JOS Referee Report

Review of ‘The Empirical Evidence Against Utility Maximization’ (JOES-12-01-

001)

Summary of the Paper

This paper summarizes many strands of empirical evidence against the textbook

economic model of decision making of a fully rational, self interested exponentially

discounted expected utility maximizer. The authors focus on 7 topics (as I interpret

them): Social preferences, cognitive ability, the construction of value, savings behavior,

alternative models of consumption, the Poliani critique and the relationship between

income and happiness.

Overview

This paper offers an interesting guide to many of the empirical findings that have driven

the rise of behavioral economics over the last 30 years. As a behavioral economist, I

think that many of the issues that are raised in the paper are extremely interesting and

worthwhile. However, I think that there are several issues that limit the paper’s

effectiveness in summarizing the weakness of the extbook model, which I list below

 The Title: Utility maximization has a technical definition, which is that

people maximize (or at least act as if they maximize) some stable utility

function. In the first instance, we don’t care what it is that determines utility,

just that there is some coherence to people’s choices. Since Samuelson, we

have known how to test whether people look like utility maximizers – we see

whether they violate WARP (or GARP, or SARP). There is indeed a literature

on whether or not people act like utility maximizers. See for example

Echenique et al [2011] and Choi et al [2007]. But this paper doesn’t look into

this problem, and as such I’d suggest a different title

 The Tone: Even as someone who has a lot of sympathy with many of the

arguments in the piece, I found the tone somewhat jarring. For example, in the

conclusion “Today’s economists do not bother to check whether their theories

are actually aligned with real world behavior”. This will come as a bit of a

surprise to the thousands of applied economists who thought they did exactly

that. Even if the point is more that we don’t check whether the underlying

assumptions on which we build our theories on is correct, this will come as a

surprise to the thousands of behavioral economists who work on many of the

issues described in this paper.

This is one example of what I believe to be a theme running through the paper

which is “economists are blinkered idiots who are willfully ignoring the way

in which people behave when they build their models, and therefore say all

sorts of stupid things” This is a view that may (or may not) have been valid 30

years ago, but I don’t think it is today. (Almost) every major economics

department has someone who works on behavioral issues, and almost all

important economic issues have been considered in the light of the

phenomena that the authors discuss (social preferences, temptation and self

control, etc). A look at the February edition of the AER shows an article on

the origins of co-operation, one on the effect of confusion on asset prices, one

of the effect of conflict on social preferences and one on the behavioral

foundations of mircrocredit. It is therefore in my opinion unfair and unhelpful

to label all economists as ignorant (or dismissive) of behavioral issues.

Of course, this is not to say that all economists spend all their time using or

designing behavioral models. Some of them think that the more traditional

models of behavior capture what is important for the question they are

studying. Whether they are correct in this belief or not is an empirical

question, and an extremely important one, but not one this paper does a good

job of dealing with. In fact, I would argue that it presents an extremely one

sided view of the data: while it is true that the factors that the author presents

in this paper are important for behavior, it is also true that the forces

considered by traditional economics are also extremely important. In fact, if

you open any major economics journal at random, you will find articles that

describe how a model that boils economic behavior down to an (obviously

untrue) set of primitives can actually do a surprisingly good job of explaining

many phenomena. A crucial question for behavioral economists is identifying

which behavioral phenomena are quantitatively important for understanding

which questions. It would be great if this survey could try to do this in a more

evenhanded way

 The level of detail and depth of analysis: I think that the article had two

problems with regard to the thoroughness of its analysis. First, I think that,

after 30 years or so of behavioral economics, an article such as this needs to

do more than just describe the existence of various behavioral phenomena, but

say something about how we model them, and the evidence for and against

these models. This seems to be pretty much entirely absent from this paper:

for example there is no discussion of inequality aversion as an explanation for

social preferences, quasi-hyperbolic discounting as a model of temptation and

self control or prospect theory as an explanation for reference dependence and

probability weighting. This is important with regard to the discussion above,

in the sense that these are models that potentially may work better that the

standard econ 101 model, and so a wider population of economists should be

using them.

Second, the article contains a number of unsubstantiated (and possibly untrue)

claims that at the very least need to be backed up. This is particularly the case

with regard to the cause of the financial crisis. This is a question that could

use a survey article in itself, but it is not obviously clear that the issues raised

in this paper offer a more convincing explanation of what went on that (for

example) the presence of financial frictions and credit multipliers. I would

therefore drop these claims (or, if I am wrong, do a better job of backing them

up)

 Materiel covered, and organization. By and large, the article covers many of

the ‘big hits’ of behavioral economics. However, the organization seems to be

a little arbitrary. For example Intergenerational Justice seems to be related to

social preferences, yet is in a different section, while temptation and self

control issues turn up in section 5 and section 8. One way to organize the

paper that would (in my opinion) make sense would be

o Utility maximization, value construction and framing effects

o Social norms and preferences

o Complexity and computational costs

o Temptation and self control – including issues of discounting but also

preference for commitment, which is currently not discussed

o Choice under risk and uncertainty – including a discussion of

violations of expected utility and ambiguity aversion, which is

currently missing

o Reference dependent preferences – including the endowment effect,

but also status quo bias and the reflection effect (which are currently

not discussed)

o The effect of stakes, learning and experience: The authors discuss this

somewhat, but it seems so ubiquitous that I wonder if it is worth

getting its own section

o Happiness.

