Explanation, rationality, and microeconomic theory

Abstract

The microeconomic theorist attempts to explain the behavior of markets as resulting from the aggregation of the effects of actions of individual economic agents engaged in rational pursuit of the ends they have in view. Commonly, the conception of rational action employed in this enterprise is the one provided by decision theory. Because it cannot take into account information about how agents conceive the actions open to them and their possible outcomes, the decision-theoretic picture of rational action is a partial model. Partial models are subject to limits on their applications. Herbert A. Simon has argued that computational complexity considerations are sufficient to show that the limits on the application of the decision theoretic model to economic questions must be severe. Recent experimental investigations have begun to provide concrete information about those limits. Detailed examination of experiments concerning what is commonly called “the preference reversal phenomenon” leads to the conclusion that people do not have complete preference orderings for amounts of money and risky assets, even in situations which are much simpler than those encountered in real economic life. Since it is a fundamental assumption of orthodox microeconomic models that such orderings exist, such models are radically defective. Consequently, a different basis for microeconomic theorizing is needed. It is methodologically misguided to argue against this conclusion by pointing out that no other known basis accounts for the range of phenomena which the orthodox model does seem to explain.

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