Today’s quotation of the day featured James Buchanan discussing the shortfalls of economic modeling in making policy decisions. His discussion focused around Homo economicus, the idea that human beings are perfectly rational, economically maximizing individuals. While this is a simple abstraction, useful in models, it does have limiting factors to it. But, from it, we can derive many useful insights on how humans maximize their utility (that is, satisfying as many wants as possible).
From Homo economicus, we derive many of the “laws” of economics. Aspects like the Law of Demand and Supply, marginal costs, marginal benefits, specialization, and exchange all arise from the study of Homo economicus. From these lessons, we can derive the utilization-maximizing function (marginal revenue = marginal cost), equilibrium results (quantity demanded = quantity supplied), indifference curves, and the like. The “Economics as a Science” side of economics.
Of course, the real world doesn’t act like that. People don’t go around, drawing indifference curves, calculating the marginal revenue and marginal costs every time they go to the grocery store. People are not Terminator, as a former professor of mine once said. But these calculations do go on, but at a more sub-conscience level.
Consider the following: You are playing catch with a friend in the park. Just a friendly game, tossing a baseball back and forth. Your friend tosses the baseball to you. Your mind and body, in fractions of seconds, calculates the speed of the ball, the angle of the throw, takes into account various external factors (such as wind) and estimates where the ball will be after T time passes. The end result is you raising your glove to catch the ball. In that short time, you become a physics machine, doing complex equations without even realizing it. Heck, you don’t even need to know the math you’ve done to do it! Physics is the science of trying to explain the actions taken during this game of catch. Physicists derive formulas to explain the various motions of you and your friend.
The situation is the same in economics. You go into the grocery store and see various items and various prices. Why do you choose to buy some items and not others? Preference, price, availability of various substitutes, etc all play into your thinking at an unconscious (and sometimes conscious) level. The indifference curves and Supply & Demand charts economists draw are a means of exploring and explaining these often sub-conscious items.
The idea of Homo economicus (and, perhaps its physics counterpart Homo physicus) is a simplification. It is not perfect. People will deviate from their prescribed outcomes. Clumsy me will miss the ball thrown at me. A person will make an impulse buy and regret it later. Deviations will occur. But the lessons we learn from Homo economicus are valuable in expanding human knowledge into the study of allocation of scarce resources. Great care must be taken both not to put too much emphasis on Homo economicus outcomes, but also not dismiss its usefulness.