Homo Economicus: What’s Wrong with the Rational Economic Man?
Classical physics offered more to economic modeling than any other field of natural science — is quantum physics the future?
“Orthodoxy means not thinking- not needing to think. Orthodoxy is unconsciousness.”
-George Orwell, Nineteen Eighty-four (1949)
Suppose you were offered to make a choice between two bets: bet A gives you a 9/10 chance of winning $10, while bet B has a 1/10 chance of winning $100. Which one of the mentioned two deals would you prefer?
Such scenarios, whereby individuals are required to make choices in the face of uncertainty are not rare. On the contrary, such decision-making extends from the way we choose to pick stocks with varying levels of risk and return in the stock market, to the way we choose what beverage to drink in a bar. Being an issue with such far-reaching implications, it lies therefore at the heart of economic thought, whose primary aim is to analyze the way we make decisions, both individually and collectively, in the face of scarcity.
In order to explain how individuals and societies make choices, the concept ‘homo economicus’, the rational economic man, was introduced by classical economists as an abstraction of actual individuals. As Smith famously quoted in his classic work The Wealth of Nations: “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 self-interest.” The sole function of the rational economic man in the economy was to seek efficiency in maximizing their self-interest.
Newtonian physics and classic economics
This efficiency maximizing abstraction of individuals made by Classical economists owes much gratitude to the Newtonian physicists of the era and their realization of the phenomenon of diffraction of light through a glass prism, whereby individual photons of light would take the most efficient path. Newton’s contemporary, Gottfried Wilhelm Leibniz, explained the idea by comparing God to an architect “who utilizes his location and the funds destined for the building in the most advantageous manner.”
Representing societal individuals as Newtonian particles enabled classical economists to make Newtonian calculations about how prices would be set in a market economy, or to arrive at what William Stanley Jevons called a “mechanics of self-interest and utility.”
According to classical economists, the decision-making of our rational economic man in the face of uncertainty would be explained by what is called the expected utility theory, whereby the economic agent would pursue his aim of self-interest maximization, and choose the deal that would maximize his/her expected utility. The expected utility of each deal was to be calculated by multiplying the likelihood of occurrence with the value of the outcome to the individual, and whichever deals provided the greatest expected utility to the individual, that deal was to be pursued. Therefore, according to this theory, individuals would choose Bet B (1/10*100=$10) over Bet A (9/10*10=$9), in order to maximize their expected utility.
However, a similar game conducted in an experimental setting by Tversky and Thaler in 1990, provided circumstantial results, whereby individuals would not follow the path prescribed by the classical economists and always prefer the bet which provided the maximum expected utility. The choices made by actual individuals, it turns out, were highly influenced by the situation they were in. If the person was playing the game themselves, then 71% of the participants preferred to go with Bet A, because of their dislike for the uncertainty of outcomes that affected their self-interest. On the other hand, if their job was to price the game for someone else, they suddenly turned on their calculators, with 67% correctly considering Bet B as more valuable.
Such a reversal in preference can be more clearly recognized if you ask a cigarette smoker to rank his/her utility of smoking and quitting. People trying to quit smoking will rank the utility of not smoking in the future higher than that of smoking (which is why they are trying to quit). However, if asked to rank the utility of actually stopping smoking right now, they often prefer to reverse their preferences and pull out a cigarette, in defiance of classical economic logic.
Errors in the fundamental theory
Now, the key role of economic science in modern society has far-reaching implications, and fundamental classical economic principles such as the expected utility theory lie a priori on theories of management, finance, and commerce. Therefore, errors in fundamental economic theories such as that of the expected utility theory (clearly been pointed out in the field of Behavioural Economics by Kahneman and Tversky in their famous work Thinking Fast and Slow) has far-reaching consequences to several other related fields of social science.
In defense of their classical logic, economists do seem to consider such results as a consequence of ‘irrational’ behavior and simply rule them out, even mocking Behavioural Economics considering it to be “psychology of stupidity” which makes no sense to the realm of pure economic thought. However, they remain silent about the consequences of their errors such as what happened in the financial crises of 2008/09.
The key error in part of classical economic logic as concluded by behavioral economists lies in their unrealistic assumption of ‘homo economicus’, and thus due to the vast differences in the behavior of conscious individuals with that of Newtonian particles that obeyed mechanical laws. However, this in no way would imply that physics should have no partake in explaining economic phenomena, in fact, physics has offered more to economic modeling than any other field of natural science. The problem with Economics here lies in the accepted orthodoxy about the hard-to-swallow assumptions unchanged since the Newtonian era, and in its failure to adapt to the rapid evolution that our knowledge of physical phenomena has undergone.
Welcoming the quantum age
Quantum physics offers an elegant explanation of the phenomena, with a great deal of relevance to economic thought and the concept of homo economicus. The errors in economic principles that are mainly due to the false assumption of the rational economic man, can be resolved using quantum logic. The fundamental difference between classical and quantum logic lies in the fact that the first allows only for Aristotelian or binary distinction, while quantum logic sees a system as being in a superposition of multiple states, which snaps down to a single answer only at the time of measurement.
We are less like Newtonian particles fixating our preferences based on a mechanical law, and more like Schrodinger’s cat existing in more than one state at the same time, at least until we need to make a choice.
To explain what this has to do with our concept of a rational economic man, it makes sense only from a classical logic point of view to speak about the fixed linear preferences of a rational economic man, while in the context of quantum logic, such an approach stops making sense. Preferences of individuals are described by a time-varying probabilistic function that is sensitive to both measurement and context. Our preferences seem to lack a hard and fast rule, and change according to spatial-temporal circumstances.
For example, we might usually prefer red wine with a meal, but we can occasionally choose white or rose depending on the exact situation. We are less like Newtonian particles fixating our preferences based on a mechanical law, and more like Schrodinger’s cat existing in more than one state at the same time, at least until we need to make a choice.
Quantum formalism of economic phenomena is ideally suited for handling situations where consumer behavior depends on infinitely many factors and that the consumer is not aware of any preference until the matter is brought up. Applying quantum decision theory to such cases makes it possible to explain the counterintuitive results of the fore-mentioned experiment by complementing the utility function with another attraction function that describes sub-conscious preferences, such as risk-aversion, and their quantum interference with the uncertain prospects, which classical Economics fails to account for.
The real problem with economics, I believe lies in its orthodoxy, and not in its derivation of principles from the realm of physical thought. On the contrary, the realm of quantum physics has to offer much more to the realm of Economics in the contemporary era, and thus, to enable contemporary economists to explain the behavioral aspects of economic agents in modern society.