Irrational Behavior and Economic Theory

Author(s): Gary S. Becker

Source: The Journal of Political Economy, Vol. 70, No. 1 (Feb., 1962), pp. 1-13
Published by: The University of Chicago Press
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 THE JOURNAL OF
POLITICAL ECONOMY
VolumeLXX FEBRUARY 1962 Number
i

IRRATIONAL BEHAVIOR AND ECONOMIC THEORY'

GARY S. BECKER
Columbia University

I. INTRODUCTION of a well-ordered function,such as a

it has longbeenagreed or
utility profit function.
economictheory Strongand even violentdifferences
ALTHOUGH
thattraditional
"assumes"rationalbehavior,at developed,however,at a different level.
onetimetherewas considerable disagree- Critics claim that householdsand firms
mentoverthemeaning of the word "ra- do notmaximize, at leastnotconsistent-
tional." To many,the word suggested ly,that preferences are notwellordered,
an outdatedpsychology, lightning-fast and that the theory is not usefulin
calculation,hedonisticmotivation,and explaining behavior.Sometheorists have
otherpresumablyunrealistic behavior. replied that economic theory is valid
As economictheorybecamemoreclear- only as a broad tendency,not in each
ly and precisely formulated, controversyspecificinstance;some noted that the
over the meaningof the assumptions "proofofthe puddingis in the eating,"
diminishedgreatly,and now everyone and arguedthat this theorygives use-
fulpredictions eventhoughdecisionsdo
moreorlessagreesthatrationalbehavior
not "seem" to be rational;still others
simplyimpliesconsistentmaximization claimedthat onlyrationalbehaviorhas
1 My greatestdebt is to A. A. Alchian for the
muchchanceof survivinga veryharsh
stimulationprovided by his article of more than
a decade ago ("Uncertainty,Evolution and Eco-
competitive world.
nomicTheory,"JournalofPoliticalEconomy,LVIII The purpose of this paper is not to
[June19501),and forcommentson various drafts, contribute still anotherdefenseof eco-
beginningin the summerof 1957. I am also indebted
to M. Friedman for insightfuloral and written
nomicrationality. Ratherit is to show
statements(see "The Methodologyof Positive Eco- how the important theoremsof modern
nomics,"in Essays in PositiveEconomics[Chicago: economics resultfroma generalprinciple
Universityof Chicago Press, 1931]) on economic
rationality,to seminar groups at Columbia, the
whichnotonlyincludesrationalbehavior
National Bureau ofEconomicResearch,NorthCar- and survivor arguments as specialcases,
olina State College, UCLA, and Stanford,and to but also much irrationalbehavior.No
Z. Griliches,H. G. Johnson,H. G. Lewis, J. Mincer,
P. J. Nelson,and G. J. Stigler.I alone am responsi-
matterwhat the intent,some readers
ble, however,forany remainingerrors. mightbelievethattheeffect ofthisdem-
1
2 GARY S. BECKER
onstrationis to provideanotherand more
powerfuldefenseofeconomicrationality.
I believe it does provide an important
defense of the theoremsof modern eco-
nomics, although, of course, the only
ultimate defense is an empirical one,
and no new empiricalmaterialsare intro-
duced. Since, however, these theorems
are shown to be consistentalso with an
extremelywide class of irrational be-
havior,a defenseofthemis not necessari-
ly a defense of individual rational be-
havior. Indeed, perhaps the main con-
clusion of this study is that economic
theory is much more compatible with
irrationalbehavior than had been pre-
viously suspected.
Although economists have typically
been interestedin the reactionsof large
marketsto changesin different variables,
economic theoryhas been developed for
the individual firmand household with
market responses obtained simply by
blowing up, so to speak, the response
of a typical unit. Confusionresultedbe-
cause comment and analysis were di-
rectedaway fromthe marketand toward
the individual,or away fromthe econo-
mist'smain interests.Those arguingthat
rationality is only a broad tendency,
or that only a few units need behave
rationallyin orderformarketsto do so,
werewell aware ofthe difference between
marketand individuallevels of analysis.
Unfortunately, however,one can equally
well argue that irrationalityis only a
broad tendency,or that only a fewunits
need behave irrationallyin orderformar-
kets to do so. An argumentsupporting
rationalityat the marketlevel must im-
ply that rational unit responses would
tend to outweigh irrational ones. This
paper clearly distinguishesbetween the
market and individual levels and pro-
duces such an argument implying ra-
tionality at the market level. Perhaps
it will help shiftthe analytical interests
of economiststoward the same level as
theirsubstantiveinterests.
Section II firstpresentsthe traditional
theory of household choices and then
shows why its main implication-that
market demand curves are negatively
inclined-can also be derived from a
wide varietyof irrationalbehavior. Sec-
tion III develops similar argumentsfor
firms,and IV summarizesthe discussion
and adds a few additional implications.
