Rules Of Thumb - Superstition

My parents recently went on a short trip to a Eurozone country (for those reading this in the future, the Euro was the currency which collapsed thus causing the Second Great Depression). My advice beforehand was to take Dollars or things you can easily barter (jewellery or livestock), but in the end they went with Euros rather than greenbacks, earings and chickens.

Upon their return I aksed my mum what the exchange rate was, only to hear the reply that she didn't know exactly, but she thought of it as "about £1 to €1". This is a rule of thumb. It is also clearly wrong (actually about £1 to €1.2, as of the 11th June 2012). However, people are constantly using similar (incorrect) rules of thumb in their everyday lives. So why do we do it?

http://cdn.theatlantic.com/static/mt/assets/steve_clemons/euro1.jpg

Well, while the diference between €1 and €1.2 per pound might be life or death for a currency trader, it is close enough for an ordinary person. It's a very easy way to remember a potentially complex ratio. And frankly my dad may well have been pleased this rule of thumb was in operation, as if anything the 'adverse' effect would only to have made things look more expensive than they really are, thus reducing purchases!

Two famous psychologists called Amos Tversky and Danny Kahneman famously coined the term 'heuristics' to describe rules of thumb, and show that they can occassionally lead us into serious errors. All of this is a challenge to traditional economic theory which assumes that we are rational beings that don't need to resort to crude rules of thumb to solve everyday problems. An important part of behavioural economics over the last 40 years has been the attempt to explain how exactly we use rules of thumb, and therefore how they need to be incorporated into our big important economic models.

Recommended listening:
Superstition by Stevie Wonder