Neva Goodwin, Julie A. Nelson, Frank Ackerman and Thomas Weisskopf
(Tufts University and University of Michigan, USA)
© Copyright 2004 Goodwin, Nelson, Ackerman and Weisskopf
In past issues of the post-autistic economics review, writers have pointed out the many failings of contemporary economics education and research. A variety of alternatives in instruction have been suggested, including a greater emphasis on economic problems (rather than technique) and a wider conceptual base. But how, in fact, can this be implemented?
Take, for example, the idea that people are actually much more psychologically complex than the self-interested rational choice-makers that populate neoclassical theory. How could this be explained, in simple language and with emphasis on economic implications, to students at the start of their economic studies? And since instructors will, at least in the near future, continue to have to incorporate at least some of the neoclassical model—even if only to help their students avoid being duped—how can that model be incorporated? We venture the following passages as an example of how this may be done, and welcome your comments.
These passages are abridged from “Chapter 2: Economic Actors and Organizations” of Microeconomics in Context by Neva Goodwin, Julie A. Nelson, Frank Ackerman and Thomas Weisskopf (Boston and New York: Houghton Mifflin, copyright date 2005, available as of August 2004). Reproduced by permission. More information on this textbook and related teaching materials may be found at the Global Development and Environment Institute website, http://www.ase.tufts.edu/gdae/. The authors may be contacted at firstname.lastname@example.org.
Motivation and Behavior
Economics is a social science--it is about people, and about how we organize ourselves to provide the means for life and its flourishing. Ultimately, all economic behavior is human behavior.
What motivates people, and how do these motivations translate into economic behavior? Economists generally make an assumption of purposeful or instrumental behavior. Such behavior is motivated by particular goals, and actions are undertaken as means to those ends. Most often, we assume that these goals are conscious and—at least from a person’s own perspective—are intended to advance individual and/or social well-being.
Intrinsic and Extrinsic Motivations
A first distinction to be drawn concerning goals is to note that people act from both extrinsic and intrinsic motivations.
We say that an action is extrinsically motivated, or motivated by “outside” forces, to the extent that the action is taken for a reason that lies outside of a person’s character and his or her relation to the activity itself. Usually these reasons have to do with either reward or punishment.
Money is obviously one of the primary extrinsic motivators. You may work, run a business, make a deal, or study economics because you believe these activities will bring you financial rewards. Besides having financial motivations, people may also undertake activities because they fear the consequences of doing otherwise, or in the hope of gaining some other extrinsic reward, such as high social status or increased power. People frequently use extrinsic motivators to try to change the behavior of others. Economists talk about the various incentives set up by systems of reward and punishment. Employers offer monetary bonuses or “employee of the week” certificates to encourage good work. The government offers tax rebates to encourage energy conservation and fines the worst polluters. A university may tie scholarship money to maintenance of a certain grade point average. In all these cases, the organizations are relying on monetary or nonmonetary incentives to change behaviors by acting on extrinsic motivation.
Traditionally, economists have paid a great deal of attention to incentives, and to financial incentives in particular. Because of this emphasis, economists are often able to point out where incentives exist and may have effects on behavior, even when the incentives have been created unintentionally and are unnoticed by other analysts.
For example, suppose a civic group is concerned about teens who don’t finish high school, and so it creates a center for dropouts. The center offer dropouts individualized instruction, paid child care, and a weekly monetary stipend. The civic group’s intent, of course, is simply to support dropouts and help them finish their schooling. But what incentives does this create for those students who are still in school but are considering dropping out? These current students will have an increased incentive to drop out in order to qualify for the center’s greater benefits. In this case, creating a program to solve a problem could cause the problem to increase! The civic group might do more good by devoting some of its resources to improving the support services provided at the school itself.
The attention that economists give to incentives can play a valuable role in evaluating the wisdom of various policies, whether in communities, businesses, or elsewhere. The focus on extrinsic motivations and financial incentives needs to be put in context, however, by also considering other reasons for people’s actions.
