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http://ppe.sagepub.com/Politics, Philosophy & Economics
http://ppe.sagepub.com/content/3/1/59The online version of this article can be found at:
DOI: 10.1177/1470594X04039982
2004 3: 59Politics Philosophy EconomicsDennis C. Mueller
Models of Man: Neoclassical, Behavioural, and Evolutionary
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Models of man: neoclassical,behavioural, and evolutionary
Dennis C. MuellerUniversity of Vienna, Austria
abstractFor most observers of economics from both inside and outside the science, theterm economics is synonymous with neoclassical economics. It is the
methodology of neoclassical economics that defines the discipline of
economics. Mainstream economics is neoclassical economics and anyone
entering the discipline today who wishes to obtain an appointment at one of
the leading universities of the world is well advised to master its techniques.
The fact that virtually every winner of a Nobel prize from Paul Samuelson up
to his student Joseph Stiglitz has been a practitioner of neoclassical economics
is ample proof of the methodologys triumph. Despite the dominance of this
methodology, however, neoclassical economics has been subject to a steady
stream of criticisms and proposals for alternative methodological approaches
throughout its life. This article focuses on two relatively recent challenges to
the neoclassical orthodoxy that seem to have taken hold of a non-negligible
minority of the profession, some of whom can be found at leading
universities. These two challenges come from behavioural economics and
evolutionary economics. The article describes the strengths and weaknesses of
both of these methodological approaches and contrasts them with that of
neoclassical economics. It concludes that all three methodologies have
something positive to contribute to the study of human behaviour.
keywords neoclassical economics, behavioural economics, evolutionary economics
What is economics? The simplest definition is that economics is whatever econ-
omists do. Since economists do many things and use various methodologies in
their work, one might argue that there is no core methodology that defines eco-
nomics. Most observers of economics from outside the discipline (and many
from within it) would disagree with this statement, however. For many, the
politics,philosophy & economics article
DOI: 10.1177/1470594X04039982
Dennis C. Mueller is Professor of Economics at the University of Vienna, Institut fr
Wirtschaftswissenschaften, 1210 Wien, BWZ Bruehner Str. 72, Vienna, Austria
[email: [email protected]] 59
SAGE Publications Ltd
London
Thousand Oaks,CA
and New Delhi
1470-594X200402 3(1) 5976
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science of economics is synonymous with neoclassical economics, and it does
have a well-defined methodology. Indeed, it is this methodology thatdefines eco-
nomics.
When one scans the pages of the leading economics journals today one soon
reaches the conclusion that neoclassical economics has come to dominate the
discipline in the 100 or so years since it was invented.1 Every doctoral pro-
gramme in economics at the leading universities around the world consists
almost exclusively of courses that train students to use the tools of neoclassical
economics. Mainstream economics is neoclassical economics and anyone
entering the discipline today who wishes to obtain an appointment at one of the
leading universities of the world is well advised to master its techniques.
When one contemplates the achievements of neoclassical economics over the
past century, it is easy to understand its triumph over alternative methodologies.
The application of neoclassical techniques to the study of prices from Alfred
Marshall through to John Hicks and Paul Samuelson has contributed greatly to
our understanding of how markets function. Proofs that perfect competition canlead to a Pareto optimal allocation of resources are elegant defences of free-
market processes. In addition, neoclassical economics has been equally valuable
in explaining how markets can fail and describing the remedies that should be
applied to correct these failures. The fact that virtually every winner of a Nobel
prize from Paul Samuelson up to his student Joseph Stiglitz has been a practi-
tioner of neoclassical economics is ample proof of the methodologys triumph.2
If further proof is needed, it can be found outside the narrowly defined limits
of the field of economics. No leading law school in the USA today thinks that it
can get by without an economist or two on its faculty. Leading political science
departments also typically contain people who were either trained as economistsor who are conversant with and utilize the techniques of neoclassical economic
modelling. Anthropology, biology, and sociology have all been invaded,
although not yet conquered, by people who use the methodology of neoclassical
economics. Moreover, economists have even had the effrontery to take on the
philosophers and apply their analytic techniques to such questions as liberalism,
social justice, and fairness.3
Despite all of these obvious achievements, neoclassical economics has been
subject to a steady stream of criticisms and proposals for alternative methodo-
logical approaches throughout its life. Indeed, its birth in Vienna gave rise to a
tremendousMethodenstreitwithin the German-speaking economics community.My goal in this article is not to review the many criticisms of neoclassical
economics that have been made down through the years and the variety of alter-
native methodologies that have come forward. Instead, I shall focus on two rela-
tively recent challenges to the neoclassical orthodoxy that seem to have taken
hold of a non-negligible minority of the profession, some of whom can be found
at leading universities. These two challenges come from behavioural economics
and evolutionary economics.
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The next three sections take up in turn neoclassical, behavioural, and evolu-
tionary economics. In each section, I shall first briefly describe the main elements
of the methodological approach and then both its advantages and disadvantages.
The final section tries to draw some lessons from the preceding discussion for the
choice of an appropriate methodology for modelling man.
I. Neoclassical economics
A. MethodologyNeoclassical economics is built upon the bedrock of methodological individual-
ism. All modelling starts from the analysis of individual behaviour. Each indi-
vidual has goals, which can either be expressed as some sort of function or
axiomatically with a preference ordering. Each individual behaves rationally.
