The Irrationality of Rationality

[Invariance]

The Irrationality of Rationality.

I apologize for this being as long and as disorganized as it is – I began with several paragraphs, but the more I wrote, the more I needed to write! I have divided it up so that it is more readable.* Some of the maths symbols might have been altered by copying it from word. - Vinnie.

Introduction:

At the centre of modern micro-economic theory are its claims about rationality, and its depiction of the consumer as a utility optimizing, selfish creature (some economists such as Veblen have criticized this). I won’t bore you with the mathematical ‘proofs’ of these rationality and psychological assumptions (they are known as the ‘completeness’, ‘transitivity’, ‘non-satiation’ and ‘convexity’ assumptions). Essentially, the principle of rationality can be summed up in the statement: if aRc and bRc then aRc, which translated means ‘If our agent thinks that bundle a is at least as good as bundle b and that bundle b is at least as good as bundle c, then they also think that bundle a is at least as good as bundle c.’ This is all lovely, but isn’t really in dispute at this particular time (but will be when trying to aggregate demand from an individual and then it becomes very, very funny. But that’s a joke for another day). However, the rationality principle, as I will explain below, essentially assumes an undynamic, static and non-evolutionary view of consumer’s tastes which is up for criticism.

Optimization:

What I want to look at is the concept of optimizing – that consumers will choose, from a number of commodities, the bundle that best maximizes their utility (‘enjoyment’ in lay terms. Economists say that consumers can ‘ordinally measure’ the utility of a commodity in ‘utils’). The possible bundles are restricted by income – hence, consumers maximize their utility in what is known as the economically feasible consumption set (economists assume that consumers spend all their income, savings are a form of ‘delayed consumption.’)

Okay, here’s an example: let’s say there are two commodities – Marx’s Capital and a Che T-shirt (which any typical lefty is deemed to have). The possible combinations of these commodities (the bundles) are: 0 Capital, 0 Che-shirt; 1 Capital, 0 Che-shirt; 0 Capital, 1 Che-shirt and; 1 Capital, 1 Che-shirt. In other words, there are four possible bundles, of which one will maximize the consumer’s utility.

Okay what’s my point? My point is that let’s forget the guy on the corner who sells copies of Green Left and let’s go to a leftist supermarket. Suddenly, instead of being faced with two commodities we are faced with… a thousand – Lenin’s collected works, the writings of Trotsky, Mao’s little red books, and even the rarities of Enver Hoxha. Well, how many bundles do we have? Instead of writing each possible I’ll do the short-hand maths: the number of choices is equal to the number of units being considered + 1 to the power of how many goods. So, in our above model it was 2^2 = 4. If there was 3 goods, it would be 2^3 = 8 possible bundles.

1000 goods? Well, that would equal 2^1000. That seems like a small number – it isn’t. I’ll ‘spell’ it out for you:

10, 715, 086 , 071, 862, 673, 209, 484, 250, 490, 600, 018, 105, 614, 048, 117, 055, 336, 074, 437, 503, 883, 703, 510, 511, 249, 361, 224, 931, 983, 788, 156, 958, 581, 275, 946, 729, 175, 531, 468, 251, 871, 452, 856, 923, 140, 435 ,984 ,577 ,574 ,698 ,574, 803, 934, 567, 774, 824, 230, 985,421, 074, 605, 062, 371, 141, 877, 954, 182, 153, 046, 474, 983, 581, 941, 267, 398, 767, 559, 165, 543, 946, 077, 062, 914, 571, 196, 477, 686, 542, 167, 660, 429, 831, 652, 624, 386, 837, 205, 668, 069, 376

Yeah, it’s a big one.

How Big is Your Brain?

How big would your brain need to be to remember that many combinations? Well, let’s pretend that each neuron can remember the utility of 100,000,000,000 different bundles (I’m no brain scientist, but this sounds like a very optimistic assumption/myth!). The grey matter comprises about a kilo of your brain and contains 100,000,000,000 neurons, each weighing 1/100,000,000 grams. Following me?