II. HOUSEHOLDS
Traditionaltheory.-Traditionaltheory
assumes that householdschoose the best
collectionof commoditiesconsistentwith
the limited resourcesavailable to them.
To determinewhich collectionis "best"
a preferenceor utilityfunctionis intro-
duced with the propertiesthat any col-
lection A always gives more,less, or the
same utility as any other collection B
(the consistencyassumption), and that
if A is preferredto B, and B to C, A
must be preferredto C (the transitivity
assumption). The best collection pro-
duces more utility than any feasible
alternative. This theory is usually il-
lustrated geometricallyby the diagram
shown in Figure 1: commodity X is
plotted along the horizontal axis, the
"other" commodityY along the vertical
axis, AB is the budget line and OAB
definesthe feasiblecollections,and pref-
erences are representedby the set of
equal utilityor indifferencecurves. The
best collection must be on AB at the
point p where AB is tangent to an in-
difference curve.
A change in relative prices or real
income would change the location of the
best collection,and the fundamentalthe-
orem of this theoryis that the demand
curve for any commodity,real income
held constant, must be negatively in-
 IRRATIONAL BEHAVIOR AND ECONOMIC THEORY 3

lined. In Figure1 a changein the budget eitherthe marketor the household level
line fromAB to CD increasesthe relative and are of littlepractical use.
price of X and reduces that of Y, and The utilityapproach to household de-
attempts to hold real income constant cisions has been extensively criticized
by holding the ratio of money income ever since its conception,although both
to a Laspeyres price index constant.2 formulationand criticismhave changed
This is the methodmost commonlyused drasticallyovertime.Today, criticseither
in empiricaldemand studies to separate denythat householdsmaximizeany func-
relative price from real income effects. tion or that the functionmaximized is
The best collectionis changed fromp to consistentand transitive.In effect,they
p', and the fundamentaltheoremstates
that p' is to the left and above p, or Y
less X and more Y is chosen. Since the
demand curve of a market with many C II
householdsis usually obtained by hori-
zontal summationof the individual de-
mandcurves,it would simplybe a blown-
up or macroscopic reproductionof the
individualmicrocurvesand, consequent-
ly, would also be negativelyinclined.3 A
Market demand curves of many com-
modities have been extensivelyinvesti-
gated empiricallyand almost invariably
are found to be negativelyinclined,4as
predicted by traditional theory, while
household demand curves, on the other
hand,have seldombeen investigatedand
littleis known about them. Other impli- o D B X
cations of utility theory5have almost
FIG. 1
never been empiricallyinvestigated at
2 It is well
known that real income would be deny that households act "rationally"
approximately heldconstantin thesensethat house- since rational behavior is now taken to
holdswouldtendto remainon the same indifference
curve. signifymaximizationof a consistentand
3 Even if household demand curves were inter-
transitivefunction.6
dependentthe marketcurvewould tend to be nega- How can these extensivecriticismsbe
tively inclined,but more or less elastic than the reconciled with the fact that the main
averagemicrocurve,dependingon whether"band-
wagon" or "snob" effectspredominated. implicationof utilitytheory-that mar-
Widespread confidencein the universalityof
ket demand curves would be negatively
negative marketcurves has, however,resulted in inclined-has been consistentlyverified
some "cheating." Other findingsare oftensimply empiricallyand found extremelyuseful
not published or altered until more "reasonable"
findings
emerge. in practical problems? Perhaps one ex-
IThe whole set of implications can be sum- 6 See, e.g., W. Edwards,"The Theory ofDecision
marizedin the negativesemi-definiteness of a cer- Making," PsychologicalBulletin,LI (July, 1954);
tain quadratic form. See, e.g., P. A. Samuelson, reprintedin Some TheoriesofOrganization,ed. A. H.
The FoundationsofEconomicAnalysis (Cambridge, Rubensteinand C. J. Haberstroh(Homewood,fli.:
Mass.: Harvard UniversityPress, 1947), p. 114. Richard D. Irwin,Inc., 1960).
4 GARY S. BECKER
planation is that the assumptions of a
theory are often "tested" individually
ratherthan as a whole,or what amounts
to the same thing,ratherthan by their
implications.Surelyanotheris that many
criticismsare really aimed only at the
normativeimplicationsof utilitytheory.
In this paper I suggest a reconciliation
along verydifferentlines; principally,by
showingthat negativelyinclinedmarket
y in relative prices also tends to produce
C decision rule. In particular, the funda-
A in opportunitiesalone and is largelyinde-
o D B X
FIG. 2
demand curves resultnot so much from
rationalbehaviorper se as froma general
principlewhich includes a wide class of
irrational behavior as well. Therefore,
households can be said to behave not
only "as if" they were rational but also
"as if" they were irrational: the major
piece of empiricalevidencejustifyingthe
firststatement can equally well justify
the second.
