Problems at the foundation of economics
My physics training tells me economics views some things in a weird way.
In physics, if your theory predicts something to happen a certain way and it happens differently, you say your theory is wrong, at least partly, and you work to improve it. Nature is always correct. You try to get your theory to predict what nature does.
When economics predicts people to behave some way and they don’t, economists often say the people are biased. Or acting in error or irrationally.
A physicist would never say an electron was biased. It’s weird when I read some economist saying someone whose behavior violates a theory made an error, was biased, or acted irrationally. From my perspective, the theory needs work. Perhaps the model’s concept of rationality requires assumptions that don’t fit what we observe.
That seems to me a problem at the foundation of economics.
It makes me wonder how much the so-called “homo economicus” lies at the foundation of economic theory. How far off will these assumptions lead economic theory?
Homo economicus, or economic human, is the concept in many economic theories of humans as rational and narrowly self-interested actors who have the ability to make judgments toward their subjectively defined ends. (Wikipedia)
I know people are working on and winning Nobel Prizes about these things, but they bear repeating. Specifically, I think Daniel Kahneman won a Nobel Prize for what people call behavioral economics.
Working with my Model shows me how much people’s behavior depends on their perceptions and beliefs, which depend on your environment and history. How you view and value a good or service may differ widely from how I do. You won’t value the same thing the same way today as tomorrow.
My favorite example — the Ultimatum Game
The ultimatum game illustrates my case, though I could pick from many other examples that illustrate people behaving “contrary to their economic interests.”
The ultimatum game is a game often played in economic experiments in which two players interact to decide how to divide a sum of money that is given to them. The first player proposes how to divide the sum between the two players, and the second player can either accept or reject this proposal. If the second player rejects, neither player receives anything. If the second player accepts, the money is split according to the proposal. The game is played only once so that reciprocation is not an issue. (Wikipedia)
In industrialized countries, first players tend to offer fifty-fifty splits and second players tend to reject offers less than 20%.
I remember a business school professor describing a second player rejecting any non-zero amount as irrational, since any amount increases their net worth.
This interpretation seemed crazy to me. The second player may value many things more than the amount of money they’re rejecting. Maybe they want to punish the other player, even anonymously. Maybe the amount of money doesn’t amount to enough to care. Maybe they think the experiment will continue in another way. You can imagine other reasons.
In any case, any theory that predicts behavior that doesn’t happen needs work, and theories that all people will always value some money over no money miss the point. Any theory the prescribes how people should value things monolithically seems to miss a big part of how humans perceive and value things.
I would suggest the second players believe they behave rationally.
But rarely do I hear people say such theories need work. They tend to suggest the second players who reject free money don’t understand economics. At least that’s what I’ve observed.
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