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1-Page Summary of Animal Spirits

Introduction

In America, the free market is a huge part of our economy. However, many people believe that it can operate on its own without government intervention. They think that the free market is guided by rational self-interest and doesn’t need any regulations. On the other hand, there are some who argue that the free market isn’t always predictable or rational and often gets manipulated by forces beyond self-interest. These mysterious forces are known as animal spirits, and they’re what make a free market economy require added regulations.

The Influence of Animal Spirits

Traditionally, economists believe that the free market will always be stable and rational. They think government should not interfere with it because the market is able to fix itself. This belief comes from Adam Smith’s book The Wealth of Nations where he argues that everyone would do what was best for themselves if they were all following their self-interests.

Smith argues that in a free market, everyone has access to the same information because prices communicate how much people are willing to pay for something. This means producers can tell if they’re producing enough of what’s wanted and at what price. Consumers can see how efficient the production is and whether or not it’s worth their money. In this way, we all have the power to make our own decisions about what we want and need, which benefits everyone involved.

On the most basic level, free market optimism is based on several beliefs about human nature. These include the assumption that humans can use reason to gather data and make rational decisions. Indeed, both the Age of Enlightenment and free market economics presume this ability for reason to be humanity’s definitive trait. However, it’s also worth noting that although humans are capable of behaving rationally at times, they don’t always do so. Human behavior is highly susceptible to bias, groundless fears, naïve optimism, and emotionally charged rhetoric.

Since human nature is not just rational, but also emotional and psychological, economic theories should be based on that fact. They shouldn’t ignore the influence of emotions or psychology in our decision making process.

While free market theories can explain many things, they still have trouble explaining certain trends. For example, long-term unemployment and racial discrimination are hard to account for using those theories. To understand the other dimensions of markets better, it’s important to recognize that human reason isn’t the only driving force behind market behavior.

“Animal spirits” is a term used by economists to describe the non-economic factors that influence economic activity. These external forces include emotions, perceptions, histories and psychologies of humans. They can be just as powerful as rational self-interest in determining how people act in the marketplace. By studying these animal spirits, we can create an interpretive framework for understanding why people make certain decisions and understand some of the economy’s strange turns.

Confidence

When people are deciding what to do, they consider various factors and options. However, at the end of the day, their decision might be influenced by more than logic and reason. For example, a homeowner who wants to rebuild after a hurricane might talk with his family about it or consult financial experts before making a final decision.

At the same time, homeowners might be influenced by what their neighbors decide to do. For example, a homeowner could have a neighbor who has lived in her house for 20 years and decides not to rebuild after a hurricane. If most of that person’s neighbors also choose not to rebuild, then the person might follow suit even if she believes it is worth rebuilding.