2: Critiques of Neoclassical Rationality

2: Critiques of Neoclassical Rationality

Behavioral economics fundamentally challenges the neoclassical model's core assumption of the homo economicus – a perfectly rational, self-interested agent with stable preferences, unbounded cognitive abilities, and flawless self-control. Critiques center on the empirical evidence demonstrating systematic deviations from this idealized model in real human behavior.

1. The first major critique targets unbounded rationality. Neoclassical theory assumes individuals effortlessly gather all relevant information, compute complex probabilities, and optimize decisions to maximize utility (or profit). However, Herbert Simon's concept of bounded rationality highlighted that cognitive limitations (time, information, processing power) make true optimization impossible. People instead rely on mental shortcuts (heuristics) which, while often efficient, lead to predictable and systematic errors (cognitive biases). Work by Kahneman and Tversky, like the famous framing effects and base rate neglect experiments, provided overwhelming evidence that human judgment systematically violates the axioms of rational choice (like invariance and Bayesian updating), as seen in phenomena like the Allais Paradox.

2. Secondly, the assumption of pure self-interest is contested. Neoclassical models typically ignore social motivations. Experiments like the Ultimatum Game reveal that individuals strongly value fairness, reciprocity, and punishment of unfair behavior, even at a personal cost. People reject objectively beneficial offers if perceived as unfair, contradicting pure profit maximization. Similarly, real-world behaviors like charitable giving or costly punishment in public goods games demonstrate the importance of social preferences.

3. Thirdly, the critique addresses unbounded willpower and stable preferences. Neoclassical models assume individuals consistently act according to their long-term goals. Evidence of time inconsistency, however, shows preferences reversing as the moment of choice approaches. People heavily discount the future in the short term, leading to procrastination, undersaving, and addiction – behaviors explained by models like hyperbolic discounting, contradicting the exponential discounting assumed in neoclassical theory. This reveals a conflict between short-term desires and long-term intentions, implying imperfect self-control.

4. Finally, critiques highlight the methodological limitations of relying solely on revealed preference (inferring preferences only from choices). If choices are systematically biased or context-dependent, revealed preference becomes unreliable for inferring true welfare. These collective critiques established that the neoclassical model, while elegant, is descriptively inaccurate. Understanding the actual psychological mechanisms driving economic decisions became the imperative, forming the bedrock of behavioral economics.