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Eyes wide open.

To B.E. or not to B.E.?

April7

A constant theme spanning our behavioral economics presentation was the concept of rationality. Rationality is a simplifying assumption in traditional economic theory. Consumers are homo economicus. They are assumed to be logical, self-interested, utility-maximizing agents. Behavioral economics, however, does not assume consumer rationality; in fact, it assumes nothing. BE is primarily concerned with the bounds of rationality. In other words, behavioral economists are interested in testing the limits of rational expectations. As a school of thought, BE takes observed human behavior as a starting point and relishes in the complexity of it.

Several times in class, we brought up examples of this complexity in human behavior. We examined a few cognitive biases by stating the rational decision (the “should”) and then countering with the actual decision (the reality) made in experimental settings. We explained that people predictably and systematically acted irrationally.

Still, I think it is important to define what exactly is meant by acting rationally” or “acting irrationally.” What exactly does it mean to be rational? What exactly does it mean to be irrational?

Rationality has a very specific meaning within economics; it refers to a set of mathematical assumptions economists use to describe our preferences, and how they lead to actions. Economists never meant for this model to be descriptive—it was simply a convenient way to substantially reduce mathematical complexity. It is a modeling convention rather than a description of human behavior or an ideal to be followed. The economically rational individual is used as a stand-in for the generic or universal individual. For it’s easier to quantify and model an individual unaffected by emotions and stress and who is consistently prudent and logical.

The problem with this assumption is that the rational individual is not a representation of the average person. Rather, it it an extreme; the economic individual is not in the middle of the bell curve, but to the far right. True, economic models treat deviations from the homo economicus assumption as irrationality and error. But I don’t believe it’s just a few irrational outliers skewing the model. I believe every individual, every data point in one context or another acts according to another set of principles; people behave in a way that makes sense to them, not necessarily in a way that is “rational.”

 

posted under Econ488

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