Specific Comments

 In section 1, it is probably worth discussing some of the different models of other

regarding preferences, such as fairness [Rabin 1993] or inequality aversion

[Bolton and Ockenfels 2000] and the evidence for and against these models. Also

in the context of altruism, discussing the warm glow vs cold prickle [Andreoni

1995]

 This is not my area, but I feel that section 2.3 is overstating the case. While there

is evidence that in some cases punishment and social norms are substitutes, is the

author really claiming that the amount of cheating is always inversely related to

the benefit of doing so? Surely this is not the case?

 In section 2.4, the first thing that ‘standard economics doesn’t take into account’

about communities is, I think something that a lot of (completely standard)

economists think about - particularly in the network literature - at least as far back

as Rees [1966]

 When discussing the limits of computational ability, it is probably worth

discussing the rational inattention literature started by Sims [2003] and the related

evidence. In the game theoretic context, the level K model and related evidence

should be discussed (e.g. Costa-Gomes et al 2001)

 The claim at the end of section 3.2 is overly strong. There are at least some

occasions in which learning and experience do reduce ‘irrationality – for example

List [2003]

 In order to serve its purpose as a survey article, I think it would be good if the

authors could give some more details about the biases listed by Barbaris and

Thaler [2003]

 I’m not sure why the endowment effect is listed under evidence from cognitive

psychology. Wasn’t this first discussed in the economics literature?

 The claim at the end of the first paragraph on page 25 seems to be another

example of overreach. There are many possible reasons that stadium owners

behave in this way, of which you have listed one.

 The ‘three real world problems’ discussed on page 30 are not convincing reasons

to discard standard economic methodology. The first is something that could

easily be incorporated into standard models. The author makes a nice point that

this should be done, but there is nothing ‘behavioral’ about this. The second point

is wrong in the sense that these models are precisely trying to capture some

particular social norms. Of course, there may be others that are also worth

considering, but that does not mean that the exercise in this book is not

worthwhile. Third, the question of whether social planner solutions can be

implemented by the market is a large and well studied area in its own right

 Section 6 ignores an enormous economic literature on consumers who have to

search in order to find out information on the goods that they may want to buy,

for example Stahl [1989]

 For many reasons I found the section on the Polanyi critique unconvincing, and I

would drop it.

 I don’t agree with the claim at the top of section 8 that “Ultimately, the subject of

economics is (or ought to be) about how materiel resources can be used for the

benefit of human beings”. This is one of its aims, but economics is a science

(whereby we want to understand how stuff works), not just a policy exercise.

 The discussion of happiness misses out any discussion about the problems of

measuring happiness, and in particular what we learn from happiness surveys.

 The claim about happiness and set points at the top of page 43 is very strong, and

needs to be either weakened or backed up.

References

Andreoni, James, 1995. "Warm-Glow versus Cold-Prickle: The Effects of Positive and

Negative Framing on Cooperation in Experiments," The Quarterly Journal of Economics,

MIT Press, vol. 110(1), pages 1-21, February.

Gary E. Bolton & Axel Ockenfels, 2000. "ERC: A Theory of Equity, Reciprocity, and

Competition," American Economic Review, American Economic Association, vol. 90(1),

pages 166-193, March.

Syngjoo Choi & Raymond Fisman & Douglas Gale & Shachar Kariv, 2007. "Consistency

and Heterogeneity of Individual Behavior under Uncertainty," American Economic

Review, American Economic Association, vol. 97(5), pages 1921-1938, December.

Costa-Gomes, Miguel & Crawford, Vincent P & Broseta, Bruno, 2001."Cognition and

Behavior in Normal-Form Games: An Experimental Study," Econometrica, Econometric

Society, vol. 69(5), pages 1193-1235, September.

Federico Echenique & Sangmok Lee & Matthew Shum, 2011. "The Money Pump as a

Measure of Revealed Preference Violations," Journal of Political Economy, University of

Chicago Press, vol. 119(6), pages 1201 - 1223.

John A. List “Does Market Experience Eliminate Market Anomalies?” The Quarterly

Journal of Economics Vol. 118, No. 1 (Feb., 2003), pp. 41-71

Rabin, Matthew. 1993. "Incorporating Fairness Into Game Theory and Economics." The

American Economic Review.83, 1281-1302.

Rees, A. (1966) “Information Networks in Labor Markets," American Economic Review,

56, 559-566.

Sims, C.A. 2003. Implications of Rational Inattention. Journal of Monetary Economics

50(3), 665-690.

Stahl, "Oligopolistic Pricing with Sequential Consumer Search," American Economic

Review, 79, September 1989, 700-712