In the AMC series “Mad Men”, Don Draper, an ace Ad-exec at the fictional (but no doubt prestigious) NY advertising firm Sterling-Cooper was sharing a cocktail with potential client, and possible lover, Rachel Menken. He learns that she has never married because she has never been in love. Draper leans back, and in a world-weary voice says,
“The reason you haven’t felt it is because it doesn’t exist. What you call love was invented by guys like me to sell nylons.”
A tad exaggerated perhaps, but it has a sliver of truth. Advertising is one of the most ubiquitous forms of mass media, and its very prevalence irritates economists.
Consumer theory can be distilled to two simple questions, plus two critical assumptions.
a) What are my feasible choices?
b) What is my best choice, considering my set of feasible choices?
Since almost any choice in a feasible set can be justified, an additional assumption is needed, which is called revealed preference or consistency. If two objects are in a feasible set, imaginatively called A and B, and A is chosen over B, then whenever A and B are both feasible, A will always be chosen over B. A good way to put it is the feasible set and the individuals preferences are independent of each other. The second assumption is that the individual doesn’t suffer from a lack of appropriate knowledge: i.e. he knows the problem, he is aware of the choices, he knows what he wants, etc…
Of course there are many technical details that need not interrupt the rest of this post. These juicy bits form many a grad school midterm, final and prelim, and are surely not the victims of neglect. The important thing to note is that this is the economic model of the Rational Man.
Many people believe that this is not a literal description of human behavior. In fact, economists don’t believe in the literal interpretation. Like sophisticated exegistes, they believe in the model in the sense of an intelligent lay-person believes that the bible isn’t the literal truth but is the correct interpretation of God’s will.
Specifically, even if people don’t make decisions like the rational man, people behave as if they do. It is people’s actual behavior that interests economists, not the exact procedure that generates this behavior.
Thus, ANY model of behavior that generates consistent choices (briefly defined above as consistency). This is the reason why assumption two is a non-starter – economists don’t care if people can’t compute with cray-like ability. Ultimately, as long as people’s behavior fits the rational man model, whether or not man makes choices in this particular way is irrelevant.
However, the key problem with this paradigm is this: what if the choice set and preferences are NOT independent? In this case, the procedure of the choice is important. To make this as stark as possible, suppose that A, B and C are elements in a set, and given this our individual wants A. However, if ABCD are the elements, B is the choice.
You may be asking: how relevant is this? This phenomenon permeates human decision making. You need only look at the psychology literature. In his book “Modeling Bounded Rationality” by Ariel Rubinstein, he summarizes the issue as the following:
a) Framing Effects
b) Tendency to Simplify Problems
c) Search for Reasons
These effects do indicate that advertising makes sense from an economic point of view. The consequence of the fact that preferences are changeable in very systematic ways is that purchasing decisions can be affected by marketing and advertising. One final rationalization of the rational man approach is that the three effects are mistakes, in the sense that once they know it’s a mistake, consumers or traders change their behavior accordingly. Merely labeling them as mistakes is not useful because the fact that they are systematic makes them economically relevant.
The important big-picture questions then are: the extent to which preferences or procedures are manipulable, does this persist, and how do people learn about their ‘mistakes’.
Looking at the nitty-gritty details, Prof. Rubenstein explains how to model these three effects, which I’ll detail later. This is a technical challenge, and is a non-trivial change in the rational man model.
Posted by outinfour 
Posted by outinfour 
Posted by outinfour 