A generalapproach.-Economists have
long been aware that some changes in
the feasibleor opportunitysets of house-
holds would lead to the same responsere-
gardlessof thedecisionrule used. For ex-
ample, a decrease in real income neces-
sarily decreases the amount spent on
at least one commodity,and the aver-
age percentage change in expenditures
on all commoditiesmust equal the per-
centage decrease in income. These the-
orems, although "obvious" and "arith-
metic," have been extremelyuseful in
practical problems. It has seldom been
realized, however, that the change in
opportunitiesresulting from a change
a systematicresponse,regardlessof the
mental theorem of traditional theory-
that demand curves are negatively in-
clined-largely results fromthe change
pendent of the decision rule.
Since the budget line CD in Figure
2 has a higherrelativepriceforcommodi-
ty X and a lower price for Y than does
AB, the set OCD inclosed by CD offers
more opportunityto consume Y and
less opportunityto consumeX than does
the set OAB. If point p representsthe
amountsofX and Y (Xo, Yo) that would
be chosen from OAB by a particular
decision rule, OCD can be said to offer
smaller opportunity to consume more
than Xo of X and greater opportunity
to consume more than Yo of Y than
OAB does. If the amount of any com-
moditychosenbya decisionrulewereposi-
tively related to its availability,less X
than Xo and more Y than YO would
necessarily be chosen from OCD. De-
mand would be negatively related to
priceforall such decisionrules,no matter
how they differedin otherrespects.
The traditionaltheoryof rational be-
havior is easily shown to be a rule that
depends on the effectof a change in rela-
tive prices on the distributionof oppor-
tunities.In equilibriuma rationalhouse-
hold would gain the same utility from
 IRRATIONAL BEHAVIOR AND ECONOMIC THEORY
spending an additional dollar on any
commodity.A change in relative prices
would shiftmarginal as well as average
consumptionopportunitiestoward rela-
tively cheaper and away frommore ex-
pensive commodities because a dollar
now buys more of the formerand less
of the latter.Consequentlyan additional
dollar at the old equilibrium position
would add more utilityif it were spent
on the formerthan the latter. Hence
rationalhouseholdswould have an incen-
tive to change theirconsumption,along
with the opportunityset, toward rela-
tively cheaper and away frommore ex-
pensive commodities.
Not onlyutilitymaximizationbut also
many other decision rules, incorporat-
ing a wide variety or irrationalbehav-
ior,7lead to negativelyinclined demand
curvesbecause of the effectof a change
in prices on opportunities.This will be
demonstratedwith two models of irra-
tional behavior that encompass both a
wide and an allegedly "realistic" class
ofbehavior.On the one hand, households
are often said to be impulsive,erratic,
and subjectto never-ending whim,and on
the otherhand, inert,habitual,and slug-
gish. One view alleges that momentary
impulsesbeget a confusingarrayof undi-
rected change, the other that the past
permitslittle currentchange or choice.
Between these two extremeslies a wide
spectrumof irrationalbehavior, partly
determinedby the past and partly by
currentimpulses.
If the implications of such behavior
are to be fullydeveloped, the attributes
of "impulsiveness" and "inertia" must
be given a precise and quantitative for-
mulation.To that end, impulsivebehav-
7 Any deviationfrom utilitymaximizationis con-
sidered "irrational" in this paper: a more precise
or philosophicaldefinitionis not required for our
purposesand is not attempted.
5
ior will be representedby a probabilistic
model in whichdecisionsare determined,
so to speak, by the throwof a multisided
die; inertbehavior by a model in which
decisions are determined by the past
wheneverpossible (the meaning of this
clause is fully developed shortly); and
intermediatebehaviorby a weightedav-
erage of these extremes.I believe these
models do effectivelycapture the spirit
of the strongestand most frequentcriti-
cisms of utility theory, although this
cannot be rigorouslyshown.In any case,
they vividly illustrate how irrational
choices can also be systematicallyaf-
fected by a change in the distribution
of opportunities.
Impulsive households are assumed to
act "as if" they only consulteda proba-
bility mechanism: no preferencesystem
or utilityfunctionis consulted. Indeed,
to eliminateany vestige of utilitymaxi-
mization, it is assumed that every op-
portunityhas an equal chance of being
selected.8Althoughthe consumptionof
a single household could not be deter-
minedin advance, the average consump-
tion of a large number of independent
households would almost certainly be
at the middle of the opportunityset,
which is also the (mathematically) ex-
pected consumptionof a single house-
hold. If opportunitieswere initially re-
strictedto the budget line AB in Figure
2, the average consumption of many
householdswould be close to p, the mid-
point of AB, with differenthouseholds
uniformlydistributedaround p.
A change in relativeprices which held
a market-weighted Laspeyres price index
constant would rotate the budget line
8 Zvi Grilichespointedout to me that thismodel
was also presentedin a very briefappendix to the
article by R. L. Marris, "ProfessorHicks' Index
NumberTheorem,"Reviewqf EconomicStudies,
XXV (October,1957), 25-39. The Appendixis said
to be based on a conversationwithHarry Johnson.
