When I teach the concept of rational decision-making in my ECONS102 class, we quickly move onto talking about many of the ways in which rationality fails to represent 'real-world' decisions made by real people. This draws on decades of insights from behavioural economics, and I group those insights together into four areas: (1) heuristics (or rules of thumb); (2) present bias; (3) loss aversion; and (4) framing. Within each category there are several biases that we can discuss. However, that barely scratches the surface of the hundreds of biases that psychologists, behavioural scientists, and behavioural economists have identified (see this list on Wikipedia).
Yet, despite all of these biases that are known, the rational behaviour model persists in economics. The reason why the model persists is because there isn't a better single model that captures the biases, as well as the occasions when people do act rationally. We need a better model.
On the Works in Progress site, Jason Collins has an incredibly insightful article along these lines. He draws a fascinating parallel with early astronomy:
From the time of Aristotle through to the 1500s, the dominant model of the universe had the sun, planets, and stars orbiting around the Earth.
This simple model, however, did not match what could be seen in the skies. Venus appears in the evening or morning. It never crosses the night sky as we would expect if it were orbiting the Earth. Jupiter moves across the night sky but will abruptly turn around and go back the other way.
To deal with these ‘anomalies’, Greek astronomers developed a model with planets orbiting around two spheres. A large sphere called the deferent is centered on the Earth, providing the classic geocentric orbit. The smaller spheres, called epicycles, are centered on the rim of the larger sphere. The planets orbit those epicycles on the rim. This combination of two orbits allowed planets to shift back and forth across the sky.
But epicycles were still not enough to describe what could be observed. Earth needed to be offset from the center of the deferent to generate the uneven length of seasons. The deferent had to rotate at varying speeds to capture the observed planetary orbits. And so on. The result was a complicated pattern of deviations and fixes to this model of the sun, planets, and stars orbiting around the Earth.
Instead of this model of deviations and epicycles, what about an alternative model? What about a model where the Earth and the planets travel in elliptical orbits around the sun?
By adopting this new model of the solar system, a large collection of deviations was shaped into a coherent model. The retrograde movements of the planets were given a simple explanation. The act of prediction became easier as a model that otherwise allowed astronomers to muddle through became more closely linked to the reality it was trying to describe...
Behavioral economics today is famous for its increasingly large collection of deviations from rationality, or, as they are often called, ‘biases’. While useful in applied work, it is time to shift our focus from collecting deviations from a model of rationality that we know is not true. Rather, we need to develop new theories of human decision to progress behavioral economics as a science. We need heliocentrism.
Once you hear it explained, the parallel between early astronomy and current economic theory is obvious. As Collins observes (and I encourage you to read his entire article), we need a new model. We can continue to investigate cognitive biases, and make minor ad hoc adjustments to models and policies to try to take account of the latest biases. However, as long as the underlying model is rational behaviour, we are going to continue to lack a proper understanding of human decision-making.
We need a model where cognitive biases are no longer exceptions to the model, but are instead explained by the model itself. It sounds obvious, but it's going to take a spark of genius. Where is the Copernicus of economics?
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