next election. Pick a “blame the government” candidate or one that can work within it. I hate to break it you anti-establishment voters but the crux of your argument boils down to a set of irrational beliefs. You really think a President can magically: get all of the money out of politics, lower taxes to near zero, make higher education free, rid the US of all crime of any kind, level the playing field for all the world’s peoples, make the rest of the countries on the planet play nice with each other, modernize the infrastructure, make carbon emissions disappear worldwide, and have our military become so powerful that the entire rest of the world cowers at the mere mention of our country’s name. In four to eight years. Those of us with reality as a basis say, “good luck with that.”

Dis: A Latin prefix meaning “apart,” “asunder,” “away,” or having a negative or reversing force

It seems to me that many voters right now are trying to run away from reality. They want people not like them to cease to exist, and they want money to cease to exist. In the case of extreme “conservatives”, they want to enjoy a privileged lifestyle without all those “others” not like them mucking things up. If they currently do not have what they consider to be a privileged lifestyle, they will latch on to somebody who they think will bestow it upon them when their leader successfully rids the country of those others. In the case of extreme “liberals”, they want equality, transparency, and a “flat playing-field” for all. Either way, voters appear to want the fundamental forces of competition to disappear and they want their leader to make money obsolete as a means of distributing resources. They want to blow-up our system and rebuild it according to the vision that they believe their leader has. In other words, ostensibly "anti-establishment" voters, paradoxically, appear to want a dictator right now. Forget all that messy “free and democratic” stuff, let’s create utopia right now.  “My utopia.”

Establishment: The existing power structure in society; the dominant groups in society and their customs or institutions; institutional authority

As you can see, a utopia depends on whose perspective you’re viewing it from. Interestingly, the framers of the United States Constitution recognized that about 219 years ago. And so they attempted to create an establishment that would be flexible enough to accommodate all comers. And don’t it beat all that this crazy, novel system works! A system that allows the pedestrian populace, not only the elite intellectuals or the wealthy, not just a king or a Khan, but everyone who can legally establish a right to vote, to have a say in the policy, works!! And this preposterous system has created unprecedented progress on all fronts. Health and longevity, scientific discovery, inclusion, care for the infirm, widespread wealth and well-being... It is certainly still a work in progress, and that is by design. Our establishment allows for people to believe whatever they wish and express it so long as, in doing so, they do not harm others. Oh sure, progress has a way of hurting people’s feelings. In order for progress to happen, some people have to change their minds, admit that they were wrong, even! A psychological pain so great, that most people will choose to go to their graves before saying “I’m sorry.” But our establishment allows for that, too. I like our establishment. I don’t agree with the opinions or beliefs of many of the individuals who make it up, but I respect that they have the right to believe what they like and espouse their opinions. And I’m voting “establishment” because of it.

Tarianism: A set of word endings that, without a root word, are nonsensical

As of the past several months, I feel like I have been dropped into an alternative universe. It seemed impossible that two people so utterly at odds with one another in almost every way could possibly have put at risk the most well-established and formerly stable political system in the world. I find myself actively avoiding the news. In this piece, I have posited that the last economic crash awakened a basic fear in our populace. A fear that, without someone to make everything “right” again, we will all fall prey to forces beyond our control and die miserable deaths at the hands of those “others”.  Maybe I’m biased, but I believe that this whole ridiculous political mess belies a need for better economic education. The concept of a “law” of supply and demand is being thrown around a lot lately, and it behooves us to understand that certain equilibria don’t always work for everyone. And I firmly believe that our current political system does a pretty good job of balancing competing interests. It is perfect? No. Is there money buying policy? Yes. Do transfer payments encourage free-ridership? Sometimes. Should we allow businesses to make mistakes? Sometimes. But hopefully, one thing is amply clear now. “It’s the economy, stupid!” isn’t just an admonishment to political hopefuls, it’s a battle cry that everyone can get behind. And I just happen to think that the establishment candidate understands that the best.

John von Neumann Was a Big Fat Idiot

Since I know that almost nobody reads my articles, I feel quite comfortable in insulting geniuses. I am also comfortable that one of my heroes will never know that I totally poached his title.  Thank you, Al Franken! Keep up the good work in congress!  IF there happen to be any economists out there reading this, you know that John von Neumann is the economics analog to Albert Einstein.  For those of you who have never heard his name before, you should know that John von Neumann discovered the Mutual Assured Destruction equilibrium strategy for InterContinental Ballistic Nuclear weaponry, designed implosion lenses for the Manhattan Project, founded the field of study known as continuous geometry (developed from the algebra he invented), introduced stochastic computing and artificial intelligence to the world, and originated the concept of self-replicating spacecraft that could mine resources from an entire other planet.  In other words, we can credit him with much of the preservation and success of the free world.