So…how heavy would your brain be if it could remember that many combinations?

A) The weight of a normal human brain?
B) The weight of a small truck?
C) The weight of Earth?
D) The weight of the Universe?
E) Heavier?!

Well… it would weigh 10^244 times as much as the universe. Now people can justifiably call you big-headed, and vice-versa.

How Long Does It Take You to Shop?

Another question – how long would it take to optimize – i.e. recall the utility of each combination – supposing that we could recall the utility of a single bundle in 1/10,000,000,000,000,000,000,000,000,000,000,000,000 ,000,000,000,000,000,000,000,000,000,000,000,000,0 00,000,000,000,000,000,000,000,000th of a second (this is rather fast!)?

It would take 10^200 seconds. In other terms, 10^180 times the age of the universe. Raise this next time someone hassles you about your slow shopping habits.

Let’s be Rational:

Okay, enough fun with numbers. My point is, that the idea that consumers consider the utility of each particular bundle is patently false – and absurd – I dare say its irrational! Consumers do consider their budgets/income when deciding tastes (no thanks homothetic preferences!).

Neoclassical economics (in order to avoid the problems with aggregating individual demand curves) declared the golden principle of homothetic tastes. To quote my mircroeconomics book, Microeconomics – a Modern Approach, Andrew Schotter, 3rd ed., 2001, page 68:

‘When a consumer has homothetic preferences, all goods are superior and purchased in the same proportion no matter what the consumer’s income. In a world where all consumers have homothetic preferences, we might think of rich people as simply expanded versions of poor people. The tastes of such rich people do not change as their incomes change. They allocate their incomes exactly the way they did when they were poor. They just buy proportionally more of each good as their income grows.’

I hope you found that as humorous as I did when I first read it. In effect, Schotter is saying that if Bill Gates spent 10% of his income on pizza when he just another university computer science nerd, then he now spends 10% of his total income on pizza. In other words, he spends hundreds of millions on buying pizza for his own consumption.

Alternatively, the poor man who happens to get rich (we all know how often that happens!) did not change his spending habits at all – he still lives in a cardboard box (just an extremely large one). Likewise, the rich man spends the same amount he did on healthcare when he was poor – none. Going from the opposite direction, how many pieces of art work would a poor person have if they spent the same proportion that a wealthy person spends on art? A thousandth of a Mona Lisa?

It means that your spending habits will not change from when you are 16 to when your 60.

Clearly such statements are absurd and contrary to all empiricism. Yet for Neoclassical economics to work it essentially assumes that (1) there is only one consumer in society – or a endless number of drones and (2) there is only one commodity in society (I’ll cover that in another thread). This comes from the paradigm which asserts the uniqueness of the individual! The great theory that the market maximizes social welfare depends on these assumptions. It falls with them also.

To get back on point, we rely on habit, convention, culture, even flat-out ignoring / being ignorant of potential commodities – and a variety of things which may very well inhibit our ability to make utility optimizing decisions! When faced with such vast options we may use segmented optimizing – e.g. 100 possible combinations of food with a buy/not buy approach. Sure, there would still be 10^31 possible combinations, and your brain would still weigh about a million tonnes, but we’re getting there!

Optimisation: a good example of neo-classical economics using mathematics which are aesthetically pleasing but empirically laughable – time and what is physically/mental possible do matter.

Further Examination of Rationality Assumptions:

The Weak Axiom of Revealed Preference (WARP) stated that if a consumer chooses bundle A once when bundle B is also affordable, then the consumer will always choose A instead of B, regardless of relative prices. As Varian puts it: ‘If a bundle (x1, x2) is purchased at prices (p1, p2) and a different bundle (y1, y2) is purchased at prices (q1, q2) then if p1 x1 + p2 x2 ≥ p1 y1 + p2 y2, then it must NOT be the case that q1 y1 + q2 y2 ≥ q1 x1 + q2 x2. If the y-bundle is affordable when the x-bundle is purchased, the x-bundle must not be affordable.’