People are intrinsically motivated, or motivated by “inside” forces, to the extent that the reason for action lies in the person or in the activity itself. Intrinsic motivations include direct enjoyment of the activity itself, as well as ethical values such as honesty and loyalty. They also involve issues of identity, such as the feeling of “who you are” or “what our organization is about.” Intrinsic motivations are what make you want to do something, without respect to rewards or threats from the outside.
You may produce a superior economics term paper because you enjoy learning or because you feel you “owe it to yourself” always to do your best. A government employee may resist a bribe because it is the honest thing to do. Most people choose their work partly on the basis of extrinsic motivations like money and status, but also partly on the basis of intrinsic motivations concerning what they like to do, what kind of person they want to be, and what kind of mark they want to leave on the world. Often both extrinsic and intrinsic motivations are at work.
Self-Interest, Altruism, and the Common Good
Whose interests do people care about? In a famous statement from The Wealth of Nations, written in 1776, Adam Smith declared, “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.”
Many people coming after Smith have interpreted these words in a special way. They have assumed that if people in an exchange economy just follow their own self-interest, acting in the way that most benefits them as individuals, the goal of societal well-being will follow automatically. Many economists of the 20th century read Smith’s words out of context and saw them as clever proof that there is no need to for people to think “benevolently” about each other or about society as a whole. This has been used as an ethical justification for following unfettered economic self-interest.
Adam Smith, among others, would have disagreed with this extreme view. (His other most notable work, The Theory of Moral Sentiments, addressed at great length the need to take into account the welfare of others). Exchange may fail to promote social well-being for a number of reasons. People may be badly informed. The situation may entail positive and negative externalities not taken into account in individual self-interested decisions. And, as also pointed out by all major philosophical and religious teachings, purely self-interested decisions are often at odds with basic ethical concerns.
The opposite of pure self-interest would be pure altruism. In this case, you simply desire to help other people, with no thought about yourself. A soldier who throws himself on a grenade to save his comrades or a mother who pushes her child out of the way of an oncoming car and is crushed herself are classic—and extreme—examples of altruism.
Perhaps more relevant to economics is the fact that much economic behavior may be motivated by a desire to advance the common good—the general good, of which one’s own interests are a part. Advancement of the common good means seeing your own well-being as connected to the larger well-being of society. For example, even as children we find that learning to share, and not always grabbing or whining for the best toy, leads to more prolonged games and a much more pleasant social environment for everyone—including us. Social theorist Howard Margolis points out that in many social situations people act according to a rule he calls being "neither selfish nor exploited." That is, people are often willing to participate in the creation of social benefits, as long as they feel that others are also contributing.
More and more, economists are realizing that a well-functioning economy cannot rely only on self-interest; it also depends on a culture that includes taking into account the common good. Without such values as honesty, for example, even the simplest transaction would require elaborate safeguards or policing.
If everyone in business cheated whenever they thought they could get away with it, business would grind to a halt. If everyone in the government took bribes, meaningful governance would disappear. In addition, people have to learn to work together to overcome problems of externalities. In regard to children or the ill, who cannot take care of themselves through market exchange, some “benevolence” is obviously in order as well. Self-interest may indeed, in some cases, serve the common good, but it cannot be the only motor for an economy that serves the well-being goals of the society. Indeed, self-interest alone cannot even be efficient. Imagine if you were afraid to put down your money before having in your hands the merchandise you wished to purchase—and the merchant was afraid that as soon as you had what you wanted you would run out of the store without paying. Such a situation would require police in every store—but what if the police also operated with no ethic of honesty?
Fortunately, recent experimental research on human behavior demonstrates that people really do pay attention to social norms, and they are willing to reward those who follow the norms and to punish people who violate them, even when this has a cost in terms of their narrow self-interest.
In the “Ultimatum Game,” for example, two people are told they will be given a sum of money, say $20, to share. One person gets to propose a way of splitting the sum. For example, this first person may offer to share $10 with the second person, or only $8 or $3, and plan to keep the rest. The second person can’t offer any input to this decision but gets to decide whether to accept the offer or reject it. If the second person rejects the offer, both people will walk away empty-handed. If the offer is accepted, they get the money and split it as planned.