He may yet turn out to be the savior (or ultimate destroyer) of all mankind. Seriously.  So, of course, he dabbled in economics a bit and, according to Wikipedia, “Von Neumann's functional-analytic techniques—the use of duality pairings of real vector spaces to represent prices and quantities, the use of supporting and separating hyperplanes and convex sets, and fixed-point theory—have been the primary tools of mathematical economics ever since.”  By many people’s accounts, John von Neumann was the smartest person who has ever lived.  So here’s why I think he was a big fat idiot.

In economics, one of his many major accomplishments is the definition of the “rational actor”.  Yes, John von Neumann was so incredibly brilliant he even designed the ultimate human being.  This uber-individual is the omniscient and omnipotent consumer, able to know all prices of every good everywhere and also know the exact amount of utility (the economics version of pleasure and/or well-being) each good would provide her. She knows exactly how much income she must make to purchase that set of goods, exactly how to go about making that much money, and exactly how to value her time on this planet in order to maximize her own utility, and then maintain that level of utility by optimizing her trade-offs among the options available in each moment of her life.  And this infallible automaton, the “Econ”, is engineered by integrating a set of five axioms, which John von Neumann defined.  Each rational actor, including you, dear reader, can, without error, determine their preferences with ordinal certainty through:

1. Completeness - People have well-defined preferences, and so you always know which thing or set of things you’d prefer when compared to another thing or set of things.  A critical feature of the way von Neumann defines “things”, however, is that these things might be of uncertain outcome.  In other words the “things” are probabilistic and so are most often referred to as lotteries.  But Econs can discern exactly what the odds are for any lottery and so can determine exactly which risks they’d like to take.  In math-speak: for any 2 gambles g and g' in G, either g is preferred to or is equivalent to g' or g' is preferred to or is equivalent to g.  Now we add that for any gamble in G, there exists some probability such that the decision-maker is indifferent between the "best" and the "worst" outcome. This may seem irrational if the best outcome was, say, $1,000, and the worst outcome was being run over by a car.  However, think of it this way - most rational people might be willing to travel across town to collect a $1,000 prize, and this might involve some probability, however tiny, of being run over by a car.  So the probability of collecting the prize plus the probability of dying, together, would create a “thing” in von Neumann’s world.  And an Econ can easily determine if collecting $1,000 is 99.999% probable and dying in car wreck on the way is 0.001% probable, or if collecting and dying in a wreck are each 50/50% probable (presumably based upon the Econ’s texting habits), and they can therefore easily determine what lotteries they prefer to others.  No problem, right?  Let’s move on to the next axiom now, shall we?

2. Transitivity - Preferences are consistent so that if you prefer one thing to a second thing and prefer a third to the second, then you prefer the third thing to the first thing.  This holds for sets of things as well.

3. Continuity - Some negligibly small change in the thing or set of things will not make you change your mind about your preferences. In math language this assumption states that the upper and lower contour sets of a preference relation over lotteries are closed.

4. Independence or Substitution - Irrelevant events or outcomes do not change your preferences. This means that if a decision-maker is indifferent between two possible outcomes, then they will be indifferent between two lotteries which offer those outcomes with equal probabilities, if the lotteries are identical in every other way; i.e., the outcomes can be substituted. So if the agent (actor/decision-maker) is indifferent between outcomes x and y, then they are indifferent between a lottery giving x with probability p, and z with probability (1-p), and a lottery giving y with probability p, and z with probability (1-p). NOTE THAT the outcome “z with probability (1-p)” is the same in BOTH lotteries and is, therefore, irrelevant!!  Similarly, if x is preferred to y, then a lottery giving x with probability p, and z with probability (1-p), is preferred to a lottery giving y with probability p, and z with probability (1-p).  Got it?  OK, then.

5. Monotonicity - This big ugly word simply means that a gamble which assigns a higher probability to a preferred outcome will be preferred to one which assigns a lower probability to a preferred outcome, as long as the other outcomes in the gambles remain unchanged. In this case, we're referring to a strict preference over outcomes, and don't consider the case where the decision-maker is indifferent between possible outcomes.  This has been described as the “more is always more” axiom.

Thanks to http://www.econport.org/content/handbook/decisions-uncertainty/basic/von.html for easy access to a good description of JvM utlity axioms.

In case you aren’t familiar with the term “axiom”, an axiom is defined as a self-evident truth or a universally accepted principle or rule.  Now…  I ask you…  Is it self-evident that you are able to know whether you prefer rocky mountain oysters to hagis if you have never experienced either?  According to these axioms, John von Neumann says it is because you can.  Clearly, this individual known as the “Econ” is equally as fictitious a creature as the rainbow-farting unicorn.

