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Apropos of nothing: that is the weirdest stock photo I've seen in months, the caption underneath it is asinine, and the guy on the left sort of looks like Matt

Apropos of nothing: that is the weirdest stock photo I've seen in months, the caption underneath it is asinine, and the guy on the left sort of looks like Matt Damon. Apropos of the article: the headline is really making hay out of a tangential point. Sure, the "poor vs. rich" angle gets more clicks and inbound links. But the real point -- which is a huge one, as far as the field of economics is concerned -- is that the "rational (and by implication, homogeneously rational) actor" presumption is under fire. It's been under fire before because people have been shown, time and again, to behave economically irrationally. But this time it's under fire because people have been shown to react heterogeneously to the same stimuli and incentives. (Not really touched upon in the article, but also worth mentioning: a third major critique in recent years has been the revelation that classical economics was highly skewed by the idiosyncrasies of the Western cultures in which it was cultivated and codified. It turns out that not everyone around the world behaves like 19th-20th Century Austrians, Britons, or Americans.) All of this is huge, I repeat, because pretty much every foundational theory in classical economics is predicated on homogeneity and rationality. Every single one. The entire field. Even a preponderance of modern economics is undergirded by flawed assumptions borrowed from classical models. I, for one, am really excited by the modernist, behaviorist, relativist, empiricist and frequentist challenges to classical economics. This is sort of like seeing a paradigm shift in a highly influential field of study play out in something resembling real time. Economics has always been based on statistics -- even highly sophisticated statistics -- but the inputs, so to speak, have been pretty unsophisticated. These challenges will help drag economics into the 21st century.

