Heroic Assumptions

   A basic assumption of Economics 101 is that people make rational decisions about how they utilize resources available to them. This, however, comes from another assumption -- that people are rational. Indeed, sometimes they are, but often they are not.
   Another heroic assumption is that the stock market is a barometer of the nation's economy, and thus predicts when, where and how consumers will spend their money, and on what. Perhaps a better metaphor would be that investors on Wall Street comprise a thermometer, and reflect the rise or fall of the public's propensity to buy or sell stuff.
   Alan Greenspan, former chairman of the Federal Reserve Board, used the phrase "irrational exuberance" to describe investor behavior during the dot.com bubble of the 1990s. And Robert Shiller also used it as the title of his book on behavioral economics.
   While early studies of the "abysmal science" focused on the premise that people were rational and made rational decisions, more recent observations have changed that outlook.
  Scientists have long used assumptions to develop theories, which then are applied to reality to check on their validity. Economics, however, is not a pure science, as can be said of chemistry or physics. It is a social science, and deals with human behavior, using the assumption that human do indeed behave rationally often enough to justify some of the theoretical assumptions.
   'Tain't so, McGee. At least, not always.
  People often react to circumstances and events through their emotions. But emotions -- such as fear and love -- are not rational. If they were, they wouldn't be emotions.
   Granted, people give reasons for their behavior, and in some circumstances -- being charged by a rogue elephant or attacked by a rabid wolf, for instance -- the emotion of fear is well founded. 
  Nonetheless, fear remains an emotion, even as victims of the attack rationalize their fear by citing the behavior of other creatures. That, however, is done from observing what actually is happening, not from speculating on what might happen. Then again, it might not.
   Speculating is a very useful strategy, when based on observable qualities and events that would, assuming nothing else changes, lead to a new situation.
   And there lies the classic assumption of Economics 101 -- the ceteris paribus assumption, from the Latin for "other things equal."
   That, however, can become a heroic assumption, that other things will remain on par with each other and there will be no changes.
   But history shows that people -- their actions, attitudes and customs -- do indeed change, sometimes slowly over a long period, and sometimes radically swiftly.
  As every investor knows, past performance is no guarantee of future returns. But it can be a useful gauge, applicable to horse races as well as to the stock market.
  The same can be said of political candidates.