Now, I know that John von Neumann knew that he was acting as the equivalent of Dr. Frankenstein when he created the axiomatic automaton that is the “Econ” of today’s staunch economics modelers. He knew that only he, himself - the guy who predicted that if France didn’t re-militarize after WWI that WWII would ensue - only he could really be held to such omniscient and omnipotent standards.  But other economists and politicians use the concept of the “rational actor” as though there are 7 billion of them walking the earth.  The fact is that we are all really just a bunch of bumbling fools who buy cheese flavored chips with no actual cheese in them and work for less than we are worth simply because we don’t know what other people who do the same job are making.

Like any other social scientists, Economists can only observe choices, and economists have presumed that people’s choices are the manifestation of a rational train of thought, specifically the train of the onerously rational axioms above, and that people, therefore, make choices by connecting rational decisions to all the possible actions they can take according to their logical, probabilistic consequences (the outcomes), and then perform the action (make the observable choice) that is connected to the outcome with the highest utility.  If all those things happen, then we say that the actor is behaving rationally.  But long ago psychologists discovered the impulse - behavior where action is taken without substantial conscious deliberation being involved.  Some behavior is even instinctual or habitual where almost no conscious behavior occurs prior to the action or set of actions.  One estimate states that 80% of all human activity is completed without conscious intervention (Freud thought 90%).  And this isn’t just breathing and walking! We’re talking driving, eating, speaking, interpersonal interactions, posture, mannerisms, moods and emotions, anything that is considered “routine” or “habit”, cognitive habits and biases...

The fact is that we Humans do most of the things that we do without any conscious cognitive intervention whatsoever. And that means that we Humans make mistakes. And not just once in awhile, but all the time.  I know that I, for one, make utility-destroying choices every day. Just today I went to a grocery store for eggs and milk and came back with several other items including, not one, but, two bags of Australian licorice, which I regret buying because I have already gained 5 pounds since starting my PhD program due to eating such things and sitting for longer periods of time while studying. I am currently sitting at a computer at nearly 11 pm and I have promised myself to go running in the morning to try to shed these pounds, so I regret being up late.  Let’s see... what else...  I disappointed my son by choosing to go to a different event than his water polo match, I blew off making dinner (to go to the grocery store) and so we ate out which meant that we spent more money than we would have if I had waited until after dinnertime to go to the grocery store, and I wore horribly uncomfortable shoes to the event I went to earlier and I now have a blister on my pinkie toe.

And that’s not even a personal record for regrets in one day.  When I think back to the number of choices I made, versus the number of decisions I made, there is a large discrepancy.  Many of the things I did I did out of automaticity.  When something is missing from the cupboards you go to the grocery store.  ‘Cause that’s what you do.  In other cases, I was making active choices without really thinking about all of the consequences (go to grocery now did not equal spending money to get take-out for dinner when I left for the grocery store).  Sometimes I knew what the consequence might be, but made up an excuse to go ahead and do what I wanted to anyway (wear the cute shoes, you’ll be sitting most of the time anyway).  And sometimes I had to do what I had to do in spite of the fact that it would have a negative impact on some other aspect of my utility at some other point in time (go to networking event because you are restarting a career – feel bad about missing son’s thing later).  We could consider the last choice here as rational, right?  I knew that I would be destroying utility in one part of my life by gaining utility in another.  I knew what the trade off would be.  But here’s the kicker.  I should not regret missing my son’s water polo game if I was aware of the trade off.  If someone could please tell my amygdala that, I’d appreciate it. These are just a few of the ways in which we do things without thought and/or with thought but without a full understanding of the consequences.  I often think back to my college years and think that I would have chosen different courses and studied more “if only I knew then what I know now.”  Stuff it, John von Neumann.  I’m not going to feel bad about not becoming a brain surgeon.

Okay, okay... I am done using old John as my whipping boy, but let me wrap this up by making my true point.  We Humans are fallible; subject to beliefs, emotions, habits and impulse.  It should be clear that having a rationale is not the same as acting rationally or no one would ever eat an artificially flavored snack chip or drink a third martini. Decisions and choices are not the same thing, and, moreover, often our choices in one aspect of our lives have an impact on another at a different point in time and our non-Econ brains simply can’t make the connection.  But philosophers and economists alike have, for centuries, extolled the rationale as the means to an end for a rational act and I find this patently illogical.  Rationales and rationality are not the same thing and they need to be extracted from one another once and for all.  In recent books and papers economists have taken to distinguishing the difference between “Humans” and “Econs” and I, for one, appreciate it.  In fact, let us economists begin to allow for the vagaries of the Human mind as a HUGE driver of economic activity.  ‘Cause, let’s face it!  If we all were able to know exactly how to maximize our potential from the moment of birth the world wouldn’t need lawyers or yoga teachers and then where would the world be, I ask you?