Maximization, Learning and Economic Behavior

Abstract: The rationality assumption that underlies mainstream economic theory has proved to be a useful approximation, despite the fact that systematic violations to its assumptions can be found. That is, the assumption of rational behavior is useful in understanding how many successful economic institutions function, while it is also true that actual human behavior falls systematically short of perfect rationality. The current analysis provides a possible explanation of this apparent inconsistency. It suggests that mechanisms that rest on the rationality assumption are likely to be successful when they create an environment in which the behavior they try to facilitate leads to the best payoff for all agents on average, and most of the time. Review of basic learning research suggests that under these conditions people quickly learn to maximize expected return. The review also shows that there are many situations in which experience does not increase maximization. In many cases experience leads people to underweight rare events. In addition, the current paper suggests that it is convenient to distinguish between two behavioral approaches to improve economic analyses. The first, and more conventional approach among behavioral economists and psychologists interested in judgment and decision making, highlights violations of the rational model and proposes descriptive models that capture these violations. The second approach studies human learning in order to clarify the conditions under which people quickly learn to maximize expected return. The current review highlights one set of conditions of this type, and shows how the understanding of these conditions can facilitate market design.