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American Economic Association

From Homo Economicus to Homo Sapiens
Author(s): Richard H. Thaler
Source: The Journal of Economic Perspectives, Vol. 14, No. 1 (Winter, 2000), pp. 133-141
Published by: American Economic Association
Stable URL: http://www.jstor.org/stable/2647056
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This optimism will induce me to predict that economics will become more like I want it to be. 2.) The false consensus effect will trap me into thinking that other economists will agree with me-20 years of contrary evidence notwithstanding. Overconfidence. George Wu. Number1-Winter 2000-Pages 133-141 From Homo Economicus to Homo Sapiens Richard H. Overconfidence will induce me to make forecasts that are bolder than they should be. we can't imagine ever thinking otherwise. people believe they are better forecasters than they really are. Thaler esponding to a requestfor a forecastis especiallytrickyfor someone like me.In a related phenomenon. Research in psychology suggests that certain biases are very likely to creep into my forecasts about the future of economics (or anything else). . On the first day of my MBA class on decision-making at the University of Chicago. 3.Illinois.We all tend to be optimistic about the future. This makes it hard for us to realize that what we know may be less than obvious to others who are less informed. asked his students two questions: Do you have a cell phone? What percentage of the class has a cell phone? Cell phone owners thought 65 percent of the class had mobile phones. The False ConsensusEffect. Universityof Chicago. yet half are inevitably disappointed. every single student expects to get an above-the-median grade. while the immobile phoners thought only 40 percent did. who specializes in other people's biases. Optimism(and wishfulthinking).Chicago. My colleague. GraduateSchoolof Business. The curse of knowledge will lead * RichardH. 1. Thaleris theRobertP. 4. Ask people for 90 percent confidence limits for the estimates of various general knowledge questions and the correct answers will lie within the limits less than 70 percent of the time. The Curseof Knowledge.Journal of EconomicPerspectives-Volume14. We tend to think others are just like us. (The right answer was about halfway in between.Once we know something. GwinnProfessorof Economicsand BehavioralScience.

and have learned the same lessons from them (lessons I now take for granted).134 Journal of Economic Perspectives me to think that others will have read the same articles I have. it would not make very interesting reading (or writing). the alternatives are not very attractive. contestants are told to guess a number from 0 to 100. the equilibrium in this game is zero. In making some forecasts for the future of economics. Recently. and so on. In any other setting. 1992). the Financial Times ran a "guess the number" game contest using the rules . guessing zero is not a good strategy. with the goal of making their guess as close as possible to two-thirds of the average guess. economists who began formalizing the micro foundations of Keynes developed more rational models. and have never even heard of the findings that have so influenced my thinking. when in fact others have been busy reading entirely different material. In this game. Rationally. in the sense that they will form expectations about the guesses of others can carry out as many levels of deduction as necessary. I realize that the forecast most likely to be right is to predict that economics will hardly change at all. either. for example. (Have I mentioned status quo bias?) Although such a forecast has the virtue of brevity. and then with the rational expectations hypothesis of Muth. compare Keynes's simple consumption function with the life-cycle hypothesis. I had the opportunity to play this game for quite large stakes (Thaler. Reversing a 50-year Trend Economics in the first half of the 20th century was much more of a social science. with trepidation. In a world where all the players are known to be fully rational. However. Homo Economicus Will Begin Losing IQ. Lucas. forecasts that are guaranteed to contain every bias mentioned above. The IQ of Homo Economicus became bounded only by the IQ of the smartest economic theorist! My prediction is that this trend will be reversed in favor of an approach in which the degree of rationality bestowed to the agents depends on the context being studied. Writers such as Irving Fisher and John Maynard Keynes stressed psychological factors in their explanations of economic behavior (Loewenstein. then Model A is better than Model B. however. it would be embarrassing to commit (in writing) all the mistakes I spend weeks warning my students to avoid. I am going to make six bold predictions about how economics will develop over the next couple decades. To illustrate how this can work in practice. as well as some others. At my request. So. economic agents began to be more explicitly optimizing. consider the "guess the number" game first studied by Rosemarie Nagel (1995). You have been warned. In the 1950s. With the mathematical revolution that began to take off in the 1940s with the likes of John Hicks and Paul Samuelson." The aesthetic in the field became that if the agents in model A are smarter than the agents in Model B. Eventually the models came to include agents that detractors called "hyperrational. 1997).

