The theory of rational choice or the rational actor model is one of the great glories of modern social science. However, there is an increasing amount of criticism of some of the assumptions of rational choice theory. Indeed, the psychologist Daniel Kahneman (of Princeton University) won the Nobel Prize in Economics in October, 2002, for his work showing that consumers (and others) sometimesviolate the assumptions of rational choice theory. See also Web Note 2.6 below on “loss aversion.”
Rational choice theory has been an extraordinarily fruitful hypothesis in economics and the social sciences generally. There is no clear definition of rational choice, but some of the elements of the theory are the assumption that all decisionmakers can identify the alternatives open to them and canconsistently rank them in order of preference. That sounds undemanding, but it turns out that they assumption may—in some circumstances and for some people—make tremendous demands on their cognitive abilities.
In the last 25 years or some (and increasingly of late) a literature that is critical of rational choice theory has appeared that calls into question some of the predictions of rationalchoice theory. We will have occasion to refer to this literature repeatedly throughout these notes; so, here all we seek to do is to draw out some general characteristics of this literature (called “behavioral economics”) and to give some examples.
One of the most important aspects of the literature that is critical of rational choice theory is that it does not find that people, asdecisionmakers, are irrational. Rather, the literature finds that people have systematic and persistent biases in their perceptions and judgments. It is important to recognize that these are systematic biases—that is, that they run in the same way. They are not, for instance, symmetrically distributed around an average or most common response. To take a concrete example, people tend to be overly optimisticabout future events having to do with themselves. They believe that they are going to happier, wealthier, or more successful than will actually be the case. Students believe that they are going to get higher grades than they will. (Almost all the students in a given class believe that, like the children in Lake Wobegon, they are all above average.) This would not be an optimism bias if attitudes aboutfuture states were randomly and symmetrically distributed around a most common response, with about half of the people thinking they are going to do poorly and half thinking that they are going to do well.
Also, these biases are persistent; they occur again and again in people of all ages and socioeconomic circumstances.
These findings regarding cognitive biases typically arise from laboratoryexperiments. Psychologists, economists, lawyers, and others want to see if a particular prediction of rational choice theory (hereafter, RCT) is borne out in actual decisions. So, they set up an experiment designed to test the RCT prediction, conduct the experiment, and compare the results with the prediction.
An example has to do with the famous economic dictum that “bygones are bygones” or that“fixed (or sunk) costs should not matter.” Consider this example. You have purchased a season ticket to a series of concerts to be held at the local auditorium throughout the next year. The ticket cost $450 and entitles you to the same seat at each of the concerts. Now suppose that you have attended and enjoyed several of the concerts. There is a concert tonight, but you have had a long dayalready; you’re tired and hungry; and you would rather not forgo dinner and go the concert, at which you may well fall asleep. These are all sensible reasons for not going to the concert. But a very common one that is not sensible is this: “I’ve paid for the season ticket. If I don’t go, that expenditure is a waste.” The season ticket expenditure has already been made and will stay the same whether...
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