Not Rational Utility Maximisers

One cornerstone of neoclassical economic thought is the assumption in microeconomics (and microfounded macroeconomics) that humans behave as “rational utility maximisers”.

Yet this assumption is increasingly outdated. Empirical findings in behavioural economics show that the neoclassical assumption of utility maximisation has very little basis in reality.

First, it is crucial to define what we mean by utility maximisation. Paul Samuelson, one of the grandfathers of the neoclassical New Keynesian school defined consumer rationality as follows:

• Completeness — Given any 2 bundles of commodities A & B , the consumer can decide whether he prefers A to B (A≻B), B to A (B≻A), or is indifferent between them (B≈A).

• Transitivity — If (A≻B) and (B≻C) then (A≻C).

• Non-satiation — More is preferred to less.

• Convexity — Marginal utility falls as consumption of any good rises.

This definition remains dominant in neoclassical economics today.

Sippel (1997) tested whether consumers really adhered to these four rules. He gave his student test subjects a budget, and a set of eight priced commodities to spend their budget on:

UtilityMaximisation

This was repeated ten times, with ten different budget and price combinations. Sippel found that 11 out of 12 of his test subjects’ behaviour failed to meet Samuelson’s criteria for rational utility maximisation. Sippel repeated the experiment later with thirty test subjects, finding that 22 out of 30 did not meet Samuelson’s criteria. Sippel concluded:

We conclude that the evidence for the utility maximisation hypothesis is at best mixed. While there are subjects who appear to be optimising, the majority of them do not.

It is interesting that some individuals obey the rules set out by Samuelson, and that some don’t. Human behaviour is highly variable from individual to individual. If the hypothesis of utility maximisation is right about a subset of individuals, but wrong about much of the general population, then this underlines the variability of human behaviour. And different circumstances call for different decision-making frameworks — some individuals may act like rational utility maximisers under some sets of circumstances and not others. This is really an area that deserves much, much more empirical study.

The evidence so far suggests that humans are complex animals whose decisions are multi-dimensional. This could be because our brains have evolved to use different neuro-circuitry for different decisions. According to the behavioural economist Daniel McFadden:

Our brains seem to operate like committees, assigning some tasks to the limbic system, others to the frontal system. The “switchboard” does not seem to achieve complete, consistent communication between different parts of the brain. Pleasure and pain are experienced in the limbic system, but not on one fixed “utility” or “self-interest” scale. Pleasure and pain have distinct neural pathways, and these pathways adapt quickly to homeostasis, with sensation coming from changes rather than levels. Overall, presumably as a product of evolution, our brains are organized well enough to keep us alive, fed, reproducing, and responsive to but not overwhelmed by sensation, but they are not hedonometers.

All of this points to the idea that microeconomics needs a new framework based on neurological and behavioural evidence, not decades-old assumptions that are unsupported by empirical evidence.

About these ads

76 thoughts on “Not Rational Utility Maximisers

  1. Wrapped-up in the theory that humans act “rationally” and strive to maximize their economic destiny is the argument that not all actors in an economy are working with the same sets of education, economic and market information.

    It was not “rational” for individuals making $50,000 a year to take out a mortgage of $500,000 to purchase a home. The historical economic and financial data points clearly show the above scenerio to have a negative outcome for BOTH the lender and the borrower. (An irrational decision)

    Yet even the smartest (supposedly) men and women in the world (Ahem, Ben Bernanke) failed to notice this, seemingly, quite obvious outcome.

    In fact, it could be said that in order for such a large percentage of the population to pursue economic outcomes that have a negative utility for themselves, family, business, nation and world, that it would take participants at the highest levels of government, business and academia spreading economic misinformation.

    What has still not been factored in the mainstream economic circles is the sideffect of THEIR economic failings. Try defining an economic “rational” decision when the gate keepers of rational cannot detect or differentiate a rational economic decision from a non-rational one. Indeed, as stated above, what if irrational economic decisions are largely the result of misinformation from the top down (intentional or not), educational disparities and good ole fashion greed.

