I would like to start by wishing a happy new year to each distinguished reader of this section and wishing them prosperity for 2023 and beyond.
How come it’s so hard to keep those “new year, new you” promises to exercise more and put away more money for retirement? Most conventional economic models’ underlying agent might easily keep to these goals. Homo economicus is the term used to describe these individuals. Individuals with the traits of Homo economicus are hyper-rational individuals who put themselves first at all times. This indicates that a homo economicus will always choose the optimal choice for themselves when given a choice. Many people will appreciate listening to pleasant street music, but they won’t contribute financially to the performer. This is because the music exists regardless of whether or not homo economicus chooses to pay for its existence. This frees up the funds for other pressing needs. To return to the original example, there are several advantages to maintaining a regular workout routine or saving for retirement. A homo economicus will have little trouble keeping their New Year’s resolution because they are motivated to achieve maximum utility over time.
One of the most common financial goals for the new year is to begin saving more for retirement. A homo economicus will always consider multiple options before picking the best one. It makes the most sense to stick to the New Year’s resolution of accumulating more money for retirement. People who aren’t entirely logical often struggle to reach the same conclusions. As a preliminary matter, it is usually impossible to calculate every conceivable facet of a decision or outcome. Take, for example, a hot summer day in a seaside town, when you are in need of ice cream but can’t find any. The prices, wait times, and flavour rankings of all the ice creams on offer would be impossible to keep straight in one’s head. A homo economicus, however, is supposed to know, despite the fact that there is rarely complete information. Therefore, it can be challenging to make the utility-maximizing choice when there are numerous alternatives, such as how to spend one’s money.
Richard Thaler’s “nudge” studies further imply that people’s decisions are affected by the order in which options are given to them. Chocolate at the grocery store checkout would not tempt a homo economicus, but putting it at eye level in a waiting room may. This demonstrates that the order in which options are presented can have an effect on the final choice. In other words, starting to save money for retirement is challenging for non-perfectly rational beings because there are many choices to choose between, and some will be presented as more tempting than others.
Many people also make it a goal to improve their health by exercising more frequently beginning in the new year. A homo economicus will keep this promise to themselves because regular exercise increases their utility over time. A homo economicus, however, lacks empathy and will only look out for themselves. A friend in need may convince an irrational person to forego their workout to help out. In contrast to the idealised homo economicus, real people sometimes prioritise the happiness of those around them over their own. Similar to how some fictional characters might donate money to a charity without expecting anything in return, some actual humans might do the same. A rational homo economicus would never act in this way. Even more so, those who aren’t entirely rational are profoundly affected by their environments. It’s easy to fall prey to prejudice when people’s choices about them are so visible and easy to influence. If everyone in one’s social circle makes plans to be together, it can be difficult to prioritise one’s workout routine.
Read also: Nigerians welcome New Year with mixed feelings
Basically, a homo economicus may easily keep their New Year’s resolutions because doing so will maximise their utility. While the homo economicus may benefit from these options, most actual humans have a tough time choosing between them.
To a homo economicus, context and presentation of options matter little. On the other hand, a homo economicus does not suffer from any cognitive biases. However, those of us who aren’t entirely logical fall prey to a variety of cognitive biases. Most people, according to research by Kahnemann and Tversky, have a low tolerance for taking chances. It means, for instance, that if the chance of winning less money is higher, individuals will choose it above the chance of winning more money. The study of this phenomenon, and the reasons for the disparity in valuation between gains and losses, is known as prospect theory. In conclusion, real people don’t have an abundance of time or data to make decisions. On top of that, they are affected by the bounds of their own mind. “Bounded rationality” is a term used to describe people’s limited ability to make sound decisions. Decisions can be hindered by things like a lack of information or cognitive biases. Most people’s deviation from the perfectly rational actions of a homo economicus can be explained by the concept of bounded rationality.
Both the assumption that homo economicus behaves differently from most real humans and the reason why a homo economicus would keep up their New Year’s resolution have been discussed. Still, it’s fair to wonder why most individuals find it so challenging to start exercising regularly or saving for retirement. All of the external and internal causes listed above play a role. Hyperbolic discounting is a well-established explanation. Most people, according to the theory of hyperbolic discounting, value immediate gratification more than larger payoffs further in the future. Many people, for instance, would rather pay $20 now than $40 in a year. An individual’s willingness to wait for a reward is reflected in the discounting rate. Specifically, the discounting rate is shown when participants are asked how much more they would be willing to accept in exchange for $20 now vs receiving the same amount of money a year from now. Of course, this changes depending on the individual and the circumstances. Those who struggle to put off immediate rewards for longer periods of time will have a greater discounting rate.
What does this have to do with irrational people’s resolutions for the New Year? Many people place a greater emphasis on the here and now than they do on the distant future, as was implied earlier. Therefore, if a genuine human being who is subject to constrained rationality has to decide between starting to exercise and continuing to watch a nice movie, many people will opt to continue watching the good movie. Even if the real person knows that exercise is good for them in the long run, this remains true. Unfortunately, the long-term benefits of improved health are typically less appealing in the present than the immediate benefits of keeping on watching the movie. Aside from making it hard to keep New Year’s resolutions, hyperbolic discounting also explains why people put off making changes or overbuy at other times of the year.
Given how far off the concept of homo economicus is from how humans actually behave, it is intriguing to ponder why it is utilised in economic models at all. Actually, homo economicus is still highly helpful despite the fact that it is not an ideal description of human behaviour. The concept of Homo Economicus facilitates the modelling of various economic ideas. Although these models don’t perfectly reflect reality, they are nonetheless useful for gaining insight into economic patterns. Simply put, the analysis of economic decision-making is greatly aided by the existence of a homo economicus.
