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http://ppe.sagepub.com/content/3/1/59The online version of this article can be found at:

DOI: 10.1177/1470594X04039982

2004 3: 59Politics Philosophy EconomicsDennis C. Mueller

Models of Man: Neoclassical, Behavioural, and Evolutionary

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Models of man: neoclassical,behavioural, and evolutionary

Dennis C. MuellerUniversity of Vienna, Austria

abstractFor most observers of economics from both inside and outside the science, theterm economics is synonymous with neoclassical economics. It is the

methodology of neoclassical economics that defines the discipline of

economics. Mainstream economics is neoclassical economics and anyone

entering the discipline today who wishes to obtain an appointment at one of

the leading universities of the world is well advised to master its techniques.

The fact that virtually every winner of a Nobel prize from Paul Samuelson up

to his student Joseph Stiglitz has been a practitioner of neoclassical economics

is ample proof of the methodologys triumph. Despite the dominance of this

methodology, however, neoclassical economics has been subject to a steady

stream of criticisms and proposals for alternative methodological approaches

throughout its life. This article focuses on two relatively recent challenges to

the neoclassical orthodoxy that seem to have taken hold of a non-negligible

minority of the profession, some of whom can be found at leading

universities. These two challenges come from behavioural economics and

evolutionary economics. The article describes the strengths and weaknesses of

both of these methodological approaches and contrasts them with that of

neoclassical economics. It concludes that all three methodologies have

something positive to contribute to the study of human behaviour.

keywords neoclassical economics, behavioural economics, evolutionary economics

What is economics? The simplest definition is that economics is whatever econ-

omists do. Since economists do many things and use various methodologies in

their work, one might argue that there is no core methodology that defines eco-

nomics. Most observers of economics from outside the discipline (and many

from within it) would disagree with this statement, however. For many, the

politics,philosophy & economics article

DOI: 10.1177/1470594X04039982

Dennis C. Mueller is Professor of Economics at the University of Vienna, Institut fr

Wirtschaftswissenschaften, 1210 Wien, BWZ Bruehner Str. 72, Vienna, Austria

[email: [email protected]] 59

SAGE Publications Ltd

London

Thousand Oaks,CA

and New Delhi

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science of economics is synonymous with neoclassical economics, and it does

have a well-defined methodology. Indeed, it is this methodology thatdefines eco-

nomics.

When one scans the pages of the leading economics journals today one soon

reaches the conclusion that neoclassical economics has come to dominate the

discipline in the 100 or so years since it was invented.1 Every doctoral pro-

gramme in economics at the leading universities around the world consists

almost exclusively of courses that train students to use the tools of neoclassical

economics. Mainstream economics is neoclassical economics and anyone

entering the discipline today who wishes to obtain an appointment at one of the

leading universities of the world is well advised to master its techniques.

When one contemplates the achievements of neoclassical economics over the

past century, it is easy to understand its triumph over alternative methodologies.

The application of neoclassical techniques to the study of prices from Alfred

Marshall through to John Hicks and Paul Samuelson has contributed greatly to

our understanding of how markets function. Proofs that perfect competition canlead to a Pareto optimal allocation of resources are elegant defences of free-

market processes. In addition, neoclassical economics has been equally valuable

in explaining how markets can fail and describing the remedies that should be

applied to correct these failures. The fact that virtually every winner of a Nobel

prize from Paul Samuelson up to his student Joseph Stiglitz has been a practi-

tioner of neoclassical economics is ample proof of the methodologys triumph.2

If further proof is needed, it can be found outside the narrowly defined limits

of the field of economics. No leading law school in the USA today thinks that it

can get by without an economist or two on its faculty. Leading political science

departments also typically contain people who were either trained as economistsor who are conversant with and utilize the techniques of neoclassical economic

modelling. Anthropology, biology, and sociology have all been invaded,

although not yet conquered, by people who use the methodology of neoclassical

economics. Moreover, economists have even had the effrontery to take on the

philosophers and apply their analytic techniques to such questions as liberalism,

social justice, and fairness.3

Despite all of these obvious achievements, neoclassical economics has been

subject to a steady stream of criticisms and proposals for alternative methodo-

logical approaches throughout its life. Indeed, its birth in Vienna gave rise to a

tremendousMethodenstreitwithin the German-speaking economics community.My goal in this article is not to review the many criticisms of neoclassical

economics that have been made down through the years and the variety of alter-

native methodologies that have come forward. Instead, I shall focus on two rela-

tively recent challenges to the neoclassical orthodoxy that seem to have taken

hold of a non-negligible minority of the profession, some of whom can be found

at leading universities. These two challenges come from behavioural economics

and evolutionary economics.

politics, philosophy & economics 3(1)

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The next three sections take up in turn neoclassical, behavioural, and evolu-

tionary economics. In each section, I shall first briefly describe the main elements

of the methodological approach and then both its advantages and disadvantages.

The final section tries to draw some lessons from the preceding discussion for the

choice of an appropriate methodology for modelling man.

I. Neoclassical economics

A. MethodologyNeoclassical economics is built upon the bedrock of methodological individual-

ism. All modelling starts from the analysis of individual behaviour. Each indi-

vidual has goals, which can either be expressed as some sort of function or

axiomatically with a preference ordering. Each individual behaves rationally.

