Nobel Prize-winning economist and Yale University Professor Robert Shiller.

When consumers don’t make the best decisions for themselves – which happens more often than most economists like to think – markets tend to exploit their irrational behavior, according to Nobel Prize-winning economist and Yale University Professor Robert Shiller. And according to Shiller, the best solution to saving consumers from themselves may be strengthening the role of dedicated consumer protection agencies.

Shiller visited Seattle recently to talk about the dark sides of free markets, which is the central theme of his recent book, Phishing for Phools. Given our appreciation for Shiller’s work – he is famous for, among many other intellectual contributions, helping develop the Case-Shiller Home Price Index – and the fact that he was in our backyard, several Zillowites attended his talk.

Free markets are built on the idea of rational consumer behavior. But one critical flaw with market-efficient outcomes, according to Shiller, is that consumers are assumed to be self-interested and rational. But in many ways, most consumers don’t exhibit these qualities. In other words, when consumers act like “phools,” the free market foundation tends to break down and markets start taking advantage of consumers’ mistakes.

Shiller provided a number of examples to support this thinking. Checkout lines at grocery stores are full of sugary snacks and tabloid magazines meant to pull at the wallets and purse-strings of consumers susceptible to impulse buying. Slot machines offer a brief, largely harmless thrill to many casino-goers, but there are those who end up sinking massive sums of money and time into the machines – padding casinos’ bottom lines with easy profit meant to offset their riskier bets on table games and sports books.

While some consumer advocates view businesses that market to these consumers as predatory or unethical, Shiller was more apt to blame free markets themselves. The supermarket industry is highly competitive, Shiller said, with profit margins typically in the range of 2 percent. For many grocery stores, the placement of attractive items in the checkout lane is a question of survival.

“They’re not evil people,” Shiller said. “They’re just trying to survive.”

According to Shiller, the best solution to these problems are consumer protection agencies. Shiller referenced a number of public and private efforts that provide consumers with better information and empower them to make better decisions, ranging from the Food and Drug Administration to Consumer Reports magazine. Shiller noted that the recent Volkswagen diesel emissions scandal only surfaced because of the work of a public-private partnership. It was researchers in West Virginia, financed by a grant from the non-profit International Council on Clean Transportation, who blew the lid on VW’s not-so-clean “clean diesel” technology, not the market.

At Zillow, we like to think of ourselves as helping consumers make better decisions by providing reliable data about their local housing market. Professor Shiller’s comments suggest that we might also be helping the open market function more efficiently.