In 1980, Richard Thaler published his seminal paper titled “Towards a Positive Theory of Consumer Choice”. This paper is widely believed as the formal foundation for the stream of behavioural economics. It must be said, the behavioural economics originates in the works of Daniel Kanheman and Amos Tversky who published their Prospect theory: An Analysis of Decision under RIsk in 1979. These papers led to development of a field that would question the hitherto assumptions of rational choice under the neo-classical models of economics. Economic theory until then had assumed certain parameters that would determine human decision making in its pursuit for utility maximization, but these new theories seemed to put limitations on the actions of economic agents in their pursuit either to utility maximization or profit maximization. Apparently Robert Frank at Cornell began offering course on what he termed as Departures from Rational Choice. He wanted to examine why economic agents do not opt for a rational choice as posited by the orthodox theories. He went a step further and divided these actions into what he termed as Departures with Regret and Departures without Regret.
Robert Frank explains the logic behind the same in this interesting blog piece. While the piece is more about building a case for integrating Charles Darwin’s theories into the stream of behavioural economics, the post does go at some length to understand the divergences of actions of economic agents from what the neo-classical theorists believed as rational choices. There are numerous systematic cognitive errors which agents are prone and thus their choices depart from the predicted theory and thus is termed as something departures with regret. There can be multiple instances of the same such as ignorance of sunk costs. A typical example that can be cited borrowing from his piece would be going to a movie if the ticket is non-refundable even if it is raining heavily. Alternatively, one undertakes a journey despite not being well if the flight or train ticket is non-refundable. The cost benefit analysis seem to be quite skewed in these cases and perhaps result from the cognitive information constraints that affect the human economic agent.
The latter, departures without regret is what Frank would call as something undertaken in the context of the existing situation and presence of rivals in the field. He gives an interesting example of students in a B-school investing considerably on an interview suit. He argues that the conventional models assume absolute determinants of utility whereas the interview suit is a relative determinant of utility. This is where the divergence from mainstream economics occurs with reference to behavioural economics. Yet it cannot be overlooked that investing in an interview suit is perhaps the most rational choice that an agent can exercise in the relevant situation. Therefore, what would be of importance would be reconciliation of absolute and relative determinants of utility in laying the foundation for utility function of an economic agent. Consider a situation wherein an agent is appearing for interview let us say a prestigious position in technology or a financial firm. To him or her, the job is of critical import in terms of laying the foundation for their career. A big break at stage of graduation is something going to lay a path for vertical mobility. Therefore, the urge to capture the job is something immense. Yet, the job is not something available on a platter. It is more of a monopsony market that is on offer. The supply of the offer in hand is virtually perfectly inelastic, in other words, a vertical supply curve at that moment. The demand however is significant. There are many other candidates who are willing to offer their services to the firm in need of it. The choice would then be contingent on the price, yet the price, in this context, the salaries might not be the only one determining the same. In fact as theory of signalling would indicate, an offer to work at lower prices would send some signal amiss to the interviewer and thus a potential disqualifier. The interviewer would be wary of adverse selection and offer of lower price would perhaps indicate a lemon than a cherry. Secondly, the offer is not merely on monetary elements but on the attributes essential in key execution on the task at hand.
There is one dimension of absolute determinants at hand. This about the qualifications and the skill sets and the knowledge that is essential and thus tested at various quantitative and qualitative levels but with objective scheme of evaluation. Given the relative similarities in qualification and skillsets of all the job applicants, there would be narrow differentiators. What perhaps would count is the final interview, the face to face interaction whether virtually or physically. It is where the subjective parameters would come into picture and therefore, each candidate would seek to project themselves comparatively better than others. Obviously, the looks would come in handy. Looks in terms of dress and appearance would convey a signal of seriousness towards the job. In case a candidate does not look well groomed in terms of attributes essential for the job, there would be a possibility of rejection. It is important to note that while looks might be relative, it might also be absolute in certain kinds of jobs which might entail significant customer interaction.
Moreover, to each candidate, their investment would be subject to the marginal utility they generate. To each, their investment would be contingent on their budget constraints. The question of whether a candidate should spend on interview suit or use his or her skillsets to pass the selection hurdles would be relative to the marginal utility they generate relative to the money they have spent. If the ratio of marginal utility to the money they have spent is higher relative to the other goods in the basket at the moment of time, they would certainly invest more in interview suit and other grooming measures. This would occur till such time their ratio of marginal utility to the last unit of currency spent on personal grooming and appearance equalises the ratio of marginal utility to the last unit of currency spent on brushing their skillsets essential for the job at hand.
When one observes the context, it is essentially a replay of the diamond water paradox with modifications when it comes to decision to invest on interview suit for instance. There is no doubt, it is the Darwinian survival instinct that is at play. Yet, the conventional models have assumed narrow parameters for determinants of utility. The parameters could well be modified into relative determinants while building up the utility function. The utility function would still be subject to the budget constraints just that the constraints will have to be defined a bit different. Therefore, as observed in the current post, the choice to invest in interview suit itself is most rational choice rather than a departure. A pure dependence on the absolute determinants of utility in the current context of investing in education and knowledge based job attributes alone in contrast to investment on sartorial preferences would be indeed a departure from rational choice. It goes without saying, sartorial investment without skillsets of course can be termed as irrational expectations.
Thoughts on Theory and Practice 