Economic Theory: Structural Abstraction or Behavioral Reduction

29 Pages Posted: 10 Sep 2007

See all articles by Shyam Sunder

Shyam Sunder

Yale University - School of Management; Yale University - Cowles Foundation

Date Written: August 2005

Abstract

In physics, optimization is an organizing principle for natural phenomena. Entropy tends toward its maximum and marbles roll toward minimum potential energy, all without intent or purpose. Injection of this principle into economics initially followed the physicists' organizing perspective, and helped develop the powerful insights of the abstract partial and general equilibrium theory. However, humans and their institutions being their unit of analysis, it was not long before optimization in economics acquired a behavioral spin. Photons may travel along paths that minimize their travel time without intent or purpose; but economists were too human to think in a similar vein of the people buying ice cream or cars. Once optimization was posited as a behavioral principle of individual human beings, it was easy for cognitive sciences to show that it lacked descriptive validity; however, individual behavior is more complex and less predictable. The aggregate characterizations of Walrasian abstraction could not be derived starting from such complex micro-level behavior. If psychology and equilibrium theory were to be reduced into a single science, something had to give. Given the cognitive limitations humans share with all organisms, validity and relevance of the conclusions of equilibrium theory became suspect.

The marriage of economics and computers led to a serendipitous discovery: there is no contradiction between suboptimal behavior of individuals and aggregate-level outcomes derivable from assuming individual optimization. Science does not require integration of adjacent disciplines into a single logical structure. As the early twentieth century unity of science movement discovered, if we insist on reducing all sciences to a single integrated structure, we may have no science at all. In Herbert Simon's words (1996, p. 16): 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. This is the story of how we found that economists can have their cake while psychologists eat it too, including some antecedents and consequences of the discovery.

Keywords: Optimization principle, individual behavior, aggregate outcomes, reductionism

JEL Classification: B29, B49, C91

Suggested Citation

Sunder, Shyam, Economic Theory: Structural Abstraction or Behavioral Reduction (August 2005). Available at SSRN: https://ssrn.com/abstract=800786 or http://dx.doi.org/10.2139/ssrn.800786

Shyam Sunder (Contact Author)

Yale University - School of Management ( email )

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6160 (Phone)

HOME PAGE: http://www.som.yale.edu/faculty/sunder/

Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
United States

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