Structure and Behavior: A Fork in the Road for Economics

1
Structure and Behavior A Fork in the Road for
Economics

• Shyam Sunder, Yale University
• WEHIA 10
• University of Essex, U.K.
• June 113-15, 2005

2
Humanities and Science

• Science does not know its debt to imagination.
• Ralph Waldo Emerson
• Vivisection is a social evil because if it
  advances human knowledge, it does so at the
  expense of human character.
• George Bernard Shaw
• The theoretical broadening which comes from
  having many humanities subjects on the campus is
  offset by the general dopiness of the people who
  study these things.
• Richard P. Feynman (Nobel Laureate in Physics)
• Economics has an amazing capacity to summarize
  staggeringly complex phenomena by the application
  of only a handful of principles
• Charles R. Plott

3
Overview

• Origin of experimental economics in examination
  of aggregate phenomena
• Gradual, steady shift towards micro-levels due to
• Analytical process and reasoning
• Incremental research questions
• Unlike assumption in theory, people do not
  optimize well by intuition
• Today, much experimental work has shifted to
  examination of individual behavior and of
  economies populated by artificial agents
• What are the antecedents and consequences of this
  trend?
• Usefulness of organizing experimental economics
  into three streams
• Structural macro properties of social structures
• Behavioral behavior of individuals, and
• Agent-based exploration of links between the
  micro and macro phenomena
• At least the structural part of economics can be
  a science, bypassing the free-will dilemma of
  social sciences

4
Examining Market Institutions

• Chamberlin (1948) examined the behavior of a
  market institution under controlled conditions of
  his classroom
• Vernon Smith (1962), a subject of Chamberlin)
  redesigned and systematically varied the market
  conditions to examine price, allocation, and
  extraction of surplus
• Both deviated from Walrasian tatonnement
  abstraction market design fleshed out with
  details, with stock market as a guide
• Economic environment (market demand and supply)
  and market design as independent variables
• Market level outcomes as dependent variables

5
Data from Experiments

• Experiments can yield a great deal of data
• Data are limited only by interest and imagination
  of the experimenter, and ingenuity in capturing
  data without distracting subjects from their task
• Chamberlin gathered three pieces of data for each
  transaction (price, seller cost and buyer value),
  and transaction sequence
• Did not gather clock time of transactions,
  details of the bargaining process (time elapsed,
  price proposals, number of proposals, number of
  counter-parties bargained with), etc.

6
Data to Meet Experimental Goals

• Most experiments can yield a great deal of data
• We gather only what we need to learn what we wish
  to learn from the experiment
• Technology of data gathering (and possibility of
  interaction between data capture and subjects)
  serve as constraints
• Given Chamberlins goals, asking subjects to
  report their transactions immediately after they
  concluded one served well, causing little
  interference with subjects trading

7
Shift Towards Micro Phenomena

• Focus of experimental economics has gradually
  shifted from aggregate market level phenomena
  towards individual behavior
• Three factors seem to drive this shift
• Logic of analytical method
• Incremental research designs
• Empirical finding that people, acting by
  intuition alone, are not good at optimization as
  typically assumed in derivation of equilibria in
  economic theory

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Logic of Analytical Method

• It is rare for the correspondence between the
  predictions of the relevant theory, and
  experimental data, to be nil or total
• If the experimenter has no expectation of any
  correspondence between the two, even weak
  relationship is seen as half full glass of water
• However, most experiments are designed to examine
  specific theories that have some legitimate prior
  claim to predictive power
• In such situations, any imperfections of
  correspondence between data and theory are seen
  as half empty, not half full, glass of water
• Seeking a fuller explanation to close the gap
  between data and theory is a natural reaction of
  investigators

9
Search for Higher Explanatory Power

• Following this logic, analysis and discussion of
  virtually all experiments ends in a search for
  ways to increase the correspondence between data
  and theory
• Better prediction and explanation is the currency
  of scientific progress
• We look for ways to modify the model to enhance
  its explanatory power through analysisbreaking
  the problem down into smaller components
• This logical pursuit shifts research question(s)
  to the next level of detail causing
  micro-nization
• Discarding the details to step back and see the
  big picture is a less common reaction

10
Demand, Supply and Experiments

• Simple economic theory point of intersection of
  demand and supply determines price and
  allocations
• Economists deep faith in theory
• Neither Chamberlins nor Smiths data
  corresponded precisely with theory
• Smith saw half full glass of water, while
  Chamberlin saw the half empty part and set out to
  build a model to better explain the residual
  variation left unexplained by the simple
  demand-supply model (instantaneous demand/supply)

11
Incremental Research Designs

• Most research (including experimental work) is
  incremental, originating in proposals to gather
  data about some additional aspect of behavior, or
  additional analysis of existing data
• Conjectures about how such data or analysis might
  help explain residual variation
• Incremental work dominates graduate seminars
  focused on critique and replication of extant
  work
• Easy to think of additional observations,
  motivations, and information conditions
  associated with individual participants to
  improve the fit between data and model

12
Change in Models and Questions

• Both analytical logic and incremental pursuits
  change the model used
• Additional variables use up some degrees of
  freedom, but observations at micro-level are far
  more numerous than at macro-level
• Shift to micro level also changes the research
  question(s) being asked
• Why is the price equal x? might be replaced by
  why did trader y bid z?

