Are you learning “rational” economics?

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By Leif Olson

It began with a simple question: Are people rational actors? More importantly, are people rational enough that we can predict and model their behavior?

Many SAISers will recognize this as the fundamental question that economics, and, to an extent, social science in general, is trying to answer.

But, to what degree do economics courses at SAIS get at this fundamental question? After slogging through hours of calculus or game theory to answer ostensibly simple questions like which combination of goods satisfies a consumer’s preferences, many students may feel exasperated and discouraged. After all, I certainly don’t use calculus to decide what I’m buying at the grocery store, and I assume you don’t either.

Consider a game of Tic-Tac-Toe. When children play the game, normally the child who is older and has played the game before will win. This is an example of asymmetric information. Now, imagine that both players are SAIS students who have played the game several times in their respective lives. The game will, nearly every time, lead to a draw. Imagine that the game is an analogy for the simplified economic models SAISers learn in our economics classes, where a tie is the market-clearing equilibrium. Simplified systems lead to predictable outcomes.

By contrast, the real world market functions somewhat like a hyper-complex game of chess, where rational choices often are obscured amidst the complexity. Even in situations where the rational choice seems obvious, people often choose the economically irrational option for reasons that range from altruism to bias to emotional attachment.

How, then, do intelligent people reconcile the economic models they learn in Micro, Macro, Trade and Monetary with the complex reality of global economics?

When asked about the assumption that people are rational actors, Dr. Mine Senses, an Associate Professor of International Economics at SAIS, responded in good humor: “I do believe people make irrational choices…I do interact with people in my daily life.” She went on to say, “But in the aggregate—especially when we think about macro questions or trade questions, how people respond to prices in aggregate, how they respond to income changes in aggregate—do I think the models describe reality in a reasonable way? I do.”

Rather than provide a perfect model of human interaction, Dr. Senses explained that economics is just one part of a more holistic understanding. “I can totally think of contexts where the rationality assumption is invalid,” she said. “But once you understand how the model works when individuals are selfishly making decisions, it’s not too hard to modify the model so that you have individuals who also think about the greater good as well as their own welfare.”

Indeed, the models we learn in the International Economics Concentration are simplified. But one must first develop a sophisticated understanding of a simplified model in order to then incorporate more variables and bring the model closer to reality. So what are these complex variables and how can SAIS students learn about them?

Say you enter a restaurant. Should it makes a difference whether calorie count is listed before or after the price on a menu? In an economic model based on perfect information, the order in which you receive the information should not matter at all. However, as Dr. Jason Fichtner, Associate Director of the Masters in International Economics and Finance (MIEF), teaches in his Behavioral Economics course, the order often significantly alters a person’s choice. Dr. Fichtner explains that it is not just the information or the choice that matters but also “the framing of that choice, the architecture of that choice [which] changes the behavior.” “This,” Dr. Fichtner continues, “technically, is not rational.” Yet behavioral economists have discovered that calorie counts only entered the “choice architecture” of a consumer when it was the first thing they read (i.e. when the calories were on the left). According to Fichtner, when calorie counts appeared on the right side (after the price), they rarely affected people’s decision-making. This subtle behavioral tic would be left unaccounted for in a basic rational decision-making model.

When asked how to reconcile this with the four courses of the International Economics concentration, Dr. Fichtner said, “You have to understand the basics of how any sort of historical model of economics is taught before you can have discussions of the nuances and why the models don’t necessarily apply in the real world.” He continued, “In some places, behavior trumps standard economic models—but you won’t understand why, you won’t understand that nuance, until you have the foundational economics to begin with.”

The four International Economics courses are an introduction to how economics works in the real world, but they do not tell the whole story. However, if we want to understand how people act in the real world, we need a starting point to extrapolate from. “You can’t build the second floor before you build the first,” Fichtner said.

SAIS alumna Emily Hardman Rodgers, who currently works at the Millennium Challenge Corporation, agreed with Fichtner’s analysis, saying, “The basic economics courses at SAIS certainly gave me a better understanding of policy.” When asked what she would change about the economics requirement at SAIS, Rodgers stated, “I would definitely make sure students understand more policy and real-world implications surrounding economics… a lot of the courses center on figuring out equations and models that aren’t necessarily relevant in all lines of work.” She continued, “I’ve found that the fundamental assumptions [of economics] do hold in theory, but when one experiences these models in the real world, they’re normally much more complex.”

Perhaps changing the way our economics courses are taught is not the solution. As Dr. Fichtner stated, “It could be a question, not of changing the courses, but of offering more courses, and allowing students to take one of the electives as a core.” By taking a policy-oriented course which uses economic intuition, SAIS students may feel that their economics courses are more relevant. Courses like Fichtner’s Behavioral Economics will give students a perspective that may be more palatable to those left unconvinced by the assumption of human rationality.