Monday, June 8, 2015

What is a rational choice?

 Many people know that economists use models of rational choice. But what does that mean?

Ruth Marcus explains to her readers that, “Economically speaking, the decision to have children is not utility-maximizing. And yet, most of us — intentionally, passionately, joyfully — make this least rational of choices. More than once.”

The economist Richard Thaler makes similar statements in the New York Times, as well as in his new book

“Economists create this problem with their insistence on studying mythical creatures often known as Homo economicus. I prefer to call them “Econs”— highly intelligent beings that are capable of making the most complex of calculations but are totally lacking in emotions. Think of Mr. Spock in “Star Trek.” In a world of Econs, many things would in fact be irrelevant.”

Thaler goes on to explain that

 “An Econ would not expect a gift on the day of the year in which she happened to get married, or be born. What difference do these arbitrary dates make? In fact, Econs would be perplexed by the idea of gifts. An Econ would know that cash is the best possible gift; it allows the recipient to buy whatever is optimal. But unless you are married to an economist, I don’t advise giving cash on your next anniversary. Come to think of it, even if your spouse is an economist, this is not a great idea.”

The problem is that all this is a bunch of nonsense. Utility simply means satisfaction. If you are doing something “intentionally, passionately, joyfully” it seems fair to assume you are getting a great deal of utility from it. How are people “totally lacking in emotions” going to get satisfaction from anything?

What do economists actually mean by rational choice? I’ll let Gary Becker explain:

“What is meant by rational behavior? Consider first what is not meant. Certainly not that people are necessarily selfish, “economic men” solely concerned with their own well being. That would rule out charity and love for children, spouses, relatives or anyone else, and a model of rational behavior could not be so grossly inconsistent with actual behavior and still be useful. A viable definition of rationality must not exclude charity and love: indeed consistent family behavior probably requires love between family members.

                Also, rationality should not imply that each household’s decisions are necessarily independent of those made by others. Different households are linked ultimately by a common cultural inheritance and background, and they may also be linked in a more proximate way. If household j increases its consumption of X, household I might be led to change its consumption of X. Such interdependencies commonly occur, and should be consistent with our model of rational behavior.

                The essence of the model of rational behavior is contained in just two assumptions: each consumer has an ordered sort of preferences, and he chooses the most preferred position available to him.” Becker Economic Theory pages 25 and 26)

Preferences can, and often are, driven by emotions. Preferences are also influenced by the culture we live in and the people we live with.

The one thing that the rational choice approach does not do is to say what people should want. This, of course, makes the traditional economic approach very different from a behavioral economic approach that seeks to “nudge” people to do what Richard Thaler thinks they should do.   

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