She maximizes the objective function; she chooses the outcome available to her

which stands highest in her preference ordering. Additional structure is given to

the analysis by assuming that the individual makes her choices subject to certainconstraints the consumer chooses quantities given fixed prices and a fixed

budget, and a firm chooses quantities with a given cost function and demand

schedule. Two distinct applications of neoclassical economic modelling are

commonly used today. The first applies calculus to determine the outcomes of

individual actions. In some applications, such as a consumers choice of con-

sumption items, only one equation need be solved the first-order condition of

the consumers utility-maximization decision. In others, a second equilibrium

condition is often imposed, as, say, market demand equals market supply, and the

analyst has a second equation with which to work. These two equations (the first-

order condition from the individuals maximization of her objective function andan equilibrium condition when all individual choices are aggregated) form the

basic building blocks for much analysis in neoclassical economics.4

The second important analytic technique in common use today in neoclassical

economics is game theory. Here, one must distinguish between what we might

call classical or forward-looking game theory and evolutionary game theory. As

the latters name suggests, evolutionary game theory comes much closer to evo-

lutionary economics and, indeed, as we shall stress later, in some respects is even

closer to behavioural economics. Classical game theory, on the other hand,

falls squarely into neoclassical economics. The individual is assumed to have a

clearly defined objective (to obtain the highest payoff for her in the game)and behaves rationally in trying to achieve this objective, in the sense that she

chooses the beststrategy for obtaining the highest payoff among the set available

to her. In much of the rest of neoclassical economics, the choice of objective for

the individual, that is, the specification of the function, is central to the problem.

The step of deriving the first-order condition is purely mechanical. In game

theory, it is the reverse. The analyst defines the payoffs and trivially assumes that

the individual wants the highest payoff. The non-trivial part of the analysis comes

Mueller: Models of man: neoclassical, behavioural, and evolutionary

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in trying to figure out which strategy is best and in what sense it is best. As in the

rest of neoclassical economics, an additional important issue in game theory is

whether there exists an equilibrium set of strategies for a game.

B. AdvantagesThe great advantage of neoclassical economics is the precision of its predictions.

Knowing the cost function of each firm and the demand function for the

industry, the analyst can predict what each firms output will be and, thus, what

the price of the product will be by assuming that each firm maximizes its profits

by choosing, say, output. The consequences of shifts in demand, changes in costs,

and changes in the number of firms in the industry can all be predicted with great

accuracy.

A second important advantage of neoclassical economics is that it is well

suited to both positive analysis, as in the example just given, and normative

analysis. Having determined the equilibrium price in the industry, the analyst is

able to calculate the potential welfare gain from increasing the number of firmsin the industry or the level of competition. A beautiful example of the application

of neoclassical economics to a normative question is Paul Samuelsons classic

article on public goods.5 In a mere four pages, Samuelson uncovers the essential

difference between pure public and private goods and illustrates the implications

of this difference for the problem of determining the optimal quantity of a public

good. It is applications such as this that have helped neoclassical economics take

almost full possession of the methodological terrain.

C. Disadvantages

The more accurate a theorys predictions, the easier it is for it to be rejected bythe data. Neoclassical economics Achilles heel is its frequent failure to account

for many phenomena that contradict its predictions. Critics of neoclassical eco-

nomics from theMethodenstreit to the present day have all stressed the seem-

ingly large gap between its predictions and what seems to exist in the real

world.

Example one A large swath of neoclassical economics over the past century has

been devoted to proving that demand schedules have negative slopes, first using

the assumption of diminishing marginal cardinal utilities, then of diminishing

marginal rates of substitution of ordinal utilities, and lastly using axioms ofrevealed preference. Yet large-scale econometric studies invariably produce

estimates implying an awkwardly large fraction of demand schedules with

positive slopes.6

Example two The heart of neoclassical economics is marginal analysis, which

follows directly from the assumption that individuals maximize some form of

objective function. The rational individual equates the marginal benefits of an


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action to its marginal costs. Starting at least as early as Hall and Hitch, a large

number of studies have questioned whether managers of firms set prices by

equating marginal revenue and marginal costs.7 Most of these challenges have

been empirically based. Observed pricing behaviour does not accord with the

prediction of marginal analysis. Most neoclassical economists have simply

ignored these sorts of criticisms, but interestingly, those who have tried to defend

neoclassical economics against this criticism have usuallynotsought to do so by

presenting counter empirical evidence. Instead, they have usually defended the

plausibility of the rationality assumption and have appealed to general economic

events that are consistent with neoclassical analysis: price rises following the

imposition of a tariff.8

Example three The development of experimental economics has created a rich

body of research testing various assumptions and predictions of neoclassical eco-

nomics. Much of this literature directly rejects these assumptions and predictions.

Two examples will suffice to illustrate this point. A basic tenet in the public-choice literature is that rational individuals willfree ride in situations where con-

tributions to the provision of a public good are voluntary. Countless experiments

have demonstrated that they do free ride, but to a far smaller degree than one

might have expected. If 100 is the contribution to the public good that produces

the optimum quantity of the good for the collective, and 1 is the contribution that

is individually optimal, then the typical finding in an experiment testing for free-

rider behaviour is that the mean contribution of the participants is around 50.

