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THE ROAD NOT TAKEN: HOW PSYCHOLOGY WASREMOVED FROM ECONOMICS, AND HOW IT MIGHT BE

BROUGHT BACK*

Luigino Bruni and Robert Sugden

This article explores parallels between the debate prompted by Pareto’s reformulation of choicetheory at the beginning of the twentieth century and current controversies about the status ofbehavioural economics. Before Pareto’s reformulation, neoclassical economics was based on theor-etical and experimental psychology, as behavioural economics now is. Current �discovered prefer-ence� defences of rational-choice theory echo arguments made by Pareto. Both treat economics as aseparate science of rational choice, independent of psychology. Both confront two fundamentalproblems: to find a defensible definition of the domain of economics, and to justify the assumptionthat preferences are consistent and stable.

One of the most significant developments in economics over the last two decades hasbeen the growth of behavioural economics, which draws on the theoretical andmethodological approaches of psychology in explaining economic phenomena.Behavioural economists take pride in grounding their explanations on empiricalhypotheses about how human beings really think and act, rather than on deductionsfrom a priori assumptions about rational choice, and in subjecting those hypotheses toexperimental test. Viewed in historical perspective, behavioural economists are tryingto reverse a fundamental shift in economics which took place from the beginning ofthe twentieth century: the �Paretian turn�.

This shift, initiated by Vilfredo Pareto and completed in the 1930s and 1940s by JohnHicks, Roy Allen and Paul Samuelson, eliminated psychological concepts fromeconomics by basing economic theory on principles of rational choice. From then tothe 1980s, almost all the main lines of development in economic theory were aimed atextending the power and scope of rationality-based models. For example, a majorconcern from the early 1950s was to extend the theory of rational choice to deal withrisk and uncertainty. The �microfoundations� and �rational expectations� literaturessought to replace the psychologically and empirically-based assumptions of Keynesianmacroeconomics with assumptions about the preferences and beliefs of rational agents.The new sub-disciplines of public choice, law and economics, and institutional eco-nomics extended rational-choice modelling to areas of social life that had previouslybeen thought of as non-economic. The work of John Harsanyi and John Rawls initiateda literature in which social philosophy was grounded in rational individual choice.Game theory, interpreted as modelling the strategic interactions of ideally rationalagents, was seen as the logical completion of rational-choice theory; there was awidespread hope that, by providing a universal theory of choice, game theory would

* An earlier version of this article was presented to a seminar at the Centre for the Philosophy of theNatural and Social Sciences at the London School of Economics. We thank the participants in that seminar,and Nicolo Bellanca, Ken Binmore, Robin Cubitt, Ivan Moscati, Chris Starmer and three anonymous refereesfor comments and advice. Robert Sugden’s work was supported by the Leverhulme Trust.

The Economic Journal, 117 (January), 146–173. � The Author(s). Journal compilation � Royal Economic Society 2007. Published

by Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

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unify the social sciences. Against this background, behavioural economics stands out asa counter-revolution.

Our premise is that there are significant parallels between current debates about thestatus of behavioural economics and the debate which surrounded Pareto’s reformu-lation of the theory of choice. By looking at those two debates together, we believe onecan arrive at a better understanding of the fundamental question that is at issue in bothof them: should economic theory be based on assumptions about human psychology oron assumptions about rational choice? Although we cannot help revealing oursympathies with the behavioural approach, our aim in this article is not to act asadvocates on its behalf. Rather, we aim to elucidate the arguments that can be made forand against these competing methodological positions.

In the official history of economics, the Paretian turn allowed the latent possibilitiesof neoclassical theory to be exploited, and paved the way for the achievements ofmathematical economics from the middle years of the twentieth century.1 From thestandpoint of behavioural economics, however, this change of direction was not soobviously progressive. It may have diverted economics from a path of developmentwhich would have been less sharply separated from psychology, in which the concernsof what is now behavioural economics might have been more central. That possibility –the �road not taken� of our title – provides the theme for our article.

1. An Overview of the Argument

It is a central claim of our article that, before the Paretian turn, neoclassical economicswas based on what was then state-of-the-art research on the psychology of sensation.Although this research programme became less fashionable among psychologists in thedecades after Pareto’s reformulation of choice theory, it is now recognised as anintegral part of psychology; its subsequent developments are drawn on by modernbehavioural economists and by psychologists who investigate judgement and decisionmaking. Thus, what we see as the �road not taken� is a potential continuation ofnineteenth-century neoclassical economics, leading in the direction of behaviouraleconomics.

In this respect, our interpretation of the Paretian turn – or of what Pareto turnedaway from – is unconventional. Commentators who see Pareto’s reformulation asprogressive usually interpret the psychological assumptions of earlier neoclassicaleconomics as unscientific and redundant.2 But even commentators who are unsym-pathetic with the economics initiated by Pareto often see little of value in theassumptions he sought to replace. Shira Lewin’s (1996) historical discussion of the roleof psychology in economics is an example of the latter type of interpretation. Cham-pioning a tradition which combines institutionalist economics, economic sociology andthe eclectic psychology of Henry James, Lewin sees pre-Paretian neoclassical economics

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1 This �official history� was first developed in the 1930s, when it seems almost as if there was a concertedeffort by a new generation of mathematical economists to induct Pareto into the hall of fame of economics.Significantly, the first issues of both Econometrica and Review of Economic Studies began with articles on Pareto.

2 This was the first interpretation of Pareto’s revolution in the theory of choice, that of Hicks and Allen(1934), Samuelson (1938) and Savage (1954). These works have determined subsequent readings of Pareto’sshift in relation to earlier psychological assumptions. For a review, see Bruni and Guala (2001).

� The Author(s). Journal compilation � Royal Economic Society 2007

as the first step down the wrong road of theoretical abstraction. On this account, Paretomerely substituted mathematical formalism for a mechanistic form of psychology whichwas already falling into disrepute among genuine psychologists.

If, however, we are right that nineteenth-century neoclassical economics rested ona viable programme of scientific psychology, the relationship between this form ofeconomics and Pareto’s is parallel to that between behavioural and rational-choiceeconomics. We might therefore expect similarities between the arguments used byPareto in support of his reformulation and the arguments now used to defend rational-choice theory against the behavioural challenge. Equally, we might expect similaritiesbetween the arguments made by Pareto’s opponents and those made in support ofbehavioural economics. In the course of the article, we will identify many such simi-larities between the two debates.

In each debate, the advocates of psychology in economics point to a successful pro-gramme of psychologically-based economic research. In each case, their opponents offeran alternative model of economics as a separate science, independent of psychology,whose theories are founded on deductive reasoning about the formal properties ofrational choice. We will give particular attention to those current defences of rational-choice modelling which use the concept of �discovered preference�, and to parallelarguments used by Pareto. The essential idea behind the discovered preference hypo-thesis is that rational-choice theory is descriptive of the behaviour of economic agentswho, through experience and deliberation, have learned to act in accordance with theirunderlying preferences; deviations from that theory are interpreted as short-lived errors.We will show that Pareto’s conception of economics as a separate science of �logical action�rests on a similar idea. There are corresponding similarities between the counter-argu-ments used by Pareto’s opponents and by current behavioural economists. These coun-ter-arguments identify significant problems for the discovered preference approach.

In Section 2, we provide evidence for our claims about the scientific status of thepsychological assumptions of neoclassical economics, prior to Pareto. We show thateconomists who followed this approach made serious attempts to use psychologicalprinciples in their work, and were aware of some of the limitations of conventionaltheory that are now part of the subject matter of behavioural economics. In the light ofthis interpretation of early neoclassical economics, Section 3 reviews Pareto’s argu-ments for separating economics from psychology. We note how narrowly Pareto has todefine the domain of economics in order to justify his approach, and how conscious heis of the need to show – and how difficult he finds it to show – that the conditions thatdefine logical action also ensure that each individual’s preferences take the form of anordering. In Section 4, we review the discovered preference defence of rational-choicetheory, and note parallels with Pareto’s arguments. Section 5 reviews the evidence forand against the discovered preference hypothesis. In Section 6, we look at some of themain criticisms that behavioural economists have made of the discovered preferencehypothesis, and show that these correspond with the difficulties faced by Pareto.

2. The Role of Psychology in Early Neoclassical Economics

The debate initiated by Pareto’s reformulation of choice theory took place against thebackground of an ongoing programme of research at the boundaries of economics and

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psychology. This programme was not, as behavioural economics is today, a self-consciously distinct branch of the discipline: it was a central component of neoclassicaleconomics. Neoclassical economics and experimental psychology were both relativelyyoung enterprises, and the boundary between them was not sharply defined. Accordingto what was then the dominant interpretation, neoclassical theory was based onassumptions about the nature of pleasure and pain. Those assumptions were broadlycompatible with what were then recent findings in psychophysics. Neoclassical econ-omists could and did claim that their theory was scientific by virtue of its beinggrounded in empirically-verified psychological laws.