She maximizes the objective function; she chooses the outcome available to her
which stands highest in her preference ordering. Additional structure is given to
the analysis by assuming that the individual makes her choices subject to certainconstraints the consumer chooses quantities given fixed prices and a fixed
budget, and a firm chooses quantities with a given cost function and demand
schedule. Two distinct applications of neoclassical economic modelling are
commonly used today. The first applies calculus to determine the outcomes of
individual actions. In some applications, such as a consumers choice of con-
sumption items, only one equation need be solved the first-order condition of
the consumers utility-maximization decision. In others, a second equilibrium
condition is often imposed, as, say, market demand equals market supply, and the
analyst has a second equation with which to work. These two equations (the first-
order condition from the individuals maximization of her objective function andan equilibrium condition when all individual choices are aggregated) form the
basic building blocks for much analysis in neoclassical economics.4
The second important analytic technique in common use today in neoclassical
economics is game theory. Here, one must distinguish between what we might
call classical or forward-looking game theory and evolutionary game theory. As
the latters name suggests, evolutionary game theory comes much closer to evo-
lutionary economics and, indeed, as we shall stress later, in some respects is even
closer to behavioural economics. Classical game theory, on the other hand,
falls squarely into neoclassical economics. The individual is assumed to have a
clearly defined objective (to obtain the highest payoff for her in the game)and behaves rationally in trying to achieve this objective, in the sense that she
chooses the beststrategy for obtaining the highest payoff among the set available
to her. In much of the rest of neoclassical economics, the choice of objective for
the individual, that is, the specification of the function, is central to the problem.
The step of deriving the first-order condition is purely mechanical. In game
theory, it is the reverse. The analyst defines the payoffs and trivially assumes that
the individual wants the highest payoff. The non-trivial part of the analysis comes
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in trying to figure out which strategy is best and in what sense it is best. As in the
rest of neoclassical economics, an additional important issue in game theory is
whether there exists an equilibrium set of strategies for a game.
B. AdvantagesThe great advantage of neoclassical economics is the precision of its predictions.
Knowing the cost function of each firm and the demand function for the
industry, the analyst can predict what each firms output will be and, thus, what
the price of the product will be by assuming that each firm maximizes its profits
by choosing, say, output. The consequences of shifts in demand, changes in costs,
and changes in the number of firms in the industry can all be predicted with great
accuracy.
A second important advantage of neoclassical economics is that it is well
suited to both positive analysis, as in the example just given, and normative
analysis. Having determined the equilibrium price in the industry, the analyst is
able to calculate the potential welfare gain from increasing the number of firmsin the industry or the level of competition. A beautiful example of the application
of neoclassical economics to a normative question is Paul Samuelsons classic
article on public goods.5 In a mere four pages, Samuelson uncovers the essential
difference between pure public and private goods and illustrates the implications
of this difference for the problem of determining the optimal quantity of a public
good. It is applications such as this that have helped neoclassical economics take
almost full possession of the methodological terrain.
C. Disadvantages
The more accurate a theorys predictions, the easier it is for it to be rejected bythe data. Neoclassical economics Achilles heel is its frequent failure to account
for many phenomena that contradict its predictions. Critics of neoclassical eco-
nomics from theMethodenstreit to the present day have all stressed the seem-
ingly large gap between its predictions and what seems to exist in the real
world.
Example one A large swath of neoclassical economics over the past century has
been devoted to proving that demand schedules have negative slopes, first using
the assumption of diminishing marginal cardinal utilities, then of diminishing
marginal rates of substitution of ordinal utilities, and lastly using axioms ofrevealed preference. Yet large-scale econometric studies invariably produce
estimates implying an awkwardly large fraction of demand schedules with
positive slopes.6
Example two The heart of neoclassical economics is marginal analysis, which
follows directly from the assumption that individuals maximize some form of
objective function. The rational individual equates the marginal benefits of an
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action to its marginal costs. Starting at least as early as Hall and Hitch, a large
number of studies have questioned whether managers of firms set prices by
equating marginal revenue and marginal costs.7 Most of these challenges have
been empirically based. Observed pricing behaviour does not accord with the
prediction of marginal analysis. Most neoclassical economists have simply
ignored these sorts of criticisms, but interestingly, those who have tried to defend
neoclassical economics against this criticism have usuallynotsought to do so by
presenting counter empirical evidence. Instead, they have usually defended the
plausibility of the rationality assumption and have appealed to general economic
events that are consistent with neoclassical analysis: price rises following the
imposition of a tariff.8
Example three The development of experimental economics has created a rich
body of research testing various assumptions and predictions of neoclassical eco-
nomics. Much of this literature directly rejects these assumptions and predictions.
Two examples will suffice to illustrate this point. A basic tenet in the public-choice literature is that rational individuals willfree ride in situations where con-
tributions to the provision of a public good are voluntary. Countless experiments
have demonstrated that they do free ride, but to a far smaller degree than one
might have expected. If 100 is the contribution to the public good that produces
the optimum quantity of the good for the collective, and 1 is the contribution that
is individually optimal, then the typical finding in an experiment testing for free-
rider behaviour is that the mean contribution of the participants is around 50.