    Taken in total, it is amazing to this commentor, that a majority of the population today still follow much of the mainstream political, business and academic economic leaders when it is clear that their policies have clearly lead to the negative outcome of suppressing “true economic” information at the expense of maximum utility for all.

    Cliff notes version: People are greedy and they will kick you in the nuts for an extra dollar.

    • Free markets with multiple suppliers (Primary, Secondary and Tertiary Industries) is the only way to satisfy a multitude of irrational consumers. They provide a buffer system to irrationality – “Shock absorbers”.

      An example from the past. The Soviets made the peasants produce wheat to sell on the international market in order to gear up the war machine with foreign income. One suppliers (The Kohosp-collective) supplying the irrational consumer – Stalin. The system failed when crops failed. Wrong plantations at wrong time. Before that peasants would grow different vegetables to suit different buyers, and famine never occurred. Never.

    • Greedy AND irrational and short-sighted! You get kicked even if they need your support. “Bite the hand that feeds you”.

  2. Is it correct to say that:
    • Transitivity — If (A≻B) and (B≻C) then (A≻C).

    …is wrong based solely on the fact that it doesn’t account for time?

    Also, what is the basis for one person to determine the rationality of another’s actions? Is not rationality subjective?

  3. The fact that about two thirds of those in Sippel’s test did not change their preference given a change in price of the goodies does not prove much. It all depends on the size of the price change. E.g. if the relative price change was no more than say 5%, the outcome is no surprise at all.

    On the other hand if the relative price of cola and coffee was changed by 1000% then I’d expect most people to change their preference most of the time and that would confirm the utility maximising idea.

    • That doesn’t really address transitivity or completeness, which participants also violated. People’s choices are very often whimsical and irrational, as opposed to utility maximising, as much contemporary neuroscience seems to suggest.

      • The fact that one person’s choices appear to be “whimsical and irrational” to a second person does not disprove that utility maximisation is taking place, does it? If I have a sudden urge for a Chinese meal, or to endanger my life by going hang gliding or climbing Mount Everest, who is to say that is “irrational”. It’s my choice. It’s what gives me maximum pleasure or “utility”, seems to me.

        • Well, you’re defining utility in a far more general sense than Samuelson. Samuelson’s definition of including completeness, transitivity, non-satiation and convexity has more or less been falsified.

          Hal Varian redefined utility maximisation as “doing whatever people want to do relative to a budget constraint”. This is more or less what people do. However I don’t see what “doing whatever you want to do” has to do with maximising utility. It’s so general as to be unfalsifiable.

  4. “It is interesting that some individuals obey the rules set out by Samuelson, and that some don’t.”

    I think part of this might just be chance. People act based on impulses, particularly with consumption. Some might appear to ‘adhere’ to rationality but the mechanics may be very different.

    This is just a suggestion, but the mere possibility shows Friedman’s methodology is BS.

        • Unfortunately, my comments system messes up sometimes and posts new threads as replies to old threads that haven’t received any comments. As soon as someone replies to the older thread, it appears as a new thread.

      • Or actually random drift … but on the other side. What constitutes “adherence” in this study? Is it fulfilling all 4 rules? With perfect “score”? If so, it might actually be interpreted as demonstrating validity of these rules. It is obvious that people will rarely put enough effort to economize (especially in some study, with relatively little amount of money on the line). Some random variation will be natural, but mean very little. If there is some “noise” especially with trivial purchases, the rule stands.

        Anyway I don’t see how this translates to economy. What difference does it make if people make choices guided by one set of reactions of neurons or by another set of reactions. Rational thinking is a process happening in the brain, pain-pleasure is another process. They are both “valid” for economy, in the end of the day actor makes a choice. What happens in his head may be interesting for psychologist, or maybe some activist that will try convincing public “some other way is better for you!”.

  5. For some reason I tried to act rationally by sticking to the post topic, but I was not in the “mood” and sought out information (goods) that had no relevance to my demand (Desire to contribute to this post)

    Work that out.

