Rational Heuristics and Pricing: A Fresh Perspective (HEN Editorial 339)

How men­tal short­cuts shape decis­ion-making, pri­cing stra­te­gies, and key deba­tes in hete­ro­dox economics.

When che­cking all the (quite num­e­rous ;-)) items for this issue of the Hete­ro­dox Eco­no­mics News­let­ter, I was most dis­trac­ted by the lea­ding article in the recent issue of Indus­trial and Cor­po­rate Change, which is about the role of ratio­nal heu­ristics in pri­cing stra­te­gies. In my hum­ble opi­nion this fine paper con­nects two areas of rese­arch that are someh­wat under­re­se­ar­ched (maybe also under­app­re­cia­ted) in the hete­ro­dox com­mu­nity, alt­hough they sup­po­sedly carry some relevance.

One such area is the ratio­nal heu­ristics appor­ach its­elf, which is an alter­na­tive approach towards a theory of pur­po­seful decis­ion-making under uncer­tainty, that draws on the basic idea that peo­ple employ men­tal short­cuts (that reduce com­ple­xity and cap­ture relia­ble pat­terns) ins­tead of opti­miza­tion rou­ti­nes when aiming to achieve some goal (see here for a pri­mer). Today, this approach has grea­ter pro­mi­nence in psy­cho­logy and manage­ment than in eco­no­mics (for excep­ti­ons see here or here). None­thel­ess, the ratio­nal heu­ristics approach stands on the should­ers of a hete­ro­dox giant, as Her­bert Simon’s clas­sic paper on „A beha­vi­oral model of Ratio­nal Choice“ is widely con­cei­ved as an early key con­tri­bu­tion to this approach. Simon’s clas­sic intro­du­ces the well-known notion of ’satis­fi­cing’, where a ratio­nal choice is con­strued as a decis­ion that allows for rea­ching or sur­pas­sing a cer­tain aspi­ra­tion level, which is dub­bed an ‚aspi­ra­tion-level heu­ristic’ in the suc­ces­sive literature.

We sup­po­sedly use such heu­ristics or men­tal short­cuts a lot. This edi­to­rial is an ins­tance of the appli­ca­tion of such a heu­ristic, as it is based on my intui­tion that items that dis­tract me a lot are pro­ba­bly (hop­efully?) also inspi­ring for others. As this approa­ched has worked some­what well in the past it has deve­lo­ped into quite a rou­tine. Simi­larly, most daily con­sump­tion choices can be repre­sen­ted as rou­ti­nes emer­ging from past appli­ca­ti­ons of an aspi­ra­tion-level heu­ristic, while more com­plex con­su­mer-decis­ion are more com­plex exactly because eit­her one’s aspi­ra­tion or the fit bet­ween available pro­ducts and aspi­ra­tion is unclear in some way. To me it seems fair to say, that the ratio­nal heu­ristics approach allows for an evo­lu­tio­nary and cogni­tively plau­si­ble take on mode­ling and con­cep­tua­li­zing instru­men­tal ratio­na­lity in socio-eco­no­mic con­texts that can cap­ture the intui­tion under­ly­ing other beha­vi­oral argu­ments in diverse strands of hete­ro­dox eco­no­mics: Buil­ding on a shared under­stan­ding of uncer­tainty, the ratio­nal heu­ristics approach is com­pa­ti­ble with con­cepts like social emu­la­tion (as in Veblen), a con­stant mar­gi­nal pro­pen­sity to con­sume (as in Keynes), rent-see­king (‚pre­da­tory’) beha­vior (as in Veblen or Smith) or paro­chial altru­ism and asso­cia­ted issues of social iden­tity (à la Bowles/Gintis).

Aside from being a pos­si­ble umbrella con­cept sui­ta­ble for coll­ec­ting and syn­the­si­zing key ideas across hete­ro­dox schools and tra­di­ti­ons, the ratio­nal heu­ristics approach is also a sui­ta­ble can­di­date to chall­enge stan­dard inter­pre­ta­ti­ons of expe­ri­men­tal fin­dings in beha­vo­r­ial eco­no­mics. As many of you might have noti­ced, there is a ten­dency in beha­vi­oral eco­no­mics to inter­pret devia­ti­ons from the stan­dard model as a bias, that is asso­cia­ted with the sub­jects (ins­tead of being asso­cia­ted with theory, mea­su­re­ment or method!), as, e.g., in the term ’sta­tus quo bias’. Howe­ver, the sta­tus quo bias – that is, the repea­ted expe­ri­men­tal fin­ding that peo­ple assign (slightly) hig­her values to things they alre­ady own – could also be con­s­truc­tively explai­ned by a ratio­nal heu­ristics approach as some­thing I alre­ady own (and know its pro­per­ties) is asso­cia­ted with less uncer­tainty than some­thing I might acquire (which requi­res me to form some uncer­tain expec­ta­tion) – a pat­tern that could trans­late into a sta­ble evo­lu­tio­nary heu­ristic. Simi­larly, the reprea­ted fin­ding that peo­ple ‚over­weigh’ (some) small pro­ba­bi­li­ties asso­cia­ted with huge costs, while ‚under­weig­hing’ others could be explai­ned as an inter­ac­tion bet­ween a com­ple­xity reduc­tion heu­ristic (which leads us to ignore some risks) and an evo­lu­tio­nary instinct to avoid a ‚gambler’s ruin’, i.e. a cata­stro­pic event. The lat­ter mimics a pre­cau­tio­nary heu­ristic, namely Maxi­Min-approach to ratio­nal choice (lea­ding us to empha­size some risks, see, e.g., here for more details).

Having said a lot about ratio­nal heu­ristics as the first rese­arch field the befo­re­men­tio­ned paper speaks to, let me quickly add two thoughts about the second field, which is price theory. As the paper takes second-hand cars as its empi­ri­cal case, there is little con­nec­tion at first sight to the clas­sic hete­ro­dox notion of con­cei­ving pri­ces as sum of wages and mar­kups (and, maybe, mate­rial inputs). Howe­ver, the poten­tial appli­ca­tion of ratio­nal heu­ristics con­cepts to bet­ter illu­mi­nate con­crete pri­cing stra­te­gies in con­texts of oli­go­po­li­stic com­pe­ti­tion, that are often said to be gover­ned mainly by stra­te­gic con­side­ra­ti­ons (see, e.g., here and here), could very well be a frui­tul case of appli­ca­tion. Such a take could add a more expli­cit beha­vi­oral dimen­sion to recent deba­tes on infla­tion deter­mi­nants in hete­ro­dox eco­no­mics (as con­duc­ted here, here or here).

All the best,