Friday, June 25, 2004

Article: Rational Men and Women

Read what it means to be rational in economics.


Rational Men and Women

Economists have a particular view of the world. Specifically, economists assume human beings are rational.

That’s right, rational. If you are like most people, when you read the word “rational,” you sort of laughed. Most people believe there are enough irrational people out there to make the world kind of nutty at times. Most people—but not economists—equate rational with unemotional, calculating, reasonable, or logical. Irrational, then, becomes the same as emotional, uncalculating, unreasonable, or illogical.

But economists have a different meaning for the word “rational.” According to economists, a rational person is one who thinks and acts in terms of costs and benefits. Specifically, a rational person is one who tries to maximize his net benefits in life, or who seeks to maximize his utility or satisfaction.

Again, noneconomists tend to laugh. Do economists mean that human beings go around quickly calculating the costs and benefits of various activities and choose to only undertake activities where the benefits outweigh the costs? Well, yes, this is exactly what economists mean.

Instead of using argument to try to convince people that human beings are rational, economists have chosen a somewhat indirect approach to the subject. They build models to explain real-world events. Economists base their models on the assumption that people are rational; and then the economists have the rational people in their models act, choose, and think about real-world events. In other words, economists people the world of their models with rational individuals.

Now the models that economists build make predictions. If the predictions are validated by real-world data, economists then say: “See, we built a model and in that model we assumed people are rational—that they act and think in terms of costs and benefits and seek to maximize their net benefits. Our model then made certain predictions. We have collected relevant data, and the data validate the predictions. So, we conclude that if the predictions of a model based on rational individuals turn out to be true, then individuals must be rational.”

To illustrate the process, we’ll build a model based on a rational criminal. This rational criminal, we hold, thinks and acts in terms of costs and benefits. Furthermore, we hold that this criminal has two equations in his head. The first equation relates to the benefits of committing a criminal act, and the second equation relates to the costs of committing a criminal act. We assume the criminal act is burglary. The first equation, the benefit equation, is:

EB = Ps x Loot

where EB is the expected benefits of burglary, Ps is the probability of successfully burglarizing a house (getting into and out of a house with the goods), and Loot is the dollar take.

The cost equation looks like this:

EC = Pp x (I + F) + AC

where EC is the expected costs of burglary, Pp is the probability of imprisonment, I is the income the criminal gives up if caught and imprisoned, F is the dollar value the criminal puts on freedom (how much the person would pay to stay out of prison), and AC is the anguish cost of committing a burglary.

An economist would say that a criminal simply substitutes various numbers into the equations and then determines whether or not the expected benefits of the criminal act are greater than, less than, or equal to the expected costs. If the expected benefits are greater than the expected costs, the person commits the crime. If the expected benefits are less than the expected costs, the person does not commit the crime. And if the expected benefits equal the expected costs, the person flips a coin: Heads, commit the crime; tails, don’t commit the crime.

Let’s make up some numbers. Suppose the person sets the following numbers:
Ps = 80 percent
Loot = $400,000
Pp = 30 percent
I = $80,000
F = $42,000
AC = $3,000

When we substitute these numbers for the variables in our two equations, we find that the expected benefits (EB) equal $320,000 and the expected costs (EC) equal $39,600. With these numbers, the person goes ahead and commits the crime.

Now our simple two-equation model of a rational criminal makes some interesting predictions. The model predicts that:

1. If people put more locks on their doors and install more security devices in their homes, the probability of success (Ps) will fall, lowering the benefits of burglary. And, lowering the benefits of burglary will lead to fewer burglaries.

2. If more police are on the streets, the probability of being arrested after committing a crime will rise, and the probability of being imprisoned (Pp) will rise too. Thus, the costs of committing a burglary will rise, and fewer burglaries will be committed.

3. During a recession, incomes usually fall and unemployment usually rises. Thus, the income one forfeits is usually lower during a recession than during boom times. Lower income foregone (I) lowers the cost of burglary, and thus will lead to more burglaries.

4. If prison became more severe (hard labor), a person would pay more to stay out of prison (F). Paying more to stay out of prison raises the cost of burglary, and fewer burglaries will be committed.

More predictions are possible, but you get the point. Just by raising or lowering the values of the different variables in the two equations, we can make predictions that are logically consistent with the model.

Now if we collect relevant data and find that all our predictions are true, we’d have to say that our model has some merit. And what kind of person does the model assume? A rational person.

Models constructed assuming that people are rational might predict accurately or might not. If they predict accurately, it is likely they do so because what they assume about people is correct. A rational choice model of crime that predicts accurately tells us something we might not have been willing to accept earlier: criminals—no matter how irrational, emotional, or unreasonable they seem to us—are rational individuals.

What the Economist Thinks
• Arguing about whether men and women are rational is useless because so many people misunderstand what it means to be rational. Instead, it is better to build a model based on rational men and women, make predictions based on the model, and then see whether or not the model predicts correctly.

• If the model based on rational men and women predicts correctly (especially if it consistently predicts correctly), then—and only then—can we reasonably believe that men and women are rational.

Questions to Answer
1. Some people say that love is not a rational activity. In other words people “in love” do not think in terms of costs and benefits. Do you agree or disagree? Explain your answer.
Answers may vary.

2. Smith smokes cigarettes and Jones does not, so obviously both persons cannot be rational. Comment.
Different behavior is not evidence that one person is rational and the other is irrational. People perceive costs and benefits differently. For the smoker, the benefits of smoking are higher than the costs; for the nonsmoker, the benefits of smoking are lower than the costs.

3. Can a person be unhappy and rational too? Why or why not?
Sure. For example, suppose Billy’s options are (1) be operated on or (2) die. We doubt that Billy is too happy with either option, yet he will likely consider costs and benefits when making his decision about what to do.

4. Some people are said to have a bad temper—they “fly off the handle easily” or get unusually angry over little things. Are people who have bad tempers irrational while people who do not have bad tempers rational?
People who have bad tempers are not irrational. Watch them closely. They usually fly off the handle easily with people who will accept their behavior, and they don’t fly off the handle with people who will not accept their behavior. People might lose their tempers with their friends but usually not with their bosses (who can fire them).

5. Can a person be rational and uninformed? Why or why not?
Yes. In fact, when the costs of becoming informed are greater than the benefits of becoming informed, it is rational not to be informed.

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