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] | Unrealistic optimism in business can lead to a misallocation of resources and a reduction in welfare. But unrealistic optimism can also stimulate saving and investment and provide added incentives for hard work. In this paper, I explore the interaction of these two effects with respect to entrepreneurs who are overoptimistic about the productivity of their firms, and I examine the nature of the competition between such optimistic entrepreneurs and their realistic counterparts. I demonstrate that in some technological environments (such as those characterized by small firms with rapidly decreasing returns to scale) optimistic entrepreneurs may coexist with realists in competitive equilibria or even drive the realists out of business. Moreover, the resulting competitive equilibria will evince significant distortions. This is important because a large body of evidence in the psychology literature indicates that unrealistic optimism is a widespread human trait, one that may be common among business executives. |
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