In documenting these claims, we focus on three early neoclassical economists. Thefirst is William Stanley Jevons, whose Theory of Political Economy (1871/1970) is one ofthe canonical texts of the �marginal revolution�. The second is Francis Ysidro Edge-worth, whose Mathematical Psychics (1881/1967) is another canonical text, and is par-ticularly sophisticated in its use of current psychological research. Our third theorist isMaffeo Pantaleoni. Pantaleoni’s Pure Economics (1889/1898) is perhaps less originalthan the books of Jevons and Edgeworth; but Pantaleoni has particular relevance to ourarticle as a leading economist of his day who engaged in a prolonged debate withPareto.3

The usual methodology in economics at this time was John Stuart Mill’s concretedeductive method, by which theories about economic phenomena are arrived at bydeduction from a set of relatively simple empirical regularities or �laws� in which (itis claimed) the theorist can have great confidence.4 Some of these laws (forexample, the law of diminishing returns) were alleged properties of what would nowbe called production functions. Others – more important in the context of thisarticle – were alleged properties of human psychology. These laws were interpretedas tendencies in the human mind and in human behaviour – tendencies that are verygeneral and robust, but which interact with many other causal factors in deter-mining behaviour in any particular economic environment. Thus the theoriesdeduced from those laws, when applied in any concrete setting, could be expectedto generate only inexact predictions; but if the theories were used with suitableawareness of the factors that were not taken into account, their predictions wouldbe accurate to a reasonable degree of approximation in many applications. Mill(1843/1967, Book 6, Ch. 3, pp. 586–589) himself, in a chapter cautiously entitled�That there is, or may be, a science of human nature�, used the theory of oceantides as an analogy for explanation in social science. That theory explains the tidaleffects of the sun and moon on the basis of deductions from the laws of gravitation,while leaving out the more complex effects induced by the interaction of those lawswith particular oceanographical features. The early neoclassical economists, withmore grandiose scientific pretensions, drew analogies between theories of humanpsychology and pure mechanics.5

3 Throughout this Section, references to Jevons, Edgeworth and Pantaleoni are to these three books.4 For example, this method is endorsed explicitly by Jevons (pp. 87–91). Similarly, Pantaleoni defines

economics as �the laws of wealth systematically deduced from the hypothesis that men are actuated exclusivelyby the desire to realise the fullest satisfaction of their wants, with the least possible individual sacrifice� (p. 3).

5 The significance of analogies with physics in early neoclassical economics is discussed by Mirowski (1989).

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For the early neoclassical economists, economics rested on the fundamentalassumption that individuals act on self-interest. Thus, Jevons describes his theory as �themechanics of utility and self-interest� (p. 90); Edgeworth’s �economical calculus� beginswith the famous declaration that �The first principle of economics is that every agent isactuated only by self-interest� (p. 16). This assumption was not to be treated literally, asa claim about the actual motivation of all human beings in all situations. Rather, it was adefining characteristic of economics as a pure deductive science. It was intended torepresent a core tendency in human motivation, which (it was claimed) had a dom-inant influence in those areas of human life studied by economists. As Jevons put it,trying to justify his theory’s neglect of ethics, economics is concerned only with �thelowest rank of feelings� (p. 93). Pantaleoni offered an evolutionary justification forassuming self-interest, arguing that a powerful tendency to pursue pleasure and toavoid pain is implanted in our species by natural selection (pp. 9–16).

Given the assumption of self-interest, economic theories of behaviour were to bededuced from psychological laws about human wants, which in turn were understoodin terms of the pursuit of pleasure and the avoidance of pain. Pleasure and pain weretreated as sensations, of which the person who experiences them has direct knowledge.By introspection, and by the study of other people’s reports of their introspections, aninvestigator could arrive at knowledge of the laws governing pleasure and pain. For theneoclassical economists, the most significant of these laws concerned the relationshipbetween stimuli and sensations. In slightly different ways, these economists advancedthe hypothesis that, as the amount of any stimulus increases, the increment of sensationproduced by a given increment of stimulus falls. The law of diminishing marginal utility– that as consumption of any commodity increases, the increment of pleasure pro-duced by a given increment of consumption falls – was seen as a special case of thismore general law of psychology.

Thus, one of the most fundamental principles of neoclassical economics wasgrounded in a hypothesis about phenomena that are now seen as belonging to thedomain of psychology rather than economics. Consider, for example, the writer citedby Jevons as having �most clearly appreciated the nature and importance of the law ofutility�, Richard Jennings.6 Jevons quotes from Jennings’s book, Natural Elements ofPolitical Economy, published in 1855:

To turn from the relative effect of commodities, in producing sensations, tothose which are absolute, or dependent only on the quantity of each com-modity, it is but too well known to every condition of men, that the degree ofsensation which is produced, is by no means commensurate with the quantityof the commodity applied to the senses . . .

We may gaze upon an object until we can no longer discern it, listen until wecan no longer hear, smell until the sense of odour is exhausted . . . (quoted byJevons, p. 113)

6 In the preface to the 1879 edition of The Theory of Political Economy, Jevons acknowledges his recentdiscovery that Hermann Heinrich Gossen, in a book published in 1854, �has completely anticipated me asregards the general principles and method of the theory of economics�. Jevons characterises Gossen’s theoryas resting on a �natural law of pleasure� (p. 60–4).



As the second sentence in this quotation makes clear, this is a general hypothesisabout diminishing sensitivity to sensory stimuli, and not simply about tastes foreconomic commodities.

Contemporaneously with the development of neoclassical economics, the hypothesisof diminishing sensitivity was being formulated and tested by people who are now seenas founders of scientific psychology. Gustav Theodor Fechner proposed the revolu-tionary thesis that mental phenomena could be measured by finding quantitativerelationships between material stimuli and mental sensations. This idea was the foun-dation of the research programme of psychophysics. The publication in 1860 of Fech-ner’s book Elemente der Psychophysik is often considered as the birth of modernpsychology. Fechner’s work was based on a regularity found by the physiologist ErnstHeinrich Weber: the change in magnitude of a given stimulus that produces a justnoticeable change in sensation is proportional to the total stimulus. Treating a justnoticeable change as the unit of sensation, Fechner used this regularity as a method ofmeasuring the magnitude of sensations: according to the Fechner-Weber law, if stimulusincreases geometrically, sensation increases arithmetically. This research programmewas continued by Wilhelm Wundt, who is generally regarded as the first experimentalpsychologist. Wundt’s most influential book, Grundzuge der physiologischen Psychologie(1874) – published at the moment of the marginal revolution in economics – proposedthe scientific investigation of people’s introspections about their experiences ofconsciousness.

In understanding the relationship between psychology and economics at this time, itis important to recognise that, in both disciplines, introspection was treated as alegitimate source of data. The behaviourist movement in psychology, which denied thescientific status of introspection, dates only from the second decade of the twentiethcentury. (The founding text of behaviourism, John Broadus Watson’s paper �Psycho-logy as the behaviourist views it�, was published in 1913.) And in assessing, with thebenefit of hindsight, the potentialities of the nineteenth-century form of psychologic-ally-based economics, we must remember that the methodology of psychology is nolonger narrowly behaviourist.7 Modern psychology standardly uses �constructs� whichhave no directly observable correlates but which are treated as valid to the extent thatthey play a useful role in explanatory theories; constructs (such as happiness) whichrefer to individuals� affective states are in general use. The research programme ofpsychophysics initiated by Fechner is an integral part of modern psychology.

As many neoclassical economists noticed, the hypothesis of diminishing marginalutility of consumption can be interpreted as an implication of the Fechner-Weber law.8

Edgeworth was particularly aware of current work in psychophysics. Indeed, the title hechose for his major work, Mathematical Psychics, suggests that he saw it as a contributionto psychology as well as to economics. Edgeworth states as an axiom that �Pleasure ismeasurable, and all pleasures are commensurable�, by which he means not only that

7 It is perhaps unfortunate that �behavioural economics� has been adopted as the label for work at theinterface of psychology and economics. Behavioural economics is distinguished by an interest in actualbehaviour (as opposed to a normative ideal of rationality), but it is not behaviourist in the methodologicalsense.

8 More specifically, the Fechner-Weber law could be interpreted as supporting the hypothesis advanced byDaniel Bernoulli in the eighteenth century, that utility is a logarithmic function of wealth.



different sorts of pleasures felt by one person can be measured on a single scale, butalso that the pleasures of different persons are commensurable. The method he pro-poses to use to establish commensurability is �the Fechnerian method applied topleasures in general�: the interpersonal unit of pleasure is the just-perceivable incre-ment. Edgeworth appeals to the work of Fechner and Wundt to support his claim thatthis method is both theoretically valid and practically feasible. He then proposes thehypothesis that �The rate of increase of pleasure decreases as its means increase�; thework of Fechner, Wundt and other psychological researchers is cited as supportingevidence (pp. 59–62).