Some people do free ride, but many make contributions that are far larger than is

individually optimal. In aggregate, the total contributions fall far short of what

would be optimal for the group, but far above what pure free-riding behaviourwould produce.9

The second set of experiments involves the so-called ultimatum game. A fixed

amount of money, say US$20, is to be divided among two players. Player A gets

to propose a division, and B can either accept or reject the proposal. If B accepts

it, they are paid the amounts proposed by A. If B rejects the proposal, each

receives nothing. Rational self-interest on the part of both individuals leads to the

prediction that A will propose that she receives most of the money, say US$19,

and B will accept the proposed division, because getting US$1 is better than

getting nothing. Both predictions are routinely violated by participants in these

experiments. Those proposing the division are fairly generous to the otherplayers with mean divisions typically being around two-thirds for A and one-

third for B. Bs frequently reject low, but positive shares of the money.10

It is the results of experiments such as these, which have led many economists

to seek an alternative to the standard assumptions underlying neoclassical model-

ling. One such alternative is behavioural economics.


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II. Behavioural economics

A. MethodologyNeoclassical economics postulates that consumers maximize a utility function

defined over the set of consumption goods available to them, and that workers

maximize a utility function defined over their income and leisure. The assump-tion that individuals maximize utility functions follows essentially tautologically

from the premise of rational, self-interested behaviour. In this sense, neoclassical

economics is also behavioural, but it differs from what I am referring to here as

behavioural economics in that it typically assumes that all actors in a particular

situation maximize the same objective function, and the postulated objective

functions contain a fairly small number of arguments. Workers obtain utility only

from money and leisure; managers maximize profits; investors utility functions

contain only their wealth, and so on. Other assumptions (for example, that

managers pursue other goals than profits) are frequently dismissed as ad hoc.

There is nothing inherent in a methodological approach that assumes that indi-viduals maximize an objective function that requires that all people who apply

this methodological approach employ the same objective function for all people

in all situations, or limit themselves to a small set of objective functions. One

branch of behavioural economics (the one discussed in this section) breaks with

mainstream neoclassical economics by postulating different objectives for the

main actors from those commonly assumed in neoclassical economics, but in

other respects follows the same methodology as standard neoclassical eco-

nomics. Individuals are assumed to be maximizers.

A good example of what I refer to here as behavioural economics is Robin

Marris Economic Theory of Managerial Capitalism.11

The second chapter ofthis book contains a long review of sociological and psychological studies which

suggest that managers utility is more closely related to the growth of their firm

than to its profitability. Marris used this literature from outside of economics

to justify the assumption that managers maximize an objective function that

includes the growth rate of the firm. Marris theory looks like any other theory in

economics replete with first-order and equilibrium conditions. It differs from the

standard model of the firm only with respect to what it is that managers are

assumed to maximize. Nevertheless, Marris model and the other contributions to

the managerialist literature that appeared at that time and assumed that man-

agers pursued goals other than profit maximization were considered heretical by

mainstream neoclassical economists. Fritz Machlup, who had led the marginalist

counter-attack against non-marginalist theories of pricing, took the occasion of

his presidential address to the American Economic Association to defend the

assumption of profit maximization against the challenges posed by Marris and

the other managerialists.12

In 1986, I took the occasion of my presidential address to the Public Choice

Society to recommend a behaviouralist approach to modelling in the public-


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choice field. Public choice is, of course, nothing more than neoclassical eco-

nomics applied to politics. Every political actor (the voter, the politician, and the

bureaucrat) is assumed to be a self-interested, rational actor. This assumption

unfortunately leads to the prediction that a self-interested, rational voter will not

vote a not very well-supported prediction. To avoid this embarrassing predic-

tion failure, and others such as that regarding free riding discussed in the previous

section, I proposed abandoning the strong form of rationality assumption used in

neoclassical economics and public choice in favour of assuming that individuals

behaviour is conditioned by past rewards and punishments. Such operant condi-

tioning produces patterns of behaviour (often called habits) in which individuals

undertake certain actions such as voting because they have been rewarded for

undertaking similar actions in the past, or punished for not undertaking them.

By relying on behavioural psychology in this way, the social scientist is able

to retain the self-interest portion of the rational self-interest postulate. Individuals

seek to obtain rewards and to avoid punishment. Only the strong form of ration-

ality assumption must be relaxed, but even here it is not necessary to give up theanalytical advantages of assuming maximizing behaviour. Individuals can be

assumed to act as ifthey were maximizing a particular objective function. The

observed behaviour of individuals in voluntary-contribution-public-good experi-

ments and ultimatum games, for example, could be modelled by assuming that

an individual, i, maximizes an objective function of the following form:

Oi = Ui (i) + qi ji

Uj (Xj) (1)

An individual maximizes a weighted sum of his own utility and that of everyone

else. When modelling his behaviour when grocery shopping, it may be reason-able to assume that q is zero; in situations such as public-good experiments, a

more reasonable assumption may be that it is positive. In adopting such an

approach, the social scientist must make assumptions about both what goes into

the utility functions that are implicitly maximized (the Xi and Xj vectors in

Equation (1)) andabout the q-weight to be placed on the welfare of others. Here,

one can either rely on introspection (I get utility from seeing my friends become

happier and I assume everyone else does also) or more scientifically by examin-

ing the psychology and sociology literatures to see what they can tell us about

how individual preferences are formed. Experiments involving the ultimatum

game have revealed significant differences across cultures in the sizes of theoffers made by the first players and the willingness of the second players to

accept these offers.13 These experiments indicate the importance of social condi-

tioning in determining individual behaviour.

