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Yet this assumption is increasingly outdated.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.

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