25 Feb 2016

Why behavioral economics cannot predict behavior

Onno writes*

Everyone who pays a visit to the supermarket for their weekly shopping is confronted with the same ethical dilemma: do I buy organic food, or do I buy the more affordable non-organic counterparts? I’ve always felt this question to be extremely difficult to answer. Not because I have not yet decided whether or not buying organic is the right way to go, but rather because of the inner conflict this conclusion causes.

Hollywood has the tendency to depict an inner conflict with an angel on one shoulder, and a devil on the other. From the beginning on, it's obvious which choice is the right one: it's a given for me that the buying of organic food is the right decision, for many (ethical) reasons. But even with this clarity, the decision isn't any easier. The motto: “you can talk yourself into anything” seems to be leading my choice, and my decision thus ends up to be quite random and unpredictable: sometimes I go for organic food, sometimes I go for their immoral counterparts.

The field of behavioral microeconomics has a hard time accepting this unpredictability of the mind. For a long time it has assumed that people act in their self-interest and strive for wealth maximization: if you can buy an identical product for $10 and for $20, you will buy the $10 version. Because individuals that buy the expensive organic products in order to serve a moral duty hardly seem to be acting in this maxim of wealth maximization, self-interest has been redefined to “acting according to the preference of the individual”. These preferences can be anything, as well as paying more than necessary for a product, and thus the original statement “people act in their self-interest” has lost its real predictive value, and the assumption that people strive for wealth maximization should be dropped. Instead, we are left with the seemingly meaningless and uncontroversial statement: If people prefer to act in a certain way, they will act in a certain way.

Unfortunately, also this seems to hardly be the case. As Kahneman and Tversky have shown in their paper “Prospect Theory: An Analysis of Decision under Risk” [pdf], people often make choices that do not match their preferences. (i.e. taking irrational risks etc.). This paradox can be evaded by introducing the concept of bounded rationality, or other concepts such as heuristics, framing etc. It seems to me however, that this concept is desperately trying to fix an assumption of predictability which was ill-founded in the first place.

Back to the supermarket. Although my decision of this week might differ from my decision of last week, my preferences on the matter haven't changed: I do wish to do the good thing, but I do not wish to pay more than I have to. It could be said that I act according to my short term preferences when I buy the cheaper products, and that I act according to my long-term preferences when I buy the organic products. This however doesn’t explain why some days I pick my long-term preferences, and other days I don't. No concept of heuristics, framing or bounded rationality can make this prediction, as the situation or preferences haven’t changed, but my choice has.

Of course an economist would argue that they might not be able to predict on an individual basis, but rather on a larger, societal scale. It is however difficult to draw final conclusion about the prediction of larger societal patterns if individuals can’t be predicted; in the end society is made up of individuals. It is important for the branch of economics to realize that they can only indicate patterns of human behavior, rather than predict them, so there is no risk of conceptual overstretch.

Bottom Line If the principle of predictable human behavior can be refuted with a simple visit to the supermarket, it is time to let it go. The field of economics needs to prevent conceptual overstretch by realizing it cannot predict human behavior, but can merely indicate a pattern.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.


Anonymous said...

Have you ever heard about research in the fields of decision-making or at least broadly in social psychology? Your text is flawed on so many levels that I cannot even start bringing it up to date with research from the past 20 years.

Onno said...

The entire field just started boring me after 1995.

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