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The Rational Economic Man does not exist. Emotion free processing of all relevant information is a myth. But much of economics is based upon the existence of this fellow, and projecting that all market actors are Rational Economic Beings.
It is as much of a fallacy, and impediment to progress, as the unreality of "free trade."
Marc Buchanan has some interesting ideas on how to add science to understanding markets. Science beyond the crude econometrics currently used.
He challenges equilibrium theory in market analysis. Saying it is attractive but simply does not work.
[E]conomists still try to understand markets by using ideas from traditional economics, especially so-called equilibrium theory. This theory views markets as reflecting a balance of forces, and says that market values change only in response to new information — the sudden revelation of problems about a company, for example, or a real change in the housing supply. Markets are otherwise supposed to have no real internal dynamics of their own. Too bad for the theory, things don’t seem to work that way.
The 50 biggest price moves since World War II do not comply with equilibrium theory.
Computer simulation - aka artificially intelligent agents - inserted into the actual markets.
The idea is to populate virtual markets with artificially intelligent agents who trade and interact and compete with one another much like real people. These “agent based” models do not simply proclaim the truth of market equilibrium, as the standard theory complacently does, but let market behavior emerge naturally from the actions of the interacting participants, which may include individuals, banks, hedge funds and other players, even regulators. What comes out may be a quiet equilibrium, or it may be something else.
One model can predict the amount of credit that is helpful in a market, or that can be abruptly destructive. Like in our current markets. Thus regulating the amount of credit can be a way to make markets work.
Another idea is to use a very small per transaction tax to provide stability.
Another example is a model explored by the German economist Frank Westerhoff. A contentious idea in economics is that levying very small taxes on transactions in foreign exchange markets, might help to reduce market volatility. (Such volatility has proved disastrous to countries dependent on foreign investment, as huge volumes of outside investment can flow out almost overnight.) A tax of 0.1 percent of the transaction volume, for example, would deter rapid-fire speculation, while preserving currency exchange linked more directly to productive economic purposes.
Yet another idea is to use artificial agents to develop market models to prevent manipulation.
A third example is a model developed by Charles Macal and colleagues at Argonne National Laboratory in Illinois and aimed at providing a realistic simulation of the interacting entities in that state’s electricity market, as well as the electrical power grid. They were hired by Illinois several years ago to use the model in helping the state plan electricity deregulation, and the model simulations were instrumental in exposing several loopholes in early market designs that companies could have exploited to manipulate prices.
Economic traditions inhibit pursuing these ideas. It does seem that we could really improve markets with the right rules and tools.
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