Thursday, October 1, 2015

It doesn't feel like we're maximizing

I think "If" should be "It", but this is one of the things that most people who feel queasy about economics feel queasy about. We're maximizing rational agents who don't feel like rational maximizing agents.

Of course, the solution I'm putting forward to this existential intuition dilemma is that the maximizing rational agents are emergent from complex (pseudo-random) human behavior. It answers the question of why we don't personally feel drawn into pig farming if the price of bacon goes up. It also solves a tough philosophical problem: if humans are irrational and complex, why do simple theories of supply and demand work at all?

Entropic forces provide a mechanism where we go about our daily lives completely ignorant of macroeconomic (i.e. entropic) forces around us. And entropic forces maintain information equilibrium.

6 comments:

  1. Krugman somewhere refers to economists as practicing armchair psychology. I think that that is a bit generous of him. ;) It is not just that we do not feel like we are maximizing expected utility, there is good evidence that we are not. I originally started thinking of writing about chaos is human systems, in response to a recent note, but that led me to psychology, which I think is a bigger deal in terms of economic thinking. I guess that the information transfer approach is fairly agnostic about psychology, at least to a first approximation, so I beg your pardon in advance. :)

    One reason, having nothing to do with microeconomics, for thinking that human behavior is chaotic, is the fact that we humans are great rationalizers. We can think up plausible sounding reasons for just about anything we do. We are not the rational agents that we pretend to be. That makes human behavior relatively difficult to predict. For instance, suppose that we raise income taxes on the rich. According to economists, that will make the rich do less work, since their incentive to work will be less. ("Incentives matter" is the economist's battle cry.) OTOH, it could make them work more, in order to earn as much as they did before. (IT is agnostic about that, right?)

    Psychology has something to say about that, based upon experiments. (There is a question of how much those experiments generalize, OC.) Once an organism is exhibiting a behavior, which is the case with raising taxes, experiments show that reducing the expected reward (incentive) for doing that behavior strengthens the habit of doing that behavior. People (and rats and pigeons and flatworms) do more for a lesser reward. In one experiment I heard about, pigeons started out getting a pellet of food for pecking a button, and ended up having to peck the button 900 times to get a pellet of food. (!) OC, that change occurred in increments. That argues for incrementally increasing taxes on the rich making them work harder.

    But what if taxes are not a decrease in rewards, but punishment? Experiments show that keeping rewards but adding punishment reduces the behavior for a while, but it soon returns to its previous level. If taxes are punishment, then incrementally increasing taxes might have a temporary effect on work. There would be no long term effect upon how hard the rich work.

    Another possibility is that tax increases would be associated, not with work, but with the activity of paying taxes. In that case they would have no effect upon work itself. The incentives to work would remain the same.

    I actually think that incremental tax increases would have no effect on the work of the rich, or only a temporary effect.

    Humans are more satisficers than maximizers or optimizers.

    ReplyDelete
    Replies
    1. I completely agree.

      However, in the ITM we take this complex behavior as random and it works out pretty well :)

      Psychology is probably the key to understanding recessions -- and other cases of non-ideal information transfer.

      Delete
  2. Jason, it's all about price, price, price. Humans are extraordinarily cognitively efficient when faced with an asset and a price: it's like being able to hit a tree with a rock at 20 meters.

    Rationality breaks down, and cognitive drain rises where there are no prices. The cost of setting up a pig farm is extraordinarily opaque -- i.e. no prices. Once upon a time, if pig prices went up, you could start feeding a few in the back yard. No longer.

    More prices, please.

    ReplyDelete
    Replies
    1. I have no problem if this is framed in terms of an aggregate agent ... An aggregate agent appears to be perfectly rational.

      Individual agents don't seem to be, suffering from endowment effect, money illusion, etc.

      Also, if the opportunities for arbitrage (starting your own pig farm) are limited, then prices aren't efficient.

      Delete
  3. O/T: Jason, have you read this Sumner post featuring Zimbabwe and the ease with which they can keep NGDP growing?

    He seems to be implying that since CBs can cause hyperinflation, then they can successfully target any NGDP they like. Something you and I have discussed before I know.

    ReplyDelete
    Replies
    1. It is possible the could under a hyperinflation scenario target n = i + r (growth). But they'd either

      1. Must realize that i will be larger than they think next period (accelerating inflation)
      2. Use the ITM to figure out how much bigger i will be in the next period

      The hyperinflation solution creates accelerating inflation so you'd have to print les and less money. At some point printing a single Zimbabwe dollar will cause more inflation than you want.

      At least in the ITM. If you start targeting some aggregate, it might throw you off the hyperinflation solution, though.

      Delete

Comments are welcome. Please see the Moderation and comment policy.

Also, try to avoid the use of dollar signs as they interfere with my setup of mathjax. I left it set up that way because I think this is funny for an economics blog. You can use € or £ instead.