predicted by statistical models only once in every trillion years or so.

Following the Monday crash, prices rose 5 percent on Tuesday and 9 percent on Wednesday, the exchange's two largest postwar increases. The following Monday, the market fell 8 percent. It is hard to imagine a model in which such enormous daily price changes could be judged rational in the absence of any important economic news. Rather, investors seemed to be reacting emotionally to the price movements themselves.

Recent research on the stock market has also uncovered numerous "anomalies," facts which are difficult to explain within a totally rational framework. For example, stock prices tend to rise on Fridays and before holidays and fall on Mondays. It seems possible that this pattern is produced by the mood of market participants. Indeed, contrary to most Fridays, prices actually tend to fall on Fridays that occur on the 13th day of the month!

These and other examples all illustrate the basic point that people are human, not economic robots. Economists and the people who use their models—public officials, business leaders and others—must begin to acknowledge and take account of this human side of economic decision-making. A growing body of research is becoming available on how the vagaries of human nature affect economic decision-making, and it needs to be applied in making business decisions, passing laws and determining economic policy.

While traditional economic models have made numerous important contributions to our economic understanding, they can be enriched by incorporating human elements of behavior. Stubbornly clinging to them as they now exist is itself irrational.

October 11, 1988

Richard H. Thaler, the H.J. Louis Professor of Economics at Cornell University's Johnson Graduate School of Management, served on a National Research Council team that studied recent developments in the behavioral and social sciences.

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