The Strong Axiom of Revealed Preference (SARP) was what I stated in the introduction– If (x1, x2 ) is revealed preferred to (y1, y2) and (y1, y2) is different from (x1,x2), then (y1, y2) cannot be directly or indirectly revealed preferred to (x1, x2). There is also a third axiom, known as the Generalised Axiom of Revealed Preference, which I won’t get into here, but is the weakest of the three.

How have these rationality assumptions held up to testing?

A test undertaken by Sippel attempted to replicate neoclassical standards. Ten sets of budgets and relative prices were presented. Consumers were to chose from 8 goods at each budget/price ratio, where the computer calculated the budget costs. The consumers were given a period of one hour to ‘optimize.’

The results weren’t good (for neoclassical economics).

The first experient contained 12 subjects, of which 11 of 12 subjects violated the SARP and WARP assumptions. 5 violated the weaker test GARP. The second experiment contained 30 subjects, of which 22 of the 30 subjects violated SARP and WARP, 19 of 30 violated the weaker GARP. The experiments conclusion: “We conclude that the evidence for the utility maximisation hypothesis is at best mixed. While there are subjects who do appear to be optimising, the majority of them do not… we … call the universality of the maximising principle into question.”

Other experiments have shown that consumers rely more on habit to reduce the vast array of potential choices – and hence do not optimise – or do not act ‘rational’ as the economist puts it. But it is not the consumer whom is acting irrationally, but the economists.

Undynamic Nature of Rationality:

When we take time into account, two of the four economic concepts of rationality (these four being, completeness, transitivity, non-satiation and convexity) fall into question – non-satiation and transitivity.

The principle ‘more is always preferred to less’ disregards time – two bannanas may be preffered to one, and three to two, but twenty bannanas to be consumed is not an ideal situation to be in . When we consider consumption as a function of time, anyone who behaves in what economists call ‘rational’ – preferring more to less – is a nutjob.

Likewise, a consumer may prefer bundle A to bundle B at one time, and yet at another time she may prefer bundle B to bundle A; consumer’s tastes cahnge. As Steve Keen says:

“Economists might protest that these comparisons are only valid when they are all made at the same instant, but that is precisely the problem: economic theory requires that everything happens at once, when in the real world an individual’s consumption is sequential, not simultaneous.”

Completness requires an impossible level of computation by the individual consumer. And lastly, as Keen points out:

“Convexity is also a by-product of the timeless analysis of consumption, which permits economists to ignore the manner in which the consumption of one commodity interacts with the consumption of another. Convexity implies that, to keep a consumer’s utility constant, it is necessary to subtract units of one commodity while adding units of another. But if the commodities are “sugar” and “tea”, and we are considering the act of drinking tea, then it is not true that a reduction in the amount of sugar can be compensated for by an increase in the amount of tea.”

The Scientific Status of Neoclassical Economics:

Schotter makes the claim:

‘If economic theories are correct, they should be verifiable or falsifiable in the lab. In other words, if the behaviour predicted by economic theory cannot be replicated in appropriately designed experimental setting, where human subjects make decisions under a set of monetary incentives that approximate those described by the theory, then the theory must be considered severely lacking.’

What a fantastic indictment of Popper’s falsifiability and unintended endorsement for Kuhn’s view of normal science as fundamentally dogmatic. Neoclassical economics has been replicated ‘in the lab.’ People were overwhelmed trying to optimize with just 8 commodities, taking over half an hour to reach a decision.

Unsuprisingly Schotter claims that

“Normative or welfare economics deals with what ought to be rather than what is and involves prescriptive statements that may be based on value judgement. Positive economics deals with what is rather than what ought to be and involves descriptive statements that are objective and verifiable.”

Marx once said that “no school of thought has thrown around the word ‘science’ more haphazardly then that of Proudhon, for ‘where thoughts are absent, words are brought in as convenient replacements.” I think Neoclassical economics is certainly a contender for that position – claiming to be a positive, non-biased, objective and verifiable discipline, all the while being naught but the most dogmatic religion.

