Written by Amer Goel
“I’m scared of flying. Maybe I’ll become a pilot,” said no one. If they truly were scared of flying, they wouldn’t want to make it their profession. It wouldn’t be in their best interest because it goes against what makes them happy. No one has said this because no one is irrational. Or so we thought.
What does it mean to be rational? In economics, to be rational is to be self-interested and maximize utility, which is a way to quantify happiness. In a simplistic sense, a rational economic agent will always do what gives them happiness and avoid what gives them pain. It’s convenient for economists to assume everyone is rational because it lends consistency to economic models — if people follow a rational pattern of behavior then any action can be predicted systematically. However, this is a massive oversimplification. Humans are complex, unpredictable beings and rationality is not always a useful framework. In this case, when are humans rational? Are they ever? Is rationality something that we need to discard as economists, or does it still hold some modern value?
To understand rationality is to understand its origin. The school of economic rationality is called utilitarianism, in which its followers find meaning by maximizing utility. Its most influential agent was the philosopher and economist John Stuart Mill, who dissected it in his 1863 essay Utilitarianism. He defines utilitarianism as that which is “right in proportion as they tend to promote happiness, wrong as they tend to produce the reverse of happiness” (10, Mill). Any action that is a net positive (all costs and benefits accounted for, the act is still positive) will be taken, and any action that is net negative will not be.
First, I will discuss the merits of rationality outlined in a framework called Rational Choice Theory. In a 2006 paper, Frank Lovett, a Political Science professor at Washington University of St. Louis, discusses how Rational Choice Theory may still hold some modern value, even if that value is different from what it was originally intended to be. Rational models may not always be adequate in predicting outcomes, like what decision a person might make, or how often they make it (because it oversimplifies the decision-making process), but it does a good job in predicting the mechanisms of decision making. The evidence for this “lies in its comparative statistics,” which come from changing the parameters of a model and seeing how the model responds (250). When a parameter changes, the model will adjust accordingly, changing its output as a response to the change in input. Rational models are very accurate at predicting these changes, even if they’re inaccurate for output. Even if people may not consciously act rationally, it definitely looks like they do, which makes rational models good for modeling their decision-making.
Lovett’s paper gives the example of voter turnout. Adding a registration fee, specifically, should decrease voter turnout, but why? Rational Choice Theory would predict that rational economic voters now face a greater cost of voting, which will decrease net utility. For some, the cost of registering may outweigh the benefit of voting, and then they won’t vote at all, which will decrease the number of people who vote. This rational framework explains the mechanisms behind human interaction events, even if it can’t predict the output of those events.
Even so, the output is important, and it should be the main focus of economic models. The model is useless if it leads to consistently incorrect predictions. The fact that rational models give consistently wrong output could be evidence that people don’t act rationally, or so thought Daniel Kahneman. In his seminal work Thinking Fast and Slow, he gives an argument for “Prospect Theory,” the start of irrational economics, by which people don’t evaluate utility consistently and act on it even less consistently. One useful example is the point of reference.
Point of reference explains why people feel different about gains and losses. For example, take 2 options. In Option 1, you start with $1000 and gain $500, and in Option 2, you start with $2000 and lose $500. To a utilitarian, these are the same option, because the end result of $1500 is the same for both options. To most people, though, Option 1 is better. The point of reference, or starting point, in Option 1 is $1000, so the $1500 is a gain of $500. Conversely, in Option 2, the point of reference is $2000, so the $1500 is a loss of $500. Everyone prefers a win to a loss, so most people would choose Option 1 over Option 2, even though rationally they should be indifferent between them.
Given this information, which is more accurate, rationality or irrationality? Are humans ever rational? Most contemporary literature would say that people don’t act as simplistically as Rational Choice Theory prescribes them to be, but rationality has never claimed to be perfectly accurate. Economics is incredibly complicated and it’s impossible to account for, or even know, every variable inherent in an economic transaction. It’s the reason that ceteris paribus is so fundamental to economics.
Because of this, oversimplification is an unfortunate necessity, and rationality becomes the least of all evils. It is indisputable that behavioral economics, which accounts for irrationality, is a more accurate predictive methodology, but still, rationality isn’t something economists should discard. Every oversimplification will lead to inaccurate answers, but rationality is internally consistent, because every rational decision can be predicted using the same logic, and it provides a useful mathematical way to model decision making (positive or negative utility, amount of utility, utility functions, etc.). Also, rationality has proved itself, as Lovett describes, to make accurate mechanical predictions, so it is still a useful framework for economic modeling, especially for game theory/decision theory, which relies heavily on rational logic. Economists may have to change how they use rationality purposefully, looking for parameters and changes rather than accurate output, but it can still be used as an approximation of real human decisions in real time.
Even so, the definition of rationality doesn’t have to stay constant. The framework will still prove useful as long as it’s internally consistent, which means it’ll still be useful after it’s improved or reformed. Maybe there will be a world where rational economic actors will act differently. Maybe not all the ceteris need to be paribus. Maybe, with the appropriate definition, there will be a rational, predictable pilot who used to be afraid of flying.
References
Doi: 10.1177/07067437211070648 … – Journals.sagepub.com. https://journals.sagepub.com/doi/pdf/10.1177/1043463106060155.
Ganti, Akhilesh. “Rational Choice Theory Definition.” Investopedia, Investopedia, 8 Feb. 2022, https://www.investopedia.com/terms/r/rational-choice-theory.asp#toc-advantages-and-disadvantages-of-rational-choice-theory.
Ganti, Akhilesh. “Rational Choice Theory Definition.” Investopedia, Investopedia, 8 Feb. 2022, https://www.investopedia.com/terms/r/rational-choice-theory.asp#toc-advantages-and-disadvantages-of-rational-choice-theory.
Kahneman, Daniel. Thinking, Fast and Slow. Farrar, Straus and Giroux, 2013. Utilitarianism John Stuart Mill – McMaster Faculty of … https://socialsciences.mcmaster.ca/econ/ugcm/3ll3/mill/utilitarianism.pdf.