  6. This is another topic that aptly demonstrates the poverty of thinking.

    Given the ideal circumstances, people will generally act in their own perceived interests, economically and otherwise. The effectiveness of this entire system has been in its ability to use people’s natural self-interest against themselves. This type of deception, evident in all institutional propaganda, eventually manifests itself in massive societal dys-function.

    Whether it is in health care, education, warfare, banking, or the political system, the language used is nearly 180 degrees from the reality. The key to making this work is in meeting people’s short term desires, and having them give up long-term interests. For example:

    Health care – you can trash your body and still live forever.

    Banking – you can spend future income now and still meet your future financial responsibilities.

    Warfare – we are fighting for freedom and democracy throughout the world [despite the slaughtering].

    Education – you can go to college for two hours on M,W,&F, and three hours on T, Th, pay USD 15-50K/year and make this work [with student loans]

    Political system – you can have your cake and eat it too; guns, butter, health care, retirement, constant war, etc.

    Within the context of any system, the system will be taken over by individuals who use the power of the group for their self-interest. They do this, first and foremost, by convincing people of the above.

    And most people do believe, as it is human nature to want to believe that those who control you are acting in your interest [state/corporation as parental-unit].

      • Imagine if you lived out in the middle of nowhere, by yourself, or with a small family. Do you believe your decisions would be more prudent? Would you be wasting scare resources?

        Again, the individual [without influence of the group] always makes makes much better decisions [for their own well-being], or if s/he does not, then pays the proportional consequences.

        In group systems, poor decisions are often made, but the poor outcomes that follow are attenuated by the society. This built-in inefficiency becomes epidemic when systems are at the end of their useful cycle [as is this one], as it becomes difficult to make good decisions [i.e., good decisions are penalized, e.g., saving money in a ZIRP environment].

        • Excellent point.

          I have found some personality types are selfless, and others selfish.

          But generally when it comes to the State, i.e. voting preferences, people ALWAYS vote in the self interest. Even a Mickey Mouse/Donkey/Error vote is selfish.

        • BR, people vote in their PERCEIVED interests. Look at the Reagan democrats in the ’84 US presidential election who bought into the social non-sense and voted against their economic interests.

          This happens all the time, otherwise, why would anybody vote?

  7. Pingback: Not Rational Utility Maximisers | My Blog

  8. Much as the free peer-to-peer digital music service broke albums into tracks while demolishing record labels’ power over distribution and pricing, the analogy goes, colleges now face similar disaggregation and monumental disruption.

    http://www.ft.com/cms/s/0/8de6072c-60a0-11e2-a31a-00144feab49a.html#ixzz2IIn2Vh2O

    Steve Keen should setup his own course for teaching online. Students can volunteer to pay him money if they enjoy his classes. Maybe he can even accept Bitcoins!?

      • You have to pay to enter his site now. As I did not agree with all his theories I did not bother to pay.

        What I find is the people with the most passion do things for free, because it is their hobby, and I find that fanatics, are the best experts on a subject matter.

        That is why Economics as a discipline is geared towards serving the Political Masters that pay them.

        Spending Fiat money to bribe voters and create short run jobs is a long term economic disaster. Keynesian and MMT Economists are the only ones that make a living from economics. It does not make them right.

        • I’d say the dominant field for making money from macroeconomics is actually neoclassicalism, especially all the various disciplines of DSGE. Keynes wasn’t really a neoclassical, although lots of people who call themselves Keynesians (e.g. New Keynesians) are neoclassicals.

        • BR writes:
          “What I find is the people with the most passion do things for free,…”

          Absolutely!!, and this is why the greatest human beings to ever walk the planet were dirt poor.

        • John, I believe that when you read enough history, you begin to get the idea that it truly doesn’t matter what “it” is that becomes institutionalized, only that it does, because then those who control, can begin the process of applying this [whatever it is] and find a way to make everybody else pay for it.

          Consider the unlimited number of bizarre things that governments do only because their are individuals profiting from it. Government is the ultimate institution in this regard because of their ability to legally steal from its “citizens,” formerly known as serfs, formerly know as slaves.