If the two individuals act only from narrow financial self-interest, then the first person should offer the second person the smallest possible amount—say $1—in order to keep the most for himself or herself. The second person should accept this offer because, from the point of view of pure financial self-interest, $1 is better than nothing.
In fact, researchers find that deals that vary too far from a 50/50 split tend to be rejected. People would rather walk away with nothing than be treated in a way they perceive to be unfair! In the context of social relations, even the most selfish person will gain by serving the common good, making an offer close to 50/50, and thus walking away with about half the total sum (close to $10). Players who look only at their own potential gain may end up with their offers being refused, and have to walk away empty-handed.
Concern for the atmosphere we all breathe, and concern about poverty that contributes to crime and violence, are examples of real-world cases in which serving the common good may lead to better living for yourself and your family. In such cases, the assertion attributed to Adam Smith should be turned around: concern for the common good may be the best way of serving your own self-interest!
Habit, Constraint, or Choice?
What did you eat at your last meal? Why did you eat that, in particular? Because economists want to explain economic behavior, we need to pay attention to why people act the way they do. Take a minute and think about your answer to the second question.
Perhaps your first thought was that you had “the usual”—you ate those particular foods because that is what you usually eat. In this case, we would say that your behavior arose largely from habit. Behavior that arises from habit or custom tends to be fairly slow-changing and is often related to social roles, family, cultural institutions, and the like. Your particular eating habits are probably related to, for example, your particular age, sex, and ethnic background and where you grew up. Habitual behavior is often performed repetitively and fairly automatically, without conscious thought. You may think that the only “normal” breakfast in the world is cereal and milk. Or you may think, on the contrary, that the only “normal” breakfast is rice and fish. In neither case have you given a lot of thought to what you eat.
Or perhaps you explained your eating in terms of “what the cafeteria was serving” or “what I could afford.” In this case, we would say that your behavior reflected the constraints that you faced. You may have wanted to eat something quite different, but you faced limits on your behavior. In a small way, someone else had power over you. The cafeteria manager’s decisions strongly determined your behavior. You knew the police would arrest you if you left a restaurant or grocery store without paying. In this case, the level of your economic resources was important to your behavior. The more you have—in terms of time, money, and transportation—the more you can go where you want and eat whatever you want, freer of constraints.
Or, lastly, did you think carefully about what you were going to eat, making conscious choices between one item and another, based on factors like your personal taste preferences, your goals concerning weight, and/or what you know about nutrition? This would be an example of choice behavior, in which the important factors are your motivations, your knowledge, and your decision-making capabilities.
Actual behavior may arise from habit, constraint, choice, or combinations of all three factors.
Rationality, Goals, and Information
Traditionally, economists have tended to be especially interested in choice behavior. Given this emphasis, the question “How do people choose?” arises. Economists generally assume that people have the capacity to make rational choices.
In common speech, when we use terms like “rational” or “reasonable” to describe an action, we mean both that the goal of the action is rational and that the process leading to the action was intelligent, appropriate, and thoughtful. It is not particularly rational, in the sense of “sane,” for example, for a person to base all his actions on the goal of being a rock star if he has no talent, or to have a goal of committing a heinous murder. These goals would generally be considered crazy because they are not related to achievable states of personal and social well-being. Or an action could be judged irrational if the goal is reasonable but the actions taken are not. For example, it is not irrational for a person to have a goal of maintaining a healthy and attractive body weight. Yet a young woman suffering from the mental illness of anorexia may act on the basis of a belief that her body looks grotesquely fat, while in fact she is emaciated. The anorexic's weight loss may be based on the underlying goal of wanting to be attractive, but in fact her judgment is distorted by a neurotic perception.
Do choices that are rational, in the sense of deriving from a thoughtful and appropriate process, always lead toward the desired goals? Perhaps not. Because the information base on which we make our choices is imperfect, and because the processes of human reasoning and group decision-making are also often imperfect, we can only say that rational choices will normally be expected to move individuals and organizations towards their goals. Rationality means that people weigh the costs and benefits of alternative actions, relative to their goals, when faced with a significant decision—not that people always make perfect decisions.