(I would address alternative models for analyzing economic behaviour, but it is more appropriate elsewhere. Needless to say, neo-classical economics was a distinct departure/dissent from the classical (e.g Smith, Ricardo, Malthus) view of analyzing society from the viewpoint of classes – which Marx expropriated and turned it against its creators. Any model which takes into account classes – capitalists, workers, peasants, landlords - or even uses appropriate income groups not altogether removed from classes – is far likely to do a better job at analyzing aggregate market behaviour, rather than starting from the isolated individual. Marxists, post-Keynesians/neo-Ricardians, feminists, evolutionary economists take this approach.)

* I make no claim at being credited for pointing out the absurdity of this – the mathematics/humour is entirely borrowed from economist Steve Keen. Other experiments, which replicated neo-classical paradigm in all its splendour , showed that a consumer was overwhelmed in trying to optimize with just 8 commodities. I’m sure many of us can sympathize with that. Google the ‘curse of dimensionality’ for why.

[Cumannach]

Nice work.

You seem to know alot about bourgeois economic theory- can I ask you, are what are the theoretical explanations the give for 'Fair Trade' and 'buy local'?

[Invariance]

[FONT=Verdana]I have a basic understanding of why bourgeoisie economists oppose 'fair trade' (they argue that it takes the form of a subsidy and distorts the price mechanism of 'supply and demand' which must necessarily magically provide the best to society as a whole, which is largely nonsense since their model of supply and demand is nonsense).

I can explain the reasoning behind free-trade, or more importantly tell it like it is, from more of a political economy point of view, however. And I think its much more useful for Marxists to do so, as I'll show.

It largely started with an English economist called David Ricardo. The theory is known as comparative advantage. Let's first look at a situation of what is known as 'absolute advantage.'

Table 01: Output Per Unit of Labour

[/FONT] [FONT=Verdana] ____________Wine (gallons)_____ Cloth (yards)
England [/FONT] [FONT=Verdana] ____________4 [/FONT][FONT=Verdana]_________________2
Portugal __________ 8 [/FONT] [FONT=Verdana] _________________1[/FONT][FONT=Verdana]

So, in the production of Wine, England can produce 4 gallons per one unit of labour, whereas Portugal can produce 8 - Portugal has an absolute advantage in the production of wine, and England has an absolute advantage in the production of Cloth.

To demonstrate that trade will take place, its necessary to show that each nation could gain by trading by increasing their specialisation in either commodity. If England transfers a unit of labour from the wine to the cloth industry, and Portugal transfers a unit of labour from the cloth to the wine industry, the total output of both wine and cloth is increased while the same total quantity of labour is applied. Although the transfer of labour out of the wine industry in England reduces output by 4 gallons, the application of another unit of labour in the wine industry in Portugal increases output by 8 gallons, so that the total world production is increased by 4 gallons more (formerly 12, now 16). Likewise, while cloth output falls by 1 in Portugal, the added unit of labour in England increases output by 2 yards and the total production of cloth globally, by 1 yard. Thus, the total output of the world is larger as a result of transferring labour to the industries which have an absolute advantage.

Next, we need to determine if prices that would benefit both nations can be established by international trade. Let's say in England 1 yard of cloth would trade for 2 gallons of wine; the price of cloth is twice the price of wine. The English would be willing to trade cloth for wine if they could receive more than 2 gallons of wine for 1 yard of cloth. In Portugal the internal prices for wine would be 8 gallons of wine for 1 yard of cloth. If they could trade anything less than 8 gallons of wine and receive an exchange in 1 yard of cloth they would do so. Therefore, the international prices of wine and cloth would benefit both nations and both would gain from trading at prices between 7.9 gallons of wine for 1 yard of cloth and 2.1 gallons of wine for 1 yard of cloth.

But what about if a country has an absolute advantage over ALL of the production of commodities?

Table 02: Output Per Unit of Labour
[/FONT] [FONT=Verdana]
______________Wine (gallons)______Cloth (yards)
England [/FONT] [FONT=Verdana]_____________12[/FONT][FONT=Verdana]_________________ 6
Portugal____________ 8[/FONT][FONT=Verdana]_________________ 1[/FONT][FONT=Verdana]

Now England is more productive than Portugal in both commodities, hence, cost of production measured in labour time are less in England for both goods.