The salient feature of behavioural economics that differentiates it from main-

stream neoclassical economics is that it relies upon concepts and findings from

psychology and perhaps other social sciences to inform its assumptions about

what it is that individuals maximize, what goes into an individuals utility func-


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tion. Although it has probably had its biggest impact on the finance literature,

leading contributors to this growing field have also taken up a variety of other

questions.14

B. AdvantagesThe chief advantage of behavioural economics is that by relying upon a morecomplex and accurate description of individual preferences, it can explain

phenomena (even economic phenomena) that are poorly accounted for by the

more naive assumptions about individual preferences that characterize much of

neoclassical economics.

Example one Robert Frank presents considerable evidence that wage profiles in

firms and other institutions are much flatter than predicted by the marginal

productivity theory of wages.15 Citing works from psychology, sociology, and

philosophy, Frank develops the argument that people obtain satisfaction fromknowing that they are paid relatively more than their peers. Status is an impor-

tant component of an individuals utility function and thus high-productivity

workers are content with smaller increments in pay over the average, whereas

low-income workers must be given higher wages than their productivity levels

warrant.

Example two Throughout the 20th century the movement of stock prices has been

too large relative to future movements in dividends, if one accepts the hypothe-

sis that the markets expectations about future dividend movements are rational.16

Relying on psychological studies, Robert Shiller accounts for the wide swings inshare prices by arguing that investors exhibit herd-like behaviour, and are seized

by considerable over-optimism when share prices are rising and exaggerated

pessimism when they crash.17

Example three Public-choice scholars invariably assume that citizens vote to

advance their narrow self-interest. A voter supports a tax reduction only if she

stands to benefit personally from it. Survey evidence continually rejects this

assumption. Large fractions of the population support policy changes that harm

themselves, but benefit other members of the community.18 One way to account

for this kind of behaviour is to assume that citizens maximize an objective func-tion of the type depicted in Equation (1) when they vote withq > 0. John Hudson

and Philip Jones have provided a direct confirmation of this explanation.19 They

conducted two surveys of voters in Bath, UK. Voters were asked to comment on

different policy proposals regarding changes in taxes and expenditure on health,

education, and social benefits. Voters first identified their preferred policy, and

then stated (1) whether they thought that the policy would benefit themselves

personally and (2) whether they thought that the policy would be in the publics


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interest. From the answers to these questions Hudson and Jones inferred magni-

tudes of q of 0.66 for the 1988 survey and 0.73 for the 1992 survey.

C. DisadvantagesIntentionally flying an airplane into the side of a building is not what most

people regard as rational behaviour. One could, nevertheless, model such actions

assuming that the actor maximized an objective function that was a weighted sum

of his utility in this life and his utility in the afterlife. With enough weight placed

on the afterlife, the action becomes rational. Ex post, any behaviour can be made

consistent with the postulate of rational self-interest by appropriate modification

of the objective function to be maximized. The tautological nature of the assump-

tion of utility maximization raises the danger, if one takes too many liberties with

what goes into the utility function, of the existence of a plethora of behavioural

models, each one designed to explain individual behaviour in a particular situa-

tion. Neoclassical economics main advantage of being a unified and relatively

simple model of human behaviour that makes powerful predictions is lost. Thiscriticism of behavioural economics is taken up in the concluding section of this

article.

III. Evolutionary economics

A. MethodologyThe branch of economics commonly referred to as evolutionary economics can

legitimately be said to have been born with the publication of Nelson and

Winters An Evolutionary Theory of Economic Change.20 This book presents

both a broadside attack on standard neoclassical economics and an alternativemethodological approach to that which it criticizes. Nelson and Winter challenge

the two fundamental assumptions that underlie neoclassical economic modelling:

that individuals are rational in the sense that they maximize well-defined objec-

tive functions and that markets and other economic systems are in (or tend

toward) equilibrium. They thus propose replacing the first-order conditions that

one obtains from the assumption that individuals maximize well-defined objec-

tive functions with equations that represent the routines or rules of thumb that

people in the real world follow. A mark-up pricing rule is a good example of such

a rule of thumb.

Herbert Simon was also highly critical of the assumption that individuals con-sciously maximize specific objective functions.21 Growing out of his work there

developed the Carnegie school of economics.A Behavioral Theory of the Firm

by Richard Cyert and James March was an early product of this school.22 Cyert

and March modelled the behaviour of a specific firm using a computer program

which incorporated the various rules of thumb and routines that they observed in

the firm. Nelson and Winters approach is very much in line with this earlier

work of Simon and Cyert and March. They too rely heavily on computer pro-


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grams in their analysis. The equations embedded in these programs replace the

first-order and equilibrium conditions of neoclassical economics. The work of

Nelson and Winter differs from the earlier work of the Carnegie school mainly in

so far as they are concerned with the dynamic evolution of a firm or industry.23

Headings such as evolutionary economics, evolutionary game theory, and

even neoclassical economics itself are sufficiently broad that the kinds of

research they delineate covers a range of methodological styles. Not all scholars

who call themselves evolutionary economists, for example, go as far as Nelson

and Winter in abandoning the concepts of maximizing behaviour and equilibria.