Some people do free ride, but many make contributions that are far larger than is
individually optimal. In aggregate, the total contributions fall far short of what
would be optimal for the group, but far above what pure free-riding behaviourwould produce.9
The second set of experiments involves the so-called ultimatum game. A fixed
amount of money, say US$20, is to be divided among two players. Player A gets
to propose a division, and B can either accept or reject the proposal. If B accepts
it, they are paid the amounts proposed by A. If B rejects the proposal, each
receives nothing. Rational self-interest on the part of both individuals leads to the
prediction that A will propose that she receives most of the money, say US$19,
and B will accept the proposed division, because getting US$1 is better than
getting nothing. Both predictions are routinely violated by participants in these
experiments. Those proposing the division are fairly generous to the otherplayers with mean divisions typically being around two-thirds for A and one-
third for B. Bs frequently reject low, but positive shares of the money.10
It is the results of experiments such as these, which have led many economists
to seek an alternative to the standard assumptions underlying neoclassical model-
ling. One such alternative is behavioural economics.
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II. Behavioural economics
A. MethodologyNeoclassical economics postulates that consumers maximize a utility function
defined over the set of consumption goods available to them, and that workers
maximize a utility function defined over their income and leisure. The assump-tion that individuals maximize utility functions follows essentially tautologically
from the premise of rational, self-interested behaviour. In this sense, neoclassical
economics is also behavioural, but it differs from what I am referring to here as
behavioural economics in that it typically assumes that all actors in a particular
situation maximize the same objective function, and the postulated objective
functions contain a fairly small number of arguments. Workers obtain utility only
from money and leisure; managers maximize profits; investors utility functions
contain only their wealth, and so on. Other assumptions (for example, that
managers pursue other goals than profits) are frequently dismissed as ad hoc.
There is nothing inherent in a methodological approach that assumes that indi-viduals maximize an objective function that requires that all people who apply
this methodological approach employ the same objective function for all people
in all situations, or limit themselves to a small set of objective functions. One
branch of behavioural economics (the one discussed in this section) breaks with
mainstream neoclassical economics by postulating different objectives for the
main actors from those commonly assumed in neoclassical economics, but in
other respects follows the same methodology as standard neoclassical eco-
nomics. Individuals are assumed to be maximizers.
A good example of what I refer to here as behavioural economics is Robin
Marris Economic Theory of Managerial Capitalism.11
The second chapter ofthis book contains a long review of sociological and psychological studies which
suggest that managers utility is more closely related to the growth of their firm
than to its profitability. Marris used this literature from outside of economics
to justify the assumption that managers maximize an objective function that
includes the growth rate of the firm. Marris theory looks like any other theory in
economics replete with first-order and equilibrium conditions. It differs from the
standard model of the firm only with respect to what it is that managers are
assumed to maximize. Nevertheless, Marris model and the other contributions to
the managerialist literature that appeared at that time and assumed that man-
agers pursued goals other than profit maximization were considered heretical by
mainstream neoclassical economists. Fritz Machlup, who had led the marginalist
counter-attack against non-marginalist theories of pricing, took the occasion of
his presidential address to the American Economic Association to defend the
assumption of profit maximization against the challenges posed by Marris and
the other managerialists.12
In 1986, I took the occasion of my presidential address to the Public Choice
Society to recommend a behaviouralist approach to modelling in the public-
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choice field. Public choice is, of course, nothing more than neoclassical eco-
nomics applied to politics. Every political actor (the voter, the politician, and the
bureaucrat) is assumed to be a self-interested, rational actor. This assumption
unfortunately leads to the prediction that a self-interested, rational voter will not
vote a not very well-supported prediction. To avoid this embarrassing predic-
tion failure, and others such as that regarding free riding discussed in the previous
section, I proposed abandoning the strong form of rationality assumption used in
neoclassical economics and public choice in favour of assuming that individuals
behaviour is conditioned by past rewards and punishments. Such operant condi-
tioning produces patterns of behaviour (often called habits) in which individuals
undertake certain actions such as voting because they have been rewarded for
undertaking similar actions in the past, or punished for not undertaking them.
By relying on behavioural psychology in this way, the social scientist is able
to retain the self-interest portion of the rational self-interest postulate. Individuals
seek to obtain rewards and to avoid punishment. Only the strong form of ration-
ality assumption must be relaxed, but even here it is not necessary to give up theanalytical advantages of assuming maximizing behaviour. Individuals can be
assumed to act as ifthey were maximizing a particular objective function. The
observed behaviour of individuals in voluntary-contribution-public-good experi-
ments and ultimatum games, for example, could be modelled by assuming that
an individual, i, maximizes an objective function of the following form:
Oi = Ui (i) + qi ji
Uj (Xj) (1)
An individual maximizes a weighted sum of his own utility and that of everyone
else. When modelling his behaviour when grocery shopping, it may be reason-able to assume that q is zero; in situations such as public-good experiments, a
more reasonable assumption may be that it is positive. In adopting such an
approach, the social scientist must make assumptions about both what goes into
the utility functions that are implicitly maximized (the Xi and Xj vectors in
Equation (1)) andabout the q-weight to be placed on the welfare of others. Here,
one can either rely on introspection (I get utility from seeing my friends become
happier and I assume everyone else does also) or more scientifically by examin-
ing the psychology and sociology literatures to see what they can tell us about
how individual preferences are formed. Experiments involving the ultimatum
game have revealed significant differences across cultures in the sizes of theoffers made by the first players and the willingness of the second players to
accept these offers.13 These experiments indicate the importance of social condi-
tioning in determining individual behaviour.