However, trade would still be good for both nations. It is not absolute, but comparative advantage that is the criteria for establishing whether trade is beneficial. Comparative advantage is determined by examining the relative productiveness within each economy. England's comparative advantage in cloth is demonstrated by the fact that in England, each output of additional labour to cloth means the loss of 2 units of wine (12/6 = 2). Portugal's comparative advantage in wine is indicated by the fact that in Portugal the loss of only 1/8 of cloth gains another gallon of wine, whereas England must give up 1/2 yard of cloth to produce another gallon of wine.

Moving a unit of labour from the wine to the cloth industry in Engalnd increases the output of cloth by 6 yards and decreases that of wine by 12 gallons. Transferring 2 units of labour in Portugal to the wine industry increases wine output by 16 gallons and decreases cloth output by 2 yards. The net gain from these transfers of labour in the two countries is 4 gallons of wine (16-12) and 4 yards of cloth (6 - 2). Hence, England can benefit from trade with Portugal, so long as Portugal has a comparative advantage in one industry. What is important is not the productivity of the English wine industry as compared to the Portuguese, but the opportunity cost of cloth of England as compared to the opportunity cost of cloth in Portugal. The opportunity cost of cloth in England (2 galleons of wine) is less than the opportunity cost of cloth in cloth in Portugal (8 gallons of wine) and the opportunity cost of wine in Portugal (1/8 of cloth) is less than that of England (1/2 yard of cloth). Thus, when England produces cloth and trades for the wine that Portugal produces, total world output is larger and both countries gain from trade.

What if England has an absolute advantage in the production of both commodities but a comparative advantage in neither?

Table 03: Output Per Unit of Labour
[/FONT] [FONT=Verdana]
_____________Wine (gallons)_______ Cloth (yards)
England___________ 12[/FONT] [FONT=Verdana]__________________ 6
Portugal___________ 8[/FONT][FONT=Verdana]___________________ 4[/FONT][FONT=Verdana]

The opportunity cost within each nation are the same - the opportunity cost of a yard of cloth is 2 galleons of wine and the opportunity cost of a galleon of wine is 1/2 yard of cloth. The relative prices of the two goods are the same in each country - 2 galleons of wine equals 1 yard of cloth (price of cloth divided by price of wine = 2). Hence, where opportunity costs are the same, neither country has a comparative advantage and trade will not be beneficial to either nation.

Yet behind simple maths and logic and 'national benefit' lies politics and class interests, and this is no exception. Ricardo's model was employed to defeat the Corn Laws, which put a tariff on the importation of grain. Hence, food prices were artificially high. The average from 1770-79 was 45 shillings, the highest it reached was during 1801 when wheat was selling for 177 shillings a quarter. The landlords wanted the tariffs to remain, to protect the high rents they could demand from farmers.

Conversely, Ricardo represented the capitalist class who were concerned with only one thing: profit. Since wages had to, as a bare minimum, keep workers alive, and hence feed them, a high price in grain and therefore bread, meant a higher wage. This necessarily put a damper on the extraction of profits and capitalist accumulation.

Ricardo was certainly not shy about hiding his views on this:
[/FONT] [FONT=Verdana]
[/FONT]

[FONT=Verdana] It has been my endeavour to [/FONT][FONT=Verdana]show[/FONT][FONT=Verdana] throughout this work, that the[/FONT][FONT=Verdana] rate of profits can never be increased but by a fall in wages, and that there can be no permanent fall of wages but in consequence of a fall of the necessaries on which wages are expended. [/FONT][FONT=Verdana]If, therefore, by the extension of foreign trade, or by improvements in machinery, the food and necessaries of the labourer can be brought to market at a reduced price, profits will rise.” [/FONT]

[FONT=Verdana](Ricardo 1817)[/FONT][FONT=Verdana]

Ricardo wasn't interested in efficiency of production, but shifting income distribution from landlords to capitalists to allow for a higher rate of capitalist investment and exploitation. Trying to equate the interests of a nation to its workers is a very hasty generalization, especially in capitalism.

