“Normative theories tell you the right way to think”

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October 17, 2017 by AK

but what is rationality? What is rational behavior? In a word, maximizing: choosing the preferable consumption bundle given the budget constraints and certain other factors.

One word is not enough, it seems. I should link to the principal sources of inspiration and ideas for this post: two papers by Mario Rizzo and Douglas Glen Whitman (1, 2), an article by Nathan Berg and Gerd Gigerenzer, and Kenneth Arrow’s Nobel lecture.

The Wiki entry on rational choice seems a good enough primer on the rational-choice framework. In its neoclassical simplicity, rational choice theory initially imposed strict conditions on the person’s preferences and the environment in which she is making her choices. Some of the assumptions can be modified without destroying the maximizing framework: incomplete information, uncertainty, costs of acquiring and processing information can be incorporated.

However, a person’s preferences can be so different from the starting assumptions of the rational-choice framework that finding the best consumption bundle on behalf of the actor will become a meaningless task. As an extreme example, a person with cyclical preferences is an intractable case. In The Problematic Welfare Standards of Behavioral Paternalism, Rizzo and Whitman quote this admission from a standard graduate textbook in microeconomics (Mas-Colell, Whinston, Green, “MWG”):

…substantial portions of economic theory would not survive if economic agents could not be assumed to have transitive preferences.

Of course personal preferences can be so bizarre as to threaten the survival of the economic agent herself. However, mild cases of non-transitive preferences are not exceedingly rare: “transitivity assumption can be hard to satisfy when
evaluating alternatives far from common experience,” according to MWG. When it comes to incomplete preferences, the textbook goes further, admitting they are far from a freak of nature:

The strength of the completeness assumption should not be underestimated. Introspection quickly reveals how hard it is to evaluate alternatives that are far from the realm of common experience.

In other words, MWG don’t tell the reader that people with inconvenient preferences are “irrational” by themselves; rather, they are a nuisance for modeling purposes and the prudent graduate student should probably assume them away in order to pass his prelims with a minimum of worry about the workings of the real world. Equipped with a reputable PhD, he might later join a research program in behavioral economics.

If he follows in the steps of his illustrious predecessors, such as Richard Thaler, he will likely change his view of the non-neoclassical preferences from “a pain to model” to “undesirable.” Rizzo and Whitman (as well as Berg and Gigerenzer) cite this statement from Thaler’s 1991 book, Quasi Rational Economics:

A demonstration that human choices often violate the axioms of rationality does not necessarily imply any criticism of the axioms of rational choice as a normative idea.

A normative idea! At some point between 1951 and 1991, Kenneth Arrow’s assumptions must have become axioms as fundamental to our view of human nature as Euclid’s five (or at least four) are fundamental to our perception of reality. Moreover, while “normative” usually refers to statements rooted in certain values, views, or policy priorities, Thaler’s recent definition, as recorded in Misbehaving (2015), is rather more ambitious:

Normative theories tell you the right way to think about some problem. By “right” I do not mean right in some moral sense; instead, I mean logically consistent, as prescribed by the optimizing model at the heart of economic reasoning, sometimes called rational choice theory… For instance, the Pythagorean theorem is a normative theory of how to calculate the length of one side of a right triangle if you know the length of the other two sides.

As a mathematical result, Pythagoras’ theorem logically follows from Euclid’s postulates, including (necessarily) the fifth. Stripped of its intuitive basis, mathematics works like this: Here’s your set of objects; here’s the set of axioms governing them; here are the rules of inference; let’s see what you can prove. But it also happens that our everyday reality is a rather good model of Euclidean geometry. If you don’t agree, you’re free to treat the Pythagorean theorem as a positive statement and test it every time you encounter a triangular structure with a right angle.

In other words, as a statement about real-word objects shaped like rectangular triangles, the Pythagorean theorem is positive and testable, yet in Thaler’s idiosyncratic language, it is also normative. By the same logic, Newton’s laws and the energy conservation principle are normative when used to estimate the impact of a wall on a fast-moving car.

As the Russian saying goes, call me a pot if you wish, just don’t put me into the oven. If you wish to call Newtonian physics and Euclidean geometry normative because experience has shown their explanatory and predictive robustness, go ahead. If you wish to call the Pythagorean theorem or, for that matter, Arrow’s theorem, normative because they follow from their assumptions, it’s up to you…

…as long as you don’t apply your definitions to welfare economics or the study of human behavior more generally.

Following Thaler, consider this simple question, “How long is the third side of a right triangle with a hypotenuse one mile and one inch long and another side one mile long?” If your informant says, “well I don’t know, a couple of inches I guess,” you should consider the possibility that solving irrelevant problems requiring mental arithmetics gives her severe heartburn, in which case shooting off a random response is perfectly rational. Now if her life depended on measuring that cathetus, provided, of course, that she had no death wish… Otherwise, the right way – for her – to calculate that interval without a calculator at hand is to venture a quick guess.


1 comment »

  1. […] mentioned this test in my previous post. Here’s Thaler’s formulation of it, abridged by […]

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