creates a controlled experiment in which he is able to learn many things eventually. are a little slower on the uptake.000). Although modeling how this game is ac. Many economists fall into this category (clue in part to the False Consen-sus Effect and the Curse of Knowledge!) Sophisticated economic models will have agents that are both more and less sophisticated than the agents we are ulsed to modeling. In fact. 22 is two levels. Homo Economicus Will Become a Slower Learner Most economic models have no reason to introduce learning becauise agents are assumed to solve the relevant problem correctly on trial one. the most popular guesses were 33 (the right guess if everyone else chooses a nuimber at random) and 22 (the right guess if everyone else picks 33). First. HE quickly learns to correct it. the opportunity to rerun the same day repeatedly.91 and thuis the winning guess was 13. MIT. and Chicago. they still often make a mistake in applying a concept if the context is slightly disguised. Bill Mutrrayis a TV weatherman sent to report on whether the groundhog sees his shadow on Feb. and to learn from the conseqllences of his actions each time. This is why putting a question about the first part of the course on an exam covering the later part of the course is considered so unfair by the students. Even after hearing what is. The problem with many economic models of learning is that they seem to apply to a very static environment. even at our best universities such as Cornell. a completely clear explanation. An appropriate model would have to allow for two kinds of heterogeneity in sophistication.tuallyplayed is n-ot easy. with no gender inference intended) is typically taken to be a quick stuidy. Murray's character endcs up reliving the same day over and over again. However. 2. Althotugh he is a slow learner. HE makes an error. agents differ in how many levels of processing they engage in (33 is one level. some lessons are clear enough. Trhaaler 135 described above and offered two bulsiness class tickets from London to the United States as a prize (worth over $10. Only integer guesses were permitted. The average giuess was 18. Although many contestants did guiess zero or one. I predict this sort of modeling will be the norm in the futulre. Alas. to my uinbiased view.If. the stuidents I have taught over the years. In life.Richard H. and so on). and the 1 The idea that economic models of learning are similar to this movie evolved during a conversationi I had with Colin Camerer during a RtussellSage Foundation summer instittute oni behavioral economics. Second. When learning is explicitly introduced. such models seem to be directly applicable only to the situation in which Bill Murray finds himself in the movie Ground Hog Day. perchance. life is not like Ground Hog Day. each day is different. . from how to prevent accidents to how to play the piano.' In that movie. Agents who guess zero are sophisticated on the first dimension and naive on the second. It is a safe bet that we each think it was otur idea. Homo Economicus (hereafter abbreviated HE. there is heterogeneity in how much agents think about the behavior of other agents.

My prediction is that in fu-tureseminars presenters will have to explain why they are using a model with only rational agents (uinless the paper is on the history of economic thought). presenters of such models still feel compelled to explain why they need to have these quasi's mucking things up. children. show that it is possible for the quasi's. college presidents.136 Journal of Economic Perspectives most important of life's decisions. Suppose there were some less-than-fullyrational agents. and for good reason: It is false! When rational agents interact with quasi-rational agents. Althouigh papers mixing rational and quasi-rational agents have become popular over the past decade or so. most economists are happy to admit they know many people whose reasoning is qtuite flawed: their spouses. such as those by De Long et al. This means that models of saving for retirement (a hard problem with few opportunities for learning) should be very different from models of frequency of milk purchases (easier. Once these quasi-rationals started interacting with rational types. analyses of market interactions between agents of variouis types is exactly what differentiates economics from other social sciences. . or to set prices unilaterally. the rational agents cannot be expected either to take all the quasi's money. careful analyses of such situations in financial markets. it is still considered a novelty to have some quasi's in the model. I like to call them "quiasi-rational. In workshops. the rationals would quickly take all their money. typically some kind of evolution plus markets argument is offered. sociologists and anthropologists might help us improve our characterizations of economic behavior. After all. but economists are the only social scientists with the tools to analyze what happens in market contexts. Note that I am not predicting that HE will disappear from economics research. The Species Populating Economics Models Will Become More Heterogeneous Although you can get the wrong impression reading economics textbooks and journal articles. When pressed on why it is reasonable to base economic rnodels exclusively on rational representative agents. (1990). after which the quasi's would either learn or would be rendered economically irrelevant. while at the same time thinking that most of the people they interact with are at least occasionally bozos.called "noise traders" in finance circles-to end up richer than their rational counterparts (by inadvertently bearing more risk). offer only a few chances for learning! I predict that economic models of learning will become more sophisticated by making their agents less sophisticated and giving greater weight to the role of environmental factors. The argument proceeds something like this. deans. Psychologists. Indeed. with many learning chances). colleagues."meaning trying hard but subject to systematic error. and so on. such as the difficulty of the task and the frequency of feedback. in determining the speed of learning. Rarely is this argument spelled out carefully. such as choosing a career or spouse. students.