So, for people who advocate fair trade - I'm not opposed to the idea, since it necessarily seeks to maintain a higher wage for the worker, rather than trying to decrease their wages to a minimum to increase profit. Is it a revolutionary aim? Nope. But there ain't much revolutionary about being paid 20 cents for a day's work either.
[/FONT]

[Cumannach]

Indeed, and the cynical principle underpinning this theory is of course, that a country like Portugal or any country with a lowly standard of production will never actually desire to change the state of their industry, that they will be content producing raw materials rather than desire to produce manufactures. And the only way of course to do this, to allow domestic industry to develop, is to protect it from foreign competition, with tariffs against imports (unfree trade).

If you read Ha-Joon Chang you'll see him refer to Friedrich List as the one who best pointed this out during the same period; that a country needs to put up barriers to foreign imports to develop it's productive industries- and that the reason England was so opposed to free trade was because she was far advanced beside any of her rivals, and didn't want them developing their own advanced industry and blocking English imports in the process. It's interesting to read Marx's review of List's book;

http://www.marxists.org/archive/marx...45/03/list.htm

Have you ever asked your professors;

'Well, if people are rational and selfish in buying commodities, why do they buy fair trade and locally produced goods?'

[Psy]

The Irrationality of Rationality.

I wonder how bourgeoisie economists get around Occam's Razor with marginalism. Since Marginalism makes way way way more assumptions then LTV and Occam's Razor states then when multiple competing hypotheses are equal in other respects that odds are it is the one with the least assumptions. For example a supreme being creating the universe goes against Occam's Razor as it raises far more questions (due to the huge number of assumptions) then the theory answers like how was the supreme being that created everything created. And in this case you have consumers comparing the utility on countless possible decisions or a case by case judgement on effort (labor) for return (use-value).

[Invariance]

Indeed, and the cynical principle underpinning this theory is of course, that a country like Portugal or any country with a lowly standard of production will never actually desire to change the state of their industry, that they will be content producing raw materials rather than desire to produce manufactures. And the only way of course to do this, to allow domestic industry to develop, is to protect it from foreign competition, with tariffs against imports (unfree trade).

If you read Ha-Joon Chang you'll see him refer to Friedrich List as the one who best pointed this out during the same period; that a country needs to put up barriers to foreign imports to develop it's productive industries- and that the reason England was so opposed to free trade was because she was far advanced beside any of her rivals, and didn't want them developing their own advanced industry and blocking English imports in the process. It's interesting to read Marx's review of List's book;

http://www.marxists.org/archive/marx...45/03/list.htm

Your point is well taken.

Of course, the comparative advantage theory which Ricardo outlines essentially argues that society can instantly and freely transfer capital from one sector of the economy to another by opening up free trade. More likely, it would be a process where prices fall, leading to the failing of businesses, leading to the selling or winding up of businesses, leading to the transfer of that probably diminished capital to the new industry, with all the problems that would bring to the working class; unemployment, workers former skills being made redundant etc.

Check this out for a critique of the model.

Have you ever asked your professors;

'Well, if people are rational and selfish in buying commodities, why do they buy fair trade and locally produced goods?'

Essentially they argue that non-selfish behaviour is impossible: ' People are interested in their own utility and make their choices with just that in mind...While this assumption does not rule out sympathy for other human beings, it tells us that sympathy does not influence the decisions that people make.' Try and make sense of that.

So, the bourgeoisie economists/ethicist would argue that in the example of free trade, the consumer purchases free trade coffee because it makes them feel better and suit their own selfish desires.

[Cumannach]

In other words they, divest the word 'selfish' of any meaning. 'Selfish' acts then are just those acts that you want to perform- but by definition, any action you perform is an action you want to do, thus every action is selfish thus a selfish action is just an action.

[cyu]

In other words they, divest the word 'selfish' of any meaning.

Quite a good summary