1. Economic Rationality

2. Economics Allocation of scarce resources
“Economics exhibits in purest form the artificial component in human behavior …”
Occurs at all levels – individuals, business firms, markets, and economies
Outer environment: behavior of other actors
Inner environment: goals and capabilities for rational, adaptive behavior
Illustration of how outer and inner environments interact
Substantive rationality – adjustment to outer environment
Procedural rationality – ability, through knowledge and computation, to discover adaptive behavior

3. The Economic Actor Textbook economics Used
Outer: supply and demand
Inner: cost curves
Used
As description of how firms behave (positive)
As advice on how to maximize profits
Does not consider how these values are estimated

4. Procedural Rationality
Many of the values are rough estimates
How elastic is demand?
Real life involves many interacting decisions
Product quality?
How many products?
How to market?
Problem changes from one of choosing the right course of action to locating a good action

5. Supporting Economic Decisions
Operations Research
Uses linear programming (and similar techniques) to find optimal solutions to limited representations of reality
Optimal solution rarely is optimal but is often satisfactory
Artificial Intelligence
Uses rule-based reasoning (and similar techniques) to make decisions based on more aspects of a complex and less well structured reality
Solutions are good enough rather than being optimal in any respect
Satisficing – finding a solution that is good enough

6. Aspirational Levels
“Because real-world optimization, with or without computers, is impossible, the real economic actor is in fact a satisficer”
Aspirations affect what is satisfactory
Most people register slightly above/below satisfactory
Aspirations are based on historical levels
Aspirations change (up and down) over time
Many simultaneous aspirations
Satisficing meets aspirations along all dimensions

7. Markets and Organizations
Many mechanisms for coordinating actions among actors
Markets
Central planning
Bargaining and negotiation
Hierarchic organizations
Balloting procedures
Roughly 80% of human activity in the US economy takes place within organizations

8. Markets and Optimality
Assumptions of market optimization
Actors have perfect information
Actors act to maximize utility/profits
Not realistic
Markets are populated by satificers
Information is limited, time is limited, etc.
“The marvel is not that (the dancing dog) dances well but that it dances at all”

9. Order without a Planner
Complex design is often assumed to be the result of planning
Example of medieval cities
Collapse of Eastern Europe Economies
Cannot function well without smoothly operating markets
Poor performance since
Cannot function well without effective organizations
“The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action.” Friederich von Hayak

10. Uncertainty and Expectations
Feedforward (prediction) and feedback can help control for uncertainty
But actors are not independent
Actors start trying to outguess one another
“Economic chicken”, speculation
Prisoner’s Dilemma – treachery pays
Unstable solution unless satisficing rather than optimizing
Classical economics avoided such issues by focusing on situations where mutual expectations play no role

11. Bounded Rationality
There is a limit to what actors know about the state of their environment
Actors have limited time in which to determine their next action
Economic actors gradually learn about their environments to select satisficing, not optimizing, actions

12. Business Organization
Market-organization boundary
What decisions are made within vs. what is made outside of the organization
One view is to consider the transaction costs of using a market
Successful organizations structure themselves
To localize and minimize information demands of decision makers
Resulting in specialization of role
Ensuring no single person or group needs to be an expert on all aspects

13. Organizations and Uncertainty
Each market decision is impacted by the decisions of others in the market
Markets result in the type of uncertainty that causes outguessing and similar behaviors
Organizations absorb uncertainty by removing some decisions and by causing actors to be more aligned in their goals
Organizations also augment human reason by placing people in cooperative rather than competitive roles
(Docile) People can learn from one another

14. Evolutionary Models Local and global optimization
Hill climbing algorithms
Choice of metric vs. English measurements
Each step is better for current situation
No planning, no feedforward, no design
Business/economic evolution
Lamarkian – any new idea can be incorporated as soon as its success is observed
No predictable equilibrium but a complex process that continues indefinitely