"For a cur-renit review of this literature. The vertical axis shows happiness resulting fi-om these changes. see Thaler (1999). though we have given considerable attention in recent years to the irnpli2 Some of what we know about this problem falls in-tothe categoly of "mental accounlting. but does not tell us how people will spontaneously create their own frames. Some successful examples published in the last 20 years prove that this kind of work is both feasible and useful. much as perfect competition is used today. First.as in financial markets. for example. a basic finding in the psychology of perception (psychophysics). Prospect theory tells us that choices depend on the framing of a problem. the loss function is steeper than the gain function." The value function shows changes in material well-being on the horizontal axis. when a few highly trained special agents can influence maarkets.FromHomoEconomicusto Hoino Scpiens 137 At least two roles should remain. By directly studying how people attack decision-making problems. Economists Will Study Human Cognition One way of modeling bounded rationality is to reduce the informationprocessing capabilities of the agents. I predict. I'll suggest two here. namely. This. we may learn more about this problem-editing process. because humans (and other species) have a strong tendency to adapt to their environment and react only to perceived changes. by assuming that individuals will only do two steps of backward induction rather than infinite steps. will be a major area of effort over the next two decades. Finally. . especially in models with heterogeneous agents. The S-shape displays diminishing inarginal sensitivity to both gains and losses. This positive theory of decision-making under uncertainty manages to capture an enormous amount of psychological wisdom in its S-shaped "value function. having been used to explain as diverse phenomena as consuiners reaction to price changes in the supermarket to the labor supply behavior of cab drivers (Camerer. rather than levels as in expected utility theory. in the case of the numbers game discussed earlier. The most significant exemplar is the "prospect theoiy" of Daniel Kahneman and Amos Tversky (1979).2 Second. These three psychological concepts yield plenty of explanatory power. Losses hurt about twice as much as gains make us feel good. There are an enormous number of exciting ways in which a better understanding of human cognition could help us do better economics. many aspects of the standard HE model are useful as theoretical special cases. First. A more interesting research agenda is to attempt richer characterizations of economic agents via a better understanding of human cognition. Second. a property that has come to be known as loss aversion. there is a problem with prospect theoiy that cognitive psychology might help us fix. This is a sensible initial approach. they can be usefully modeled as HEs. forthcoming). but we can do more that make HE dumber. the theory is incomplete.