The same breadth of styles exists in the general area of evolutionary game

theory. Some evolutionary game theory models, such as that of H. Payton Young,

can, however, be legitimately called a part of the broader field of evolutionary

economics.24 They too relax or entirely abandon the assumption of individual

rationality. They too rely on simulation techniques to derive results. Individuals

behaviour is often assumed to be adaptive and thus this approach is also often

compatible with the behavioural approaches described in the preceding section.Given a choice between two strategies,xandy, individuals will learn to playxif

it has been more frequently rewarded with higher payoffs in the past. Here, the

contrast with standard game theory is dramatic. Whereas a player in a standard

game is only concerned withfuture payoffs to the game as depicted in the matrix

she confronts, players in many evolutionary game models are always looking at

the past to see what the highest payoffs were.

Evolutionary game theory models have been used to demonstrate how indi-

viduals can learn to coordinate on particular pairs of strategies that provide

higher long-run payoffs to both players, and more generally how conventions and

mores can emerge over time. In this respect, some of the experiments involvingthe evolution of individual behaviour in repeated games might be classified

as part of behavioural economics, for these experiments often reveal how the

behaviour of individuals in later rounds of a game is conditioned by their rewards

and punishments in earlier rounds.25 Like behavioural economics, therefore, it

can fill important lacunae in the set of phenomena that economists have pre-

viously been unable to explain.26

Evolutionary economics differs from neoclassical economics both in the tech-

niques that it employs in its analysis and in the questions that it does and can

ask. A typical study in evolutionary economics might proceed as follows. First,

examine the rules of thumb managers use when making decisions about price,research and development, and so on. Then make reasonable assumptions,

perhaps based on empirical analysis, about the relationships among the key vari-

ables. How much increase in productivity is it reasonable to expect from a given

increase in research and development spending? Build these relationships into a

computer program and use it to simulate the course of development of an indus-

try in terms of its level of productivity, prices, industrial concentration, and so on.

Evolutionary game theory proceeds in much the same way, but it tends to con-


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fine itself to a much simpler set of relationships. First, a payoff matrix is written

down. Second, a rule of thumb is defined for each player choose the strategy

that has produced the highest average payoff over the previous 10 plays of the

game. Then the game is simulated. Evolutionary game theory differs from many

studies in evolutionary economics, however, in so far as it generally involves a

search for evolutionary stable strategies and thus for equilibria of sorts. For

example, Samuelson concludes in his recent survey of the literature on evolu-

tionary game theory that it provides qualifiedsupport for the proposition that

when stable strategies emerge in evolutionary games, they take the form of a

Nash equilibrium.27 He then goes on to observe:

I view the stability implies Nash result as putting game theory on much the same foot-

ing as the rest of economics. We do not believe that markets are always in equilibrium,

just as we do not believe that people are always rational or that firms always maximize

profits. But the bulk of our attention is devoted to equilibrium models either because

we hope that equilibrium behavior is sufficiently persistent and disequilibrium

behavior sufficiently transient that behavior that is robust enough to be an object of

study is (approximately) equilibrium behavior. . . . Evolutionary game theory thus

provides little reason to believe that equilibrium behavior should characterize all games

in all circumstances. But it provides reason to hope that behavior that comes into our

field of study is likely to be equilibrium behavior. In this sense, we obtain a stronger

motivation for Nash equilibrium than provided by rationality-based models.28

Thus, evolutionary game theory is, in fact, more akin to behavioural economics

than it is to the kind of evolutionary economics espoused and practiced by Nelson

and Winter and their followers. It abandons the strong-form assumption of

forward-looking, ultra-rational behaviour that underlies neoclassical economics

and replaces it with assumptions of adaptive or learned behaviour that resemblestrong-form rational behaviour, if and when equilibria emerge. Quite unlike evo-

lutionary economics, evolutionary game theory does not abandon the quest for

equilibria, but instead searches for, and often claims to find, the same sort of

equilibria that form the core of neoclassical theory.

B. AdvantagesThe advantage of evolutionary economics is that it can answer questions that

standard neoclassical economics is either unable to answer or answers with con-

siderable difficulty. As described above, standard neoclassical economics can

give a precise answer to the question of what the structure of an industry will betoday, given certain assumptions about firm cost schedules, demand, and so on.

It is not well suited, however, to describing how an industrys structure will

evolve over time as firms invest and innovate. Describing this sort of industry

evolution is the bread and butter of evolutionary modelling. Neoclassical eco-

nomics is in its own element when it comes to describing the properties of a

static equilibrium. Even neoclassical growth models which appear to model eco-

nomic dynamics, typically describe a form of static equilibrium moving through


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time. Evolutionary economics, in contrast, can describe the dynamics of an

industry or of a whole economic system.

C. DisadvantagesNeoclassical economics at its best can reveal the essence of a problem with a

simple analytical model. Consider, for example, the prisoners dilemma game. It

contains all of the essential ingredients of a neoclassical economic model. Both

players wish to maximize their payoffs. Both choose their best strategies. An

equilibrium ensues. Few models of human interaction are simpler, and yet the

game provides a great insight into the problems individuals encounter when they

interact.

