Rational economic man – Homo Economicus

Homo Economicus is a hypothetical concept that humans are:

  • Self-interested
  • Know what they want
  • Make rational choices to maximise their utility.
  • These choices are based on concept of marginal utility.

This concept of a rational economic man is an important cornerstone of neo-classical economic theory. It creates a framework to model how consumers and firms will respond to different situations.

“Would a rational economic man, put £1 in an honesty box for a bottle of water?”

How ‘rational economic man’ is used in economic theory

Demand. If we assume rational economic man, with ordered preferences, we can make assumptions on how a changes in price will lead to changes in demand. Using a linear demand curve – with a higher price we would expect lower demand.

Model of perfect competition. This model assumes firms are profit maximisers and will respond to changes in price and super-normal profit. It also assumes consumers are rational and seeking to maximise self-interest i.e. buying for the lowest price.

Role of incentives. If man is motivated by financial gain, it suggests a free-market where individuals are rewarded for productivity will lead to more efficient economy. It is a motivation for a policy like privatisation. The argument is that if firms have a profit incentive, the managers will endeavour to cut costs and make more profit than if the firm was collectively owned.

Economists who have developed/supported model of homo economicus

  • Adam Smith – In The Wealth of Nations considered how pursuit of self-interest could lead to efficient outcome. Though it is worth noting in Theory of Moral Sentiments, Smith took a more nuanced view and hoped man would pursue ‘nobler ideals than self-interest

“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.”
― Adam Smith, The Theory of Moral Sentiments (1759)

  • William Stanley Jevons who developed theories of utility maximisation – the rational consumer choosing bundles of goods to maximise utility.
  • Vilfredo Pareto mentioned the concept homo economicus in his Manual 1906. Pareto ascribes it to Vito Volterra (Volterra 1901:436-458). According to research, the earliest mention is by Maffeo Pantaleoni’s Principii di Economia Pura (Pantaleoni 1889) (Origins of term)
  • Milton Friedman in The Methodology of Positive Economics (1953) Friedman defended the assumptions of classical economics – even if they were not actually consistent with psychological behaviour. Friedman argued the importance was the ability to predict behaviour.
  • Gary Becker. Becker was instrumental in suggesting many decisions from crime to family were related to individuals maximising their utility, e.g. if rewards from crime were greater than the cost, then people would steal.

Limitations of this theory include:

  • Behavioural economics suggesting man has many biases and examples of irrational behaviour
  • Man is not always self-interested, but can act on basis of altruism and from perspective of community/society.
  • Recipirocity. If someone does a favour to us, we like to return the favour. Similarly if someone hurts us, we may want to get a kind of revenge – even if it leads to loss of personal utility.
  • Bounded rationality – individuals lack sufficient knowledge and so make best guesses based on limited information.
  • The model places too much emphasis on extrinsic motivation – profit, higher wages more goods. In reality, we are motivated by intrinsic motivation. For example, giving to charity can give a ‘feel-good factor’. This can make it rational to give away wealth.
  • Home sociologicus. Many decisions we take are developed and framed within concept of society we live. Hence, we vote to gain social approval, even though from stictly limited perspective it is not rational to bother.
  • Gift giving is an important aspect of social interaction. We offer support to community for expectation this will lead to improve welfare for others.

Strong and weak versions of Homo-economicus

In ‘weak versions’ of homo-economicus, we can add many of these perceived limitations into the model. For example, an awareness we gain utility not just from outer materialistic gain, but acts of altruism and intrinsic motivation. In other words, it is entirely rational to give to charity, if we get a good feeling from so doing.

Economists critical of concept of homo economicus

  • Amaryta Sen – critical of narrow self-interest view of man
  • Amos Tversky / Richard Thaler – behavioural economists who questioned assumption agents are rational, e.g. investors driven by emotion rather than logic
  • Dan Ariely – Limitations of financial incentives to motivate workers, greater gain from non-financial motivation.
  • Fritz Schumacher – Need to consider environment, wider social interest and not narrow selfish interest.
  • Elinor Ostrom – Work on Commons and how individuals could co-operate to manage shared resources, seems to contradict models of pure self-interest.

A defense of Rational Economic Man

Many economists argue that although there are obvious holes in the theory of a self-interested rational economic man, it still serves as a useful starting point – so long as we remember its limitations. Paul Krugman in an essay on Milton Friedman, explains why he defends the role of rational economic man.

“For most of the past two centuries, economic thinking has been dominated by the concept of Homo economicus….

It’s easy to make fun of this story. Nobody, not even Nobel-winning economists, really makes decisions that way. But most economists—myself included—nonetheless find Economic Man useful, with the understanding that he’s an idealized representation of what we really think is going on.”

Krugman, Paul “Who was Milton Friedman?New York Review of Books (2007)

Are you a homo economicus?

It is useful to ask yourself

  • Are you rational?
  • Do you know what you want?
  • Do you act to maximise your utility?

The honest answer is probably that ‘sometimes we are, sometimes we are not.’ We all have many elements of irrational behaviour but we still try to make the best of our situation. Usually when we act we are probably thinking we are doing the right thing. If we give to charity, we do so because we get happiness from the act. However, there are also times when this narrow economic assumptions fails to explain our behaviour. There are stronger bonds of family, society, and notions of spirituality which cause us to make decisions in a way which don’t reflect the model of homo economicus. But, if you are studying economics, rational economic man provides a starting point to build theories and ideas from.

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