Irrational Behavior and Economic Theory
Irrational Behavior and Economic Theory (DOI: https://doi.org/10.1086/258584) written by Gary Becker in 1962. It was published in Journal of Political Economy (vol. 70, no. 1).
Conventional demand theory is based on the microeconomic behavioral model, with well ordered preferences and utility maximization, and the budget constraint. The author formulates an alternative theory based almost exclusively on the constraint, although the theory is relatively macroeconomic. A household cannot spend beyond its means indefinitely (i.e., this is a 'long run' economic model). Rather than assume a particular behavioral profile ("decision rule"), allow all profiles.
- Any profile where consumption is correlated with availability will result in a negatively sloped demand curve.
- Truly random profiles will also average out to a negatively sloped demand curve.
- "And what is simply more probable for a particular household becomes a certainty for a large number of independent ones."
- An "inertia" profile may not react to expansions of the constraint, but will to binding contractions. The probability that a contraction is binding is correlated with availability. Therefore, averaging out, this profile sees consumption correlated with availability.
Conventional supply theory is based almost exclusively on profit maximization. The author formulates an alternative theory again using the budget constraint. A firm similarly must at least break even to run indefinitely.
- A competitive firm, i.e. a firm that composes a small part of overall supply, faces a constant price. Their production possibilities include every level of production where average production cost is at or below that price.
- A profit maximizing firm sets production such that marginal costs equal price.
- Any profile where production is correlated with price will result in a positively sloped supply curve.
- Truly random profiles will select some production level within the production possibilities set, which is determined by price. These will average out to a positively sloped supply curve.
- A monopolistic firm faces a more complex production possibilities set; they can clear more units by reducing the market price.
- It is generally theorized that profit maximizing firms reduce production in such a scenario.
- As the price schedule shifts from competitive (constant) to noncompetitive (negatively sloped), the production possibilities set shifts such that the average production level is reduced. As such, a truly random profile replicates the theorized behavior.
In summary, the assumptions of well ordered preferences and maximization can be released, as long as you operate in the long-run or macroeconomic modeling space.
Reading Notes
Shalizi remarks that this model explains behavior equivalently to the conventional microeconomic model, and with fewer assumptions. The more parsimonious model should be retained.