For a present-day reader, Edgeworth’s discussion of the determinants of pleasure hasa particularly interesting feature. Edgeworth proposes two distinct mechanisms ofdiminishing sensitivity to stimuli. The first is the hypothesis we have just described,which corresponds with the standard neoclassical concept of diminishing marginalutility of consumption. But in addition:

But not only is the function connecting means and pleasure such that theincrease of means does not produce a proportionate increase in pleasure; butthis effect is heightened by the function itself so varying (on repetition of theconditions of pleasure) that the same means produce less pleasure. (p. 62)

In other words, the function that specifies the amount of pleasure produced bydifferent quantities of consumption in any given period – the utility function forconsumption, as conventionally understood – shifts according to the individual’s con-sumption experiences in previous periods. The more a given pleasurable experience isrepeated, the less pleasure it gives.9 Edgeworth calls this the law of accommodation, whichhe attributes to the Scottish philosopher and psychologist Alexander Bain.10 Onceagain, Edgeworth cites supporting evidence from psychophysics, in this case concern-ing visual sensations (p. 62).

This second mechanism of diminishing sensitivity corresponds closely with one ofthe most important ideas in modern behavioural economics, that preferences are ref-erence-dependent (Tversky and Kahneman, 1991). If we take a person’s reference point tobe some weighted average of her previous consumption, Edgeworth’s hypothesisimplies that a person’s utility in any given period depends not only on the absolutequantity she consumes of each good in that period, but also on differences or ratiosbetween those quantities and the corresponding quantities at the reference point. Thepsychological concept of accommodation used by Edgeworth is essentially the same asadaptation, which present-day psychologists have used to explain reference-dependence(Kahneman and Varey, 1991, pp. 131–8). Adaptation is also one of the central ideas inthe now rapidly growing literature on the economic determinants of happiness. Itoffers an explanation of the otherwise puzzling fact that, while the self-reported hap-piness of individuals is positively correlated with income in within-country cross-sectionstudies, the long-run upward trend in per capita income in western countries over the

9 Pantaleoni makes the same distinction between the two forms of diminishing sensitivity, which heattributes to Gossen. However, he merges them into a single, conventional model of diminishing marginalutility (pp. 28–38).

10 Bain’s analysis of pleasure and pain is also much cited by Jevons (pp. 84, 93, 97–8).



last fifty years has no matching trend in average happiness (Easterlin, 1974; Scitovsky,1976; Frederick and Loewenstein, 1999; Frey and Stutzer, 2002).

In fact, Edgeworth does not need to use the law of accommodation in his analysis ofmarkets, which focuses on exchange in a single time period. Even so, it is surelysignificant that he was aware of the reference-dependence of preferences, and that hecould explain, if only in general terms, how that effect might be incorporated into histheory. Reference-dependence had been put on the agenda of neoclassical economics,as a well-grounded psychological hypothesis whose economic implications were open toinvestigation. That hypothesis may have been one of the casualties of the Paretian turn.

The early neoclassical economists hoped to develop an analysis of pleasure whichwould explain the main features of human wants. As Jevons put it, reacting against JohnStuart Mill’s assertion that there is no �distinct science� of human enjoyment:

But it is surely obvious that economics does rest upon the laws of humanenjoyment; and that, if those laws are developed by no other science, they mustbe developed by economists. We labour to produce with the sole object ofconsuming, and the kinds and amounts of goods produced must be deter-mined with regard to what we want to consume. Every manufacturer knows andfeels how closely he must anticipate the tastes and needs of his customers: hiswhole success depends on it; and, in like manner, the theory of economicsmust begin with a correct theory of consumption. (pp. 102–3)

A common concern among nineteenth-century economists was to explain how wantsvary with income. One obvious regularity – the law of variety proposed by Nassau Senior – isthat the variety of goods that a person buys tends to increase with her income. It seemed tomany economists that there was a hierarchy of wants, with �higher� or �more complex�wants assuming greater significance at higher levels of income. From the perspective ofearly neoclassical economics, these regularities called for psychological explanations.

Jevons claims to provide just such an explanation. He explains the law of variety interms of diminishing marginal utility: the goods that satisfy the more basic wants havehigh marginal utility at low levels of consumption, but their marginal utility declinesrapidly as consumption increases, while the goods that satisfy the higher wants have theopposite characteristics (pp. 111–4). But, as Pantaleoni notices, there is a circularity inthis explanation. It makes a distinction between two classes of good (�necessities� and�luxuries�), with allegedly different hedonic characteristics, and then uses this hypo-thesis to explain observed differences in income elasticity; but it offers no independentcriterion for identifying whether any particular good is a necessity or a luxury.

Pantaleoni responds to this challenge by proposing a theory of the �genetic succes-sion of wants�, based on �psychological analysis and the data of physiology�. Developinganother idea from Jennings’s Natural Elements of Political Economy, Pantaleoni distin-guishes between those sensations (such as temperature, hunger and thirst) that aremediated by the �common� senses of the body as a whole, and those that are mediatedby the five �special� senses of sight, hearing, touch, taste and smell. Wants induced bycommon sensations are �primary�; those induced by special sensations are �secondary�.According to Pantaleoni’s theory, goods that satisfy primary wants have the hedoniccharacteristics of Jevons’s necessities, while goods that satisfy secondary wants have thehedonic characteristics of luxuries. More specifically, the satisfaction of one primary



want is not substitutable with that of another, and the satisfaction of secondary wants isranked lexicographically below the satisfaction of primary wants (pp. 48–55). As far aswe know, the idea of a significant distinction between common and special sensationshas never been developed further. It may well be mistaken. Even so, it illustrates hownineteenth-century neoclassical economists looked to psychology for explanations ofregularities in human tastes.

In the course of his discussion of the succession of wants, Pantaleoni points to whathe takes to be an established fact: that the �positive expansion� of wants differs from the�negative expansion�. Specifically, the tendency for increases in income to activate newwants is stronger than the tendency for decreases in income to de-activate existingwants. Pantaleoni recognises that this path-dependence is inconsistent with standardeconomic theory. He suggests that, contrary to the assumptions of that theory, theremay in fact be a tendency for a person’s �hedonic scale� at any given time to depend onpast consumption (pp. 53–4). What Pantaleoni is envisaging here seems similar toEdgeworth’s concept of accommodation. Like Edgeworth, Pantaleoni does not pursuethis line of enquiry; but his psychologically-based methodology has allowed him toentertain the hypothesis that preferences are reference-dependent and that hedonicexperience is subject to adaptation.

To sum up: for economists of the generation of Jevons, Edgeworth and Pantaleoni,the psychology of sensation was an essential part of economics. The ideas they tookfrom psychology were, from the viewpoint of the time, products of a well-establishedprogramme of psychophysical research. Although not all of those ideas have stood thetest of time, the research programme that generated them was fundamentally sound. Itwould be quite wrong to think that, when economics turned away from psychology atthe beginning of the twentieth century, it was merely dumping obsolete or unscientificintellectual baggage.

3. Pareto’s Science of �Logical Action�

In proposing that economics should cut itself off from psychology, Pareto was propo-sing a major deviation from current understandings of the nature of economicexplanation. In this Section, we look at the arguments that he used to justify this move,and at how these were received by contemporary economists. In subsequent Sections,we will compare these arguments and counter-arguments with their present-dayanalogues in the literature of discovered preference.

In proposing the separation of economics from psychology, Pareto was self-consciousand explicit. In the introduction to the paper in which he first outlines his newapproach to the theory of choice, he claims as one of its main achievements that �everypsychological analysis is eliminated� (1900/1982, p. 214). In a letter dated 1897 to thephilosopher Adrien Naville, he writes:

It is an empirical fact that the natural sciences have progressed only when theyhave taken secondary principles as their point of departure, instead of trying todiscover the essence of things. . . . Pure political economy has therefore a greatinterest in relying as little as possible on the domain of psychology. (quoted inBusino, 1964, p. xxiv).



Pareto, like other economists of his day, sees himself as using Mill’s concretedeductive method (Pareto, 1894/1966, pp. 156–7). However, he proposes that eco-nomic theories should be deduced from firmly-established empirical propositionsabout choice rather than about sensation. He claims that everything that is significant inthe existing theory of economic equilibrium can be derived from the fact of indiffer-ence, without any recourse to psychological concepts such as utility or pleasure. If wetake his approach:

[T]his entire theory . . . rests on no more than a fact of experience, that is, onthe determination of the quantities of goods which constitute combinationsbetween which the individual is indifferent. The theory of economic sciencethus acquires the rigor of rational mechanics; it deduces its results fromexperience, without bringing in any metaphysical entity. (1909/1971, Ch. 3,§36b)11

Or, as Pareto describes his position in a letter to the mathematician Herman Lau-rent: �I am not interested in the reason why man is indifferent between [one thing andanother]: I notice the pure and naked fact� (1899/1989, p. 288).

Despite the way he uses the term �metaphysical�, Pareto does not deny the scientificstatus of psychology, as practised at his time – that is, as an investigation of consciousexperience, as mediated by introspection. He also accepts that psychology is morefundamental than economics, in the same sense that physics is more fundamental thanchemistry or biology: in principle, economic phenomena have psychological explana-tions, just as chemical phenomena have physical explanations. But, he believes, eachscience makes progress by finding its own fundamental laws, and making deductionsfrom those laws (Ch 2, §1). His proposal is that economics should constitute itself as aseparate science – separate, in particular, from psychology and from sociology.

So what is economics to be the science of ? Economics – or at least pure economics – isto be the science of logical action.