13
Individual Behavior and the Dilemma of Social
Sciences

• This shift towards micro-behavior confronts
  economics with a fundamental dilemma shared among
  the social sciences
• As a science, we seek general laws that apply
  everywhere at all time, emulating physics,
  chemistry and biology
• Perfecting the scope and power of general laws of
  human behavior also implies squeezing out the
  essence of humanityour free will
• What does it mean to have a science of individual
  human behavior?

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Free Will

• Free will, independent thinking, and ability to
  choose essential to our concept of self
• We believe in our power and ability to do what we
  wish, beyond what is predictable on the basis of
  our circumstances, beliefs, and tendencies
• Ability to rise above our circumstances as the
  essence of human identity
• We can choose deliberately, in ways unpredictable
  to others
• Else, we would slip to the status we assign to
  animals, plants and inanimate objects

15
Humanities Eternal Truths

• Humanities celebrate infinite variety of human
  behavior, but no laws of behavior
• In epics and literature eternal verities, but no
  laws of behavior
• Epics (Mahabharata, Iliad)
• Duryodhana, Yudhishtira, Arjuna
• Literature (Dantes Inferno, Shakespeares
  Hamlet)
• Human truths, questions, and tendencies repeated
  through history, always with a new twist
• People choose in ways unpredictable on the basis
  of their circumstances
• Celebration of infinite variation in human nature

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Science Eternal Laws

• Identifying laws of nature valid everywhere and
  all the time
• Essence regularities of nature captured in known
  and knowable relationships among observable
  elements (including stochastic)
• Helps understand, explain, and predict
• If I know X, can I form a better idea of whether
  Y was, is or will be?
• Objects of science have no free will
• A photon does not pause to enjoy the scenery
• A marble rolling down the side of a bowl does not
  wonder about how hot the oil at the bottom is

17
Social Science Irresistible Force Meets
Immovable Object

• Free will essential to our concept of self
• Without the freedom to act, we would be no
  different than a piece of rock
• Yet, the object of study in social science is us
• As a science, it must look for eternal laws that
  apply to humanity
• But stripped of freedom to act, and subject to
  such laws, there can be no humanity

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Mismatch of Science and Personal Responsibility

• Objects of science can have no personal
  responsibility
• They do not choose do anything
• They are merely driven by their circumstances,
  like a piece of paper blown by gusts of wind, or
  a piece of rock rolling down the hill under force
  of gravity in the path of an oncoming car
• Or, perhaps an abused child who grows up to be an
  abusive parent, sans personal responsibility
• Science and responsibility do not mix well

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Neither Fish Nor Fowl

• This problem of social science is exemplified in
  the continuing attempts to build a theory of
  choice
• From science end axiomatization of human choice
  as a function of innate preferences. People
  choose what they prefer
• How do we know what they prefer? Look at what
  they choose
• The circularity between preferences and choice
  might be avoided if there were permanency and
  consistency in preference-choice relationship
  across diverse contexts
• One could observe choice in one context,
  tentatively infer the preferences from these
  observations, and assuming consistent
  preferences, predict choice in other contexts
• Unfortunately, half-a-century of research has
  yielded little predictability of choice from
  inferred preferences across contexts (Friedman
  and Sunder 2004)
• Individual human behavior appears to be
  unmanageably rowdy for scientists to capture in a
  stable set of laws
• While humanists may not take delight at such
  disappointments, but they can hardly be surprised
  (if they paid any attention to choice theory)

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Dilemma of Social Science

• Do we abandon free will, personal responsibility,
  and special human identity and treat humans like
  other objects of science?
• That is, drop the social and become a plain
  vanilla science
• Or, do we abandon the search for universal laws,
  embrace human free will and unending variation of
  behavior, and join the humanities
• Either way, there will be no social science left
• Is there a way to keep social and science
  together?

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Isolating Three Streams of Work

• Perhaps there is no general solution to this
  dilemma
• The dilemma does, however, point to the potential
  value of isolating streams of work where it may
  be more or less of a problem
• Significant parts of social sciences, and a large
  part of economics, are concerned with aggregate
  level outcomes of socio-economic institutions
• Institutions themselves do not need to be
  ascribed intentionality or free will
• Characteristics of the institutions can be
  analyzed by methods of science without running
  into these dilemmas
• This will leave analysis of individual behavior
  in the territory between science and humanities
• Agent-based models (in economics and elsewhere)
  could serve the bridging function between
  aggregate and individual phenomena
• Let us consider these possibilities

22
Individuals

• I do not have much to add on the most complex
  problem of examining individual behavior
• It seems that we shall continue to examine
  ourselves and our behavior using both humanities
  as well as science perspectives, without ever
  reconciling the two into a single logical
  structure
• There seems to be no way out