events that boui-icdedm--emi-ioiries. but since people do choose themn in real life. However.such as WilliamI1 iaiagems mriaximiiizesales subject to a profit constraint. To themi. Consider. normiiiativetheories characterize rational choice: examples would include the axioims of expected utility theory and Bayes' rule. Part of the resistanlce to such theories. Their forecasts were bearish: they thouglht it was more likely that the iiiarket would go down thani up. Expected utility theory and the life-cycle theoiy of savinlg are rationial (normnative)models that economists have Lusedalso as descriptive miodels. to have been predictable. Agenits wlho choose according to prospect theory violate fundamiental axiomiis of rational choice. Agency theory with absentminded principals (anid agenlts) would be an exciting field of inquiry. anlyreal world principal) will find it very difficult to distinguish between a bad decisionl anld a bad outcome. The self- " FoC) aiclevrC examiipleof whait absenlt-nijioided econloiics iiiight look like.138 Journal oJ'Ecu om)&ic Persp)edtives cations of boLlildedi ratioiiality. Two rmionthslater I asked them to try to recall their earlier forecast. one year in mnyclass I asked im-ystudents oii the first day of class (in late January) to make predictions about stock iimaiketreturns for the next two monlths.the iole of hinidsight bias in agency pioblems. happen aie thoulght to have beeni predictable. Needless to say. and has powerful iinplications for economics. Occasionlally econonlists have proposed explicitly Bauim0ol's(1967) theom-yof the firm in which descriptive th1eories. For examnple. see Mtllainathon (1999).A over B even when B doininates A. under certain circumstances they will choose option. high stakes situations. . A principal with a biased m-emiiory(that is.3 Economists Will Distinguish Between Normative and Descriptive Theories Psychologists distinguish between two kinds of theories: normative and de- scl iptive. Piospect theory is an example of a descriptive theory. since an unlucky exogenous event will be tlhought. for example. Thllisphenoimienioni(1-elated to the curse of knowledge mentioned earlier) is both stroiig and robust. For example. it is iiiiportant that economists develop models that predict such behavior. in hinidsight. as long as the dominance is niot too obvious. I would not want to call such choices rational. for examiiple. I think. the imiarketrose sharply over this two rnonth period. Descriptive theoiies ti-y to characterize actual choices. Bauiiiol often heard the ciitique that firinnsthat maximized sales would inevitably lose inarket share to competing firi-is that were tiying to maximize profits. They remembered beinig bullish. Economiists have traditionally used one theory to serve both the normiiativeanid descriptive purposes. we have speint less time studying the impact of A simiipleexam-ipleis "hindsight bias":after the fact. has been based on a misunderstanlding of the issues raised above regarding how competitioni will force changes in quasi-rational behavior. such descriptive theories hlave not woni great acceptanice.

a perfectly good equilibrium in which some firms are willing to accept lower profits in order to be bigger. shame. like fear. pride. Baumol's sales maximization hypothesis was suggested to him by conversations with managers. one can say that Responders react emotionally to very low offers. to the other player. So. unscientific.RichardH. this prediction leads to an auxiliary prediction that more theorists will pay attention to data. Although Elster does not define emotions explicitly. The Responder can either accept the offer. in that they are triggered by beliefs. We might get more specific and say they react indignantly. In the ultimatum game one player. in which case the Responder gets x and the Proposer gets $10-x. the profit-maximizing owners of other teams can do little except become even richer losers. contempt. and drowsiness. by which I mean that economists will devote more attention to the study of emotions. Copernicus watched the movements of the planets before devising his theoiy that the planets orbit the sun. it seems right to offer the slightly more courageous prediction that Homo Economicus will become more emotional. love. x. and makes an offer of some portion of the money. the Proposer. Kahneman and Tversky's prospect theory was derived by examining hundreds of choices between pairs of gambles. Similarly. Homo Economicus Will Become More Emotional The predictions I have made so far. for example. of course. Some economists seem to feel that data-driven theory is. somehow. disgust. are still somewhat conservative in the sense that lots of good work is already going on in the directions I suggest that the field will be headed.just the opposite is true. joy. he does offer a list of states that he says are unambiguously emotions. How can emotions be incorporated into economic analyses? The ultimatum game offers one simple example. Thaler 139 contradictory nature of this critique-that maximizing sales would cause lower market share-did not seem to bother (or occur to) its adherents. So. regret. What makes for a good descriptive theory is out-of-sample tests. Speaking very generally. say $10. or reject the offer in which case both players get nothing. and. Many of these emotions are often accompanied by states of physiological arousal. One additional point about descriptive theories: they are. Elster distinguishes this list from other "visceralfactors" (a more general term. if a baseball team owner chooses to buy a World Series victory at the expense of profits. guilt. malice. hatred. not vice versa. jealousy. envy. driven by data. There is. the prediction that Pluto would be discovered before telescopes were good enough to see it. hunger. fear. of necessity. of which a subset are: anger. What is certain is that Responders do . Experimental results reveal that very low offers (less than 20 percent of the pie) are often rejected. I refer readers to Jon Elster's (1998) recent article. is given a sum of money. liking. To get a sense of what the study of emotions entails. see Loewenstein. oh yes. 1996) such as pain. Of course. and such firms take market share away from profitmaximizing competitors. grief. indignation. the Responder. though fraught with the biases I identified early on.

