Kent's Thesis Revisited

According to Kent's thesis, the process of trading up need not involve irrationality. Why? Because people can place different values on items. Hence, when two people trade, even though one person is in some sense getting the better deal, they both end up with something that they prefer. Hence, both have acted rationally.

Consider an example. I have a paperclip and you have a pen. I really want a pen but have no use for a paperclip; you really want a paperclip and have no use for a pen. We somehow meet, both realize the other’s position, and so decide to trade.

When we trade, we both end up with something we value. Because you really value a paperclip and not a pen, you end up making a rational trade – after all, why not give up something that you don’t want for something that you do? And because I prefer a pen to a paperclip, I act rationally too.

Now, in a bartering system, this sort of process can and does happen. Indeed, in a bartering system, something like this almost inevitably happens. So if we were all forced to barter for our goods, it would be possible for someone to trade up from a paperclip to a house without any sort of irrationality.

So there is at least one circumstance -- if we must barter for our goods -- that validates Kent's thesis.

But of course we don't barter for our goods. Instead, we use money; and this changes things. Although you might prefer a paperclip to a red pen, you presumably would prefer two paperclips to one. And given that you have a pen, you could get two, and indeed perhaps twenty, paperclips by selling your pen and then using that money to buy paperclips.

So if we have a monetary system, it looks like trading a pen for a paperclip involves irrationality. After all, why get only one paperclip for your pen when you could get twenty?

There is, however, a complicating factor: transaction costs. Using money involves a certain cost.

To see this, suppose that we are sitting outside on a bench having a pleasant chat and so could easily make a trade. Suppose further that it would be quite a hassle for you to find someone who is willing to buy your pen and then find someone else who could sell you twenty paperclips. In such a situation, the transaction costs involved in using money may be greater than the difference in value between the pen and the paperclip.

In such a case it may be rational for you to forego the additional nineteen paperclips. If the time, effort and other additional costs involved in using money for the transaction were not worth nineteen paperclips, then it would be rational for you to make the trade.

In general, if the transaction costs are greater than the difference in value between two items, it can be rational for someone to make a trade even though he is trading for something that is worth less money than what he currently possesses.

So there is a second circumstance that validates Kent's thesis. If for every trade, the transaction costs were greater than the difference in value between the items traded, then someone could trade up from a paperclip to a house without there being any irrationality involved.

There is yet one final complicating factor: subjective value. Suppose that for some reason you really liked the idea of trading a pen for a paperclip. Suppose, for instance, that you believed that making such a trade would curry the favor of the gods. And suppose further that you value the favor of the gods more than you value the money you would lose were you to trade a pen for a paperclip. In such a situation, it would be rational for you to make a trade.

So we have a third circumstance that validates Kent's thesis: If for every trade, the person trading for the less expensive item placed a subjective value on the trade itself that was greater than the value of the money the he was losing, then someone could trade up from a paperclip to a house without there being any irrationality involved.

But now we must ask: in the cases of the red paperclip guy and the kid who traded from a cell phone to a Porsche, were either of these circumstances actualized?

What about the first circumstance: was it the case that the transaction costs were greater than the difference in value between the items traded?

The answer to this question is almost certainly 'no'. Why? Because the difference in value between a paperclip and a house is around $200,000. So if irrationality were not involved, the total transaction costs involved in the series of fourteen trades would have to equal $200,000. But it is very implausible to suppose that there really are such significant transaction costs. Using money may sometimes be inefficient. But it would be surprising in the extreme were it that inefficient.

What about the second circumstance: Did the people involved collectively place a subjective value on the trades that equaled the difference in value between the first and last items traded?

Here, I must admit, we run into a difficulty: How do we know the values that the people had? Indeed, it is plausible to suppose that in the case of the red paperclip guy some of the people were motivated by the notoriety and fun involved in the process. Hence, it is plausible to suppose that they would place at least some value on the act of trading itself. And perhaps the people involved collectively valued the notoriety and fun as much as they collectively valued $200,000. If so, then the trading process would not have been fueled by irrationality.

But this is where the kid who traded from a cell phone to a Porsche comes into play. In the case of the red paperclip guy people may have been motivated in part by the notoriety and the fun involved in the process. But the kid who traded up from a cell phone to a Porsche was not advertising what he was doing; hence, one could not explain away the irrationality in his series of trades by appealing to notoriety and fun.

So in the case of the kid, it seems clear that irrationality was active. But if it was active in the case of the kid, it was probably active in the case of the red paperclip guy as well.

So even though I think Kent’s thesis is true – it could be the case that no irrationality is involved in the process of trading from a red paperclip to a house– I think that a great deal of irrationality was in fact involved.