ilaksh 13y ago
That sounds like a good start, but I think you have to go much farther. Unless an economic model takes into account holistic human and ecological outcomes, its not relevant. You need to integrate physical science, psychology, and other real sciences and measurements. And then measure things like inequality and overall human well-being. Then make a serious effort to maximize human and ecological well-being. If I were an expert in how bubbles formed in water and spent all of my time thinking of ways to maximize bubble growth by sucking gases out of the water in a tank, I would be good at creating aquariums with large bubbles, but probably end up with a lot dead or sick fish.
001sky 13y ago
It turned out that actual people didn’t behave like the imaginary proxy. Economists are learning that the poor and the wealthy respond differently to austerity and stimulus. This could present challenges to politicians. If people behave differently, then policy might have to treat them differently. Preference heterogeneity by itself does not imply anything about rationality. However, that is not to say the topic is so simple. We know this empirically by looking things like revealed preference for risk taking. One example might be propensity to take risky bets, despite known zero/negative NPV expected values. These people are happy to buy earnings Vol because the distributions on the downside has such little variation (poor today = poor tomorrow). Whereas a middle class person can make more use of the savings (investment opportunities are greater, and the downside risk of less savings is too), on the one hand, and is not so desperate for upside on the other (even if its just the psychic hit of the "chance" to be rich).
jandrewrogers 13y ago
The problem is not the rationality assumption per se. It is that the set of inputs and constraints to the decision process considered in classical economics is sufficiently narrow and incomplete that it does not produce a realistic output. Actors generally appear "irrational" primarily because classical economics simplifies the modeling process by discarding relevant context that influences decision processes for the sake of simple analysis. Also, "rational" is contextual, not objective or axiomatic in any real-world finite computational system as a matter of mathematics. This is an important distinction often ignored. As a consequence, "irrationality" can be generally defined as "making a decision from a different contextual basis". Again, this defeats the desire to create absolute rules of economics that fit in a soundbite. Economics is perfectly capable of dealing with the complexities of real-world actors in theory. In practice, most economists attempt to reduce the complex dynamics implied by the theory into trivial theorems that are easy to turn into government policy. This is somewhat understandable because even approximating a pure model is computationally prohibitive. This provides a lovely framework within which any economist can come up with a narrow model that suits their particular ideological proclivities. You rarely see an economist that properly recognizes the constraints and assumptions of their model but those limitations exist nonetheless. Advanced computer science will allow us to implement the more general models directly regardless of whether or not the results are politically convenient, but it may take a while before we see it.
anigbrowl 13y ago
people have been shown, time and again, to behave economically irrationally Likewise, choices that appear irrational may turn out to be entirely sensible but for the exclusion of relevant factors. Having been quite poor in the past I can certainly distinguish between irrational choices of the 'oh fuck it, let tomorrow take care of itself' variety and rational ones of the 'this is inefficient, but satisfies constraints' type. As an example of the latter, consider riding the bus. In many places you can get a monthly pass at a substantial discount to paying multiple fares every day. But for someone who is un- or under-employed, the expected value of purchasing the monthly pass is quite different from that of someone with a predictable commute; if that person makes the wrong guess about how often s/he will travel over the month, it can result in a significant opportunity cost. Then there's the even simpler case of the person who can't accumulate enough cash at a time to buy the monthly pass, but who won't be able to get paid at the end of the week without taking the bus to work each day. Absent credit facilities, paying bus far on a day-by-day basis can be perfectly rational when viewed in the individual's overall economic context. Unfortunately, economics textbooks don't devote much attention to multiple inelastic constraints.
- digitalengineer 13y ago
  Up voted! Excellent explanation. I suppose Pawnshops/Lownsharks use the same 'need-money-right-now' angle.
- yummyfajitas 13y ago
  irrational choices of the 'oh fuck it, let tomorrow take care of itself' Having a high discount rate is not irrational. Multiple discount rates are, but a single high discount rate is perfectly rational.
  - anigbrowl 13y ago
    It depends. There have certainly been times where I've deferred some necessary purchase in favor of a frivolous one, eg choosing to pay a bill late so I could go out with friends and have beers. Now that's not so bad if you know you're going to be able to pay the bill next week, and arguably there's some psychological benefit in being social and and consuming some alcohol to de-stress, not to mention the signaling value of apparent economic liquidity. But if you discount the future too liberally, then pretty much anything can be spun as a rational choice, eg drug addiction, being a hobo, taking up crime or whatever. I smoked fairly heavily for about 20 years, which I'm sur is going to have some negative impact on my future lifespan/quality of life, if the way I felt by the time I quit is anything to go by. For all that I liked smoking at times, it was basically a symptom of nictotine addiction and I can't say my life was improved by having been a smoker. This is certainly one case where I discounted the future too heavily.
dragonwriter 13y ago
> But the real point -- which is a huge one, as far as the field of economics is concerned -- is that the "rational (and by implication, homogeneously rational) actor" presumption is under fire. Er, no, while people have been saying that this is the "real point" of various stories on internet discussion fora at least as long as I've been on internet discussion fora (which goes back to the latter half of the year 1990), its really not. The rational actor model (whose role in economics is much more limited than many people seem to think) has always -- from the day it was conceived -- been known to be a simplified model (like the "perfectly competitive market") which is a good-enough approximation for some real world interactions but fundamentally not true (it assumes, among other thing, what amounts to effective omniscience -- at least where it concerns any decision that has any impact on the actor's own experienced utility -- on the part of all actors), and also not even good enough to be useful for many important situations. No one anywhere in the social sciences thinks the rational actor model represents the underlying reality, and in economics particularly it (along with perfectly competitive markets) is baseline that works both as a basis for a highly idealized model that is important pedagogically and often useful as a basis for describing real world situations in terms of variances from (e.g., explaining empirically derived models of real-world behavior in terms of how the empirical model differs from idealized model and connecting that to a theory of how the real underlying processes differ from those that form the basis for the idealized model.)
- nhaehnle 13y ago
  In fairness, though, there is a big disconnect between what economists in the media say on average when they feel free to say whatever they like, versus what economists concede in an academic context when pressed on the matter. Part of this may be due to the fact that most economists who appear in the media are basically paid shills, but no matter the reason, it is definitely a problem for the democratic process.
bobbles 13y ago
A group of people all with the exact same expression, pose and setting has been used to represent how different we are... right...
yummyfajitas 13y ago
pretty much every foundational theory in classical economics is predicated on homogeneity I have absolutely no idea where you get this idea. Both supply and demand curves are based entirely on the concept of heterogeneity. The microfoundations of the supply and demand curves are (for simplicity assuming each customer will supply/purchase only 0 or 1 item): Supply(P) = # of suppliers with reserve price > P Demand(P) = # of customers who's reserve price < P If agents were homogeneous, then both of those curves would be a step function. Similarly, the standard economic explanation of why the poor make "bad" choices is heterogeneity - the poor have a higher discount rate than the rich.
xixi77 13y ago
Departures from rationality are interesting -- in fact, the Krussel and Smith paper and the related line of research does depart from rationality, even though in this case this is done for computational reasons. The question is, how much, and what kind, of irrationality is reasonable to admit into a model? While rationality is easy to define, there can be an infinite number of ways people can be irrational, and their decision processes would change. Macroeconomics used to assume less-than-rational, empirically calibrated decision processes and aggregate behavior that would rise from those; but these models did not adequately account for people changing their behavior, including the degree of irrationality, in response to changes in the environment.