          Society is a huge scam run by the few for their own benefit. The difference this time around is that with enough determination, you too, can join-in on the rape, plunder, and pillaging.**

          * *Only those with no ethics and a debased sense of morality need apply.

  9. Well, I hope so. Australia is in need of a man who can demonstrate that education need not rely on endless production of government backed debt for people to learn about the world in which they live.

  10. (though, to be honest, I must admit I am quite sceptical of his highly complex models; but then again, it was his work which led me to abandon the Australian property market before its big dip, so in that regard I owe the man a debt of gratitude for posting his work to the Internet)

  11. How do you value, in a collective sense, the power of intellectuals to inspire new business leaders? Can you even value that? Can you cram enough sophisticated equations into a spreadsheet to roughly determine the (expected) return on investment? What about the geniuses? The 1 in a billion who compensate for all the waste up until that single point?

  12. Along the same lines, in case anyone is interested in this topic, here’s another think about the same sort of ideas, coming this time from our good old friend, Roger!

  13. Just look at this. Amazing! A small group of dedicated car builders working away in their relatively small garage are now taking centre stage at global car shows – outcompeting the likes of Ferrari & Lamborghini for attention from the (so-called) experts!

    I personally plan on buying one in the future!!!

    http://www.falconf7.com/vision.php

  14. here’s an interesting idea; everyone smart knows the fin system is a confidence game but very few actually want to see the fin system crash so have a personal incentive to talk up confidence?

  15. interestingly, it seems, you could argue that the below applies to almost all ‘national politics’ now & the 1st elite group of ‘national leaders’ to recognise and accommodate this ‘new normal reality’ will care of game theory be the most likely to profit from this (global) dynamic

    “Much as the free peer-to-peer digital music service broke albums into tracks while demolishing record labels’ power over distribution and pricing, the analogy goes, colleges now face similar disaggregation and monumental disruption”

  16. can you really make much money from a nationalist obsessed fringe political party, ala the new neo-nazis in greece, much less remain in good company without feeling embarrassed about yourself? i have my doubt….law & order based on private property would seem to be a far more fruitful root to adopt, and also would probably inspire capital flight towards the locus of enlightenment

  17. this is y i keep saying it’s no joke Israel could become a massive zone for free trade based on the privatisation of e1 – and, perhaps more importantly to some – it would ENABLE the relevant owners to FREELY discriminate as to who IS and IS NOT allowed in E1 – you couldn’t – ie – charge that the relevant authorities were being ‘racist’ or ‘unfair’ if they decided to only accept certain types of people in their E1 – because it would be THEIR PREROGATIVE to choose who’s allowed inside just like my Dad could tell a particular person to leave his cafe if he didn’t want them in his cafe. Duh.

    • The issue with E1 is that it is necessary for a Palestinian state within the West Bank to be contiguous and viable. By building on it, Netanyahu is effectively making a one state solution of some kind inevitable. What you’re essentially advocating is a step toward a one-state free market solution, which is more or less what I agree with in the long run. But that can’t work if we only do it with the Palestinian land.

    • Yeah Bremmer is a clever guy. I asked him once about how free market solutions can continue to thrive in the era of state capitalism. He told me we needed more global governance.

  18. “Ideally, these countries will use these crises to become stronger. We’ve seen that happen in Europe, where a financial crisis has helped strengthen the European Union, largely because Europe revealed itself to be antifragile”

    and so we see why both Bremer and Taleb are not entirely correct about the current state of world affairs, the future, who knows, but as it stands, I would argue, the States are more flexible than the EU

  19. What democratic structures, pray tell, does Ian see across the EU, much less in Greece? Either he’s blinded by his fervent love of nationalism or else he considers the Golden Dawn to be some panacea to unruly political discord. Neither idea, I would suggest, is particularly inspiring.

  20. Why, also, is China “something to seriously worry about” when it becomes “the world’s largest economy” ? I’d suggest most corporate leaders look kindly on a pool of poor people wanting to ameliorate themselves from the life of misery which so many on this Earth still remain stuck in.

