Introduction to Behavioral

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Behavioral perspectives on economic rationality

Psychologists tend to take a different approach to rationality. For example, according 

to Baumeister (2001): ‘A rational being should pursue enlightened self-interest.’ This 

defi nition draws attention to three crucial concepts: ‘enlightened’, ‘pursue’ and ‘self-

interest’.  However, it is only a starting point, since all of these concepts need further 

examination.

First, the description ‘enlightened’ implies that an individual has perfect 

knowledge, something that is obviously not realistic. Sometimes the term ‘long-run 

self-interest’ is employed, which is defi nitely more useful, since we will observe many 

instances of confl icts between short-run and long-run considerations. However, an 

even more useful qualifi cation in this context is the term ‘perceived self-interest’. Many 

behavioral economists take the view that if we misjudge what is in our self-interest then 

this is not a failure of rationality; it may not even be a failure of ‘bounded rationality’, 

as we will explain shortly. There may be many reasons why we fail to judge what is in 

our ‘self-interest’ (leaving until later a discussion of how this term can or should be 

interpreted). We may have incomplete knowledge or we may have cognitive failures in 

terms of the processing of information within given time constraints. These failures are 

often ascribed to ‘bounded rationality’, and behavior that fails to achieve self-interest 

because of bounded rationality is therefore not irrational according to this criterion.

We now need to focus on a second concept: Is pursuing the same as maximizing? 

The standard model is a normative model in the prescriptive sense of achieving 

optimality because it equates pursuing perceived self-interest with maximizing 

expected utility. Again the constraints of bounded rationality are relevant. The work 

of Kahneman and Tversky in particular concludes that people tend to take a 

heuristic 

approach to decision-making. The term ‘heuristic’ means that people use simple 

‘rules-of-thumb’, often unconsciously, in order to make decisions when there is a lot 

of information involved, much uncertainty, and a realistic time constraint. Thus we 

may have a personal rule always to pay by cash for purchases of less than $100, even if 

we have a credit card handy. Sometimes this can result in inconsistent or incoherent 

behavior, as we will see shortly, particularly in the various examples of preference 

reversals. What can be said at this stage is that bounded rationality is not concerned 

with optimality, or even sub-optimality; the heuristics involved in the decision-making 

processes of bounded rationality are more related to ‘

satisfi cing’.

What about cases where we misjudge what is in our self-interest even according to 

the more forgiving criterion of bounded rationality? Such instances tend to relate to 

the infl uence of ‘self-serving’ biases, discussed in Chapter 4. An often-quoted example 

of 

self-serving bias is the ‘above-average’ effect: well over half of survey respondents 

typically rate themselves in the top 50% of drivers (Svenson, 1981), ethics (Baumhart, 

1968), managerial prowess (Larwood and Whittaker, 1977), productivity (Cross, 1997) 

and health (Weinstein, 1980). Some economists and psychologists would claim that 

such acts are irrational.

We can now move on to the third concept; the term ‘self-interest’ also lends itself 

to different interpretations. Economists have traditionally measured this concept in 

terms of utility, where utility is a measure of subjective value. With the formalization 

of rational choice theory in economics, it assumed a technical shorthand for underlying 

preference orderings that obey the rationality axioms. 

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There is another aspect that merits discussion in this context. Arguably, actions 

where no deliberation is involved, sometimes called instinctive, are neither rational 

nor irrational. These actions tend to occur on the spur of the moment, like ducking a 

fl ying object likely to cause harm. Such actions are sometimes referred to as 

arational. 

Of particular relevance here are experiments carried out by Libet (1983 et al.; 1985; 

1993). These showed that brain electrical activity occurred at a signifi cant  interval 

(about 300 milliseconds) before conscious willing of fi nger movements. There has 

been much speculation and criticism regarding Libet et al.’s research fi ndings and their 

interpretation, in particular regarding the suggestion that our sensation of conscious 

will as a cause of action is an illusion (Wegner, 2002). Wegner and others hold the 

view that the sensation of will is not the real cause of our actions, but is merely an 

accompanying or following phenomenon, or 

epiphenomenon in philosophical terms.

The implication of this would be that many or indeed all of our actions may be 

arational in terms of not being caused by any kind of conscious deliberation. This is 

not to assert that conscious deliberation does not take place in many cases, but raises 

the possibility that, contrary to our intuitions, such deliberation merely accompanies 

events rather than causing them. Wilson, Lindsay and Schooler (2000) have proposed 

that we may have dual attitudes toward many things in our lives, one a rapid response 

and the other a more studied reaction that takes into account the context and our 

personal theory of what we ought to be feeling. Wegner (2002: 58) adds: ‘The conscious 

attitude will only govern our responses when we have had time to consider the situation 

and get past the automatic reaction.’

The preceding discussion introduces another factor into the consideration of 

rationality: Does rationality relate just to decision-making, involving choice and 

actions, or does it relate to attitudes and beliefs? In general, economists have tended to 

concentrate on decision-making and actions, while psychologists have often taken the 

view that, while decision-making involves deliberate choice, the formation of attitudes 

and beliefs may be beyond our conscious control, and therefore outside a discussion 

of rationality. If, as evidence like Libet’s experiments suggests, our decisions involving 

action are also outside conscious control, then attitude and belief formation can be 

claimed to be arational in the same way. 

This leads us to one other view of rationality that can be considered at this point. 

Sen (1990) is perhaps the best-known proponent of this view, stating:

Rationality may be seen as demanding something other than just consistency 

of choices between different subsets. It must, at least, demand cogent relations 

between aims and objectives actually entertained by the person and the choices 

that the person makes.

It may appear that this focus on the correlation between objectives and choices has 

the advantage that it no longer makes any assumptions regarding the nature of 

the objectives; these are simply taken as given. Sen thus considers the nature of 

our objectives to be outside the realm of rationality, on the grounds that people 

are concerned with more than wellbeing and happiness. The weakness in this view 

is that it takes an excessively narrow view of wellbeing. Our wellbeing does not just 

include material factors, it includes psychological aspects that relate to our emotions. 

Furthermore, these aspects are becoming easier to identify and measure using neural 

imaging.

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