Tuesday, April 15, 2008

More Questions About Single-Dimensional Rational People in Markets

Raj Sheelavnt’s blog, IT Strategy, “Explaining Success of Social Media” (HERE)
comes to a similar theme to Irving Wladowsky Berger in a post below, namely that what they believe is Adam Smith’s moral political economy does not fit the IT/Internet world and may need to be changed:

But Adam Smith – father of economics has concluded that rational self-interest, free market economy can lead to economic well-being and prosperity. His observations and theories is the foundation for Capitalism. But, when people are willing to work for free as in the case of Wikipedia, how can you apply ‘free market economics’ in that case. So, does this mean that social media challenges the Market Economy and Capitalism as explained by Adam Smith?

Well I have been troubled by this very question for some time until I recently read ‘Predictably Irrational ’ by Dan Ariely. According to Ariely, our understanding of economics, now based on the assumption of a rational subject, should, in fact, be based on our systematic, unsurprising irrationality. Ariely argues that greater understanding of previously ignored or misunderstood forces (emotions, relativity and social norms) that influence our economic behavior brings a variety of opportunities for reexamining individual motivation.

In the chapter on “Cost of Social Norm”, Ariely argues that we live in 2 worlds, one ruled by ’social norms’ and the other ruled by ‘market norm’. Social Norms are friendly request and wrapped in social nature and need for community (for example asking your neighbor to move your couch). This plays to warm and fuzzy human nature. On the other hand Market Norms are based on sharp edge of monetary exchanges. In this domain you get what you pay for.

He does an interesting computer based exercise to explore the affects of social and market norm…..

….Based on the above experiment, when people work in the domain of market norm, Adam Smith’s Market Economics works fine. But if people can be made to work in the domain of social norm, then Adam Smith’s Economics does not hold true. In the past social norm was constrained by space (your friends were in your neighborhood). But technology has expanded space and you can ‘virtually’ collaborate with people across multiple time zones. Now ’social norm’ can be successfully applied to motivate people to collaborate and create value based on a unique business model

Starting from incorrect assumptions about Adam Smith’s political economy it is not surprising that you get refutations of the Chicago version of Homo economicus and its ‘rational’ single-dimensional participant in human societies. But this has little to do with Adam Smith’s moral philosophy and political economy.

I shall leave it to a Chicago-trained neoclassical, or neo-neo classical, economist to respond to Dan Ariely’s (and many other’s) findings in similar experiments.


Blogger Paul Walker said...

Steven D. Levitt and John List have a short commentary in a recent issue of the Science journal on topic of behavioural economics. They see positives in the behavioural approach but they still remain somewhat skeptical. They write,

"Perhaps the greatest challenge facing behavioral economics is demonstrating its applicability in the real world. In nearly every instance, the strongest empirical evidence in favor of behavioral anomalies emerges from the lab. Yet, there are many reasons to suspect that these laboratory findings might fail to generalize to real markets. We have recently discussed several factors, ranging from the properties of the situation — such as the nature and extent of scrutiny — to individual expectations and the type of actor involved. For example, the competitive nature of markets encourages individualistic behavior and selects for participants with those tendencies. Compared to lab behavior, therefore, the combination of market forces and experience might lessen the importance of these qualities in everyday markets."

9:15 am  
Blogger Gavin Kennedy said...


Many thanks for your comments. I am inclined to agree with you that much of the behavioural experiments justify scepticism. Psychology for example has a long history of such experiments using students as the actors, who are paid a few dollars to test out hypotheses of bargaining behaviour and not real world bargainers, even by observing the latter at work.

However, so does rational theory tested purely by mathematics. Hence, I didn’t offer a rebuttal or a comment on the content in the post. Tim Harford has done much work on explaining behaviour across a wide range of activities beyond economic transactions and uses rational theory to elucidate explanations. Those who do not make the choice of the rational actor are left without an explanation. That too excites my scepticism.

1:32 pm  

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