Why does the realism of assumptions matter?

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From Rogeberg on rational addiction:

Theories of rational addiction make assumptions concerning the choice rule, preferences and beliefs of people, and derive the resulting consumption plans. … Some economists claim support from the famous as-if methodology of Friedman 1953 … which explicitly identifies prediction as the only aim of “positive economics.”…[Such] explanations may prove excellent predictive devices as long as the empirical regularities they describe remain stable… [but] this defense comes at a cost: Since someone acting as-if he was rationally solving some decision problem would not behave optimally unless this was the actual decision problem he faced, assumptions matter when we turn to welfare analysis. Nor can as-if theories claim to explain in the sense of describing the mechanism or causal process underlying a phenomena, their aim is just to relate observable quantities in the simplest, most empirically successful way. To use a metaphor… an as-if theory of a car would be of no help to a mechanic if the car broke down.

The reference point for optimality depends upon the model you’re using. If it’s not a good causal explanation of the problem then it cannot tell you about the optimality of the agent’s decision.

It’s just another reminder that we need to be really careful when moving into the realm of welfare economics because it implies numerous additional assumptions that we don’t need elsewhere.

  • http://offsettingbehaviour.blogspot.com Eric Crampton

    To me, the rational addiction model’s empirical successes say that we can’t simply assume irrationality when describing consumption of addictive goods. We’ve not proved that all addicts are rational, but we have proved that we can’t simply assume that they aren’t.

    • http://www.tvhe.co.nz jamesz

      Sure, I was quoting it more for the point about methodology than Rogeberg’s argument about the plausibility of rational addiction. I think plenty of economists are happy to use as-if justifications for their models to avoid defending the assumptions. That’s fine, as long as they don’t infer welfare consequences from the as-if predictions.

      In terms of rational addiction, I’m a bit torn. The model has some empirical support and models augmented with hyperbolic discounting seem to fit the stylised facts reasonably well. At the same time, humans don’t appear to do rational choice all that well, which casts doubt on the assumptions underpinning the model. Maybe we’ll find that there are just some tweaks that need to be made to it to properly represent people’s decision heuristics, but that’s fairly optimistic.