Economic Rationality

Economic Rationality

EconomicsAllocation of scarce resourcesEconomics exhibits in purest form the artificial component in human behavior Occurs at all levels individuals, business firms, markets, and economiesOuter environment: behavior of other actorsInner environment: goals and capabilities for rational, adaptive behaviorIllustration of how outer and inner environments interactSubstantive rationality adjustment to outer environmentProcedural rationality ability, through knowledge and computation, to discover adaptive behaviorThe Economic ActorTextbook economicsOuter: supply and demandInner: cost curvesUsedAs description of howfirms behave (positive)As advice on how tomaximize profitsDoes not considerhow these valuesare estimated

Procedural RationalityMany of the values are rough estimatesHow elastic is demand?Real life involves many interacting decisionsProduct quality?How many products?How to market?Problem changes from one of choosing the right course of action to locating a good actionSupporting Economic DecisionsOperations ResearchUses linear programming (and similar techniques) to find optimal solutions to limited representations of realityOptimal solution rarely is optimal but is often satisfactoryArtificial IntelligenceUses rule-based reasoning (and similar techniques) to make decisions based on more aspects of a complex and less well structured realitySolutions are good enough rather than being optimal in any respectSatisficing finding a solution that is good enough

Aspirational LevelsBecause real-world optimization, with or without computers, is impossible, the real economic actor is in fact a satisficerAspirations affect what is satisfactoryMost people register slightly above/below satisfactoryAspirations are based on historical levelsAspirations change (up and down) over timeMany simultaneous aspirationsSatisficing meets aspirations along all dimensions

Markets and OrganizationsMany mechanisms for coordinating actions among actorsMarketsCentral planningBargaining and negotiationHierarchic organizationsBalloting proceduresRoughly 80% of human activity in the US economy takes place within organizationsMarkets and OptimalityAssumptions of market optimizationActors have perfect informationActors act to maximize utility/profitsNot realisticMarkets are populated by satificersInformation is limited, time is limited, etc.The marvel is not that (the dancing dog) dances well but that it dances at all

Order without a PlannerComplex design is often assumed to be the result of planningExample of medieval citiesCollapse of Eastern Europe EconomiesCannot function well without smoothly operating marketsPoor performance sinceCannot function well without effective organizationsThe most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. Friederich von Hayak

Uncertainty and ExpectationsFeedforward (prediction) and feedback can help control for uncertaintyBut actors are not independentActors start trying to outguess one anotherEconomic chicken, speculationPrisoners Dilemma treachery paysUnstable solution unless satisficing rather than optimizingClassical economics avoided such issues by focusing on situations where mutual expectations play no role

Bounded RationalityThere is a limit to what actors know about the state of their environmentActors have limited time in which to determine their next actionEconomic actors gradually learn about their environments to select satisficing, not optimizing, actionsBusiness OrganizationMarket-organization boundaryWhat decisions are made within vs. what is made outside of the organizationOne view is to consider the transaction costs of using a marketSuccessful organizations structure themselvesTo localize and minimize information demands of decision makersResulting in specialization of roleEnsuring no single person or group needs to be an expert on all aspects

Organizations and UncertaintyEach market decision is impacted by the decisions of others in the marketMarkets result in the type of uncertainty that causes outguessing and similar behaviorsMarkets absorb uncertainty by removing some decisions and by causing actors to be more aligned in their goalsOrganizations also augment human reason by placing people in cooperative rather than competitive roles(Docile) People can learn from one anotherEvolutionary ModelsLocal and global optimizationHill climbing algorithmsChoice of metric vs. English measurementsEach step is better for current situationNo planning, no feedforward, no designBusiness/economic evolutionLamarkian any new idea can be incorporated as soon as its success is observedNo predictable equilibrium but a complex process that continues indefinitely