The salient feature of behavioural economics that differentiates it from main-
stream neoclassical economics is that it relies upon concepts and findings from
psychology and perhaps other social sciences to inform its assumptions about
what it is that individuals maximize, what goes into an individuals utility func-
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tion. Although it has probably had its biggest impact on the finance literature,
leading contributors to this growing field have also taken up a variety of other
questions.14
B. AdvantagesThe chief advantage of behavioural economics is that by relying upon a morecomplex and accurate description of individual preferences, it can explain
phenomena (even economic phenomena) that are poorly accounted for by the
more naive assumptions about individual preferences that characterize much of
neoclassical economics.
Example one Robert Frank presents considerable evidence that wage profiles in
firms and other institutions are much flatter than predicted by the marginal
productivity theory of wages.15 Citing works from psychology, sociology, and
philosophy, Frank develops the argument that people obtain satisfaction fromknowing that they are paid relatively more than their peers. Status is an impor-
tant component of an individuals utility function and thus high-productivity
workers are content with smaller increments in pay over the average, whereas
low-income workers must be given higher wages than their productivity levels
warrant.
Example two Throughout the 20th century the movement of stock prices has been
too large relative to future movements in dividends, if one accepts the hypothe-
sis that the markets expectations about future dividend movements are rational.16
Relying on psychological studies, Robert Shiller accounts for the wide swings inshare prices by arguing that investors exhibit herd-like behaviour, and are seized
by considerable over-optimism when share prices are rising and exaggerated
pessimism when they crash.17
Example three Public-choice scholars invariably assume that citizens vote to
advance their narrow self-interest. A voter supports a tax reduction only if she
stands to benefit personally from it. Survey evidence continually rejects this
assumption. Large fractions of the population support policy changes that harm
themselves, but benefit other members of the community.18 One way to account
for this kind of behaviour is to assume that citizens maximize an objective func-tion of the type depicted in Equation (1) when they vote withq > 0. John Hudson
and Philip Jones have provided a direct confirmation of this explanation.19 They
conducted two surveys of voters in Bath, UK. Voters were asked to comment on
different policy proposals regarding changes in taxes and expenditure on health,
education, and social benefits. Voters first identified their preferred policy, and
then stated (1) whether they thought that the policy would benefit themselves
personally and (2) whether they thought that the policy would be in the publics
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interest. From the answers to these questions Hudson and Jones inferred magni-
tudes of q of 0.66 for the 1988 survey and 0.73 for the 1992 survey.
C. DisadvantagesIntentionally flying an airplane into the side of a building is not what most
people regard as rational behaviour. One could, nevertheless, model such actions
assuming that the actor maximized an objective function that was a weighted sum
of his utility in this life and his utility in the afterlife. With enough weight placed
on the afterlife, the action becomes rational. Ex post, any behaviour can be made
consistent with the postulate of rational self-interest by appropriate modification
of the objective function to be maximized. The tautological nature of the assump-
tion of utility maximization raises the danger, if one takes too many liberties with
what goes into the utility function, of the existence of a plethora of behavioural
models, each one designed to explain individual behaviour in a particular situa-
tion. Neoclassical economics main advantage of being a unified and relatively
simple model of human behaviour that makes powerful predictions is lost. Thiscriticism of behavioural economics is taken up in the concluding section of this
article.
III. Evolutionary economics
A. MethodologyThe branch of economics commonly referred to as evolutionary economics can
legitimately be said to have been born with the publication of Nelson and
Winters An Evolutionary Theory of Economic Change.20 This book presents
both a broadside attack on standard neoclassical economics and an alternativemethodological approach to that which it criticizes. Nelson and Winter challenge
the two fundamental assumptions that underlie neoclassical economic modelling:
that individuals are rational in the sense that they maximize well-defined objec-
tive functions and that markets and other economic systems are in (or tend
toward) equilibrium. They thus propose replacing the first-order conditions that
one obtains from the assumption that individuals maximize well-defined objec-
tive functions with equations that represent the routines or rules of thumb that
people in the real world follow. A mark-up pricing rule is a good example of such
a rule of thumb.
Herbert Simon was also highly critical of the assumption that individuals con-sciously maximize specific objective functions.21 Growing out of his work there
developed the Carnegie school of economics.A Behavioral Theory of the Firm
by Richard Cyert and James March was an early product of this school.22 Cyert
and March modelled the behaviour of a specific firm using a computer program
which incorporated the various rules of thumb and routines that they observed in
the firm. Nelson and Winters approach is very much in line with this earlier
work of Simon and Cyert and March. They too rely heavily on computer pro-
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grams in their analysis. The equations embedded in these programs replace the
first-order and equilibrium conditions of neoclassical economics. The work of
Nelson and Winter differs from the earlier work of the Carnegie school mainly in
so far as they are concerned with the dynamic evolution of a firm or industry.23
Headings such as evolutionary economics, evolutionary game theory, and
even neoclassical economics itself are sufficiently broad that the kinds of
research they delineate covers a range of methodological styles. Not all scholars
who call themselves evolutionary economists, for example, go as far as Nelson
and Winter in abandoning the concepts of maximizing behaviour and equilibria.