 GARY S. BECKER
throughp, the point representing market
consumption.9The line CD represents
a compensated increase in the price of
X, and points would now be chosen
at random along CD instead of AB.
Each household could be anywhere on
CD, but again the average location of
many independenthouseholdswould al-
most certainlybe at the middle, repre-
sented by p' in the figure.It should be
clear geometricallyand is easily shown
algebraically that p' is not to the left
and above p by accident: a compensated
increase in the price of X always shifts
the midpointof the budget line upward
and to the left, while a compensated
decrease shiftsit downward and to the
right.'0
The fundamentaltheoremof rational
behavior, that market demand curves
are negativelyinclined,is, therefore, also
implied by impulsive behavior, at least
in marketswith large numbersof house-
holds. The expected demand curve of
each household must also be negatively
inclined,althoughmany actual individu-
al curves would not be." Both expected
individual and actual market demand
I Since utilitymaximizationis not assumed, a
compensatedprice change could no longerbe said
to hold the level ofutility(approximately)constant.
The importantpoint for our purposes, however,
is that empiricalstudiesusually separate pricefrom
income effectsin this way, and the negative slope
ofempiricaldemandcurvesis a valid and important
regularity,regardlessof whether utility "really"
has been held constant.
10Since the midpointof any budget line is given
by (I/2P2, I/2Pv), where I is moneyincome and
Px and Pv are unit prices,a compensatedchange
in the price of X much change the midpoint of
X in theoppositeand thatof Y in thesame direction.
11An individual demand curve is more likely
to be negativelyinclinedthe greaterthe numberof
price observationsand the longerthe time period
coveredby each one. Averagingover pricesor time
is as effectivein cancelling out erratic behavior
here as averagingover householdsis in a market.
curves are negatively inclined because
of the effectof a change in prices on
the distributionof opportunities.An in-
crease in the relative price of X shifts
opportunities away from X, increases
the fractionof those with less X than
in the initial position, and thereby in-
creases the probabilitythat an impulsive
householdwould reduce its consumption
of X. And what is simplymore probable
for a particular household becomes a
certainty for a large number of inde-
pendent ones.
Considernowa modelofinertia:where-
everpossible,householdsconsumeexactly
what they did in the past. Point p can
again representthe average consumption
of a large group of households faced
with the budget line AB, and CD the
line resulting from a compensated in-
crease in the price of X. Households
initiallyin the region Ap could remain
thereindefinitely afterthe price change,
the budget line. Some, however,would
also have to be initiallyin the half-open
regionpB, unless all were at p, and they
could not remainthereindefinitely after
prices changed, no matter how much
they wanted to, because pB would be
outside the new opportunityset OCD.
Obviously, households forced to adjust
are not by accident preciselythose with
an above average consumption of X,
foran increasein X's price shiftsoppor-
tunitiesaway fromX.
If the average household in pB had
been consuming more than OD of X,
the average amount of X consumed by
all householdswould necessarilydecline.
Those in Ap would not change,and those
in pB would have to reduce their X
since OD is the maximum X permitted
by the budget line CD. In general, the
larger the change in relative prices and
the larger the dispersionamong house-
 IRRATIONAL BEHAVIOR AND ECONOMIC THEORY
holds,'2 the more likely is it that the
maximumX permittedby the new budg-
et linewould be smallerthan the average
in pB. Althoughthe adjustments made
by households in pB cannot be deter-
mined preciselyuntil a decision rule is
specified,theirconsumptionof X would
probably decline even when not arith-
metically necessary: a wide variety of
decisionruleswould do thisbecause they
wereconsumingrelativelylarge amounts
of X, and the opportunityset shifted
away from X. The conclusion is war-
ranted, therefore,that a group of inert
consumers,along with rational and im-
pulsive ones, would tend to have nega-
tivelyinclineddemand curves.
A broad class of irrational behavior,
includinginert and impulsive behavior
as extremecases, would be encompassed
by a model in which current choices
werepartlydeterminedby past ones and
partlyby a probabilitymechanism.'3In
otherwords,these choices are a weighted
average of those made by impulsiveand
inert households. Since market demand
curvesat both theseextremeswould tend
to be negatively inclined, the market
curves of any weighted average would
also tend to be. So all behavior in this
class would reproduce the fundamental
theoremof rational behavior.
A utilitymaximizinghouseholdwould
necessarilyhave negativelyinclinedcom-
pensateddemand curvesand a consistent
and transitive"revealed" preferencesys-
tem. A compensated change in prices
to an irrationalhousehold,on the other
hand, would have very different effects.
For example, a compensated change to
a singleinert household, ratherthan to
12Averageconsumptionin pB is positivelyrelated microscopicreproductionof the market.
to the dispersionaround the over-allaverage repre-
sentedby p.
