Beyond Rationality

Circulated by Dr. Aditi Singhal

We are trying to take an even closer look at the utility theory, by analyzing its various
possible criticisms. Broadly, we can divide criticisms into two categories –
i. That can be incorporated into the theory
ii. Ones that can’t be incorporated into the theory. For that matter, their acceptance will
make the theory of utility null and void.

Through this entire module, our focus would be on the criticisms that falls into the first
category.
In our critique, we will be broadly covering following aspects - try and critique the
assumptions, consider other behavioral aspects, and discuss the moral and social norms.

Utilitarianism
According to Bentham, utilitarianism is about providing greatest possible goods for greatest
possible number of people. But there are a couple of points to be kept in mind.
i. We need to figure out a way of aggregating preferences
ii. Need to also consider the issue of interpersonal comparison

In our discussion of Rational Choice Theory (RCT), we have however, started with the
discussion on individual preferences. While we know that from a policy maker’s perspective
or from the perspective of a social scientist, what would matter more would the preferences
of the society as a whole and not just of an individual. Then why did we at all discussed
individual preferences? (Methodological individualism!).
In our discussion of individual utility, we talked about – achieving first best feasible
alternative.
We started with the discussion of preferences and using following schema we determined the
individual’s choice.
Preference + Budget Constraint Optimal Choice

Rationality of choice and hence, of underlying preferences (complete and transitive

preference orderings) has always built-in into our discussion.
While completeness and transitivity are minimalistic requirements, these are by no measure
easy to justify. Further, it is also important to note that the rationality does not necessarily
imply self- interested behavior, nor does it imply morality (can be a rational villain –
whose rationality makes him to cause maximum amount of pain).

Is RCT normative? Well, the model or the theory that we discuss is per se not because these
are simple ‘if’ and ‘then’ statements. But the results that we derive or the conclusions that we
arrive at using RCT, do have a normative connotation.

Our discussion so far has been based on deductive reasoning and hence, it becomes more
important to satisfy the assumption of our arguments, otherwise the whole theory will fall
apart.

But the reality of the matter is that most of the times a consumer may not exactly know his
preference structure. Furthermore, it is even more difficult to have transitivity, which
mostly gets violated in the choice that we make as individual consumers. However, under
certainty, when you exactly know about the outcomes, when you have perfect knowledge /
information – the assumptions of rationality are though hard to justify / prove but is still
easier to assume to hold good.

But under uncertainty, where individual needs to have preferences over lotteries (probable
outcomes), these assumptions are even more difficult to satisfy. It is because that now not
only do we need to have completeness and transitivity to satisfy, but the probabilities and
subjective beliefs defined over the different outcomes in the lottery, should also follow the
mathematical laws. Additionally, in some cases, the individual might not even know all the
plausible outcomes under a lottery, forming and belief over its occurrence or attaching any
probability to it, is a much far-fetched thought.

Moreover, the assumption of complete information under certainty is way too strong to make.
We don’t have complete information, always, nor do we have enough time to dwell on all the
available choices. As humans therefore, we seldom optimize, and we rather satisfice (=
SATISY + SUFFICE). We make use of internal mental processes - desires, imagination,
motivation, etc. to eventually make a choice that is ‘satisfactory’ and not really the ‘optimal’
one. This is what is called as bounded rationality.

We are guided by heuristics and biases as Tversky and Kahneman (1974) has talked about.
Heuristics are cognitive rule of thumbs, hard wired mental shortcuts, pattern recognition that
we make use of, almost all the time when we face a choice. Cognitive biases are when we
have inclination towards a particular belief, mostly ill supported by reason and evidence,
in making a choice.
There exist following types of heuristics and biases –

a) Misconception of chance - Individuals tend to revise their estimate of the probability

of an event depending on past occurrences, even when the events are actually
independent. Suppose, you have HHHHH from the first five flips of a coin, people
tend to assume the probability of a tail coming up on the sixth flip is pretty high —in
reality the probability of a tail coming up is exactly as it was for each flip prior to the
sixth, and is going to be the same for all subsequent flips, 1/2.

b) Availability heuristic– based on how easy is it to bring something to mind. Example -

think of your decision to travel - you have the option to either travel via public
transport or using you own vehicle. But because of the constant scare of spread of
virus, you might like to prefer travelling in your vehicle over any means of public
transport. So, here you have an availability bias, based on the information of spread of
virus that easily pops up in your mind.
c) Representative heuristic – Comparing current situation to the most representative
prototype. Example – when you are deciding if someone is trustworthy – you may try
and map the characteristics of the person for which you are deciding, with some other
person you may already know.
d) Affect heuristic – choices that are influenced by emotions that the individual is
experiencing currently. So, when a person is running high on positive emotions, her or
she will be looking situations more positively, vis-à-vis the time when he or she is
mostly cynical.
e) Anchoring and adjustment – anchoring bias involves the tendency to be overly
influenced by the first bit of information making it more difficult to consider any
 other factor. In this the individual chose a reference point and then adjusts to the
refernce point till he or she reaches a suitable decision.
Consider an example, in a handicraft shop the salesman knows that there would
definitely be bargaining by the consumer, so he would keep the price higher of the
product at say $100.
Now, the consumer would automatically anchor to $100 and would adjust the
bargaining to probably $70 and ultimately the equilibrium maybe reached at $80.
However, if the shopkeeper would have priced the product at $80 initially, that may
have been sold for around $60. Therefore, when we make decisions, we first
determine an anchor and adjust accordingly.
f) Status-quo bias / endowment effect / emotional bias- preference to current state of
affairs.
g) Aspirations – preference for a better state of affairs.