The same breadth of styles exists in the general area of evolutionary game
theory. Some evolutionary game theory models, such as that of H. Payton Young,
can, however, be legitimately called a part of the broader field of evolutionary
economics.24 They too relax or entirely abandon the assumption of individual
rationality. They too rely on simulation techniques to derive results. Individuals
behaviour is often assumed to be adaptive and thus this approach is also often
compatible with the behavioural approaches described in the preceding section.Given a choice between two strategies,xandy, individuals will learn to playxif
it has been more frequently rewarded with higher payoffs in the past. Here, the
contrast with standard game theory is dramatic. Whereas a player in a standard
game is only concerned withfuture payoffs to the game as depicted in the matrix
she confronts, players in many evolutionary game models are always looking at
the past to see what the highest payoffs were.
Evolutionary game theory models have been used to demonstrate how indi-
viduals can learn to coordinate on particular pairs of strategies that provide
higher long-run payoffs to both players, and more generally how conventions and
mores can emerge over time. In this respect, some of the experiments involvingthe evolution of individual behaviour in repeated games might be classified
as part of behavioural economics, for these experiments often reveal how the
behaviour of individuals in later rounds of a game is conditioned by their rewards
and punishments in earlier rounds.25 Like behavioural economics, therefore, it
can fill important lacunae in the set of phenomena that economists have pre-
viously been unable to explain.26
Evolutionary economics differs from neoclassical economics both in the tech-
niques that it employs in its analysis and in the questions that it does and can
ask. A typical study in evolutionary economics might proceed as follows. First,
examine the rules of thumb managers use when making decisions about price,research and development, and so on. Then make reasonable assumptions,
perhaps based on empirical analysis, about the relationships among the key vari-
ables. How much increase in productivity is it reasonable to expect from a given
increase in research and development spending? Build these relationships into a
computer program and use it to simulate the course of development of an indus-
try in terms of its level of productivity, prices, industrial concentration, and so on.
Evolutionary game theory proceeds in much the same way, but it tends to con-
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fine itself to a much simpler set of relationships. First, a payoff matrix is written
down. Second, a rule of thumb is defined for each player choose the strategy
that has produced the highest average payoff over the previous 10 plays of the
game. Then the game is simulated. Evolutionary game theory differs from many
studies in evolutionary economics, however, in so far as it generally involves a
search for evolutionary stable strategies and thus for equilibria of sorts. For
example, Samuelson concludes in his recent survey of the literature on evolu-
tionary game theory that it provides qualifiedsupport for the proposition that
when stable strategies emerge in evolutionary games, they take the form of a
Nash equilibrium.27 He then goes on to observe:
I view the stability implies Nash result as putting game theory on much the same foot-
ing as the rest of economics. We do not believe that markets are always in equilibrium,
just as we do not believe that people are always rational or that firms always maximize
profits. But the bulk of our attention is devoted to equilibrium models either because
we hope that equilibrium behavior is sufficiently persistent and disequilibrium
behavior sufficiently transient that behavior that is robust enough to be an object of
study is (approximately) equilibrium behavior. . . . Evolutionary game theory thus
provides little reason to believe that equilibrium behavior should characterize all games
in all circumstances. But it provides reason to hope that behavior that comes into our
field of study is likely to be equilibrium behavior. In this sense, we obtain a stronger
motivation for Nash equilibrium than provided by rationality-based models.28
Thus, evolutionary game theory is, in fact, more akin to behavioural economics
than it is to the kind of evolutionary economics espoused and practiced by Nelson
and Winter and their followers. It abandons the strong-form assumption of
forward-looking, ultra-rational behaviour that underlies neoclassical economics
and replaces it with assumptions of adaptive or learned behaviour that resemblestrong-form rational behaviour, if and when equilibria emerge. Quite unlike evo-
lutionary economics, evolutionary game theory does not abandon the quest for
equilibria, but instead searches for, and often claims to find, the same sort of
equilibria that form the core of neoclassical theory.
B. AdvantagesThe advantage of evolutionary economics is that it can answer questions that
standard neoclassical economics is either unable to answer or answers with con-
siderable difficulty. As described above, standard neoclassical economics can
give a precise answer to the question of what the structure of an industry will betoday, given certain assumptions about firm cost schedules, demand, and so on.
It is not well suited, however, to describing how an industrys structure will
evolve over time as firms invest and innovate. Describing this sort of industry
evolution is the bread and butter of evolutionary modelling. Neoclassical eco-
nomics is in its own element when it comes to describing the properties of a
static equilibrium. Even neoclassical growth models which appear to model eco-
nomic dynamics, typically describe a form of static equilibrium moving through
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time. Evolutionary economics, in contrast, can describe the dynamics of an
industry or of a whole economic system.
C. DisadvantagesNeoclassical economics at its best can reveal the essence of a problem with a
simple analytical model. Consider, for example, the prisoners dilemma game. It
contains all of the essential ingredients of a neoclassical economic model. Both
players wish to maximize their payoffs. Both choose their best strategies. An
equilibrium ensues. Few models of human interaction are simpler, and yet the
game provides a great insight into the problems individuals encounter when they
interact.