13 Mathematically this model is a first-order
Markov process.
7
a group of them, would not cause any
change in consumption; and although
an impulsive household would tend to
have negativelyinclined demand curves
and consistent and transitive revealed
preferences,therewould be many excep-
tions. The marketdemand curve in mar-
kets with many irrational households
would, however,be negativelyinclined,
and the market'srevealedpreferencesys-
tem could be said to be rational (con-
sistentand transitive)in the sense that
a compensated change in prices would
push the market outside its initial op-
portunityset.
Hence the market would act as if
"it" were rational not only when house-
holds were rational,but also when they
were inert, impulsive, or otherwise ir-
rational.This analytical statementmust
be distinguishedfromthe frequentlyen-
countered arithmetical statement that
a market would behave rationallyeven
if only a few households did, assuming
always that the average consumption
of other households did not move per-
versely. The same arithmetic demon-
strates that a market would behave ir-
rationallyeven if only a few households
did, again assuming that the average
consumption of others did not move
''perversely."Our statementgoes beyond
arithmeticand stems from an analysis
ofthe responsesof rationaland irrational
households.
A "representative" household would
act rationally even when actual ones
did not if "representative"simply indi-
cates a microscopicreproductionof mar-
ket responses.Economistshave gone fur-
ther and constructedalso a theory of
an actual household that is simply a
Observedmarketbehavioris used to infer
unobservedhousehold behavior without
any recognitionthat a theory of the
8 GARY S. BECKER
household need not simply reproduce
the market because market rationality
is consistentwithhouseholdirrationality.
If we may join the trendtowardborrow-
ing analogies fromthe currentlyglamor-
ous fieldofphysics,the theoryofmolecu-
lar motion does not simply reproduce
the motion of large bodies: the smooth,
"rational" motion of a macrobody is
assumed to result fromthe erratic,"ir-
rational" motionsof a verylarge number
of microbodies.
Patterning the theory of households
aftermarketresponseswas not only un-
necessary,but also responsibleformuch
bitter and rather sterile controversy.
Confidencein market rationalitymisled
some into stout defensesof rationalityat
all levels, while confidencein household
irrationalitymisled others into equally
stout attacks on all rationality. What
has apparently been overlooked is that
both views may be partlyrightand part-
ly wrong: households may be irrational
and yet markets quite rational. If this
were generallyrecognized,criticsmight
be more receptive to models implying
rationalmarketresponses,and economic
theorists to models permittingerratic
and otherirrationalhouseholdresponses.
Utility analysis does not imply that
market demand curves necessarilyhave
sizable elasticities;nevertheless,rational
behavior is popularly believed to pro-
duce sizable responses in at least some
markets. Perhaps, therefore,it would
be usefulto show that irrationalhouse-
holds can producesizable as well as nega-
tive elasticities.The market responseof
inert households depends on the disper-
sion among them, the change in prices,
and the response of those forcedto ad-
just. If the price of X rose by 10 per
cent, if households were uniformlydis-
tributed along the initial budget line,
and if those forced to adjust reduced
their average consumptionto the mid-
point of the new budget line, market
demand would decline by about 30 per
cent, giving a high elasticity of -3. 14
A smaller price change or a larger dis-
persionwould yield a stillhigherelastici-
ty. It is also significantthat a large
group of erratic households must have
unitaryelastic market demand curves.'5
So the broad class of irrationalbehavior
explicitly discussed in this paper can
generate sizable market elasticities,and
thus can reproducethis attributeof "ra-
tional" behavior as well.
Inert households in the regionAp in
Figure 2 were forced offthe boundary
and into the interiorof the opportunity
set by a shift of the budget line from
AB to CD. Although"commodities"can
sometimesbe usefullydefined,and usual-
ly are defined,so that households must
necessarilybe on the boundary,I would
usually prefer to treat this as an ad-
14 Initially,average consumptionof X would be
Xo= 1/2 Px; subsequently,it would declineto
I I ~311I
1
X1'= )P ' +12 .2Pj 88 P,'
so
31 - 44
XO 44
88
16The amount of X consumedwould be given
by the function
X= kp-
whereX is marketdemandand I marketincome.A
compensatedchange in.the price of X would hold
constantthe ratio of marketincometo a Laspeyres
priceindex.That is,
I
-,= c
hence
P
X= k *-I
Pz'
or
X *-p=
PX k'.
 IRRATIONAL BEHAVIOR AND ECONOMIC THEORY 9

ditionalimplicationof rationalbehav- sated changein priceswould stillforce

ior. Thus utility-maximizing households thoseconsuming relatively largeamounts
wouldbe on the boundarynot because ofcommodities risingin priceto change,
ofa definition,butbecauseutilitywould presumably towarda smallerconsump-
be maximized(as long as the marginal tionof thesecommodities. So an exten-
utilityof at least one commoditywas sionofirrational behaviorto coverineffi-
non-negative).Even if "expenditures" cientconsumption doesnotalterthecon-
were definedso that the entireincome clusionthatirrational householdswould
had to be spent,irrationalhouseholds tend to have rationalmarketresponses
mightnot"consume"it all becausesome to a changein prices.