The distinction between �logical� and �non-logical� action is fundamental to Pareto’smethodology. Following classical physics, Pareto describes his methodology as one ofanalysis and synthesis. To investigate complex social phenomena, we must break themdown into simpler components, and analyse each component separately. Analysis is therole of science; synthesis – re-assembling the components – is essential for practice (Ch. 1,§§21–26). When Pareto distinguishes between �pure� and �applied� economics, pureeconomics is understood as science while applied economics is understood as practice.The implication is that applied economics might need to draw on the findings ofsociology or psychology. Nevertheless, pure economics is concerned only with �logical�action.

For Pareto, an action is logical if and only if it is the result of valid instrumentalreasoning from objectively true premises. Thus, Pareto begins his exposition of �eco-nomic equilibrium� with the declaration that:

11 Throughout this Section, unless the contrary is stated, references to Pareto are to the Manual of PoliticalEconomy (1909/1971). Page numbers in other quotations from Pareto refer to the Oeuvres Completes (collectedworks).



We will study the many logical, repeated actions which men perform to pro-cure the things which satisfy their tastes. . . . [W]e are concerned only withcertain relations between objective facts and subjective facts, principally thetastes of men. Moreover, we will simplify the problem still more by assumingthat the subjective fact conforms perfectly to the objective fact. This can bedone because we will consider only repeated actions to be a basis for claimingthat there is a logical connection uniting such actions. (Ch 3, §1)

Pareto recognises that, as an implication of this definition of �logical� action, his theoryapplies only to a restricted range of human behaviour: �by considering only one part ofman’s actions and, in addition, by assigning certain characteristics to them, we havesimplified the problem enormously. The study of these actions makes up the object ofpolitical economy� (Ch. 3, §2).

So Pareto is proposing a particular definition of the domain of economic theory. Anysuch proposal confronts two obvious questions. First, one can ask whether there areoperational criteria for determining whether any given class of behaviour falls in thedomain of the theory, prior to testing the theory’s predictions about that behaviour. (Ifthe domain of a theory were defined as the class of phenomena about which it makessuccessful predictions, the theory could never be contradicted.) Second, one can askhow far the theory’s domain, as defined by the proposal, corresponds with existingunderstandings of the types of problem to which the theory can be applied. (If aproposed definition of the domain of economics excludes significant areas of currenteconomic research, one might reasonably expect a convincing justification for thatexclusion.) We now consider how Pareto responds to these questions.

Notice that Pareto uses two criteria to identify logical actions in economics. The firstis that these are actions that are repeated many times. In such situations, he claims, it isreasonable to assume that people’s beliefs about the world (�subjective facts�) coincidewith how the world really is (�objective facts�).12 In this respect, as we shall show inSection 4, Pareto anticipates the discovered preference hypothesis: he restricts thedomain of economic theory to situations in which individuals have had adequateopportunities for learning the consequences of alternative actions. The second cri-terion is that, for an economic action to be logical, it must be directed towards thesatisfaction of tastes through the acquisition of goods. Thus, the rationality of logical actions isinstrumental: economic actions (the buying and selling of goods and services) are themeans, while the satisfaction of tastes is the end. Taken together, Pareto’s two criteriaare intended to identify a category of actions that are instrumentally rational withrespect to objective facts. As Pareto puts it in his Treatise on General Sociology, actions arelogical to the extent that they �logically conjoin means to ends not only from thestandpoint of the subject performing them, but from the standpoint of other personswho have a more extensive knowledge� (1916/1963, §150).

Pareto’s first criterion, that actions must be repeated many times in order to beidentified as logical, imposes a major restriction on the class of phenomena that eco-nomics can explain. This criterion may not have excluded much of what nineteenth-century neoclassical economists sought to explain, but (as we shall detail in Section 4)

12 Pareto (1916/1963, §149) recognises that all human knowledge is ultimately subjective: what he calls�objective facts� are propositions that are generally taken to be true by well-informed people.



it excludes a huge amount of what later generations of economists have treated as theirsubject matter. Most of the economic theorists who have seen themselves as Pareto’sfollowers have not applied this criterion. For many commentators, one of the greatadvantages of grounding economic theory on the logic of rational choice rather thanon hedonism is that it widens the domain of the theory. Thus, reviewing the Manual ofPolitical Economy on its publication, Philip Wicksteed (1906, p. 817) criticises Pareto forhaving restricted the domain of economics unnecessarily, by not realising how wide arange of human behaviour can be explained in terms of indifference curves. Similarly,Hicks and Allen, in the paper which relaunched Pareto’s ideas in the 1930s, write:

The methodological implications of [the new] conception of utility . . . are far-reaching indeed. By transforming the subjective theory of value into a generallogic of choice, they extend its applicability over wide fields of human conduct.(1934, p. 45)

As we shall argue in Section 4, the discovered preference hypothesis can be seen as amovement back towards Pareto’s less ambitious conception of the applicability ofrational choice theory.

Pareto’s second criterion, that actions must be instrumental in order to be logical, isessential for his larger conception of social science. Pareto is a sociologist as well as aneconomist; he is trying to define distinct domains for these two sciences. At least asmuch as economics, sociology deals with actions that are constantly repeated. Paretogives as examples a man who removes his hat whenever he enters a drawing-room, anda Catholic who regularly attends mass. Notice that these actions satisfy Pareto’s firstcriterion; just as in the case of repeated market transactions, we have reason to expectthat actors� beliefs about the consequences of their actions will converge to theobjective facts. However, Pareto claims that these actions fail his second criterion.Rather than being instrumentally rational, they are governed by norms; people per-form them because, on their understanding of the world, �one ought to do so� (Ch. 2,§2). On Pareto’s account, these actions belong to the domain of sociology, noteconomics.

According to the instrumentality criterion, economic theory applies only tochoices that are directed towards the satisfaction of tastes. This immediately raises aquestion about the operationality of Pareto’s definition of the domain of economics.Considering only the naked facts of choice, how do we know whether or not aperson is motivated by her tastes? We cannot observe motivation itself, and (onPareto’s account) we cannot observe tastes independently of choices. Thus, wecannot identify the situations to which the theory applies, prior to observing thebehaviour that it is intended to predict. Pantaleoni (1913/1925) drew attention tothis problem in defending the use of psychology in economics. For a hedonisteconomist such as Pantaleoni, the domain of economics consists of those situationsin which individuals are motivated to seek pleasure. If – as the hedonists assert –introspection is a valid mode of enquiry and if pleasure is measurable, we have anoperational criterion for distinguishing economic acts from non-economic ones. It isnot clear that Pareto does.

Leaving aside the problem noted by Pantaleoni, Pareto’s instrumentality criterionpresupposes some theoretical model of what it is to act to satisfy one’s tastes. If the



criterion is to have content, we must be able to define a set of possible end states thatcan be brought about by economic actions, and over which a person has tastes. And ifrational choice is to be defined in terms of the satisfaction of tastes, the problem ofchoosing among actions so as to satisfy tastes must be well-defined. That requires thattastes have some formal structure. Exactly what that structure is depends on howrational choice is formalised. For Pareto, who interprets rational choice in terms ofconstrained maximisation, the requirement is that tastes take the form of an orderingover the relevant set of end states.

The need for this requirement presents Pareto with a fundamental problem: how,consistently with his methodological position, can he explain this alleged property oftastes? To understand his attempts to solve this problem, we must first ask what hemean by �tastes�. As the passage about �objective facts� and �subjective facts� shows,Pareto assumes that, after sufficient repetition of the relevant choice tasks, tastes�conform perfectly� to relevant objective facts. What kinds of facts are relevant, and whatit means for tastes to conform to those facts, are not clear. What is clear is theassumption that, after sufficient repetition, each person has a stable system of tastes,structured in such a way that problems of instrumentally rational choice arewell-defined.

Sometimes Pareto seems to be suggesting that a person can discover his true tastes, asif tastes were objective facts in themselves. Thus:

A man who buys a certain food for the first time may buy more of it than isnecessary to satisfy his tastes, price taken into account. But in a second pur-chase he will correct his error, in part at least, and thus, little by little, will endup by procuring exactly what he needs. We will examine this action at the timewhen he has reached this state. Similarly, if at first he makes a mistake in hisreasoning about what he desires, he will rectify it in repeating the reasoningand will end up by making it completely logical. (Ch. 3, §1)

It is tempting to read such passages as relying on an implicit assumption ofhedonism: one might think that the �tastes� or �desires� to which behaviour adaptscorrespond with pleasure, as analysed by other economists of the time. On thatinterpretation, the transitivity of the taste relation would be implied by the hedonisticassumption that different pleasures for a given individual are commensurable on anordinal scale.

However, although Pareto permits a hedonistic interpretation of tastes, he does notpositively endorse it.13 To the contrary, he is explicit that he is not assuming hedonism.Drawing a distinction between intrapersonal and interpersonal comparisons of sensa-tions, he says that economics is principally concerned with that class of theories whichhas as its object

13 How far Pareto rejected hedonism is a matter of dispute among historians of thought. Some com-mentators, such as Stigler (1950), argue that Pareto was inconsistent and failed to follow through the logic ofhis rejection of �metaphysical� concepts. Bruni and Guala (2001) argue that, from 1900 on, Pareto wasconsistent in eliminating psychology from the pure theory of economics. Since he did not deny the validity of anintrospectively-based analysis of sensations as psychology, his methodological position allowed him to usehedonistic language when interpreting his theory and discussing its practical application.