All significant contributions to neoclassical economics provide similar
insights. Modern neoclassical economics has become highly mathematical, but
the truly important contributions today, as in the past, differentiate themselves
from ordinary contributions by the insights and intuitions that lie behind the
mathematics. Once one understands the logic of the prisoners dilemma or, say,Akerlofs (1970) lemons problem,29 one has an insight to human behaviour that
can be applied in one situation after another. Similar insights and intuitions are
more difficult to extract from evolutionary models. These models typically con-
sist of so many equations and assumptions that one is unable to discern the main
message of the model. Thus, the lasting contributions of many studies in evolu-
tionary economics, for example, that of Nelson and Winter, are not the actual
results that were obtained from the application of the methodology, but the
exposition of the methodology itself.
The bedrock of neoclassical economics is methodological individualism. In
much evolutionary modelling, the individual and her motivation almost dis-appear, however. The individual adopts routines and the aggregation of the
carrying out of these routines produces the outcomes of interest. The focus usu-
ally is much more on the aggregates (the industry, the system, and so on) than
on the individuals who ultimately produce the outcomes. In most evolutionary
models, individuals could be replaced by programmed robots without disturbing
the underlying logic of the model.30
In a standard application of neoclassical economics, the researcher derives
from the first-order condition for profit maximization a relationship for the price
cost margin of a firm. The theory can then be tested by comparing actual with
predicted pricecost margins. In evolutionary modelling, on the other hand, onereplaces the predicted relationship from the maximization exercise with an
assumed relationship in the form of a rule of thumb a pricecost margin equa-
tion. Often this assumption comes from observing actual pricecost margins.
Clearly, in this case, the theory cannot be tested in the same way as a theory
derived in neoclassical economics is tested. The proof of the pudding for evolu-
tionary models has to be how well they explain the macro-phenomena of
interest, say, the evolution of a system. Should the model not exhibit good
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explanatory power, it is often difficult to discern what part of the model is at
fault.
The last difficulty with evolutionary economics is that it is devoid of a norma-
tive component. However well it describes what it sets out to describe, it lacks
any means for judging whether the predicted dynamics of the phenomenon
modelled produce good or bad outcomes. To make such judgements one is
driven back to the normative toolkit of neoclassical economics (consumers
surplus areas or Pareto optimality) as are Nelson and Winter when they revisit the
Schumpeterian trade-off.31
IV. Conclusions
Which methodological approach is the best? The answer to this question depends
upon both the problems one wishes to study, and upon the person giving the
answer.
Consider, first, the problem of explaining the actions of specific individuals incertain situations. A social scientist who wishes to explain the behaviour of
individuals as consumers, workers, voters, bureaucrats, priests, politicians, stock-
brokers, soldiers, and drug addicts has a series of options. At one extreme is what
we might call the universal, rational actor model all individuals maximize an
objective function (O). The starkest form of such a model would have a single
variable in the objective function: all individuals maximize their own personal
wealth (W):
O = W (2)
A slightly more general version of this model would be that all individualsmaximize a utility function that includes wealth and one or two additional vari-
ables, depending upon the type of decisions being analysed:
O = U(W,X1,X2, . . .) (3)
Moving further away from the strongest version of a universal theory we would
have:
O = U(X1,X2, . . .) (4)
All arguments of the utility function are at the analysts discretion. Moving stillfurther, we have the approach suggested above to account for altruistic and
similar sorts of behaviour in situations in which this behaviour is anticipated:
Oi = Ui (Xi) +qi ji
Uj (Xj) (5)
When one takes into account that the analyst is also free to choose the shape of
the utility function and a set of constraints and auxiliary conditions under which
the maximization process takes place, one sees that an approach to modelling
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human behaviour that is universal in so far as it posits that individuals maximize
an objective function can be quite flexible.
At the other extreme of the methodological spectrum is a pure inductive
approach. The analyst who wishes to explain the behaviour of individuals in the
nine contexts listed above constructs nine different models, each one containing
the set of variables which best explains the behaviour of the group in question.
The choice of variables in each case is determined from an examination of the
relevant literatures in sociology and psychology, what has worked in previous
studies, or simple trial and error. As one adds more arguments to the objective
function, and more auxiliary assumptions, the power of the maximizing assump-
tion is diluted. Furthest removed from the top of the list are those who abandon
the maximization assumption entirely, and assume that individuals are guided by
rules of thumb, specific mores, or other sorts of prescripts.
Where each scholar chooses to place herself along the spectrum running from
Equation (2) to a pure inductive model is largely a matter of scientific taste
ones willingness to live with weak explanatory power in some situations for thesake of the cleanness and beauty of a simple, elegant model of human behaviour
versus ones desire for high explanatory power in all situations at the cost of
analytical consistency and clarity.
Earlier in this article we discussed several examples of behaviour, such as
voting and free riding, which cannot be well explained with a simple version of
the selfish, rational actor model. My proposal is to replace this model in these
situations with a model in which individuals act as ifthey were maximizing an
objective function that included their own utility and a weighted sum of everyone
elses utility. This model could be used to explain human behaviour in all situa-
tions, even those in which the traditional rational self-interest model does well,since it allows for the possibility that the weight on other peoples utility is zero.
