{bit.ly/HEccc} Modern economic theory is founded on the principle that human beings “maximize utility”; that is, they choose the best action from among a collection of choices. This axiom is considered self-evident: why would anyone make an inferior choice, when a better option is available? However, the mathematical formulation of this axiom is far from realistic. After all, it is self-evident that human behavior cannot be described by mathematical laws. Critics have invented the term “homo economicus” to describe behavior governed by economic laws, which differs drastically from normal human behavior. We can describe homo economicus as cold, calculating, and callous. We explain each of these terms separately.
The theory of consumer behavior which is taught in business school differs drastically from the same theory taught in the economics school. The homo economicus of economists is cold – not subject to any emotional influences in his consumption decisions. In complete contrast, a fundamental axiom of consumer theory in the business school is that effective marketing appeals to emotions instead of reason. The proven effectiveness of business school methods in getting consumers to purchase a wide range of completely useless goods shows the superiority of their models of human behavior.
The term ‘maximize’ describes the assumption that homo economicus calculates the consequences of his actions to the last penny, and utilizes any opportunity for even the slightest gain. Nobel Laureate Herbert Simon observed that real human beings do not act according to this assumption. He invented the term “satisficing” to describe the observed behavior of real humans. Satisficing means making a choice which is satisfactory, or sufficient for the purpose, instead of maximizing, or searching for the best possible choice. For a wide range of situations, satisficing is a much better description of human behavior than the maximization done by homo economicus.
Finally callous refers to the assumption that homo economicus is concerned solely with his own personal gains, and does not have any concern for others. Psychologists who learned of this bizarre theory of the economists decided to test it in a simple lab experiment. They gave some amount of money, like $10, to a subject X, and asked him to divide the money with another subject Y. The subject X was completely free to choose how to divide the money, including keeping all $10 for himself and leaving none for the subject Y. In fact, almost no one did this. Many subjects split the money into equal shares while nearly all gave at least $3 to the other subject. Only economists, blinded by their theories, found these results strange. According to economists, all subjects should keep all $10 for themselves and give nothing to others. Interestingly, in experiments among college students, economics students behaved the most selfishly, occasionally even keeping the entire amount for themselves.
The discovery of the great divergence between homo economicus and real people led to the creation of Behavioral Economics. This discipline studies actual behavior of people via experiments like the one described above. This goes against modern economic theory, which uses mathematics to calculate human behavior. For a long time, behavioral economics was an outcaste subject within the economics discipline. Actual human behavior was complex and varied, and conflicted strongly with the mathematical laws according to which homo economicus behaves. Leading behavioral economists advised their students not to study the subject, since they would have difficulty finding jobs as economists. The situation changed gradually as the radically different predictions of behavioral economists often turned out to be more accurate than conventional economic theory. Robert Shiller used behavioral theories to show that stock markets were overpriced, something which was not possible in the world of the rational robots that conventional economic theories study. After the Global Financial Crisis proved him right, Shiller was awarded a Nobel Prize, and Behavioral Economics acquired a new respectability among economists. Nonetheless, mainstream economists continue to treat behavorial theories as a sideshow, and homo economicus continues to occupy the central place in modern economic theory. We cannot hope for a realistic economic theory until this situation changes, and a more realistic theory of human behavior is adopted for use by economists.
NOTE: The failures of neoclassical utility theory are extensively discussed in: The Empirical Evidence Against Neoclassical Utility Theory: A Review of the Literature, International Journal of Pluralism and Economics Education, Vol. 3, No. 4, 2012, pp. 366-414. For another discussion of this topic, see: The Fourth Poison: Homo Economicus.
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Before we introduce the behavioral aspects, lets have a consistent, logical scientific and comprehensive theory first! There ain’t one!, with the possible exception of mine in “Consequential Macroeconomics–Rationalizing About How Macroeconomics Works” (ask me for a e-copy at chesterdh@hotmail.com). Then we can begin to introduce the behavioral aspects, otherwise the process of behavioral parts first, will continue to cause the same confusion that most of us already (apparently) enjoy and like to keep the students guessing.
This article fails to mention that “maximizing utility” is a. Abstract idea and it’s not really meant to describe actual human behavior but to give a starting point from which you can study it. Behavioral economics can be considered the application of this idea. When doing economic research, we have to look at certain variables while holding others constant. Of course we know humans are much more complex but if we want to shed a small light on this complexity we must use abstraction.
The Homo Economicus is to economics what ‘Nemo censetur ignorare legem’ is to legal sciences, the fiction that every citizen knows the laws of its country
Actually a large proportion of the acts of government and large corporations can be interpreted as a concerted effort to maintain the gap between reality and economic models. For example, economics assumes that everyone has perfect knowledge, and everyone receives information immediately and concurrently. Yes, right! Very funny indeed. If any peasant obtains the necessary information to trade successfully at the same time as corporate elites, he would be severely punished for “insider trading”. The crime is not “insider trading”, but being a peasant and pretending to be an insider.
I responded to a comment on a re-blogging of this post on RWER blog. This is replicated here, as it responds to some of the comments above:
1. “Homo economics” is not a straw man in the sense that economists actually use this robot to predict how humans behave — hence their extreme surprise at the results of the ultimatum game. Colin Camerer has written that “if I had a penny for every time an economist told me that high stakes in the ultimatum game would drive behavior towards the “utiillty maximization” outcome, I would have a private jet on standby at all times.
2. The process of economic modeling, used to understand impact of policy, consists of considering what would happen in a world populated by rational robots — this is what makes it possible to do the calculations. But this is also what makes modern economic theory highly unrealistic.
3. See Julie Nelson “Poisoning the Well” to understand the impact of these assumptions of cold, calculating and callous as normal modes of behavior on actual human beings — How these lead us to suppress our natural impulses to be kind, compassionate and considerate, and act in shamefully inhuman ways.
4. I have not suggested an alternative here — but the best that I have found is given by Karl Polanyi who says that human beings act to maximize social standing. In communities which value money above all things, they will seek to acquire money and act like homo economicus. If better social norms are promoted, they will act in more human ways.
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There is a world of difference between the single person’s micro-behavior when facing a challenge in his economic position, and how the whole nation in a macro-economics sense behaves. The latter is an aggregate, when all of the possibilities for us are taken together. But this response is different from that of our individuals–there is no scaling up of our separate performances to reach the general response.
To Asad–if modeling creates a “highly unrealistic” response, then how can we get a more realistic one (and as applied to whom or what)? Actually the results of the model can and should be true for the community as a whole (when we use the correct model, as in my book, mentioned above), and the awareness of its lack of realism comes into existence only when we begin to consider the individual. So I don’t find us all behaving like a lot of robots neither singly nor collectively!
We should remember the definition of economics: how we satisfy our unending needs with the least effort– a real oxymoron, if ever there was one!
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Thanks for your appreciation — This blog has a huge number of posts which provide sharp critiques of existing theory. Most closely related to this one is:
https://weapedagogy.wordpress.com/2017/03/10/behavioral-vs-neoclassical-economics/
Also, you might enjoy reading about spirituality and development
https://weapedagogy.wordpress.com/2017/01/29/spirituality-development/
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