"purchases"mightbe lost,spoil,oraccu-
III. FIRMS
mulateunused.These householdswould
be locatedin theinterior oftheiroppor- The analysiscan easily be extended
tunitysets if the commodity space re- to thedemandforinputsby interpreting
ferredto "consumption" ratherthanto X and Y in Figure2 as inputsrather
"expenditures." than commodities, and AB and CD as
Our assumptionthat opportunitiesequal outlayratherthan equal income
are (at least initially)restrictedto the lines.A fundamental theoremof ration-
budgetlinemustgo iftheeffect of"inef- al behavioris that a compensatedin-
ficient"consumptionis to be investi- crease in the price of X would reduce
gated. Inefficient impulsivehouseholds theamountofX employedwitha given
mightassign equal probabilitiesto all outlay:less X wouldbe employedwith
pointsin the opportunity set, not just the outlaylineCD thanAB. The appli-
to thoseon the boundary.The average cabilityof Figure2 is a hintthat this
consumption of a largenumberof these theoremis derivednot so much from
householdswould almost certainlybe rationalbehavioritselfas fromthe gen-
at theset'scenterofgravity, withhouse- eral effectof a changein relativeinput
holdsuniformly distributedaroundthis prices on the distribution of employ-
point. Since a compensatedchangein mentopportunities. Even irrational firms
priceswouldshiftopportunity sets and would tend to respond"rationally"to
thuscentersofgravityaway fromcom- a changein inputprices;forexample,
moditiesrisingand towardthosefalling a largenumberofimpulsivefirms would
in price, these householdswould also on the average be located at point p
havenegatively inclinedmarketdemand whenfacedwithAB and at p', to the
curves.For example,pointc in Figure leftand above p, whenfacedwithCD."'
2 wouldbe the centerof the set OAB, Figure2 couldnotbe directlyapplied
and c', to the leftand above c, would to thedemandforinputsiftotaloutlays
be the centerof OCD.16Inefficient inert werepermittedto vary because outlay
households wouldbe initiallydistributed 17Justas a groupofimpulsivehouseholds would
throughout the opportunity set. They produce compensated commodity demandcurves
elasticity,
havingunitary firms
so impulsive would
too would tend to have negativelyin- producecompensated inputdemandcurveshaving
clinedmarketcurvesbecausea compen- unitaryelasticity, or exactlythe sameas thatpro-
ducedby firms profits
maximizing subjectto Cobb-
16The set OCD differs fromOAB onlybecause It is ratheramazing
functions.
Douglasproduction
ApC differs
fromBpD (OApD is common to both). ofCobb-Douglas
thattheseimplications functions,
SinceApC is to theleftand aboveBpD thecenter acclaimed,shouldalso
whichhavebeenextensively
ofOCD mustbe to theleftand abovethatofOAB. resultfrom modelofimpulsive
thesimplest behavior.
 10 GARY S. BECKER
lines could not thenserveas budgetlines.
More generally,sincethe traditionalana-
lytical distinction between households
and firmsis that firmsare not supposed
to be subject to budget constraints'8our
analysis of irrationalhouseholds would
seem to have littlerelevanceto irrational
firms.As long as the assumptionofprofit
maximizationis maintained, firmdeci-
sions can legitimatelybe analyzed with-
out recourse to budgetary constraints,
and the traditional distinctionis valid.
But as soon as other decision rules are
permittedthe existenceand importance
of a budget constraintbecome patently
clear, and the traditional distinctionis
blurredand perhaps even vanishes.
In my judgment the great achieve-
ment of the "survival" argument ad-
vanced by Alchian and others'9is not a
demonstrationthat survivingfirmsmust
act as if they were tryingto maximize
profits,for counterexamplescan easily
be developed,but rathera demonstration
that the decisions of irrationalfirmsare
limited by a budgetary constraint.In-
deed, the survivalargumentis reallysim-
ply a special case of a generalargument,
developed for households in Section II,
linkingthe behaviorofall economicunits
to the distributionoftheiropportunities.
Thus firmscould not continually pro-
duce, could not "survive," outputsyield-
ing negative profits,as eventually all
the resources at their disposal would
be used up.20For exactlythe same reason
households could not continually con-
sume in this sense could not "survive,"
outside the region covered by incomes.
18 See, e.g., H. Hotelling,
"Demand Functions
with Limited Budgets," Econometrica,January,
1935,pp. 66-78, and P. Samuelson,op. cit.,p. 218.
19See references
in n. 1.
20
More generally,firmscould not surviveif the
sum of profitsand net income from other sources
was less than zero.