My proposal would constitute a step away from the pure rational actor model,
but would retain some of the advantages of this approach by deriving clear pre-
dictions from the assumption of as if maximizing behaviour, predictions that
are subject to falsification. An experienced researcher would come to know when
it is reasonable to assume that an individual is likely to place a zero weight on the
utilities of other individuals, and when she is more likely to place a positive, or
perhaps sometimes a negative, weight on the welfare of others. Moreover,
because these weights are dependent on the past history of an individual, past
histories can be used to predict differences in these weights across individuals.Behavioural psychology is somewhat out of vogue now among psychologists,
and economists who resort to branches of psychology to enrich their models
often build on findings in the area of cognitive dissonance or some other
currently more popular field. All researchers working in the area of what I have
termed behavioural economics have in common, however, that they refuse to
abandon the assumption of maximizing behaviour. Their main focus is to specify
better what it is that is being maximized.
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Furthest removed from the pure rational actor model are the evolutionary eco-
nomics models. These often come close to being purely inductive in that the key
assumptions of the models are based on observations of what firms and indi-
viduals actually do, as captured in the assumed routines that they follow, and on
observed relationships between capital stock and output, research and develop-
ment and productivity change, and so on. This more inductive approach can be
justified by the more complex phenomena that the evolutionary economists wish
to describe the evolutionary developments of entire industries or economic
systems.
The choice among the three methodologies thus depends both upon the ques-
tions the researcher wishes to answer and the degree of complexity she wishes to
build into her behavioural models. For those who are content studying the tradi-
tional questions of economics (the properties of demand functions or the proper-
ties of competitive equilibria), the highly simplified and abstract models of
modern neoclassical economics will continue to be the methodology of choice.
For those who wish to extend the scope of economic modelling to explain thebehaviour of voters, politicians, bureaucrats, philanthropists, and so on, the
standard behavioural assumptions underlying most of neoclassical economics
will prove inadequate. These scholars can be expected to draw upon the rich
behavioural literature developed outside of economics to help inform them as to
what it is that individuals in these non-market situations maximize, and subject
to what constraints. Although these behavioural economists will have to sacrifice
some of the pristine simplicity of the traditional neoclassical models to obtain
better explanations of human action in different contexts, they do not have to
sacrifice the rigour that comes from assuming maximizing behaviour, if they do
not want to.Evolutionary economists will, indeed, usually wish to abandon the assumption
of maximizing behaviour. Their models must inevitably lack the precision that
comes from assuming individuals strive for the maximum that they can obtain,
and that economic and political markets reach equilibria. This feature will ensure
that many of those trained in the use of maximization models will be repelled by
the somewhat inelegant or complicated structure of evolutionary models. But
those scientists who are willing to live with such complexity are likely to con-
tinue to build their evolutionary models to describe a world which they see as
being every bit as complex as their models.
It seems clear to me that there is room for all three methodological approachesin the social sciences, and that all have something to offer in the way of increas-
ing our knowledge of human behaviour. The s in the word models in the title
of this article seems likely, therefore, to describe accurately the methodologies
that will be employed by social scientists for some time in the future.
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notes
I would like to thank Jonathan Riley and Geoffry Hodgson for comments on an earlier
draft of this article.
1. Some, such as Samuel Hollander in hisJohn Stuart Mill on Economic Theory and
Method(London: Routledge, 2000), might question just how radical an innovationneoclassical methodology was, but this need not concern us here. My arguments
still hold, even if neoclassical economics is regarded as a logical transition of
classical economics into the modern age.
2. This statement obviously hinges on ones definition of neoclassical economics,
which is taken up in Section I. The most obvious exception to this statement was
Herbert Simon, from whom I have stolen the first part of the title of this article.
3. See, for example, Jonathan Riley,Liberal Utilitarianism (Cambridge: Cambridge
University Press, 1988); Hal Varian, Equity, Envy, and Efficiency,Journal of
Economic Theory 9 (1974): 6391; William J. Baumol, Superfairness: Applications
and Theory (Cambridge, MA: MIT Press, 1986) and Ken Binmore, Game Theory
and the Social Contract I. Playing Fair(Cambridge, MA: MIT Press, 1994).Richard Posner has applied neoclassical economic reasoning to anthropology in A
Theory of Primitive Society, with Special Reference to Law,Journal of Law and
Economics 23 (1980): 153. Neoclassical economic reasoning has been applied to
biology (a discipline for which there is now even a journal devoted to this
methodological approach) by Jack Hirshleifer, Economics from a Biological
Viewpoint,Journal of Law and Economics 20 (1977): 152; Janet T. Landa,
Bioeconomics of Some Nonhuman and Human Societies: New Institutional
Economics Approach,Journal of Bioeconomics 1 (1999): 95113; and Janet T.
Landa and Michael T. Ghiselin, The Emerging Discipline of Bioeconomics: Aims
and Scope of theJournal of Bioeconomics,Journal of Bioeconomics 1 (1999):
512. James S. Coleman in his Foundations of Social Theory (Cambridge, MA:Harvard University Press, 1990) was a pioneer in introducing neoclassical economic
modelling into sociology. Examples from the fields of law and political science are
so numerous as to not require specific references.
4. Of course, there may exist several first-order conditions if the model contains
several sorts of actors: consumers, firms, regulators, and so on. Second-order
conditions can also be useful in some circumstances.
5. Paul Samuelson, The Pure Theory of Public Expenditure,Review of Economics
and Statistics 36 (1954): 3879.
6. See, for example, H.S. Houthakker and L.D. Taylor, Consumer Demand in the
United States, 2nd edn. (Cambridge, MA: Harvard University Press, 1970).
