4
I N T R O D U C T I O N
PT
•
I
The standard model of rationality in economics is essentially
a decision-making model,
which claims to be both
descriptive and
normative. This means that the model is
supposed to both accurately describe how people behave, and to prescribe how they
should behave to achieve a certain given objective.
Unfortunately, the term normative is used in two main different senses by
economists, causing confusion. Sometimes it is used in the sense of being opposite
to positive.
Positive statements relate to descriptions involving factual information.
Such statements can be judged to be correct or incorrect, often with a margin of error,
based on empirical observation.
Normative statements in this context relate to value
judgments, which are necessarily subjective, and cannot be judged to be correct or
incorrect empirically. An example is statement 1:
Statement
1 It is not fair that Firm A pays its workers such a low wage.
Such statements often include the words ‘ought’ or ‘should’; for example, we might
modify the above statement by saying:
Statement 2
Firm A ought to pay its workers a higher wage.
However, care must be exercised here, because statements including these words are
not always normative in the sense of involving a value judgment. An example is:
Statement 3
Firm A ought to pay its workers a higher wage if it wants to
maximize
profi t.
Statement 3 does not involve a value judgment, and can be evaluated empirically. Of
course, one can question the social value of profi t, but that is a separate issue.
Confusion can arise because the last type of statement is also often referred to as
normative. In this context the term normative is interpreted as a statement that refers
to behavior as it should be if it were to accomplish goals in an optimal way, in contrast
to a descriptive statement that describes behavior as it actually is.
It is perhaps preferable to label it as prescriptive, as opposed to descriptive.
Prescriptive statements can be considered as policy implications, for individuals, fi rms
or governments, in terms of being guides to behavior, assuming a particular objective or
set of values. Thus such statements, or ‘normative theories’ as they are often referred
to, tend to involve some kind of optimization. A fundamental example is the theory
of expected utility maximization. Prescriptive statements in the above sense always
follow logically from descriptive statements; for example, Statement 3 can be restated
as follows:
Statement 4
In Firm A’s situation a higher wage will maximize profi t.
A more precise prescription would determine the specifi c level of wage that would maximize
profi t. Thus such prescriptive statements can also always be evaluated empirically.
Normative, in the sense of prescriptive, statements have various sources of appeal
to social scientists (Niv and Montague, 2008):
1 Throughout evolutionary history animal behavior has been shaped and
constrained by its infl uence on fi tness, so a reasonable starting point for theory or
model development is to view a particular behavior as an optimal or near-optimal
adaptation to some set of problems (Kacelnik,
1997).
5
N AT U R E O F B E H A V I O R A L E C O N O M I C S
CH
•
1
2 Discrepancies between observed behavior and the predictions of normative
models are often illuminating. They can shed light on the neural and informational
constraints under which animals make decisions, relating to Simon’s concept of
bounded rationality, leading to heuristics and biases. Alternatively, they may
suggest that animals are in fact optimizing something other than what the model
assumed.
3 Treating behavior as optimal allows for the generation of computationally explicit
hypotheses that are directly testable. A simple example is the ‘marginal cost equals
marginal revenue’ rule for profi t maximization.
When referring to normative statements as value judgments, it should be noted that
sciences in general, including social sciences like economics, are not in any privileged
position in terms of making such statements. The privilege which scientists enjoy is that
they are better able to understand the factual implications of value judgments. Thus while
an economist may not have any superior ‘moral authority’ in judging whether Firm A is
acting fairly, she may be able to point out that its existing low wage strategy is likely to
cause more labor unrest, higher labor turnover, and higher recruiting and training costs.
As far as this book is concerned our interest is not the validity of normative
statements as value judgments but the question why people make certain value
judgments; this is a psychological issue that has important policy implications in the
prescriptive sense. We will also see that the standard model is essentially a normative
model in this prescriptive sense, while behavioral approaches are largely based on
descriptive models. Indeed, Tversky and Kahneman (1986) claim that no theory of
choice can be both normatively adequate and descriptively accurate.
Take the example of a game of tic-tac-toe (‘noughts and crosses’), where two
players compete on a three-by-three grid to fi rst succeed in placing three of their own
marks in a straight line. As is well known, in this game the best play from each player
results in a draw. In other words, there exists a strategy for each player that ensures that
they will not lose regardless of how their opponent plays (and if their opponent makes a
mistake it will allow them to win). Call this their rational strategy. It is clear that if they
seek to win they should adopt this strategy. Likewise, assuming that they know this and
behave accordingly, this strategy will accurately account for their moves in the game.
Most situations faced by economic actors are more complex than a game of tic-tac-
toe. A purely rational decision model will not account for how most individuals react in
a large range of situations. If we still want to understand and explain their choices, what
we need is not a model that is able to explain moves along the best-response strategy
path but instead a model that explains moves along the actual-response strategy path
which in many instances could be bettered. In this sense, individuals appear to act
irrationally to the extent that they deviate from the best-response path.
But what do we mean by ‘rational’ here? The terms ‘rationality’, and its opposite,
‘irrationality’, are used extensively in economics, and particularly in connection with
behavioral economics. It is in many ways a fundamental assumption underlying the
whole of the discipline. Indeed many people think of behavioral economics as being
an approach to understanding why people act irrationally. For example, the behavioral
economist Dan Ariely has written extensively about the subject in his popular books
Predictably Irrational and
The Upside of Irrationality (2008; 2010). In the context of
our game of tic-tac-toe, players knowingly deciding against the adoption of the best
response strategy would act irrationally in the sense that they would not choose the
means best suited to further their end of seeking to win the game.