Lecture 1 - Instrumental Rational Choice PDF

Preview

Summary

Taught by Jeremy Larner...

Description

Lecture 1 – Instrumental Rational Choice Book to read – nudge Introduction 

    

Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses o Fundamentally about decisions and choices The concept of choice underpins economics - a trade-off between alternatives Economists study behaviour in order to explain and predictable to prescribe policies to government Economists use models, which comprises of variables and assumptions, e.g. behaviour = f (ends, means) Variables: what we study, e.g. behaviour, ends, means Assumption underlying economic theory: behaviour or choice is rational

Instrumental Rationality 





Rational choice theory - when faced with several courses of action, people usually do what they believe is likely to have the best overall outcome (Elster 1989) o When people are given a choice, they decide rationally o You align up all your choices, work out the outcome for each choice and then choose the one with the best outcome In economics, rational choice is instrumental: the individual has a set of preferences and will choose the action that he correctly calculates to be the most instrumental in satisfying his preferences (i.e. that maximises his utility) o Instrumental rational choice means that you can summarise the outcome of a choice with just a single number and the one with the highest number has the best outcome o This is also known as utility The economic man (homo economicus) is model of thinking where agents (decision-makers) behave in an instrumentally-rational manner

Components of Rationality (this may appear in a lot of essays) 



There are two things that impact on the choice of the action: preferences and beliefs Preferences are the things you like, that make you happy, the things you want to achieve

        







Preferences are below actions because preferences are set and cannot be changed “reason is slave to the passions” – our reason cannot control our passion; it has to do what our passion wants. We can’t change what our preferences are Because of this, we don’t see our preferences as right or wrong Beliefs are things that we can’t control Beliefs are impacted by your preferences but they are what you expect will happen because of the action Again, we cannot choose our beliefs, we can choose what to do (even maybe ignore your beliefs) but we cannot change what we believe Your beliefs should come from evidence – from your experiences or other people’s experiences There is some interaction between belief and evidence o If you have strong beliefs, you might see evidence in a different way Preferences can also impact on your evidence o Depending on how important a decision is will depend on how much evidence you collect o E.g. a preference could tell you that the outcome of something is very important and this could tell you that you need to find more evidence in order to make a better decision Elster’s model says that the action we take (the choice that we make) is impacted by our preferences (what we like and what we don’t like) and our belief (how we see things changing). Our belief comes from evidence Sometimes our preferences impact our beliefs – this is not rational o This is known as wishful thinking  where we want something to happen so much that we start to believe it’ll happen o E.g. playing the lottery – if you think rationally about winning the lottery, you will realise that there is little chance of you winning so no point of entering but if you believe what could happen if you win, intuitively your belief can make the probability higher than it mathematically is Another common problem when looking at the interaction between beliefs and evidence is something called conformation bias o We are not very good at viewing evidence in a completely rational way o E.g. women being bad drivers  if someone sees a woman driving badly, it will add to their belief that women are bad drivers but if they see a man driving badly, this will not impact their belief o Conformation bias means that we are good at spotting evidence and filing it into our brain when we believe it is correct and we are not so good at spotting evidence which we do not believe in o You are not updating your beliefs in the face of evidence

Anomalies There is empirical (real world) evidence that people do not conform to the predictions of instrumental rationality when making economic decisions. People do not always

Preferences do not obey axioms, beliefs are not formed

take the most rational action

People are not always self-interested Culture affects decisions Individual differences affect decisions Wealth  Happiness

correctly and optimal decisions based on preferences and information are not always taken, e.g. actions influenced by context, framing, order of presentation, etc. (L3&4) People demonstrate pro-social preferences even though this adversely affects their material welfare, e.g. giving to others/charity, being fair, being recipricol (L5&9) People from different cultures behave differently under the same economic circumstances, e.g. Americans are more fair than Peruvian gathers (L6) Different people behave differently under the same economic circumstances, e.g. females more risk averse than males (L7) Greater material welfare is not strongly associated with greater subjective well-being/happiness across individuals, within individuals and across nations (L8)...