. . . to compare the sensations of a man in different situations, and to deter-mine which of these he would chose. . . . [S]ince it is customary to assume thatman will be guided in his choice exclusively by consideration of his ownadvantage, of his self-interest, we say that this class is made up of theories ofegotism. But it could be made up of theories of altruism (if the meaning of thatterm could be defined rigorously), or, in general, of theories which rest on anyrule which man follows in comparing his sensations. It is not an essentialcharacteristic of this class of theories that a man choosing between two sen-sations choose the most agreeable; he could choose a different one, following arule which could be fixed arbitrarily. (Ch.3, §11)

Notice that Pareto is interpreting tastes as subjective comparisons of sensations. Sothe set of end states over which tastes are defined is the set of possible sensations.However, the ranking of different sensations for a given person need not be in terms ofmore and less pleasure for that person. The theory assumes only that each personcompares sensations according to some fixed rule.

Given this understanding of tastes, Pareto’s problem is to justify the assumption thattastes take the form of an ordering of sensations. What grounds do we have for thisassumption? Repetition alone does not provide an adequate explanation. The signifi-cance of repetition is that it allows the learning of what Pareto calls objective facts. Therelationship between actions and sensations is such an objective fact, and we mightexpect that with repetition, individuals would become able to predict the sensationsthat would result from alternative actions. But what is at issue is not individuals�knowledge of the processes that induce their sensations, but the rules they useto compare the sensations themselves. Unless we can assume that people comparesensations as different quantities of some common objective attribute, we seem to haveno grounds for assuming that these comparisons are transitive.

Pareto was very conscious of this difficulty for his theory. In mathematical terms, thisis the integrability problem. Pareto treats a consumer’s marginal rates of substitution atany given point in commodity space as �facts of experience� that in principle can bediscovered by observing the consumer’s behaviour. If there are only two goods, thismeans that we can infer the slope of an indifference curve at each point; by repeateduse of this method we can plot a family of indifference curves. But if there are morethan two goods, how can we be sure that the marginal rates of substitution we observe atthe different points can be integrated into indifference surfaces? In other words: howcan we be sure that the consumer’s fixed rule – the rule that lies behind the regularitieswe observe in his behaviour – takes the form of an ordering of end states? Paretostruggled with the integrability problem for many years. He first mentions it in a letterto Pantaleoni in 1891,14 and dedicated a good part of his energies to it in his last workson pure economics (Pareto, 1909/1971, Appendix; Pareto, 1911/1982, pp. 597, 614).

14 In a letter to Pantaleoni dated 14 December 1891, Pareto (1984, I, p. 121) referred to the mathematicianGiovan Battista Antonelli (1886), who was the first to deal with the integrability problem. Pareto mentionedthe integrability problem again in a series of articles on demand theory, in which he specified that �whenthere are only two goods, the equation [of the indifference curves] can always be integrated� (1892–93/1982,p. 299, footnote).



The truth is that the problem, as Pareto conceptualised it (by analogy with the problemof �open� and �closed� cycles in thermodynamics), cannot be solved.15

The significance of the integrability problem for Pareto’s whole project seems tohave been missed by the theorists who took up his approach in the 1930s. Hicks (1939,p. 19) criticises Pareto for spending so much energy on the �mysterious problem ofopen and closed cycles�. According to Hicks, this problem �fascinates mathematicians,but it does not seem to have any economic importance at all�. Of course, the problem isswept under the carpet if one simply assumes that preferences are transitive, as becamestandard practice in choice theory in the middle years of the twentieth century. ButPareto’s methodological strategy is to create economic theories by deduction fromfirmly-established empirical laws. If economics is to be a separate science, based on lawswhose truth is to be treated as axiomatic, we have to be very confident in those laws.Otherwise, we are in danger of creating an complex structure of internally consistenttheory which has no correspondence with reality. For Pareto, it seems, local indifference– the existence of stable marginal rates of substitution at each given point in com-modity space – was a sufficiently solid fact on which to build a theory. But the idea thatindifference is transitive right across commodity space was only a speculative hypo-thesis, for which, at the time he was writing, no solid evidence existed.

Notice that the problem of justifying the transitivity assumption does not arise soobviously in the hedonistic economics that Pareto is challenging. If the sensationsresulting from consumption can be measured along a single psychophysical dimensionof pleasure, it is immediately obvious that comparisons of sensations must be transitive.Of course, the hypothesis that pleasure is one-dimensional is vulnerable to contradic-tion by psychophysical research, but the advocates of hedonistic economics wereentitled to treat it as an adequate working hypothesis. But, in the absence of directevidence of the transitivity of indifference, Pareto needs to find a theoretical derivationof transitivity from non-psychological premises.

A similar issue arises in relation to the shape of indifference curves. Pareto recognisesthat, in the overwhelming majority of cases confronted by economists, indifferencecurves are convex to the origin. However, he also knows that there are occasionalanomalous cases in which indifference curves are concave (Ch. 4, §§34, 45). Presum-ably for this reason, he does not feel entitled to treat the convexity of indifferencecurves as a firmly established empirical law. Thus, for Pareto, the fact that convexityalmost always holds can be registered only as a highly reliable but unexplained regu-larity in tastes. Noting the psychophysical findings of Fechner and Wundt, he explicitlyrejects their relevance in explaining convexity of preferences:

. . . in the great variety of economic uses [i.e. cases in which goods are usedin some way, but not necessarily consumed], there are many that are too farremoved from the phenomena to which Fechner’s law applies. It is betterto resort directly to experience, and the latter shows us that for a great manyuses and consumptions the elementary ophelimity [i.e. marginal utility] doesindeed diminish with an increase in the quantities consumed. (Ch. 4, §33)

15 On the integrability problem and its significance for Pareto, see Chipman et al. (1971), Mirowski (1989)and Bruni (2002).



Notice that Pareto does not challenge the scientific status of psychophysics but onlyits external validity with respect to economic phenomena. There is an echo here of thescepticism with which many present-day economists view the suggestion that resultsfrom experimental psychology might be relevant for economics.

Pareto’s hedonist opponents took a contrary position. They could reply that, whileconvexity is not a law of economics, the Fechner–Weber Law is a law of psychophysics,and that that psychophysical law is useful in explaining the general tendency towardsconvexity of preferences. As we showed in Section 2, the hedonists believed that otherreliable generalisations about preferences, beyond transitivity and convexity, could bederived from psychological hypotheses. They no doubt expected that as psychology andeconomics progressed, still more such generalisations would be found. Pareto’s pro-posal to constitute economics as a separate science seemed to them to be a perverserefusal to use relevant data. In Pantaleoni’s words:

I claim that we cannot take away from economics the data coming from psy-chology. I cannot see what, by virtue of this renunciation, we gain, but I seewhat we lose. . . . I cannot see the convenience of not utilising laws regardingtastes and pains that we know to be true, and that are the reasons of economicactions. (1913/1925, pp. 8–9)

Nevertheless, over the first half of the twentieth century, Pareto’s rationality-basedapproach to the theory of choice gradually displaced the psychological approachadvocated by Pantaleoni. It seems that Pareto’s reservations about the general appli-cability of the concept of logical action and his concerns about the justification oftransitivity were quietly forgotten.

4. Behavioural Economics and the �Discovered Preference� Defence of RationalChoice Theory

We now move forward in time to current debates about the status of behaviouraleconomics.

In retrospect, the publication of Daniel Kahneman and Amos Tversky’s paper�Prospect Theory� in Econometrica in 1979 can be seen as a defining moment forbehavioural economics. By presenting a body of experimental data which appeared tocontradict conventional economic theories of decision making, and by proposing analternative theory of non-rational behaviour based on psychological hypotheses,Kahneman and Tversky challenged the prevailing methodology of economics.

Behavioural economics is one response to this challenge. It is an attempt to intro-duce into economics some of the theoretical and methodological approaches of psy-chology. Theoretically, the aim is to model economic agents in ways that take accountof the affective responses that decision problems evoke in human beings and of thecognitive processes that are used in human decision making. Thus, for example,behavioural economists have considered how decisions are influenced by loss aversion,myopia and anticipated regret, and by perceptions of fairness and reciprocity; and theyhave tried to model the heuristics that people use in processing probability informationand in assigning valuations to goods. Methodologically, there is an emphasis onempirical investigation of individual behaviour, using experimental techniques



modelled on those used in experimental psychology as well as more conventionalmethods of empirical economics.

