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Challenging the Rationality of Economic Agents

Many Macroeconomists defend the idea that micro-founded models, which rely on optimization problems for both households and firms, can be determinant tools for deriving the relationships between macroeconomic variables. However, these models generally have as a starting point some assumptions that are often questioned and sometimes even revised.

In this context, the hypothesis of rational behaviour of the agents has been a topic of disagreement between economists. For instance, Paul Krugman is very reluctant to believe in Milton Friedman`s homo economicus who is able to represent his preferences in terms of a mathematic expression –utility function-, and that his decisions are simply commanded by rational calculations for maximizing utility. Additionally, he argues that choices between any two goods reflect considerations about the marginal utility, that is, the extra benefit that a consumer receives from getting a small amount of his alternatives. Hence Krugman firmly believes that central to economic analysis is to recognize that rationality is merely a strategy to order and simplify the real complexity of economic life.

Concerning the veracity of the hypothesis of rational behaviour, there was this article in The EconomistThe Economics of Watching TV: The Irrationality of Couch Potatoes– that called my attention for the creativity of its economic analysis and the interesting results that come from it. The author describes with humour the return home of a normal worker (again, picture him as Friedman`s homo economicus) after a day full of cost-benefit analysis, and so he sits down in the couch and puts his utility-maximizing feet up. He checks the programs on TV and ranks his channels` options, figuring out his optimal channel preferences according to the level of satisfaction that he obtains from them. One of the conclusions of the article is that people don`t switch to other channel quickly, that is, they would rather putting off switching to a different channel even though they prefer another program. Clearly, in this daily-life example the assumption of perfect rationality breaks down. Possible explanations include imperfect information in the sense that channels advertise the next show between ad breaks, so some viewers stay tuned, the minimization of the costs of finding the optimal channel, or even procrastination.

In fact, Ted O’Donoghue and Matthew Rabin in Economics of Procrastination found out that sometimes standard economic models are not enough to explain the behaviour of economic agents. They introduce the concept of Present-biased preferences to argue that agents have a tendency to postpone hard tasks for the next day despite how small the immediate cost associated with it is. Consequently, people will actually believe that they will accomplish that task in the following day if they are unaware of the precise extent of this bias. Moreover, the authors highlight that this unrealistic optimism about their actions in the future is mostly explained if one considers time-inconsistent preferences, so that one`s choice of future actions depends on the moment you are asked to make that choice.

To sum up, as the Economist Guy Sorman points out in Economics Does Not Lie, it is quite hard to be precise in economic science because it is like a mirror of the imperfections of human nature. As I mentioned above, there are several daily-life events that put at stake the strength of the assumption of Rationality in economic behaviour, but my personal view is that we should not drop this assumption because it is crucial to get other important results out of an economic model. An important point is, however, to understand the limitations of models and sometimes to take them into account in our economic analysis.

Ana Luísa Correia

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Author: studentnovasbe

Master student in Nova Sbe

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