Accounting for Choices in Economics

Economics is sometimes characterized as the “science of rational choices over the allocation of scarce resources” or even more straightforwardly as the “science of choices”. In a recent blog, Chris Dillow makes some interesting remarks about people’s economic behavior. He notes that our behavior is often partially unconscious and/or habit-based. Moreover, the set of available options is quite frequently severely restricted such that there is few room to make voluntary choices. Finally, many decisions are actually more or less random and grounded on social norms, conventions and other factors on which we barely reflect. The conclusion is then that

“when we ask “why did he do that?” we must look beyond “max U” stories about mythical individuals abstracted from society and look at the role of habit, cultural persistence and constraints.”

These are interesting and important remarks because they directly concern the scope of economics as well as the meaning of the key concept of choice. It seems that Dillow is using the choice concept according to its folk meaning. According to the latter, to properly say “she chooses x” requires at least that (a) one has several available options at her disposal to choose between and (b) she opts for one of the available option consciously and voluntarily. However, I would argue that this is not how economists generally use and understand the choice concept. They rather use a concept of choice* in a technical sense. To put it using some jargon, in economics choices* are basically behavioral patterns that correlate with changes in opportunity costs. In other words, when we say that economics is the science of choices*, what is actually meant is that it studies how some particular variable reflecting for instance the consumption level of a given good, changes as the good’s relative price or consumers’ information change. This definition of choice* has at least two noteworthy implications:

1) Economists are not interested in individual choices per se. Economists almost always work at some aggregated level and they do not aim at explaining the choices made by specific individuals or firms. They are rather interested in the properties of aggregate demand and supply.

2) Economists are agnostic regarding the specific mechanisms through which economic agents are making choices. In particular, there is no presumption that these choices are conscious and not habit-based. The U-Max framework only assumes that individual choices are responsive to change in opportunity costs, not how and why they are responsive.

These two implications work in conjunctions. Choices* need not be conscious nor based on any form of complex calculus but they are however intentional: choices (in both the folk and technical meanings) are about something and they are the product of the agents’ intentional states (desires, beliefs, wants…). As philosophers of mind have emphasized, there is nothing paradoxical in the combination of unconsciousness and intentionality. The U-Max framework, as well as decision and game theory as a whole are tools that are particularly well-fitted to study intentional behavior, whether conscious or not. These tools indeed assume that individual choices are responsive to changes in opportunity costs which, in special cases (e.g. addictive behavior), may not be true. However, this is mostly irrelevant as long as responsiveness is preserved at some market level. Gary Becker’s paper “Irrational Behavior and Economic Theory” provides an extreme example of this point. It shows how we can derive “well-behaved” demand and supply functions with individual agents (households and firms) using “irrational” decision rules. This result is by no way a necessity: there are cases where irrational behavior will lead to unconventional demand and supply functions and because of income effects even rational behavior at the individual level can generate upward-slopping demand curves. Generally speaking, institutions matter: the way exchanges are organized will determine the aggregate outcome for a given profile of preferences and production costs.

All of this depends on the claim that economists are not interested in explaining individual choices. Economists with the strongest revealed-preference stance are likely to agree with this claim. But there are many economists who are likely to disagree, considering that accounting for individual choices is necessary to understand aggregate outcomes such as a financial crisis. More generally, I would argue that attempting to explain individual choices can hardly be avoided in the numerous cases where multiple equilibria exist. The point is that to explain why a given equilibrium has been selected, it will most of the time be required to understand how individuals make choices. Here, whether choices are habit- or calculus-based, conscious or automatic, and so on, may matter. For instance, Thomas Schelling famously pointed out in The Strategy of Conflict the important of focal points to account for the way people are able to coordinate without communicating. As Schelling made it clear, focal points are not determined by the mathematical properties of the game nor by purely instrumental considerations. They depend on cultural, social and aesthetic features.

A slightly more complex example but which is even more relevant, especially in industrial organization, is the existence of multiple (Bayesian perfect) equilibria in incomplete information games. In incomplete information games, one player (the “principal”) ignores the other players’ (the “agent”) type. The agent’s choice may sometimes convey an information to the principal and helps him to identify the agent’s type. Such games typically have multiple equilibria with some of them separating and other pooling ones. Which equilibrium is implemented is partially determined by the way the principal interprets the agent’s choice. Under a separating equilibrium, the principal interprets the agent’s choice in such a way that it provides him with an information about the agent’s type. This is not the case under a pooling equilibrium. Of course, since under a pooling equilibrium all agents behave the same way whatever their type, observed behavior cannot serve as a basis to infer agents’ type. But the fact that all agents behave the same is itself a rational response to their own understanding of the way the principal will interpret their choice at the equilibrium.

My point is thus that in strategic interactions where players have to think about how other players are thinking, it is less clear that economists can safely ignore how people make choices. Given the same set of “fundamentals” (preferences, technology, information distribution), different behavioral patterns may arise and these differences are likely to be due to the way individual agents are choosing.

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