7. R.L. Hall and C.J. Hitch, Price Theory and Business Behavior, Oxford EconomicPapers (May 1939): 1245.
8. See, for example, Fritz Machlup, Marginal Analysis and Empirical Research,
American Economic Review 36 (1946): 51954, and for a fuller discussion and
additional references, Dennis C. Mueller, The Corporation and the Economist,
International Journal of Industrial Organization 10 (1992): 14770; reprinted in D.
Hausman (ed.), The Philosophy of Economics: An Anthology, 2nd edn. (Cambridge:
Cambridge University Press, 1993).
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9. The pioneering contributions to this strand of the literature were by Gerald Marwell
and Ruth E. Ames. See Gerald Marwell and Ruth E. Ames, Experiments on the
Provision of Public Goods I: Resources, Interest, Group Size, and the Free Rider
Problem,American Journal of Sociology 84 (1979): 133560; Experiments on the
Provision of Public Goods II: Provision Points, Stakes, Experience and the Free
Rider Problem,American Journal of Sociology 85 (1980): 92637.10. See, for example, Georg Kirchsteiger, The Role of Envy in Ultimatum Games,
Journal of Economic Behavior and Organization 25 (1994): 37389. This article
also contains additional references.
11. Robin Marris, The Economic Theory of Managerial Capitalism (New York: Free
Press, 1964).
12. Fritz Machlup, Theories of the Firm: Marginalist, Behavioral, Managerial,
American Economic Review 57 (1967): 133.
13. See the discussion and references to the literature in Theodore C. Bergstrom,
Evolution of Social Behavior: Individual and Group Selection,Journal of
Economic Perspectives 16 (2002): 6788.
14. For a recent survey of the behavioural finance literature, see Robert J. Shiller, FromEfficient Markets Theory to Behavioral Finance,Journal of Economic Perspectives
17 (winter 2003): 83104. Other important contributors include George Akerlof,
The Economic Consequences of Cognitive Dissonance,American Economic
Review 72 (1982): 30719; Robert H. Frank, Choosing the Right Pond(New York:
Oxford University Press, 1985); Robert H. Frank, Passions with Reason: The
Strategic Role of the Emotions (New York: Norton, 1988); Richard Thaler, Quasi
Rational Economics (New York: Russell Sage Foundation, 1991).
15. Frank, Choosing the Right Pond.
16. Robert J. Schiller, Do Stock Prices Move Too Much to be Justified by Subsequent
Changes in Dividends?,American Economic Review 71 (1981): 42136.
17. Robert J. Shiller,Irrational Exuberance (Princeton, NJ: Princeton University Press,2000).
18. Jeffrey W. Smith, A Clear Test of Rational Voting, Public Choice 23 (fall 1975):
5567; Paul N. Courant, Edward M. Gramlich and Daniel L. Rubinfeld, Why
Voters Support Tax Limitations Amendments: The Michigan Case,National Tax
Journal 33 (1980): 120.
19. John Hudson and Philip R. Jones, The Importance of the Ethical Voter: An
Estimate of Altruism,European Journal of Political Economy 10 (1994):
499509.
20. Richard Nelson and Sidney G. Winter,An Evolutionary Theory of Economic
Change (Cambridge, MA: Harvard University Press, 1982). As my discussant at the
workshop where this article was first presented, Geoffrey M. Hodgson, correctlypointed out that Thorstein Veblen might well be thought of as the inventor of
evolutionary economics. Veblens contributions to economics are largely ignored
today, however, by both those working in the mainstream and those in
evolutionary economics. See Thorstein B. Veblen, The Theory of the Leisure Class:
An Economic Study of the Evolution of Institutions (New York: Macmillan, 1899);
The Place of Science in Modern Civilization and Other Essays (New York:
Huebsch, 1919).
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21. Herbert A. Simon,Models of Man (New York: Wiley, 1957).
22. Richard M. Cyert and James G. March,A Behavioral Theory of the Firm
(Englewood Cliffs, NJ: Prentice Hall, 1963).
23. For a recent survey of the literature on evolutionary economics that focuses on the
evolution of firms and industries, see Richard R. Nelson and Sidney G. Winter,
Evolutionary Theorizing in Economics,Journal of Economic Perspectives 16(2002): 2346.
24. H. Peyton Young, The Evolution of Conventions,Econometrica 61 (1993): 5784.
25. See, for example, Raymond Battalio, Larry Samuelson and John van Huyck,
Optimization Incentives and Coordination Failure in Laboratory Stag Hunt Games,
Econometrica 69 (2001): 74964. See also the discussion in Larry Samuelson,
Evolution and Game Theory,Journal of Economic Perspectives 16 (2002): 4766.
26. See, for example, Robert Sugden, The Evolution of Rights, Cooperation and
Welfare (New York: Basil Blackwell, 1986); Karl Warneryd, Conventions,
Constitutional Political Economy 1 (1990): 83107; Michihiro Kandori, George
Mailath and Rafael Rob, Learning, Mutation, and Long Run Equilibria in Games,
Econometrica 61 (1993): 2956; Young, The Evolution of Conventions.27. Samuelson, Evolution and Game Theory.
28. Ibid., pp. 589.
29. George Akerlof, The Market for Lemons, Quarterly Journal of Economics 84
(1970): 488500.
30. Some critics of neoclassical economics might argue that homo economicus also
behaves like a robot.
31. Nelson and Winter,An Evolutionary Theory of Economic Change, Ch. 14.
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