Behavioral Bias: Fallacy of composition

Definition (Via Wikipedia)

A fallacy of composition arises when one infers that something is true of the whole from the fact that it is true of some part of the whole (or even of every proper part).

Examples (Via Wikipedia)

In Keynesian macroeconomics, the “paradox of thrift” theory illustrates this fallacy: increasing saving (or “thrift”) is obviously good for an individual, since it provides for retirement or a “rainy day,” but if everyone saves more, it may cause a recession by reducing consumer demand.

The thrift of any member of a group is beneficial to that member.
Therefore, the thrift of the group as a whole is beneficial to that group as a whole.

Another example is the Tragedy of the Commons where an individual would benefit from his unlimited access to a finite resource but the collective unrestricted demand from the whole group would eventually doom the resource through over-exploitation.

SimoleonSays:

The fallacy of composition can also be used to understand certain elements of bubbles & panics. For example if there is a fire in a theater, it’s in the best interest for each person to run to the exit. If everyone runs for the exit at the same time, a disastrous situation is likely to brew.

Similarly, in a market panic it’s in the interest of each person to exit positions as quickly as possible unfortunately mass behavior (like this) results in a feedback loop and further declining prices.

About Miguel Barbosa

I run this site.

04. December 2009 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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