Matthew Rabin's (1993) model of fairness.Cass Sunstein and all the editorsfor helpfulcomments. GeorgeLoewenstein. like me. which is an attempt to explain such behavior (specifically. recontracting requires interaction that can be made difficult by spite. In a recent study of this issue. m The authorwould like to thank Colin Camerer. The Coase theorem prediction that the allocation of resources is independent of the assignment of property rights depends on the willingness of the parties to a lawsuit to recontract. If some of my predictions about the future of economics come true. (Old economists. each generation of scientists builds on the work of the previous generation. a conservative economist might (emotionally) scoff: "If this were a better way of doing economics. Andrei Shleifer. Others will follow. As economists become more sophisticated. Still. it hurts both parties.PeterDiamond. Conclusion My predictions can be summarized quite easily: I am predicting that Homo Economicus will evolve into Homo Sapiens. young economists will have done the work. since they turn down offers in which they receive a small share of the pie and take zero instead. we can hope that new scholars in other disciplines can do for economics what cognitive psychologists such as Kahneman and Tversky have already done: offer us useful findings and theories that are relatively easy to incorporate into economic models. In not a single case did the parties even attempt to contract around the court order. Unfortunately. Nonetheless. It seems logical that basing descriptive economic models on more realistic conceptions of economic agents is bound to increase the explanatory power of the models. can't learn new tricks any better than dogs. Ward Farnsworth (1999) interviewed attorneys from over 20 nuisance cases in which injunctive relief was sought and either granted or denied after full litigation before ajudge. Building models of rational.140 Journal of EconomicPerspectives not act to maximize their own payoffs. unemotional agents is easier than building models of quasi-rational emotional humans. This prediction shouldn't be an outlandish one. Rejecting a positive offer in the ultimatum game is spiteful.Jesus Santos. we would already be doing it that way!" Why aren't all my predictions already true? And why should I expect things to change? One reason economics did not start out this way is that behavioral models are harder than traditional models.) A few of these young economists are already on the horizon. the resisting of unfair offers) is based partly on emotions. Spite is not confined to ex-spouses. Simultaneously. Theorems too hard to prove 20 years ago are found in graduate student problem sets today. their ability to incorporate the findings of other disciplines such as psychology improves. such behavior is more common than economic theorizing would lead us to expect. I need only mention the word "divorce"to bring to mind all-too-many familiar examples. . However. I will close with a very safe prediction.

Nagel. Lawrence Summers. Ward. "Out of Control: Visceral Influences on Behavior.98. 65:3. Thaler. "Unraveling in Guessing Games: An Experimental Study. forthcoming." Journal of Economic Literature. "Prospect Theory in the Wild. eds. Daniel and Amos Tversky.85:5. Richard H. Andrei Shleifer. 1996. pp. "Do Parties to Nuisance Cases Bargain After Judgement? A Glimpse of the Cathedral. 1998. Bradford. "Incorporating Fairness into Game Theoiy and Economics. "Mental Accounting Matters. Jon.From Homo Economicus to Homo Sapiens 141 References Baumol. 1990. ed. Elster. Rosemarie. XXXVI." working paper. pp. 12811302. 1992. Loewenstein. William. 47-74." Organizational Behavior and Human Decision Processes. Kahneman. "Noise Trader Risk in Financial Markets. pp. . 703-38." Universityof Chicago Law Review. 805-24.Kahneman." American EconomicReviezv. Valueand Growth. 183-206. New York: Cambridge University Press.47:2. George. Mullainathon. pp. MIT Economics Department.June 16." FinancialTimes. "Prospect Theory: An Analysis of Decision under Risk. J. 83. pp. Farnsworth. pp. 1967. Business Behavior. New York: Russell Sage Foundation." In Chioices.Frames."Journal of Behavioal Decision-making. Camerer. George. Loewenstein. "Emotions and Economic Theory. 3-34. pp. 1995. 1999." in ChoiceOver Time. pp. Rabin. Daniel and Amos Tversky. Colin. 373-436.March.6. pp."Journal of PoliticalEconomy.New York: Harcourt Brace. 1997."American EconomicReviezv.Values.66.12. 263-91. Richard H. and Robert Waldmann. De Long. "The Fall and Rise of Psychological Explanations in the Eco- nomics of Intertemporal Choice. Matthew.December. 1313-1326. George and Jon Elster. Sendhil. 1993."Econometrica. "GivingMarketsa Human Dimension. 1979.March. 1999. 1999. 1997. Thaler. "A Memory Based Model of Bounded Rationality. Loewenstein.