All significant contributions to neoclassical economics provide similar

insights. Modern neoclassical economics has become highly mathematical, but

the truly important contributions today, as in the past, differentiate themselves

from ordinary contributions by the insights and intuitions that lie behind the

mathematics. Once one understands the logic of the prisoners dilemma or, say,Akerlofs (1970) lemons problem,29 one has an insight to human behaviour that

can be applied in one situation after another. Similar insights and intuitions are

more difficult to extract from evolutionary models. These models typically con-

sist of so many equations and assumptions that one is unable to discern the main

message of the model. Thus, the lasting contributions of many studies in evolu-

tionary economics, for example, that of Nelson and Winter, are not the actual

results that were obtained from the application of the methodology, but the

exposition of the methodology itself.

The bedrock of neoclassical economics is methodological individualism. In

much evolutionary modelling, the individual and her motivation almost dis-appear, however. The individual adopts routines and the aggregation of the

carrying out of these routines produces the outcomes of interest. The focus usu-

ally is much more on the aggregates (the industry, the system, and so on) than

on the individuals who ultimately produce the outcomes. In most evolutionary

models, individuals could be replaced by programmed robots without disturbing

the underlying logic of the model.30

In a standard application of neoclassical economics, the researcher derives

from the first-order condition for profit maximization a relationship for the price

cost margin of a firm. The theory can then be tested by comparing actual with

predicted pricecost margins. In evolutionary modelling, on the other hand, onereplaces the predicted relationship from the maximization exercise with an

assumed relationship in the form of a rule of thumb a pricecost margin equa-

tion. Often this assumption comes from observing actual pricecost margins.

Clearly, in this case, the theory cannot be tested in the same way as a theory

derived in neoclassical economics is tested. The proof of the pudding for evolu-

tionary models has to be how well they explain the macro-phenomena of

interest, say, the evolution of a system. Should the model not exhibit good


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explanatory power, it is often difficult to discern what part of the model is at

fault.

The last difficulty with evolutionary economics is that it is devoid of a norma-

tive component. However well it describes what it sets out to describe, it lacks

any means for judging whether the predicted dynamics of the phenomenon

modelled produce good or bad outcomes. To make such judgements one is

driven back to the normative toolkit of neoclassical economics (consumers

surplus areas or Pareto optimality) as are Nelson and Winter when they revisit the

Schumpeterian trade-off.31

IV. Conclusions

Which methodological approach is the best? The answer to this question depends

upon both the problems one wishes to study, and upon the person giving the

answer.

Consider, first, the problem of explaining the actions of specific individuals incertain situations. A social scientist who wishes to explain the behaviour of

individuals as consumers, workers, voters, bureaucrats, priests, politicians, stock-

brokers, soldiers, and drug addicts has a series of options. At one extreme is what

we might call the universal, rational actor model all individuals maximize an

objective function (O). The starkest form of such a model would have a single

variable in the objective function: all individuals maximize their own personal

wealth (W):

O = W (2)

A slightly more general version of this model would be that all individualsmaximize a utility function that includes wealth and one or two additional vari-

ables, depending upon the type of decisions being analysed:

O = U(W,X1,X2, . . .) (3)

Moving further away from the strongest version of a universal theory we would

have:

O = U(X1,X2, . . .) (4)

All arguments of the utility function are at the analysts discretion. Moving stillfurther, we have the approach suggested above to account for altruistic and

similar sorts of behaviour in situations in which this behaviour is anticipated:

Oi = Ui (Xi) +qi ji

Uj (Xj) (5)

When one takes into account that the analyst is also free to choose the shape of

the utility function and a set of constraints and auxiliary conditions under which

the maximization process takes place, one sees that an approach to modelling


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human behaviour that is universal in so far as it posits that individuals maximize

an objective function can be quite flexible.

At the other extreme of the methodological spectrum is a pure inductive

approach. The analyst who wishes to explain the behaviour of individuals in the

nine contexts listed above constructs nine different models, each one containing

the set of variables which best explains the behaviour of the group in question.

The choice of variables in each case is determined from an examination of the

relevant literatures in sociology and psychology, what has worked in previous

studies, or simple trial and error. As one adds more arguments to the objective

function, and more auxiliary assumptions, the power of the maximizing assump-

tion is diluted. Furthest removed from the top of the list are those who abandon

the maximization assumption entirely, and assume that individuals are guided by

rules of thumb, specific mores, or other sorts of prescripts.

Where each scholar chooses to place herself along the spectrum running from

Equation (2) to a pure inductive model is largely a matter of scientific taste

ones willingness to live with weak explanatory power in some situations for thesake of the cleanness and beauty of a simple, elegant model of human behaviour

versus ones desire for high explanatory power in all situations at the cost of

analytical consistency and clarity.

Earlier in this article we discussed several examples of behaviour, such as

voting and free riding, which cannot be well explained with a simple version of

the selfish, rational actor model. My proposal is to replace this model in these

situations with a model in which individuals act as ifthey were maximizing an

objective function that included their own utility and a weighted sum of everyone

elses utility. This model could be used to explain human behaviour in all situa-

tions, even those in which the traditional rational self-interest model does well,since it allows for the possibility that the weight on other peoples utility is zero.