Other economists, however, have responded to the same challenge by defendingexisting economic theory and methodology. Initially, many economists reacted toKahneman and Tversky’s work, and to behavioural economics more generally, bydenying that there was any case to answer. They objected to various features of theexperimental techniques customarily used by psychologists – particularly the commonpractice of not providing incentives in decision tasks – as inappropriate for testingeconomic hypotheses. Ex post rationalisations, consistent with conventional rational-choice theory, could often be found for apparent anomalies observed in specificexperiments. Thus, anomalies were interpreted as artefacts of particular experimentaldesigns, rather than as evidence of fundamental properties of decision-making beha-viour. But as experimental economics developed over the course of the 1980s and1990s, the terms of debate gradually changed. Systematic violations of standard theory,such as the common consequence effect, the common ratio effect, the Ellsberg para-dox, preference reversal, the endowment effect, the rejection of positive offers inultimatum games and the choice of dominated strategies in public good games, werereplicated in experiments which controlled for the factors that previously had beeninvoked in explaining anomalies as artefacts. Increasingly, economists have come toaccept that decision-making behaviour, as observed in laboratory environments,diverges systematically from the predictions of standard theory, and that those diver-gences are in accord with the predictions of psychologically-based theories.16 Anycredible defence of the received theory of rational choice must take account of thesefacts.

We are particularly concerned with one such defence, based on the idea of discoveredpreference. The discovered preference strategy has been used by a number of leadingexperimental economists, including Vernon Smith (1989, 1994), Charles Plott (1996)and Ken Binmore (1999). The positions held by these writers are not identical butshare many common features. We shall distil these common features into a compositeargument, which we take to be broadly consistent with each writer’s own position. Weshall show that these writers� understandings of the relationship between psychologyand economics are remarkably similar to Pareto’s.

The general strategy of this defence is to claim that conventional theory capturescore elements of economic behaviour by isolating certain causal factors and abstractingfrom the rest. The existence of systematic deviations between theoretical predictionsand real-world behaviour can then be accepted without calling into question thevalidity of the �pure� theory – provided those deviations can be interpreted as resultingfrom specific causal factors from which the theory has abstracted.17

16 For reviews of this evidence, see Camerer (1995; 2003, Ch. 2), Ledyard (1995) and Starmer (2000).17 The discovered preference strategy must be distinguished from more pragmatic defences of rational

choice theory which appeal to parsimony. For example, John Hey and Chris Orme (1994) analyse the extentto which alternative theoretical models of choice under risk fit a body of experimental data. They find that,for a majority of their subjects, behaviour deviates significantly from the predictions of expected utility theory,in the directions predicted by psychologically-based hypotheses; but, noting that the observed deviations arerelatively small, they argue that expected utility theory predicts behaviour to a �reasonable approximation�(p. 1322). This latter kind of defence does not claim that the standard theory is valid in any specific limitingcase, but only that its predictions are accurate enough for economists� purposes.



This strategy has obvious precedents in natural science. To use an example which wastaken as a methodological model by many early neoclassical economists, consider howtheoretical mechanics may, on occasion, use such modelling assumptions as that a bodyhas mass located at a point, that a projectile meets with no air resistance and so on. Forpractical purposes, these assumptions are justified on the grounds that they simplify theanalysis while permitting predictions that are correct to a reasonable approximation.Notice, however, that this methodology rests on more than an appeal to parsimony.The factors that are being �assumed away� in the model are understood well enough forus to be able to recognise circumstances in which they are (almost) absent. Forexample, although no real bodies have mass but not extension, we can find ones forwhich the distance between extremities is very small relative to mass. Thus, the pre-dictions of pure mechanics can be tested by investigating what happens as we approachthe limiting cases referred to by the theory. And we can define the domain of thetheory in a non-arbitrary way, as consisting of those situations in which the idealisingassumptions are approximately true.

The discovered preference argument follows a similar methodological strategy. Itscentral claim is that conventional theory describes the behaviour of individuals whoknow which actions best satisfy their preferences. The theory abstracts from the processes bywhich individuals discover how to satisfy their preferences: it simply assumes that thoseprocesses, whatever they may be, have been completed. The domain of applicability ofthe theory is restricted to situations in which, to an acceptable approximation, thatassumption holds. Just as pure mechanics has empirical content by virtue of opera-tional criteria for identifying circumstances in which the impact of factors that are notmodelled (friction, air resistance and so on) is minimal, so rational-choice theory hasempirical content by virtue of operational criteria for identifying circumstances inwhich the learning process can be expected to be almost at an end. Smith, Plott andBinmore propose such criteria, intended to guide the design of experiments and theinterpretation of experimental findings.

The criteria proposed by these three writers are broadly similar. The essentialrequirements are that, in relation to a given decision problem, the individuals whosedecisions are being studied have had adequate opportunities and incentives to gatherrelevant information and to engage in relevant deliberation, and have faced thatproblem sufficiently many times to have been able to learn by trial and error theconsequences of alternative actions. Smith, Plott and (with qualifications) Binmoreoffer the hypothesis that rational-choice theory performs reasonably well in predictingbehaviour when these criteria are satisfied.18 Following Plott, we will call this the discoveredpreference hypothesis.

The discovered preference hypothesis allows that, when the criteria for adequatelearning have not been satisfied, systematic violations of conventional theory may occur.According to the hypothesis, those violations result from errors in decision makingwhich, given appropriate opportunities, incentives and feedback, decision makers can

18 Binmore treats his proposed criteria as preconditions for valid tests of rational-choice theory. Hemaintains that some predictions of classical game theory – specifically, the prediction that Nash equilibria thatare not subgame perfect are not selected – are contradicted in valid tests. However, Binmore’s rhetoric ismainly directed against the claim, which he attributes to �the school of Kahneman and Tversky�, that eco-nomic theory fails in the laboratory (p. F16). See also footnote 18 below.



learn to correct. It is accepted that psychologically-based theories may be able toexplain regularities in those errors. But that (it is said) does not challenge the validityof rational-choice theory, because rational choice theory abstracts from the causalfactors that the psychologically-based theories are explaining.

Further, Smith and Plott argue that many real-world market institutions satisfy thelearning criteria that they propose. Indeed, it sometimes seems as if, for Smith andPlott, the essential hypothesis of discovered preference is that the behaviour of agentsin repeated markets is as predicted by rational-choice theory, or (a weaker hypothesis) thatprices and traded quantities in repeated markets are as predicted by that theory.19

However, there would be an unsatisfactory element of mystery about a bald claim thatrational-choice theory explains behaviour inside but not outside repeated markets.Such a claim would immediately prompt the question: What is special about repeatedmarkets? Since rational-choice theory is based on hypotheses about the preferencesand beliefs of individual agents, it seems that the most credible explanation of the(supposed) observation that the theory makes reliable predictions about repeatedmarkets is that such markets induce agents individually to act according to the theory.Then, the question becomes: What mechanisms within repeated markets induce agentsto act according to rational-choice theory? We take it that Smith and Plott are offeringthe discovered preference hypothesis as an answer to that question.

It is important to realise that the discovered preference hypothesis implies muchmore than that inconsistencies within the behaviour of a representative individual �goaway� as she accumulates experience. It is an essential part of the hypothesis thatpreferences are discovered in whatever processes of learning occur, and not merely thatthey are constructed. If a person’s preferences are constructed in response to the par-ticular decision tasks that she faces, we have no reason to expect that the learningprocess is path-independent, and hence no concept of underlying preferences that canbe �discovered� (Plott, 1996, p. 227–8).20

This is not just a matter of semantics. Economic theory relies heavily on the methodof comparative statics, which compares alternative equilibrium states while holdingpreferences constant. Thus, the consistency properties that are attributed to preferencesmust hold across equilibria. If we are to treat the discovery of preferences as aphenomenon of disequilibrium (as the discovered preference hypothesis does), wemust be able to assume that the end state of this discovery process is path and context-independent. For example, consider the prediction of price theory that the impositionof an excise tax on a good increases its price and reduces consumption. This dependson the assumption that preferences are unaffected by the imposition of the tax. If thediscovered preference hypothesis is correct, individuals� first responses to the tax mightbe quite unlike the theoretical prediction; responses will settle down only as prefer-ences are discovered. If the comparative statics are to work, we must be able to modelthis discovery process as a process of convergence to some underlying preferenceordering that is the same in both the without-tax and with-tax environments.

19 The distinction between these two hypotheses is discussed by Loomes et al. (2003).20 In this respect, Binmore (personal communication) does not endorse the discovered preference

hypothesis as we have formulated it. He proposes that experience has a general tendency to eliminateinconsistencies, but allows that learning may be path-dependent.



However, the concept of discovered preference should not be interpreted so lit-erally as to claim that preferences are never learned. It is obvious that individuals�preferences can change over time, and that these changes sometimes occur inresponse to experiences induced by participation in markets. Economists in generalhave no need to deny that, nor do Smith, Plott and Binmore. Conventional com-parative-static analysis works by holding preferences constant. This is not a generalclaim about the nature of preferences but a modelling strategy which is useful tothe extent that the preferences of the relevant agents are reasonably stable withrespect to whatever experiences are induced by the specific workings of the marketbeing analysed. The advocates of the discovered preference hypothesis are com-mitted only to a corresponding claim about the degree of stability of underlyingpreferences.

It should by now be clear that there is a close parallel between the concept ofdiscovered preference and Pareto’s concept of logical action. Both concepts relate toactions that are repeated sufficiently many times for errors to be eliminated. In eachcase, there is an assumption that, after errors have been eliminated, actions will revealunderlying preferences which satisfy standard conditions of internal consistency. Themain difference between the two concepts is that Pareto’s definition of �logical action�includes an criterion of instrumentality, for which there is no explicit analogue in theliterature of discovered preference. In Section 6 we will ask whether a coherent conceptof discovered preference can dispense with that criterion.