Optimization vs. Bounded Rationality
We have worded our discussion of rationality rather carefully so far, trying not to claim too much. However much more ambitious claims have sometimes been made, making this a rather contentious topic. In particular, rational behavior is used in the traditional model, as we will soon see, to mean behavior that best moves a person towards his or her goals. This kind of behavior is called optimizing.
In 1978, Herbert Simon, a psychologist, won the Nobel Memorial Prize in economics by zeroing in on the question of information, with some surprising results. He pointed out that optimization is normally not possible for human beings, because it requires making the best decision out of the entire universe of possible choices. “Universe” here does not mean planets and stars, but rather the largest possible imaginable set of choices. Your “universe” of possible breakfasts, for example, includes everything from cereal to snake meat.
Under most circumstances it is not feasible to gather the information that is needed in order to identify the entire range of possibilities. Could someone at least identify the optimum point at which to cease gathering additional information? Simon showed that complete knowledge is required even in order to identify that optimum point. Moreover, the effort to find out what additional information might be out there, and to gather it, can be very costly in time, effort, and money.
Accordingly, Simon said, people rarely optimize: instead they do what he called satisficing; they choose a level of outcome that would be satisfactory and then seek an option that at least reaches that standard.
Satisficing can be done in a way that resembles the search for an optimum outcome. If an individual finds that the "satisfactory" level was set too low, a search for options that meet that level will result in a solution more quickly than expected, or perhaps even multiple solutions; the level may then be adjusted to a tougher standard. Conversely, if the level is set too high, a long search will yield nothing, and the satisficer may lower his or her expectations for the outcome. Even with such adjustments, however, satisficing is not the same as optimizing.
Another explanation for behavior has been called meliorating, which may be defined as starting from the present level of achievement and continuously attempting to do better. A simple example is the fisherman who has found a whole school of haddock but only wants to keep one for his supper. When he catches the second fish he compares it to the first one, keeps the larger, and throws the other back. At the end of the day, the fish he takes home will be the largest of all those caught.
One result of using melioration as the real-world substitute for theoretical optimization is its implication that history matters: people view each successive choice in relation to their previous experience. It is commonly observed, for example, that people are reluctant to accept a situation they perceive as inferior to previous situations. This psychological “path-dependency” (that is, where you are going depends on where you have been) is relevant to feelings about rising prices, and even more so to attitudes toward declining wages.
Satisficing and meliorating may both be included under the term "bounded rationality." The
general idea is that, without surveying all possible options, people adopt some more-or-less arbitrarily defined subset of the universe to consider. In your breakfast decision, you probably limited your choices to a narrow subset of possible foods.
The concept of bounded rationality thus limits the universe to which decision making is to be applied. Within this limited universe, processes such as satisficing and meliorating are rational behaviors that would normally be expected to move people toward their goals.
Now or Later?
One last dimension of motivation and behavior is crucially important. What time frame do people consider when they have the chance to make significant choices about how they are going to behave?
At one extreme, you probably know someone who has the attitude “Life is short, and tomorrow is uncertain, so let’s have a good time now.” Economists would tend to say that this person has a very high time discount rate, meaning that in his or her mind, future benefits are very much discounted or diminished, when weighed against the pleasures of today. Such an individual will tend to save little, spend a lot, and not expend much effort worrying about the future.
You might also know people who seem to live by the attitude “I’ve got to work hard and prepare now; enjoying myself will have to wait for later.” Economists would say that people like this have very low time discount rates if by their current work they are gaining benefits for tomorrow. The later benefits loom large (that is, are not “discounted”) in their decisions. Such individuals will tend to scrimp and save and expend a lot of effort planning for the future.
Time discount rates are important in all sorts of situations. Economists usually assume that anyone investing in a college education has a relatively low time discount rate, since present pain is involved in forgoing income or relaxation in order to study for some expected future gain. Company leaders with high time discount rates may concentrate on making this quarter’s financial statement look good, whereas those with more concern about the future will look toward longer-term goals. In deciding on environmental regulations, people working at government agencies are forced to make decisions about how much weight to put on the welfare of future generations. The lower the adopted discount rate, the more important safeguarding the well-being of future generations appears.