My proposal would constitute a step away from the pure rational actor model,

but would retain some of the advantages of this approach by deriving clear pre-

dictions from the assumption of as if maximizing behaviour, predictions that

are subject to falsification. An experienced researcher would come to know when

it is reasonable to assume that an individual is likely to place a zero weight on the

utilities of other individuals, and when she is more likely to place a positive, or

perhaps sometimes a negative, weight on the welfare of others. Moreover,

because these weights are dependent on the past history of an individual, past

histories can be used to predict differences in these weights across individuals.Behavioural psychology is somewhat out of vogue now among psychologists,

and economists who resort to branches of psychology to enrich their models

often build on findings in the area of cognitive dissonance or some other

currently more popular field. All researchers working in the area of what I have

termed behavioural economics have in common, however, that they refuse to

abandon the assumption of maximizing behaviour. Their main focus is to specify

better what it is that is being maximized.


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Furthest removed from the pure rational actor model are the evolutionary eco-

nomics models. These often come close to being purely inductive in that the key

assumptions of the models are based on observations of what firms and indi-

viduals actually do, as captured in the assumed routines that they follow, and on

observed relationships between capital stock and output, research and develop-

ment and productivity change, and so on. This more inductive approach can be

justified by the more complex phenomena that the evolutionary economists wish

to describe the evolutionary developments of entire industries or economic

systems.

The choice among the three methodologies thus depends both upon the ques-

tions the researcher wishes to answer and the degree of complexity she wishes to

build into her behavioural models. For those who are content studying the tradi-

tional questions of economics (the properties of demand functions or the proper-

ties of competitive equilibria), the highly simplified and abstract models of

modern neoclassical economics will continue to be the methodology of choice.

For those who wish to extend the scope of economic modelling to explain thebehaviour of voters, politicians, bureaucrats, philanthropists, and so on, the

standard behavioural assumptions underlying most of neoclassical economics

will prove inadequate. These scholars can be expected to draw upon the rich

behavioural literature developed outside of economics to help inform them as to

what it is that individuals in these non-market situations maximize, and subject

to what constraints. Although these behavioural economists will have to sacrifice

some of the pristine simplicity of the traditional neoclassical models to obtain

better explanations of human action in different contexts, they do not have to

sacrifice the rigour that comes from assuming maximizing behaviour, if they do

not want to.Evolutionary economists will, indeed, usually wish to abandon the assumption

of maximizing behaviour. Their models must inevitably lack the precision that

comes from assuming individuals strive for the maximum that they can obtain,

and that economic and political markets reach equilibria. This feature will ensure

that many of those trained in the use of maximization models will be repelled by

the somewhat inelegant or complicated structure of evolutionary models. But

those scientists who are willing to live with such complexity are likely to con-

tinue to build their evolutionary models to describe a world which they see as

being every bit as complex as their models.

It seems clear to me that there is room for all three methodological approachesin the social sciences, and that all have something to offer in the way of increas-

ing our knowledge of human behaviour. The s in the word models in the title

of this article seems likely, therefore, to describe accurately the methodologies

that will be employed by social scientists for some time in the future.


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notes

I would like to thank Jonathan Riley and Geoffry Hodgson for comments on an earlier

draft of this article.

1. Some, such as Samuel Hollander in hisJohn Stuart Mill on Economic Theory and

Method(London: Routledge, 2000), might question just how radical an innovationneoclassical methodology was, but this need not concern us here. My arguments

still hold, even if neoclassical economics is regarded as a logical transition of

classical economics into the modern age.

2. This statement obviously hinges on ones definition of neoclassical economics,

which is taken up in Section I. The most obvious exception to this statement was

Herbert Simon, from whom I have stolen the first part of the title of this article.

3. See, for example, Jonathan Riley,Liberal Utilitarianism (Cambridge: Cambridge

University Press, 1988); Hal Varian, Equity, Envy, and Efficiency,Journal of

Economic Theory 9 (1974): 6391; William J. Baumol, Superfairness: Applications

and Theory (Cambridge, MA: MIT Press, 1986) and Ken Binmore, Game Theory

and the Social Contract I. Playing Fair(Cambridge, MA: MIT Press, 1994).Richard Posner has applied neoclassical economic reasoning to anthropology in A

Theory of Primitive Society, with Special Reference to Law,Journal of Law and

Economics 23 (1980): 153. Neoclassical economic reasoning has been applied to

biology (a discipline for which there is now even a journal devoted to this

methodological approach) by Jack Hirshleifer, Economics from a Biological

Viewpoint,Journal of Law and Economics 20 (1977): 152; Janet T. Landa,

Bioeconomics of Some Nonhuman and Human Societies: New Institutional

Economics Approach,Journal of Bioeconomics 1 (1999): 95113; and Janet T.

Landa and Michael T. Ghiselin, The Emerging Discipline of Bioeconomics: Aims

and Scope of theJournal of Bioeconomics,Journal of Bioeconomics 1 (1999):

512. James S. Coleman in his Foundations of Social Theory (Cambridge, MA:Harvard University Press, 1990) was a pioneer in introducing neoclassical economic

modelling into sociology. Examples from the fields of law and political science are

so numerous as to not require specific references.

4. Of course, there may exist several first-order conditions if the model contains

several sorts of actors: consumers, firms, regulators, and so on. Second-order

conditions can also be useful in some circumstances.

5. Paul Samuelson, The Pure Theory of Public Expenditure,Review of Economics

and Statistics 36 (1954): 3879.

6. See, for example, H.S. Houthakker and L.D. Taylor, Consumer Demand in the

United States, 2nd edn. (Cambridge, MA: Harvard University Press, 1970).