5. Discovered Preference: The Evidence

As good experimental economists, Smith, Plott and Binmore treat the discoveredpreference hypothesis as a working hypothesis, to be accepted only if it is confirmed bythe evidence. All three writers illustrate their arguments by describing cases in which,they claim, apparent violations of rational-choice theory are compatible with the dis-covered preference hypothesis. Experimentally observed anomalies are attributed toexperimental designs that give insufficient opportunities and incentives for learning. Indesigns which provide such opportunities, it is claimed, the frequency of anomaliestends to fall as subjects gain experience, decaying to levels at which anomalies havelittle practical significance.

There is significant dissonance here between the literature of discovered preferenceand Pareto’s arguments. In the modern debate about behavioural economics, one ofthe central issues is whether (or under what conditions) individual behaviour is aspredicted by standard economic theory; psychological mechanisms are invoked asexplanations of deviations from that theory. At the time that Pareto wrote, the possi-bility of such deviations was not a live issue. The dominant view was that the neoclassicalmodel of utility-maximising behaviour was descriptively valid, to a reasonable degree ofapproximation and when applied within what was then seen as the domain of eco-nomics. This supposed regularity in human behaviour was thought to be explained by atheory that was grounded in the psychology of sensation. Pareto agreed that thisregularity existed but proposed an alternative explanatory scheme. Thus, in arguing forhis reformulation of economics, Pareto did not feel the need to make systematic ap-peals to evidence about how economic agents behave.



Because the empirical evidence bearing on the discovered preference hypothesishas no obvious analogue in the earlier debate, we review it only briefly. We begin bynoting that, as so far advanced, that hypothesis does not specify how much oppor-tunity and incentive for information-gathering and deliberation, or how much trial-and-error learning, is sufficient for rational-choice theory to work. This might seemto allow too much leeway for ex post rationalisations of observed behaviour: inprinciple, failures of rational-choice theory can always be explained by claiming thatopportunities for deliberation and learning have been insufficient. Nevertheless, thediscovered preference hypothesis provides a useful organising framework forempirical investigation of the effects of deliberation and experience on the pre-dictive success of rational-choice theory. Ultimately, what matters are the quantita-tive impacts of specific kinds of deliberation and experience on the frequency ofspecific anomalies, and one can investigate such impacts without taking any positionon how large they must be in order to confirm the discovered preference hypo-thesis.

A large part of the evidence cited by Smith, Plott and Binmore in support of thediscovered preference hypothesis comes from experimental designs in which prefer-ences are induced. An induced-preference experiment is designed to investigate howindividuals behave, given that their preferences satisfy particular assumptions. For eachsubject, hypothetical preferences, corresponding with the assumptions that are to beinvestigated, are created by the experimenters. An incentive scheme is then put in placewhich ensures that each subject’s monetary payoff from the experiment is monotoni-cally increasing in the hypothetical preferences that have been created for her. Theexperimental task is described to subjects in a way that makes the monetary payoffs assalient as possible and discourages other motivations (such as a competitive desire towin more than other subjects, or altruistic concerns about other subjects� payoffs). Suchdesigns can be used to test whether laboratory subjects acting on induced preferencesbehave in accordance with the predictions that economic theory makes for people withthe corresponding actual preferences.

The balance of evidence supports the following general conclusion. In the earlystages of induced-preference experiments, subjects often act contrary to theoreticalpredictions; but over time, given adequate incentives, sufficiently simple decisionproblems and sufficient repetition, they gravitate towards those actions that best satisfytheir induced preferences. In other words: if different actions in an experimentalenvironment consistently lead to different monetary payoffs, laboratory subjects whoare motivated to maximise their own payoffs can learn to choose actions which are infact payoff-maximising. A typical example of this general tendency is an experimentcited by Binmore (1999, pp. F18–9), in which subjects played the same two-person zero-sum game in repeated trials against changing opponents. Over successive plays, subjectsgravitated towards minimax strategies. In such a game, each player’s minimax strategyis a payoff-maximising reply to the minimax strategy played by his opponent; so theevidence is of gravitation towards behaviour that is payoff-maximising for each indi-vidual, given the behaviour of the others.

In addition to the evidence from induced-preference experiments, the proponentsof the discovered preference hypothesis cite evidence from two other broad classes ofexperimental design.



The first of these consists of experiments in which subjects interact with one anotherin environments which provide cues for motivations other than individual payoff-maximisation – for example, other-oriented motivations such as altruism, reciprocity orfairness. These experiments are designed to test whether subjects act on self-interest inthe presence of such cues. Examples of such experiments include ultimatum games,prisoner’s dilemma games, and games in which individuals can make voluntary con-tributions to public goods. Plott (1996, pp. 233–5) cites the well-established result that,in public goods games, voluntary contributions tend to fall as games are repeated.Binmore (1999, pp. F19–20) cites an ultimatum game experiment in which, afterrepetition, subjects� behaviour became more self-interested. Plott and Binmore usethese examples to suggest that experimentally-observed behaviour that appears toreveal other-oriented motivations may in fact result from errors which subjects learn tocorrect. However, it is not at all clear that the balance of evidence supports this con-clusion. For example, the decay of voluntary contributions in repeated public goodsgames can be explained by the hypothesis that some subjects are self-interested whileothers are motivated by reciprocity throughout the repetitions; contributions decline asthe reciprocators learn about the behaviour of their self-interested co-players (Bardsleyand Moffatt, 2005). The �restart effect� found by James Andreoni (1988) – the tendencyfor a break between rounds of play to induce an increase in contributions – is alsosuggestive of a continuing motivation for reciprocity.

The second class of experiments investigates whether individuals� actual preferencessatisfy the various consistency properties assumed by conventional economic theory.Such experiments typically compare subjects� responses to two or more different tasks,selected to test some consistency condition. In each task, considered in isolation,conventional theory makes no specific predictions about how an individual will act; butthere is a prediction about how behaviour in one task relates to behaviour in another.For example, preference reversal is an inconsistency between the ranking of two lot-teries revealed in a binary choice task and the corresponding ranking revealed in twovaluation tasks. Smith (1994, pp. 117–8) and Plott (1996, pp. 229–31) both cite apreference reversal experiment, carried out by James Cox and David Grether (1993), inwhich subjects� valuations were repeatedly elicited in second-price auctions. The usualpattern of preference reversal was observed in relation to the valuations elicited in thefirst auction that subjects faced; but after the auction had been run five times, thenumber of reversals had fallen by about 40%, and the classic asymmetric pattern (inwhich low-probability high-prize �$ bets� are given higher valuations than high-prob-ability low-prize �P bets�, but P bets are preferred in the binary choice task) had almostdisappeared.21 Plott’s interpretation of this result is: �The classical preference reversalcan be seen as a product of inexperience and lack of motivation, and it goes away withexperience in a market setting� (p. 231). This, he suggests, is an instance of a moregeneral phenomenon: apparent violations of the rationality assumptions of economictheory, as observed in experiments, are �fostered by limited information, conditioned

21 Using the valuations elicited from subjects in the first of five repeated auctions, there were 24 �predicted�reversals and 2 �unpredicted� reversals among 60 subjects. The corresponding figures for the fifth auctionwere 10 and 8 (Cox and Grether, 1996, p. 390).



by the nature of perceptions and attention which, with experience under suitableincentives, does not persist� (p. 229).

Again, however, other interpretations are possible. The second-price auction mech-anism used by Cox and Grether to elicit valuations has the property that, after eachauction has been completed, subjects are told the market price (since subjects arebidding to sell, this is the second lowest bid). Cox and Grether report that subjects� bidsin later auctions were positively correlated with market prices in earlier auctions, andinterpret this as an indication that market mechanisms provide information whichhelps individuals to eliminate inconsistencies in their preferences (p. 400). But ifsubjects adjust their reported valuations in the direction of previously-observed marketprices – which are summary statistics of the reported valuations of all participants in theauction – the adjustment process is path-dependent: preferences are being shaped bythe institution in which they are expressed, and not merely being discovered. There isevidence from other experiments that this kind of shaping effect occurs and can workto reduce the frequency of preference reversals as second-price auctions are repeated(Knetsch et al., 2002; Loomes et al., 2003).

Since the publication of the papers by Smith, Plott and Binmore, the question of howfar the frequency of anomalies decays with experience has become an important focusof research in behavioural and experimental economics. We do not have space toreview this work here, but we believe it is a fair summary to say that the evidence ismixed, and that no general answer to the question has yet emerged. The indications sofar are that some anomalies do tend to decay with experience, while others do not. Forexample, there is growing evidence that, as experience increases, disparities betweenwillingness-to-pay and willingness-to-accept valuations are reduced. This seems to bedue partly to people learning not to use the bargaining ploy of over-stating valuationswhen selling and under-stating them when buying, and partly due to their becomingless loss-averse as they gain experience of selling (List, 2003; Loomes et al., 2003; Plottand Zeiler, 2005). In contrast, the tendency for stated valuations to be influenced bysalient but objectively irrelevant �cues� has been found to persist despite repeatedexperience of trade and consumption (Ariely et al., 2003).

