From Homo economicus to Homo sapiens

Behavioral economics has become an active and well-established research program in economics that makes a wide-ranging critique of standard rationality thinking. Yet why has the “new” behavioral economics become successful so quickly when bounded rationality thinking as developed in the now “old” behavioral economics had relatively little impact on economics? One possible reason is that economists are now convinced that the introduction of more realistic psychological assumptions into economics is likely to improve prediction, and they take prediction more seriously. Behavioral economists have consistently argued that their models have solid empirical foundations that produce better results, and instrumentalist economic methodology emphasizing prediction has been influential in economics since the case made for it by Milton Friedman (Friedman 1953). A second and related possible reason is the unexpected impact of laboratory experiments on economics. Having long denied laboratory experiments are possible in economics, economists have been arguably caught off balance in judging their value, and as a result they have been perhaps overinclined to accept the evidence from the lab and thereby the arguments of behavioral economists. However, I will emphasize a third possible reason, namely, that the adjustment involved in introducing psychological assumptions into economics appears to many economists, at least thus far, to be compatible with much of standard theory. Individual economic agents are still the focus, they interact in markets, and whereas they are boundedly rational, they still aim to optimize, if only somewhat less successfully. Simon’s program, in contrast, proposed a quite different view of the economic process as well as an individual conception that abandoned optimization for satisficing. In effect it demanded revolution rather than reform, and too much would have had to go from standard theory for Simon’s program to have attracted many adherents.

However, the view that the behavioral economics program is compatible with much of standard economics may not be accurate if the ways in which behavioral economics revises the standard Homo economicus conception undermines the idea that economics is essentially about individuals’ interaction in markets. We saw in the last chapter that prospect theory produces a multiple selves account of the individual, an important manifestation of which is a present-bias type of choice anchoring in intertemporal decision making. As we will see in this chapter, one response to this is to recommend that benevolent rational experts design decision contexts and choice architectures for irrational decision makers – the “libertarian paternalism” of Richard Thaler and Cass Sunstein. Such a strategy emphasizes interaction between individuals outside of markets, and thus makes it unclear whether economics is still primarily about individuals’ interaction in markets, and whether behavioral economics’ introduction of psychological assumptions into economics is as compatible with standard economics as some may believe. What, then, does behavioral economics’ revised utility function conception of the individual actually involve? As good an answer as any to this question comes from Richard Thaler, whose Journal of Economic Perspectives “anomalies” series has done much to popularize behavioral economics, and who gives a concise and clearly motivated view of how the individual conception of behavioral economics is different from the traditional conception. For him, behavioral economics should be seen as replacing the traditional Homo economicus conception with a Homo sapiens conception of the individual, in which the latter exercises ordinary human rationality in real world settings (Thaler 2000). His argument is that the thrust of postwar economics was to increasingly populate economic models with hyperrational economic agents, whose capacities were only limited by “the IQ of the smartest economic theorist;” but with greater emphasis on realism he believes we can expect that “this trend will be reversed in favor of an approach in which the degree of rationality bestowed to the agents depends on the context being studied” (ibid., 134). Thus, if Kahneman and Tversky’s prospect theory is seen as “contextualizing subjectivity,” Thaler might be said to see behavioral economics’ bounded rationality Homo sapiens conception as “contextualizing individuality.”