Homo Economicus

Neuroeconomics

The term homo economicus, or economic man, is the sometimes satirical portrayal of humans as agents who are consistently rational, narrowly self-interested, and who pursue their subjectively-defined ends optimally.

In game theory, homo economicus is often modeled through the assumption of perfect rationality. It assumes that agents always act in a way that maximize utility as a consumer and profit as a producer, and are capable of arbitrarily complex deductions towards that end. They will always be capable of thinking through all possible outcomes and choosing that course of action which will result in the best possible result.

The homo economicus model can be contrasted to ‘homo reciprocans’ (reciprocating human), theories of humans as cooperative actors who are motivated by improving their environment through positive reciprocity (rewarding other individuals) or negative reciprocity (punishing other individuals), even when without foreseeable benefit for themselves.

As a theory on human conduct, it also contrasts with the concepts of behavioral economics, which examine cognitive biases and other irrationalities, and to ‘bounded rationality,’ which assumes that practical elements such as cognitive and time limitations restrict the rationality of agents.

The term ‘economic man’ was used for the first time in the late nineteenth century by critics of John Stuart Mill’s work on political economy: ‘[Political economy] does not treat the whole of man’s nature as modified by the social state, nor of the whole conduct of man in society. It is concerned with him solely as a being who desires to possess wealth, and who is capable of judging the comparative efficacy of means for obtaining that end.’ Later in the same work, Mill stated that he was proposing ‘an arbitrary definition of man, as a being who inevitably does that by which he may obtain the greatest amount of necessaries, conveniences, and luxuries, with the smallest quantity of labor and physical self-denial with which they can be obtained.’

Adam Smith, in ‘The Theory of Moral Sentiments,’ had claimed that individuals have sympathy for the well-being of others. On the other hand, in ‘The Wealth of Nations,’ Smith wrote: ‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.’ This comment now suggests the same sort of rational, self-interested, labor-averse individual that Mill proposed.

Economists in the late 19th century—such as Francis Edgeworth, William Stanley Jevons, Léon Walras, and Vilfredo Pareto—built mathematical models on these economic assumptions. In the 20th century, the rational choice theory of Lionel Robbins came to dominate mainstream economics. The term ‘economic man’ then took on a more specific meaning: a person who acted rationally on complete knowledge out of self-interest and the desire for wealth.

Homo economicus bases its choices on a consideration of its own personal ‘utility function.’ Consequently, the homo economicus assumptions have been criticized not only by economists on the basis of logical arguments, but also on empirical grounds by cross-cultural comparison. Economic anthropologists have demonstrated that in traditional societies, choices people make regarding production and exchange of goods follow patterns of reciprocity which differ sharply from what the homo economicus model postulates. Such systems have been termed the ‘gift economy’ rather than market economy.

Economists Thorstein Veblen, John Maynard Keynes, Herbert A. Simon, and many of the Austrian School criticize homo economicus as an actor with too great an understanding of macroeconomics and economic forecasting in his decision making. They stress uncertainty and bounded rationality in the making of economic decisions, rather than relying on the rational man who is fully informed of all circumstances impinging on his decisions. They argue that perfect knowledge never exists, which means that all economic activity implies risk. Austrian economists rather prefer to use as a model tool the ‘homo agens’ (man as an acting being).

Empirical studies by cognitive psychologist Amos Tversky questioned the assumption that investors are rational. In 1995, Tversky demonstrated the tendency of investors to make risk-averse choices in gains, and risk-seeking choices in losses. The investors appeared as very risk-averse for small losses but indifferent for a small chance of a very large loss. This violates economic rationality as usually understood. Further research on this subject, showing other deviations from conventionally defined economic rationality, is being done in the growing field of experimental or behavioral economics. Some of the broader issues involved in this criticism are studied in decision theory, of which rational choice theory is only a subset.

Behavioral economists Richard Thaler and Daniel Kahneman have criticized the notion of economic agents possessing stable and well-defined preferences that they consistently act upon in a self-interested manner. Using insights from psychological experiments found explanations for anomalies in economic decision-making that seemed to violate rational choice theory. One such anomaly was the ‘endowment effect,’ also known as ‘divestiture aversion,’ the finding that people are more likely to retain an object they own than acquire that same object when they do not own it.

Other critics of the homo economicus model of humanity, such as Swiss economist Bruno Frey, point to the excessive emphasis on extrinsic motivation (rewards and punishments from the social environment) as opposed to intrinsic motivation. For example, it is difficult if not impossible to understand how homo economicus would be a hero in war or would get inherent pleasure from craftsmanship. Frey and others argue that too much emphasis on rewards and punishments can ‘crowd out’ (discourage) intrinsic motivation.

The emerging science of ‘neuroeconomics’ suggests that there are serious shortcomings in the conventional theories of economic rationality. Rational economic decision making has been shown to produce high levels of stress hormones. It is also linked to the dopaminergic system, which is activated upon achieving a reward. Upon failure to achieve a reward, pain receptor regions of the left pre-frontal cortex show activity, and serotonin and oxytocin levels drop, as does the immune response. That pattern is associated with a generalized reduction in the levels of trust.

Unsolicited ‘gift giving,’ considered irrational from the point of view of homo economicus, by comparison, shows an elevated stimulation of the pleasure circuits of the whole brain, reduction in the levels of stress, optimal functioning of the immune system, and activation of areas of the brain associated with the placebo effect and building social trust (substantia nigra, the striatum, and the nucleus acumbens). Mirror neurons result in a win-win positive sum game in which the person giving the gift receives a pleasure equivalent to the person receiving it. This confirms the findings of anthropology which suggest that a gift economy preceded the more recent market systems where win-lose or risk-avoidance lose-lose calculations apply.

Economists tend to disagree with these critiques, arguing that it may be relevant to analyze the consequences of enlightened egoism just as it may be worthwhile to consider altruistic or social behavior. Others argue that we need to understand the consequences of such narrow-minded greed even if only a small percentage of the population embraces such motives. Free riders, for example, would have a major negative impact on the provision of public goods.

Yet others argue that homo economicus is a reasonable approximation for behavior within market institutions, since the individualized nature of human action in such social settings encourages individualistic behavior. Not only do market settings encourage the application of a simple cost-benefit calculus by individuals, but they reward and thus attract the more individualistic people. It can be difficult to apply social values (as opposed to following self-interest) in an extremely competitive market; a company that refuses to pollute, for example, may find itself bankrupt.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.