Maximization, learning, and economic behavior

Abstract

The rationality assumption that underlies mainstream economic theory has proved to be a useful approximation, despite the fact that systematic violations to its predictions can be found. That is, the assumption of rational behavior is useful in understanding the ways in which many successful economic institutions function, although it is also true that actual human behavior falls systematically short of perfect rationality. We consider a possible explanation of this apparent inconsistency, suggesting that mechanisms that rest on the rationality assumption are likely to be successful when they create an environment in which the behavior they try to facilitate leads to the best payoff for all agents on average, and most of the time. Review of basic learning research suggests that, under these conditions, people quickly learn to maximize expected return. This review also shows that there are many situations in which experience does not increase maximization. In many cases, experience leads people to underweight rare events. In addition, the current paper suggests that it is convenient to distinguish between two behavioral approaches to improve economic analyses. The first, and more conventional approach among behavioral economists and psychologists interested in judgment and decision making, highlights violations of the rational model and proposes descriptive models that capture these violations. The second approach studies human learning to clarify the conditions under which people quickly learn to maximize expected return. The current review highlights one set of conditions of this type and shows how the understanding of these conditions can facilitate market design.decisions from experience | mechanism design | contingencies of reinforcements | experience-description gap | reinforcement learning E conomics has long used idealized models of perfectly rational individual behavior as useful approximations for explaining market institutions and other economic phenomena. Many of the successful economic inventions (e.g., trading, commodity markets, auctions, matching market institutions) seem to work in ways that are well accounted for by rational models. For example, trading is most likely to be successful when all sides benefit from the trade. Careful empirical studies show, however, important violations of the rationality assumption (e.g., refs. 1-3). Thus, it seems that the usefulness of the leading economic analyses may be enhanced by relaxing the rationality assumption and improving the descriptive value of the underlying models, in part by identifying where the perfect-rationality approximations work more or less well and the purposes for which they may be more or less useful.Much of what has come to be called behavioral economics can be described as an attempt to make economic analyses more accurate by modifying the rational model to incorporate psychological insights. The most basic rational model, the expected value rule, models people as assigning cash equivalents to possible outcomes, and then selecting th...

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