  21. See Jim Willie argues, as David does above, that China should/is invoking its own, new version of the SWIFT system – presumably, at least in part, to exclude the Dollar – but in a global economy this idea is (still) very far from constituting an optimal currency area; and is being discussed by a chap from London while at the same time the American Banker is talking about Bitcoin – I mean to say, it should be clear that erecting one (relatively) inflexible system in place of another is unlikely to sustainable serve the future for very much longer.

    http://www.americanbanker.com/issues/177_10/bitcoin-digital-currency-bank-risks-1045734-1.html?zkPrintable=1&nopagination=1

  22. note also how james seems to think that “debtor governments” should continue “borrowing” despite the “stigma” of pushing debt onto citizens who did not voluntarily sign up for whatever particular portion of (international) debt you may be thinking about?

  23. privatising e1 could also invalidate, from a legal point of view, all or at least large chunks of the USGovt debt – because by and large the particular “debtors” were never individually consulted – ie most people have not volunteered their signature for any of this supposedly insurmountable government debt – and no, voting for a person every 4 years does not count – and last I checked for a contract to be valid you need consent in the minds of all relevant parties

  24. The US does what it wants for several reasons. First and foremost, nobody can do anything about what the US does. It controls the skies, the water, and the land. It controls the financial system, the internet, and just about everything else.

    Secondly, nobody else wants to be ruling the world at the moment. Would you?

    Thirdly, the US still has ALL of the advantages that made it what it became, so once this country does get its financial house in order, we should expect another golden era in the US.

    Now, that doesn’t say that WWIII might not break-out and change things radically, but based on what’s happening now, the US has ALL the advantages, geography, food production, technology, global military predominance, education [higher], political stability, two oceans and two friendly countries as boarders, control of space, on and on and on….

    ….and the GREATEST advantage of all, the US has the meanest bastards on the planet, willing to doing whatever it takes to give this country the advantage. And THIS is the true measure of “success” in the human world!!

  25. Pingback: Nietzsche, Austrianism, Neoclassicalism & Subjectivism | azizonomics

  26. cash loan payday debt reply financial money send consolidation posts message credits withdraw community oneclickcash loans service state dec policy licensed nov relief cow husband lenders minutes phone privacy amount seconds complete called paid fast consumer system access tips
    approvedwith automatically owed data lender calls anonymous preferred pay approved secure
    I pay a visit day-to-day some web sites and websites to read content, except this website gives
    quality based articles.

  27. Pingback: Debunking Economics Part 1.5: The Myth of the Rational Consumer | The Curious Leftist

  28. Thanks for a marvelous posting! I seriously enjoyed reading it, you happen to be a great author.
    I will make sure to bookmark your blog and will often
    come back later in life. I want to encourage you continue your great
    job, have a nice day!

  29. Oh my goodness! Impressive article dude! Thank you
    so much, However I am encountering issues with your RSS.
    I don’t understand why I can’t join it. Is there anybody else having similar RSS issues?
    Anybody who knows the solution will you kindly respond?
    Thanks!!

  30. Pingback: The Promise and Perils of the Public ‘Nudge’

  31. Pretty great post. I just stumbled upon your weblog and wanted to mention that I’ve
    truly enjoyed surfing around your weblog posts.
    In any case I’ll be subscribing in your rss feed and I’m hoping you write once more very soon!

  32. you are truly a good webmaster. The web site loading pace is amazing.

    It seems that you are doing any unique trick. Furthermore, The contents are masterpiece.
    you have performed a great task on this topic!

  33. Howdy! I know this is kinda off topic but I was wondering if you
    knew where I could locate a captcha plugin for my comment form?
    I’m using the same blog platform as yours and I’m having trouble finding one?
    Thanks a lot!

  34. You actually make it seem so easy with your presentation but
    I find this matter to be actually something that I think
    I would never understand. It seems too complicated and extremely broad for me.

    I’m looking forward for your next post, I will try to get the hang of it!

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s