Psychologists study how people behave and define rational behaviour around conventional human behaviour.
Traditional economists define "a priori" how a rational person behaves - They define what rational behaviour is before studying empirical data about human behaviour.
Non-mainstream economics rejects neoclassical economics and finance.
"A priori" economic notions about human behaviour in microeconomics:
- Consumers maximise utility subject to budget .
- Firms maximise profits subject to demand.
- Markets converge to supply=demand equilibrium.
"A priori" economic notions about human behaviour in macroeconomics:
- Agents in economy have "rational expectations".
- Economy in "rational expectations equilibrium".
"A priori" economic notions about human behaviour in finance:
- Investors maximise expected returns subject to investment opportunities.
- Asset market prices reflect corectly anticipated doscounted future cash flows.
Empirical research generally finds that the economic "a priori" model does not fit actual human behaviour.
Neoclassical economic theory asks questions such as “How do markets populated by rational traders behave?”.
The “Axioms of Revealed Preference”, first developed by Paul Samuelson, obey the following rules: Completeness, Transitivity, Non-satiation, and Convexity
Objections to Samuelson’s “Revealed Preference” include:
- Indifference curves unobservable.
- Shouldn't base science on unobservable entities.
Hicksian compensated demand curves - If consumer income was reduced to cancel out income effect then all such demand curves would be downward sloping.
Samuelson’s “Revealed Preference” argues that indifference curves can be inferred from behavior.
Sippel (1997) tried to test Samuelson’s “Revealed Preference” experimentally.
Sippel found that the results were "not too favourable to the neoclassical theory of consumer behaviour..." He found that the neoclassical definition of rational behaviour is irrational.
Consumption is an "exponential complexity" problem - The number of combinations scales exponentially as additional commodities are considered.
Humans drastically reduce the dimensionality of choice by applying the following:
Satisfice - Choose satisfactory bundle.
Prioritise - Consider most desirable item in bundle and ignore others.
Habit - Buy as always with some change.
Categorise - Purchase within categories.
Normal behaviour must violate Revealed Preference model because Revealed Preference behaviour is computationally impossible.
Therefore, "rational behaviour" for real-world consumers is making a satisfactory consumption decision in finite time.
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