In both cases the word "survive" sim-
ply refersto a resource constraint on
behavior and does not literally distin-
guish"life" from"death," althoughsome
households and firmsmay actually die
fromtryingto "live" beyondtheirmeans.
Had the meaningof survivalin this con-
textbeen understood,numerouspointless
discussionsof the application of biologi-
cal survival theoriesin economics could
have been avoided.
Price and cost
A
D
C
d~~~~~~~~~~~
I I I
I I i
lI
I I
o Qe Qe QC Q. QU
Output
FIG. 3
Since the regioninclosedby the income
constraintis called the consumptionop-
portunityset of households, the region
of non-negativeprofitscan appropriately
and naturally be called the production
opportunityset of firms.For example,
households with the budget line AB in
Figure 2 have the consumptionoppor-
tunityset OAB, and firmswiththe aver-
age cost curve AC and demand curve
dd shownin Figure3 have the production
opportunityset QeQu.Justas households
choose theirconsumptionsubject to the
limitationthat they spend no more than
the available income, so firmscan be
assumed to choose their output subject
 IRRATIONAL BEHAVIOR AND ECONOMIC THEORY
to thelimitationthat theyspend no more
than the maximum profitwhich could
have been earned. The entire amount,
so to speak, would be spent at outputs
yieldingzero profits;nothing would be
spent if profitswere maximized; and a
positivebut less than the entireamount
would be spent at any other admissible
output. The traditional conclusion that
firmsare not subject to a budget con-
straintis clearly valid when profitsare
maximized: nothing would be "spent"
and so no constraintcould be operative.
With any other decision rule, however,
a constrainton total expendituresmight
be operative because somethingwould
be spent.
A change in cost or demand condi-
tions would change production oppor-
tunitysets and forceeven irrationalfirms
to respond systematically.Many vari-
ables influencethese sets,and I have not
tried to determinethe response of irra-
tionalfirmsto changesin all ofthem.It is
instructive,however,to considerexplicit-
ly some differencesbetweenmonopolistic
and competitiveoutputs: a well-known
theoremis closely associated with prof-
it-maximizing behavior,and even skepti-
cal readers might be impressed by a
demonstrationthat a wide varietyof ir-
rational behavior would reproduce this
theorem.
Industrialcosts would be the same as
a firm's,except fora difference in units,
in industrieshaving many independent,
identical firms,but the industrial de-
mand curve would be more elastic than
the firm's.The AC curve in Figure 3
can, therefore,measure both industry
and firm average costs, DD industry
and dd firm demand conditions. Line
DD is drawn so that the competitive
equilibrium of profit-maximizing firms
occurs at a price of Ad and a per firm
output of OQ,, where presumablymar-
11
ginal costs equal price. If the industry
became a completelymonopolisticcartel,
DD would measure firmas well as indus-
trial demand and dd would no longer
be relevant. A famous and ancient the-
orem states that, if profitswere always
maximized, output per firmunder the
cartel would be less than OQ,.
Completelyimpulsivefirmswould as-
sign an equal probabilityto all available
outputs and select one at random: no
marginal cost function would be con-
sulted and certainlyno attempt would
be made to equate marginal cost and
marginal revenue. If the industrywas
"competitive,"thesefirmswould be uni-
formlydistributedalong the opportunity
set Qe, Quwithan average output almost
certainlyat the midpoint.Let Od again
be the equilibriumpriceand OQ, average
output, where OQ, is now simply the
midpoint of Qe Q. and not necessarily
a point equating marginal cost to price.
Cartelization would shiftthe firm'sde-
mand curve to DD and shiftthe oppor-
tunityset to the left of Qe Q. to Q' Qu.
If outputs were again chosen random-
ly, firms would be uniformlydistrib-
uted along Q' Q' and average output
would almost certainly be at its mid-
point, which is to the left of OQ6.
In the same way inertand many other
kinds of irrational firmscan be shown
to reproducethese famous theoremsof
neoclassicaleconomics.The fundamental
explanation is that a change fromcom-
petition to monopoly shiftsthe produc-
tion opportunityset toward lower out-
puts, whichin turnencouragesirrational
firms to lower their outputs. At best
only of indirectimportanceis the effect
on the marginal revenue function,the
explanationalways givenforprofit-maxi-
mizingfirms.