6. Discovered Preference: Methodological Controversies

The discovered preference hypothesis has generally met with scepticism from beha-vioural economics. Among such responses are papers by Colin Camerer (1996),Kahneman (1996), George Loewenstein (1999), Graham Loomes (1999), Chris Star-mer (1999) and Robin Cubitt, Starmer and Robert Sugden (2001). These commen-tators have pointed to the possibility of alternative interpretations of the evidence ofthe effects of experience, along the lines we sketched in Section 5. More significantlyfor our comparative purposes, they have made theoretical and methodological criti-cisms of the discovered preference hypothesis which parallel problems faced by Pareto.We focus on two particularly important criticisms.

The first of these concerns the limits that the discovered preference hypothesis placeson the domain of rational-choice theory. If the theory applies only to decision problemsthat have been repeated many times, many economically significant decisions – forexample, choices about education, between alternative careers, about buying and selling



homes – lie outside the domain of the theory. While some decisions that involve knownrisks (for example, modest gambling on games of chance) fall within the domain, allproblems of choice under uncertainty (interpreted as referring to events for which rel-ative frequencies are unknown) must also be excluded. Public goods are outside thedomain of the theory too. The standard economic theory of public goods assumes thatindividuals have consistent preferences with respect to public goods; but since thosepreferences are not directly revealed in any decision problems faced by those individuals,there is no mechanism for the correction of error.

It should be said that the proponents of the discovered preference hypothesisacknowledge that it implies the need for some serious rethinking about the scope ofconventional economic theory. For example, Plott (1996, p. 226) accepts that �new tasks� –decision problems that are faced without experience – �abound in economics�. Binmore(1999, p. F17) notes that he is proposing significant restrictions on the domain of eco-nomic theory, and asks rhetorically: �But have we [economists] not got ourselves intoenough trouble already by claiming vastly more than we can deliver?� He goes on to denybelieving that consumer theory is relevant to the behaviour of customers buying low-costitems in supermarkets. One might have thought that such behaviour would be a paradigmcase of consumer choice but Binmore claims that the theory applies only if customers can�find the time to research the value of the products on sale�. Still, the radical implicationsof these domain restrictions give pause for thought. The implication is that, if economicsis to define itself as the application of rational-choice theory to situations of repeatedchoice, it must retreat from much of its established territory.

The extent of retreat that is now required is much greater than it was when Paretoproposed defining economics in terms of logical action. One might say that this is theconsequence of the fact that twentieth-century economists ignored Pareto’s reserva-tions about the applicability of rational-choice theory: if Pareto was right, large parts ofthe work of his successors were misguided. But one might reach a different conclusion:that economics has found it needs theories of behaviour and preference which apply tosituations other than those of repeated choice, and so cannot restrict itself to theanalysis of discovered preferences.

The second criticism of the discovered preference approach is that it lacks an ade-quate theoretical explanation of the consistency properties that it attributes to theunderlying preferences that are �discovered�. Of course, whether the discovered pref-erence hypothesis is true or false is ultimately an empirical matter; if it turns out to beconfirmed by the evidence, behavioural economists will have to accept it. But if it istrue, it identifies a major regularity in human behaviour which calls out for anexplanation. Conversely, if there were a credible theory which predicted such a regu-larity, there would be more grounds for confidence in the discovered preferenceinterpretation of the existing evidence.

The discovered preference approach treats rational-choice theory as an abstraction,arrived at by assuming that the processes by which individuals learn how to satisfy theirpreferences have been completed. But the assumption that individuals are capable oflearning what their preferences are does not license the hypothesis that those prefer-ences are context-independent or that they satisfy axioms such as transitivity or thesure-thing principle. This is essentially the same problem that Pareto faces when hetries to justify the transitivity of indifference.



In modern versions of the theory of choice, axioms of consistency of preferences areusually justified as formal principles of rationality. That is, no claim is made aboutwhich particular set of preferences is rational for a given individual. Instead, the claimis that any preferences that fail to satisfy the axioms are internally inconsistent, andthereby irrational. A variant of this argument asserts that preferences that are inconsis-tent in this sense are vulnerable to �Dutch books� or �money pumps� – that is, vulnerableto exploitation by arbitrageurs. At best, such arguments might explain why, afterlearning processes have been completed, those preferences that are revealed inrepeated choices satisfy the axioms.22 But they would not explain the (assumed) con-text-independence of the discovery process. For example, suppose that an individual’spreferences do not automatically satisfy the standard consistency conditions, but arerevised in the direction of consistency whenever inconsistencies come to light – eitherbecause the individual has a desire to be consistent, or because he learns that incon-sistent preferences are exploited to his disadvantage by arbitrageurs. That processmight ultimately generate preferences which – in so far as they are revealed in whateverdecision problems are faced repeatedly – satisfy the consistency axioms. But thereseems no reason to assume that such preferences are independent of the decisionproblems through which they are generated. So, if preference consistency is inter-preted merely as a matter of formal rationality, it is hard to explain the context-independence attributed to discovered preferences.

This problem might be overcome by invoking a substantive, rather than formal,concept of rationality. That is, we might stipulate that a person’s underlying prefer-ences rank outcomes in terms of some objective measure which serves as the standardof rationality. For example, if an objective measure of pleasure could be defined foreach outcome, we might stipulate that a rational person always prefers more pleasure toless. Then, underlying preferences inherit the consistency properties of the relevantmeasure, and it would be coherent to postulate that individuals learn their underlyingpreferences through experience (for example, through experience of the amounts ofpleasure generated by different actions). In Plott’s presentation of the discoveredpreference hypothesis, there are hints that he may have in mind some instrumentalconcept of rationality, in which an individual’s choices are rational to the extent thatthey deliver what that individual really �wants�:

People acquire an understanding of what they want through a process ofreflection and practice. In a sense, they do not know what they want and it maybe costly, or even unpleasant, to go through the process of discovery. Attitudediscovery is a process of evolution which has a direction, and in the final stageresults in the �discovery� of a consistent and stable preference. (1996, p. 227)

But if this is what is intended by the proponents of the discovered preferencehypothesis, a critic is entitled to ask what objective measure is being used as thestandard of rationality, and what evidence there is that, after learning processesare complete, people choose the actions that maximise the value of that particular

22 Cubitt and Sugden (2001) show that an individual’s responses to decision problems can be invulnerableto money pumps without those responses being rationalisable in terms of context-independent and consistentpreferences.



measure. If (as one might naturally expect) the measure is of some mental experience,such as pleasure, answering such questions will require the concepts and methods ofpsychology: economics will not be a separate science after all. That is exactly theproblem that led Pareto to start on his doomed quest for a solution to the integrabilityproblem.

More concretely, suppose the discovered preference hypothesis were to be based onthe more fundamental hypothesis that individuals seek to maximise pleasure. Then awhole range of additional tests would be possible and new theoretical questions wouldbe opened up. It might be possible to investigate directly whether people maximise netpleasure. Indeed, this question is already being investigated by behavioural economists.Some of the results of these investigations suggest that human beings� mental capacitiesfor recording affective experiences in memory and retrieving them later are subject tosystematic limitations and errors (Kahneman et al., 1997). If individuals� memories ofaffective states are systematically biased, it is hard to see how any experiential learningprocess could discover the true relationship between actions and affective states.

7. Conclusion

Pareto and the modern exponents of the discovered preference approach can be seenas pursuing a common project: to show that economics can be a separate science ofrational choice, independent of psychology. In trying to achieve this objective, theyconfront a common set of methodological problems, of which two are particularlyfundamental and particularly difficult to solve. The first problem is to find and tojustify a definition of the domain of economics within which rationality-based theoriespredict successfully, which is not vacuous (as it would be if the domain were defined toconsist of exactly those choice problems for which the predictions of rational choicetheory succeed) and which is wide enough for economics to have something useful tosay about the real world. The second problem is to find consistency conditions for�rational� preferences, secure enough to serve as the basis for reliable deductiveinferences and with enough substance to allow a science of rational choice to havepredictive power, without appealing to contestable hypotheses that derive from psy-chological theory or experiment. Pareto and the discovered preference theoristsgrapple with these problems – with what success, we leave the reader to judge.

For most of the twentieth century, however, mainstream economics represented itselfas a separate science without bothering much about these problems. Limits to thedomain of rational choice theory were not discussed; there was an implicit presumptionthat the theory was universal in its application – applying, for example, under uncer-tainty as well as under certainty and objective risk, to public as well as to private goods,to altruistic as well as to self-interested behaviour, and to politics as well as to eco-nomics. The preferences of economic agents were assumed to satisfy strong axioms ofconsistency; these axioms were motivated on a priori grounds but not tested against theevidence of real decision-making behaviour. But now behavioural economics has calledthe bluff. It can no longer be taken for granted that the Paretian turn – the project ofseparating economics from psychology, of grounding economics on principles ofabstract rational choice – was the path of progress. The road not taken was perhaps nota dead end after all.



University of Milan-BicoccaUniversity of East Anglia

Submitted: 3 February 2004Accepted: 13 September 2005

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