TCS Daily

Sound Assumptions

By Donald Boudreaux - June 21, 2004 12:00 AM

The most hackneyed justification for dismissing economic analysis is the alleged unreality of the assumptions that economists use as bedrocks for their analyses. "Silly economists!" exclaim opponents of policies that enjoy widespread consensus among the intellectual heirs of Adam Smith -- policies such as free trade, eliminating price controls, and avoiding government protection of monopolies. "They build their theories on such absurd assumptions about human behavior that all conclusions they draw are untrustworthy. Honestly, are people really rational and self-interested? Ha, ha, ha, ha!"

While some economists carelessly mischaracterize the basic assumptions underlying their theories, and a few others intentionally use assumptions that wiser thinkers recognize as indefensible, ordinary, workaday, basic economics rests upon assumptions about human behavior that no one who understands these assumptions rejects as absurd.

Take the assumption that people are rational. It is not an assumption that people are emotionless automata like Star Trek's Mr. Spock. Nor is it an assumption that emotions never distort decision-making, or that people are omniscient. It is merely the following three-pronged understanding that the typical human adult

- is goal-oriented
- learns
- has preferences that are transitive.


To be goal-oriented means that each of us acts to achieve ends of our own choosing. For each person, the goal might be noble; it might be depraved. It might be a long-standing goal; it might be one just alighted upon and soon to be replaced by another goal. The content and stability of goals are not central to the assumption of rationality. All that is required is that each of us acts purposefully most of the time.

If you doubt that people generally act purposefully, next time you're in a supermarket observe your fellow shoppers. You'll not see a single one (above the age of two) tossing items randomly into her shopping cart. Instead, each shopper has some idea of what she wants and how much money she wishes to spend. She chooses which items to buy in a way that, in her judgment, best fulfills her plans. Likewise at the mall, at car dealerships, at any place that people spend resources -- even in Congress. People -- even Congresspeople -- act purposefully and not randomly.

People Learn

If I try a new ice-cream flavor and discover that I dislike it, I'm unlikely to try it again. If I notice that I especially enjoy reading novels recommended by my wife, I'm more likely to read novels that she recommends. I learn. And I'm not unusual. Each of us learns -- some more quickly than others, some more deeply than others -- but each of us learns. Each of us adjusts our plans and actions according to new information that we receive.

Transitive Preferences

Preferences are transitive when the following is true: If John prefers apples to bananas, and if he also prefers bananas to cantaloupe, then John prefers apples to cantaloupe. Despite the hoity-toity jargon, the concept is straightforward. It's also an assumption that clearly applies to everyone.

To see why, imagine if John's preferences are not transitive -- say, suppose he prefers apples to bananas, bananas to cantaloupe, and cantaloupe to apples. Gazing at the offerings of a fruit stand, John might first spot bananas displayed beside cantaloupe. "Oh, I like them both, but I prefer bananas to cantaloupe. I'll buy the bananas. But wait! Look at those apples! Because I prefer apples to bananas, I'll instead buy apples. But, wow, there are cantaloupes and I prefer cantaloupe to apples. I'll return the apples and instead get some yummy cantaloupe. But, hey! What about those bananas, which I prefer to cantaloupe, I'll skip the cantaloupe and get the bananas....."

This person would never reach a decision. He would, we say, "cycle" until and unless a conclusion is foisted on him by some outside force (such as the bananas and cantaloupe rotting away as our decision-nonmaker cycles endlessly).

Because we observe ourselves and others routinely making choices, we can be confident that at each decision-making moment each of us has transitive preferences.

That's it; that's all that the assumption of rationality embraces. And that's all that this assumption must embrace in order for basic economics to be valid.


What about the assumption of self-interest? It, too, is equally inoffensive. All that economists need to be true on this front is that each person generally cares more about himself, his loved ones, and his friends than he cares about strangers.

Economic theory does not require that each individual care exclusively about himself; it doesn't require that each individual have no concern for strangers. And it is certainly not an assumption that each person desires only maximum monetary wealth or material goodies.

Whenever I explain this assumption to audiences, I ask the following question to someone whom I have never before met: "Were I to plead a genuine need, could I have one of your kidneys?" Emphasizing that I want an honest answer, the answers I receive range from "no!" to "probably not."

I then ask this person "If your ill mother asks you for a kidney, would you give one to her?" The answer is always "yes!"

The answers ring true, for each of us knows that the typical person cares more about himself, his loved ones, and his friends than he cares about strangers.

So there you have it. The bedrock assumptions about human motivation that undergird basic economics -- hardly so wild or nutty as to justify dismissing all of economics. I assume that, from here on in, all critics of economics will keep these points squarely in mind.

The author is chair of the Department of Economics, George Mason University. You can find more of his writing at Café Hayek.


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