There is no one “right” time discount rate. An extreme disregard for the future is probably irrational in most cases. But in some circumstances—say, for a person diagnosed with a fatal disease, or who faces a high probability of being killed in street violence—it may be understandable.
Extreme concern for the future is also irrational if it means that an individual never gets around to enjoying the benefits of his or her labors, during a whole lifetime. However, strong arguments can be made for taking the future very seriously when discussing actions with significant multigenerational consequences, such as environmental policies. The question of “now or later” is important in many economic decisions.
Economic Actors in the Traditional Model
Traditional economic theory focuses on a simple mechanical model of economic activity where the central economic actors are assumed to be profit-maximizing firms and utility-maximizing households. It is worth exploring how this model differs from the broader “contextual” approach we emphasize here.
Only Individual Actors
In the traditional, neoclassical model of economic behavior, the economy is assumed to be made up of only individual economic actors. “Firms” are treated as though they simply and seamlessly absorb information, make decisions, and take action. Similarly, “households” are treated as though they were uncomplicated individual persons. Little attention is paid to the people and modes of organization—custom, consent, administration or exchange—that make up these entities as organizations. Nor is much attention paid to any ambiguities or conflicts that might arise in coming to decisions, or to how the entities might influence each other (for example, the effect of firms’ advertising on households’ preferences).
Rather than envisioning layers of organizations mutually evolving over time, the traditional model portrays only well-defined entities interacting at arm’s length.
A Limited Set of Activities
The traditional model of the economy includes just three economic activities and makes strong and limiting assumptions about the relationships between activities and actors, as follows: Production, accomplished by firms; exchange, performed in markets; and consumption, done by households. The usual “circular flow diagram” illustrates the workings of the economy portrayed in this model. But such a portrayal leaves out some key actors and activities.
For example, the natural resource base of the economy does not appear in the traditional circular flow diagram. Because of this, the economy portrayed is a little like a “perpetual motion machine,” in that the economy it portrays can apparently keep on generating products forever without any inputs of materials or energy. The necessity of resource maintenance activities is ignored.
Likewise, the governments are absent, as though an economy could function without laws, public goods, and other public services. Community groups and non-profits are also absent. Although households appear, they are assumed not to be involved in production activities. Transfers (one-way distribution, in contrast to two-way exchange) are not mentioned.
Restrictive Assumptions about Behavior
In the basic traditional model, actors are assumed to be extrinsically motivated. That is, people are assumed to work, produce, and engage in buying and selling purely for financial gain (unless explicitly noted otherwise). Purchases of goods and services for personal use are assumed to be made because these will bring consumers “utility” or satisfaction of their desires. Even today, the phrase “he was economically motivated” is usually interpreted as meaning motivated by money or profit. These goals are taken for granted; in contrast to how we use the term “rationality” in common speech, economists do not question the rationality of agents’ goals.
In a further simplification—which is enormously useful in facilitating mathematical modeling—it is assumed that all behavior is purely motivated by self-interest (except in rare and special cases, which are explicitly noted). The model also focuses on choice behavior and ignores behavior determined by habit or outside influence.
Finally, the model applies a rather extreme definition of rationality and an even more extreme assumption about the informational basis of choice making. Rather than construing rational processes just as something that helps actors move in the direction of their goals, the model assumes that actors behave with perfect rationality. Actors are assumed to choose the absolutely best action—the one that actually does maximize profit (the assumed goal of firms) or utility (the assumed goal of households). This idea of rationality can, in mathematical treatments, be reduced to precise statements derived from logic. The basic traditional model also assumes perfect information. In spite of Simon's work on satisficing in the late 1970s, it was only near the end of the 20th century that many economists began to consider more carefully the problems caused by costly and/or incomplete information.
The assumptions of extrinsic motivation, self-interest, perfect rationality, and perfect information are simplifications that make it possible to construct many elegant theories. But in order to do justice to real world economies, we will also need to develop tools for analysis for cases where these assumptions do not hold.
 The Wealth of Nations, 1776, Book I, Chapter 2. Emphasis in original.