Our discussion of changes in input
prices and the degree of competitionin-
12 GARY S. BECKER

dicates that irrational firms can give strainton opportunitieswould be as real

very rationalmarketresponses,and this to firms as to households. The word
seemingparadox offersa solutionto the "firm" in this context includes founda-
heated and protracted controversybe- tions and other private non-profitor-
tweenmarginalistsand anti-marginalists. ganizations, governments,and persons
Confidencein the irrationalityof firms choosingoccupationaland industrialem-
induced the latterto conclude that mar- ploymentas well as "commercial"organ-
ket responseswere also irrational,while izations. Opportunitysets apply, then,
confidencein the rationalityof markets to all decision units with limited re-
inducedthe formerto concludethat firms sources.
were also rational. Apparentlyfew real- Even irrational decision units must
ized that both kinds of "evidence" could accept realityand could not,forexample,.
be valid and yet both inferencesinvalid, maintain a choice that was no longer
so that each side might be partly right withintheir opportunityset. And these
and partly wrong. Basically, what is sets are not fixed or dominated by er-
missingin the controversyis a systematic ratic variations, but are systematically
analysis of the responses of irrational changed by different economicvariables:
firms;in particular,of how opportunity a compensated increase in the price of
sets and thus the decisions of irrational some commoditieswould shiftconsump--
as well as rational firms are affected tion opportunitiestoward others;a com-
by changes in differentvariables. For pensated increase in the price of some
such an analysis reveals that irrational inputswould shiftproductionopportuni-
firmswould often be "forced" into ra- ties toward others; or a compensated
tional market responses. Consequently, decrease in the attractiveness of some
anti-marginalistscan believe that firms occupationswould shiftemploymentop-
are irrational,marginaliststhat market portunitiestowardothers.Systematicre-
responsesare rational, and both can be sponses might be expected, therefore,
talkingabout the same economic world. with a wide variety of decision rules,
includingmuch irrationalbehavior.
IV. SUMMARY AND CONCLUSIONS
Indeed, the most importantsubstan-
Economists have long recognizedthat tive result of this paper is that irra-
consumptionopportunitiesof households tional units would oftenbe "forced" by
are limited to those costing no more la change in opportunities to respond
than the income available, but not that rationally.For example,impulsivehouse-
productionopportunitiesoffirmsare lim- holds would tend to have negativelyin-
ited in exactly the same way to those clined demand curves because a rise in
yielding non-negative profits-or to a the price of one commoditywould shift
somewhatlargerset when incomeis also opportunitiestoward others,leaving less
receivedfromothersources.This neglect chance to purchase this one even impul-
resultsfromthe almostexclusiveconcern
21See A. A. Alchian and R. A. Kessel, "Com-
with profit-maximizing firms,for they petition,Monopoly, and the Pursuit of Pecuniary
and they alone are not affectedby the Gains," paper given at the Universities-National
constrainton production opportunities. Bureau Conferenceon Labor Economics,April 22-
23, 1960, and my The Economicsof Discrimination
If firmsmaximized utility rather than (Chicago: Universityof Chicago Press, 1957), chap.
profits21or behaved irrationally,the con- iii.
 IRRATIONAL BEHAVIOR AND ECONOMIC THEORY
lively. Otherirrationalhouseholdswould
likewisetend to have negativelyinclined
demand curves,irrationalfirmsnegative-
ly inclined demand curves for inputs,
and irrationalworkerspositivelyinclined
supply curvesto occupations.
If irrationalunits, nevertheless,often
respond rationally, what accounts for
the deep and prolonged animosity be-
tween marginalists and anti-marginal-
ists, Veblenites and neoclassicists, and
other groups differingin the degree of
rationality attributed to economic de-
cision units? The major explanation un-
doubtedlyis that formalmodels of irra-
tional behavior have seldom been sys-
tematically explored-in particular, to
determinehow changes in opportunities
impinge on irrationalbehavior. A sub-
sidiary explanation is that little atten-
tion has been paid to the distinction
betweengroup or marketand individual
responses.This distinctionis unnecessary
in traditionaltheoriesof rational behav-
iorbecause a market'sresponseis usually
simplythe macro-versionof an individu-
al's response.A group of irrationalunits
would, however,respondmore smoothly
and rationallythan a single unit would,
and undue concentrationat the individu-
al level can easily lead to an overestimate
13
of the degreeof irrationalityat the mar-
ket level.
When market responses of irrational
units sometimesdiffersubstantiallyfrom
the responses of rational units, empiri-
cal evidence on actual responses would
be crucially importantin assessing the
extentof individualrationality.The kind
of evidence traditionallyused, the nega-
tive slope of market demand curves or
the positive slope of market demand
curves or the positive slope of market
supplycurves,is equally consistentwith
individual irrationalityand cannot dis-
criminate between them. Inadequate
attentionhas been paid to gatheringrele-
vant evidenceapparentlybecause oppor-
tunitysets and theireffecton the market
responses of irrational units have been
inadequately appreciated.
I explicitlyanalyzed only simplemod-
els ofirrationalbehaviorin whichcurrent
choices were partly determinedby past
ones and partlyby probabilityconsidera-
tions. Much additional work is required
to formulaterigorouslyothermodels and
to determinetheirimplications.Although
many of these would surely differ,an
importantarea of agreementwould re-
sult from common responses to shifts
in opportunities.Such is the main lesson
to be learned fromthis paper.