ilaksh 13y ago

That sounds like a good start, but I think you have to go much farther. Unless an economic model takes into account holistic human and ecological outcomes, its not relevant. You need to integrate physical science, psychology, and other real sciences and measurements. And then measure things like inequality and overall human well-being. Then make a serious effort to maximize human and ecological well-being. If I were an expert in how bubbles formed in water and spent all of my time thinking of ways to maximize bubble growth by sucking gases out of the water in a tank, I would be good at creating aquariums with large bubbles, but probably end up with a lot dead or sick fish.

001sky 13y ago

It turned out that actual people didn’t behave like the imaginary proxy. Economists are learning that the poor and the wealthy respond differently to austerity and stimulus. This could present challenges to politicians. If people behave differently, then policy might have to treat them differently. Preference heterogeneity by itself does not imply anything about rationality. However, that is not to say the topic is so simple. We know this empirically by looking things like revealed preference for risk taking. One example might be propensity to take risky bets, despite known zero/negative NPV expected values. These people are happy to buy earnings Vol because the distributions on the downside has such little variation (poor today = poor tomorrow). Whereas a middle class person can make more use of the savings (investment opportunities are greater, and the downside risk of less savings is too), on the one hand, and is not so desperate for upside on the other (even if its just the psychic hit of the "chance" to be rich).

jandrewrogers 13y ago

The problem is not the rationality assumption per se. It is that the set of inputs and constraints to the decision process considered in classical economics is sufficiently narrow and incomplete that it does not produce a realistic output. Actors generally appear "irrational" primarily because classical economics simplifies the modeling process by discarding relevant context that influences decision processes for the sake of simple analysis. Also, "rational" is contextual, not objective or axiomatic in any real-world finite computational system as a matter of mathematics. This is an important distinction often ignored. As a consequence, "irrationality" can be generally defined as "making a decision from a different contextual basis". Again, this defeats the desire to create absolute rules of economics that fit in a soundbite. Economics is perfectly capable of dealing with the complexities of real-world actors in theory. In practice, most economists attempt to reduce the complex dynamics implied by the theory into trivial theorems that are easy to turn into government policy. This is somewhat understandable because even approximating a pure model is computationally prohibitive. This provides a lovely framework within which any economist can come up with a narrow model that suits their particular ideological proclivities. You rarely see an economist that properly recognizes the constraints and assumptions of their model but those limitations exist nonetheless. Advanced computer science will allow us to implement the more general models directly regardless of whether or not the results are politically convenient, but it may take a while before we see it.

anigbrowl 13y ago

people have been shown, time and again, to behave economically irrationally Likewise, choices that appear irrational may turn out to be entirely sensible but for the exclusion of relevant factors. Having been quite poor in the past I can certainly distinguish between irrational choices of the 'oh fuck it, let tomorrow take care of itself' variety and rational ones of the 'this is inefficient, but satisfies constraints' type. As an example of the latter, consider riding the bus. In many places you can get a monthly pass at a substantial discount to paying multiple fares every day. But for someone who is un- or under-employed, the expected value of purchasing the monthly pass is quite different from that of someone with a predictable commute; if that person makes the wrong guess about how often s/he will travel over the month, it can result in a significant opportunity cost. Then there's the even simpler case of the person who can't accumulate enough cash at a time to buy the monthly pass, but who won't be able to get paid at the end of the week without taking the bus to work each day. Absent credit facilities, paying bus far on a day-by-day basis can be perfectly rational when viewed in the individual's overall economic context. Unfortunately, economics textbooks don't devote much attention to multiple inelastic constraints.