23
Institutions

• Experimental economics started out as
  investigation of aggregate level outcomes of
  market institutions using human subjects
• Attention has gradually shifted from aggregate
  outcomes to micro behavior
• Logic of analytical approach
• Incremental research designs
• A third reason is that predictions of aggregate
  outcomes (equilibrium analysis) are typically
  made assuming optimization by individuals
• Cognitive psychology showed that individuals are
  not very good at optimization by intuition
• This mismatch between the optimization assumption
  actual behavior at individual level has given
  additional impetus to micro-nization of
  experimental economics
• Thanks to recent findings using agent-based
  methods, we can conduct the study of
  social-economic institutions using methods of
  science

24
Optimization and Equilibrium

• The standard approach of economic analysis has
  been to assume that individuals choose actions by
  optimizing given their preferences, information
  and opportunity sets
• Interaction of individual actions in the context
  of institutional rules yield outcomes (e.g.,
  prices and allocations), equilibrium outcomes
  being of special interest
• Equilibrium predictions derived from assuming
  individual rationality could be suspect when such
  rationality assumption is not valid
• Agent-based simulations suggest that individual
  rationality can be sufficient but not necessary
  for attaining equilibria in the context of
  specific market institutions

25
What Makes the Difference
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Why Equilibrium without Individual Optimization

• Why do the markets populated with simple
  budget-constrained random bid/ask strategies
  converge close to Walrasian prediction in price
  and allocative efficiency
• No memory, learning, adaptation, maximization,
  even bounded rationality
• Search for programming and system errors did not
  yield fruit
• Modeling and analysis supported simulation results

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Inference

• Perhaps it is the structure, not behavior, that
  accounts for the first order magnitude of
  outcomes in competitive settings
• Computers and experiments with simple agents
  opened a new window into a previously
  inaccessible aspect of economics
• Ironically, it was not through computers
  celebrated optimization capability
• Instead, through deconstruction of human behavior
• Isolating the market level consequences of simple
  or arbitrarily chosen classes of individual
  behavior modeled as software agents

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Optimization Principle

• In physics marbles and photons behave but are
  not attributed any intention or purpose
• Yet, optimization principle has proved to be an
  excellent guide to how physical and biological
  systems as a whole behave
• At multiple hierarchical levels--brain, ganglion,
  and individual cellphysical placement of neural
  components appears consistent with a single,
  simple goal minimize cost of connections among
  the components. The most dramatic instance of
  this "save wire" organizing principle is reported
  for adjacencies among ganglia in the nematode
  nervous system among about 40,000,000
  alternative layout orderings, the actual ganglion
  placement in fact requires the least total
  connection length. In addition, evidence supports
  a component placement optimization hypothesis for
  positioning of individual neurons in the
  nematode, and also for positioning of mammalian
  cortical areas.
• (Makes you wonder what went wrong with human
  design when you see all the biases and
  incompetence of human cognition.
• Could it be just the wrong benchmark?)
• Questions about forests and questions about
  trees

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Optimization Principle Imported into Economics

• Humans and human systems as objects of economic
  analysis
• Conflict between mechanical application of
  optimization principle and our self-esteem (free
  will)
• Optimization principle interpreted as a
  behavioral principle, shifting focus from
  aggregate to individual behavior
• Cognitive science we are not good at optimizing
• Increasing willingness among economists to
  abandon the optimization principle

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Dropping the Infinite Faculties Assumption

• Conlisk
• Empirical evidence in favor of bounded
  rationality
• Empirical evidence on importance of bounded
  rationality
• Proven track record of bounded rationality models
  (in explaining individual behavior)
• Unconvincing logic of unbounded rationality
• All reasons focus on the trees not forest

31
Equilibrium and Simon

• Simon in the third edition of The Sciences of the
  Artificial wrote
• This skyhook-skyscraper construction of science
  from the roof down to the yet unconstructed
  foundations was possible because the behavior of
  the system at each level depended on only a very
  approximate, simplified, abstracted
  characterization of the system at the level next
  beneath. This is lucky, else the safety of
  bridges and airplanes might depend on the
  correctness of the Eightfold Way of looking at
  elementary particles.
• Indeed, the powerful results of economic theory
  were derived from a very approximate,
  simplified, abstracted characterization of the
  system at the level next beneath,the economic
  man so maligned, and its scientific purpose and
  role so misunderstood, by many who claim to be
  followers of Simon

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Economics Structural or Behavioral

• Economics can be usefully thought of as a
  behavioral science in the sense physicists study
  the behavior of marbles and photons
• Given the pride we take in attributing the
  endowment of free will to ourselves, this
  interpretation of behavior is a hard sell in
  social sciences
• To build on the achievements of theory, it may be
  better if we think of optimization in economics
  as a structural principle, Just as physicists
  (and many biologists) do
• This will allow us to focus on structural stream
  of economics in the tradition of sciences
• Individual behavior is likely to remain as a
  shared domain of humanities and sciences
• Modeling specific behaviors as software agents in
  the context of specific economic institutions
  allows us to make conditional statements about
  the links between individual and aggregate level
  phenomena (as in the case of ZI agents)

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Thank You

• Please send comments to
• Shyam.sunder_at_yale.edu