7. R.L. Hall and C.J. Hitch, Price Theory and Business Behavior, Oxford EconomicPapers (May 1939): 1245.

8. See, for example, Fritz Machlup, Marginal Analysis and Empirical Research,

American Economic Review 36 (1946): 51954, and for a fuller discussion and

additional references, Dennis C. Mueller, The Corporation and the Economist,

International Journal of Industrial Organization 10 (1992): 14770; reprinted in D.

Hausman (ed.), The Philosophy of Economics: An Anthology, 2nd edn. (Cambridge:

Cambridge University Press, 1993).


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9. The pioneering contributions to this strand of the literature were by Gerald Marwell

and Ruth E. Ames. See Gerald Marwell and Ruth E. Ames, Experiments on the

Provision of Public Goods I: Resources, Interest, Group Size, and the Free Rider

Problem,American Journal of Sociology 84 (1979): 133560; Experiments on the

Provision of Public Goods II: Provision Points, Stakes, Experience and the Free

Rider Problem,American Journal of Sociology 85 (1980): 92637.10. See, for example, Georg Kirchsteiger, The Role of Envy in Ultimatum Games,

Journal of Economic Behavior and Organization 25 (1994): 37389. This article

also contains additional references.

11. Robin Marris, The Economic Theory of Managerial Capitalism (New York: Free

Press, 1964).

12. Fritz Machlup, Theories of the Firm: Marginalist, Behavioral, Managerial,

American Economic Review 57 (1967): 133.

13. See the discussion and references to the literature in Theodore C. Bergstrom,

Evolution of Social Behavior: Individual and Group Selection,Journal of

Economic Perspectives 16 (2002): 6788.

14. For a recent survey of the behavioural finance literature, see Robert J. Shiller, FromEfficient Markets Theory to Behavioral Finance,Journal of Economic Perspectives

17 (winter 2003): 83104. Other important contributors include George Akerlof,

The Economic Consequences of Cognitive Dissonance,American Economic

Review 72 (1982): 30719; Robert H. Frank, Choosing the Right Pond(New York:

Oxford University Press, 1985); Robert H. Frank, Passions with Reason: The

Strategic Role of the Emotions (New York: Norton, 1988); Richard Thaler, Quasi

Rational Economics (New York: Russell Sage Foundation, 1991).

15. Frank, Choosing the Right Pond.

16. Robert J. Schiller, Do Stock Prices Move Too Much to be Justified by Subsequent

Changes in Dividends?,American Economic Review 71 (1981): 42136.

17. Robert J. Shiller,Irrational Exuberance (Princeton, NJ: Princeton University Press,2000).

18. Jeffrey W. Smith, A Clear Test of Rational Voting, Public Choice 23 (fall 1975):

5567; Paul N. Courant, Edward M. Gramlich and Daniel L. Rubinfeld, Why

Voters Support Tax Limitations Amendments: The Michigan Case,National Tax

Journal 33 (1980): 120.

19. John Hudson and Philip R. Jones, The Importance of the Ethical Voter: An

Estimate of Altruism,European Journal of Political Economy 10 (1994):

499509.

20. Richard Nelson and Sidney G. Winter,An Evolutionary Theory of Economic

Change (Cambridge, MA: Harvard University Press, 1982). As my discussant at the

workshop where this article was first presented, Geoffrey M. Hodgson, correctlypointed out that Thorstein Veblen might well be thought of as the inventor of

evolutionary economics. Veblens contributions to economics are largely ignored

today, however, by both those working in the mainstream and those in

evolutionary economics. See Thorstein B. Veblen, The Theory of the Leisure Class:

An Economic Study of the Evolution of Institutions (New York: Macmillan, 1899);

The Place of Science in Modern Civilization and Other Essays (New York:

Huebsch, 1919).


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21. Herbert A. Simon,Models of Man (New York: Wiley, 1957).

22. Richard M. Cyert and James G. March,A Behavioral Theory of the Firm

(Englewood Cliffs, NJ: Prentice Hall, 1963).

23. For a recent survey of the literature on evolutionary economics that focuses on the

evolution of firms and industries, see Richard R. Nelson and Sidney G. Winter,

Evolutionary Theorizing in Economics,Journal of Economic Perspectives 16(2002): 2346.

24. H. Peyton Young, The Evolution of Conventions,Econometrica 61 (1993): 5784.

25. See, for example, Raymond Battalio, Larry Samuelson and John van Huyck,

Optimization Incentives and Coordination Failure in Laboratory Stag Hunt Games,

Econometrica 69 (2001): 74964. See also the discussion in Larry Samuelson,

Evolution and Game Theory,Journal of Economic Perspectives 16 (2002): 4766.

26. See, for example, Robert Sugden, The Evolution of Rights, Cooperation and

Welfare (New York: Basil Blackwell, 1986); Karl Warneryd, Conventions,

Constitutional Political Economy 1 (1990): 83107; Michihiro Kandori, George

Mailath and Rafael Rob, Learning, Mutation, and Long Run Equilibria in Games,

Econometrica 61 (1993): 2956; Young, The Evolution of Conventions.27. Samuelson, Evolution and Game Theory.

28. Ibid., pp. 589.

29. George Akerlof, The Market for Lemons, Quarterly Journal of Economics 84

(1970): 488500.

30. Some critics of neoclassical economics might argue that homo economicus also

behaves like a robot.

31. Nelson and Winter,An Evolutionary Theory of Economic Change, Ch. 14.


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