digitalengineer 13y ago
Up voted! Excellent explanation. I suppose Pawnshops/Lownsharks use the same 'need-money-right-now' angle.
yummyfajitas 13y ago
irrational choices of the 'oh fuck it, let tomorrow take care of itself' Having a high discount rate is not irrational. Multiple discount rates are, but a single high discount rate is perfectly rational.
- anigbrowl 13y ago
  It depends. There have certainly been times where I've deferred some necessary purchase in favor of a frivolous one, eg choosing to pay a bill late so I could go out with friends and have beers. Now that's not so bad if you know you're going to be able to pay the bill next week, and arguably there's some psychological benefit in being social and and consuming some alcohol to de-stress, not to mention the signaling value of apparent economic liquidity. But if you discount the future too liberally, then pretty much anything can be spun as a rational choice, eg drug addiction, being a hobo, taking up crime or whatever. I smoked fairly heavily for about 20 years, which I'm sur is going to have some negative impact on my future lifespan/quality of life, if the way I felt by the time I quit is anything to go by. For all that I liked smoking at times, it was basically a symptom of nictotine addiction and I can't say my life was improved by having been a smoker. This is certainly one case where I discounted the future too heavily.

dragonwriter 13y ago

> But the real point -- which is a huge one, as far as the field of economics is concerned -- is that the "rational (and by implication, homogeneously rational) actor" presumption is under fire. Er, no, while people have been saying that this is the "real point" of various stories on internet discussion fora at least as long as I've been on internet discussion fora (which goes back to the latter half of the year 1990), its really not. The rational actor model (whose role in economics is much more limited than many people seem to think) has always -- from the day it was conceived -- been known to be a simplified model (like the "perfectly competitive market") which is a good-enough approximation for some real world interactions but fundamentally not true (it assumes, among other thing, what amounts to effective omniscience -- at least where it concerns any decision that has any impact on the actor's own experienced utility -- on the part of all actors), and also not even good enough to be useful for many important situations. No one anywhere in the social sciences thinks the rational actor model represents the underlying reality, and in economics particularly it (along with perfectly competitive markets) is baseline that works both as a basis for a highly idealized model that is important pedagogically and often useful as a basis for describing real world situations in terms of variances from (e.g., explaining empirically derived models of real-world behavior in terms of how the empirical model differs from idealized model and connecting that to a theory of how the real underlying processes differ from those that form the basis for the idealized model.)

nhaehnle 13y ago
In fairness, though, there is a big disconnect between what economists in the media say on average when they feel free to say whatever they like, versus what economists concede in an academic context when pressed on the matter. Part of this may be due to the fact that most economists who appear in the media are basically paid shills, but no matter the reason, it is definitely a problem for the democratic process.

bobbles 13y ago

A group of people all with the exact same expression, pose and setting has been used to represent how different we are... right...

yummyfajitas 13y ago

pretty much every foundational theory in classical economics is predicated on homogeneity I have absolutely no idea where you get this idea. Both supply and demand curves are based entirely on the concept of heterogeneity. The microfoundations of the supply and demand curves are (for simplicity assuming each customer will supply/purchase only 0 or 1 item): Supply(P) = # of suppliers with reserve price > P Demand(P) = # of customers who's reserve price < P If agents were homogeneous, then both of those curves would be a step function. Similarly, the standard economic explanation of why the poor make "bad" choices is heterogeneity - the poor have a higher discount rate than the rich.

xixi77 13y ago

Departures from rationality are interesting -- in fact, the Krussel and Smith paper and the related line of research does depart from rationality, even though in this case this is done for computational reasons. The question is, how much, and what kind, of irrationality is reasonable to admit into a model? While rationality is easy to define, there can be an infinite number of ways people can be irrational, and their decision processes would change. Macroeconomics used to assume less-than-rational, empirically calibrated decision processes and aggregate behavior that would rise from those; but these models did not adequately account for people changing their behavior, including the degree of irrationality, in response to changes in the environment.