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Models of Man: Neoclassical, Behavioural, and Evolutionary

Dennis C. Mueller Politics Philosophy Economics 2004 3: 59 DOI: 10.1177/1470594X04039982 The online version of this article can be found at: http://ppe.sagepub.com/content/3/1/59

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politics, philosophy & economics

SAGE Publications Ltd London Thousand Oaks, CA and New Delhi 1470-594X 200402 3(1) 5976

article

Models of man: neoclassical, behavioural, and evolutionary

Dennis C. Mueller
University of Vienna, Austria

abstract

For most observers of economics from both inside and outside the science, the term economics is synonymous with neoclassical economics. It is the methodology of neoclassical economics that defines the discipline of economics. Mainstream economics is neoclassical economics and anyone entering the discipline today who wishes to obtain an appointment at one of the leading universities of the world is well advised to master its techniques. The fact that virtually every winner of a Nobel prize from Paul Samuelson up to his student Joseph Stiglitz has been a practitioner of neoclassical economics is ample proof of the methodologys triumph. Despite the dominance of this methodology, however, neoclassical economics has been subject to a steady stream of criticisms and proposals for alternative methodological approaches throughout its life. This article focuses on two relatively recent challenges to the neoclassical orthodoxy that seem to have taken hold of a non-negligible minority of the profession, some of whom can be found at leading universities. These two challenges come from behavioural economics and evolutionary economics. The article describes the strengths and weaknesses of both of these methodological approaches and contrasts them with that of neoclassical economics. It concludes that all three methodologies have something positive to contribute to the study of human behaviour. neoclassical economics, behavioural economics, evolutionary economics

keywords

What is economics? The simplest definition is that economics is whatever economists do. Since economists do many things and use various methodologies in their work, one might argue that there is no core methodology that defines economics. Most observers of economics from outside the discipline (and many from within it) would disagree with this statement, however. For many, the
DOI: 10.1177/1470594X04039982 Dennis C. Mueller is Professor of Economics at the University of Vienna, Institut fr Wirtschaftswissenschaften, 1210 Wien, BWZ Bruehner Str. 72, Vienna, Austria [email: dennis.mueller@univie.ac.at]

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science of economics is synonymous with neoclassical economics, and it does have a well-defined methodology. Indeed, it is this methodology that defines economics. When one scans the pages of the leading economics journals today one soon reaches the conclusion that neoclassical economics has come to dominate the discipline in the 100 or so years since it was invented.1 Every doctoral programme in economics at the leading universities around the world consists almost exclusively of courses that train students to use the tools of neoclassical economics. Mainstream economics is neoclassical economics and anyone entering the discipline today who wishes to obtain an appointment at one of the leading universities of the world is well advised to master its techniques. When one contemplates the achievements of neoclassical economics over the past century, it is easy to understand its triumph over alternative methodologies. The application of neoclassical techniques to the study of prices from Alfred Marshall through to John Hicks and Paul Samuelson has contributed greatly to our understanding of how markets function. Proofs that perfect competition can lead to a Pareto optimal allocation of resources are elegant defences of freemarket processes. In addition, neoclassical economics has been equally valuable in explaining how markets can fail and describing the remedies that should be applied to correct these failures. The fact that virtually every winner of a Nobel prize from Paul Samuelson up to his student Joseph Stiglitz has been a practitioner of neoclassical economics is ample proof of the methodologys triumph.2 If further proof is needed, it can be found outside the narrowly defined limits of the field of economics. No leading law school in the USA today thinks that it can get by without an economist or two on its faculty. Leading political science departments also typically contain people who were either trained as economists or who are conversant with and utilize the techniques of neoclassical economic modelling. Anthropology, biology, and sociology have all been invaded, although not yet conquered, by people who use the methodology of neoclassical economics. Moreover, economists have even had the effrontery to take on the philosophers and apply their analytic techniques to such questions as liberalism, social justice, and fairness.3 Despite all of these obvious achievements, neoclassical economics has been subject to a steady stream of criticisms and proposals for alternative methodological approaches throughout its life. Indeed, its birth in Vienna gave rise to a tremendous Methodenstreit within the German-speaking economics community. My goal in this article is not to review the many criticisms of neoclassical economics that have been made down through the years and the variety of alternative methodologies that have come forward. Instead, I shall focus on two relatively recent challenges to the neoclassical orthodoxy that seem to have taken hold of a non-negligible minority of the profession, some of whom can be found at leading universities. These two challenges come from behavioural economics and evolutionary economics.
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Mueller: Models of man: neoclassical, behavioural, and evolutionary

The next three sections take up in turn neoclassical, behavioural, and evolutionary economics. In each section, I shall first briefly describe the main elements of the methodological approach and then both its advantages and disadvantages. The final section tries to draw some lessons from the preceding discussion for the choice of an appropriate methodology for modelling man.

I. Neoclassical economics
A. Methodology Neoclassical economics is built upon the bedrock of methodological individualism. All modelling starts from the analysis of individual behaviour. Each individual has goals, which can either be expressed as some sort of function or axiomatically with a preference ordering. Each individual behaves rationally. She maximizes the objective function; she chooses the outcome available to her which stands highest in her preference ordering. Additional structure is given to the analysis by assuming that the individual makes her choices subject to certain constraints the consumer chooses quantities given fixed prices and a fixed budget, and a firm chooses quantities with a given cost function and demand schedule. Two distinct applications of neoclassical economic modelling are commonly used today. The first applies calculus to determine the outcomes of individual actions. In some applications, such as a consumers choice of consumption items, only one equation need be solved the first-order condition of the consumers utility-maximization decision. In others, a second equilibrium condition is often imposed, as, say, market demand equals market supply, and the analyst has a second equation with which to work. These two equations (the firstorder condition from the individuals maximization of her objective function and an equilibrium condition when all individual choices are aggregated) form the basic building blocks for much analysis in neoclassical economics.4 The second important analytic technique in common use today in neoclassical economics is game theory. Here, one must distinguish between what we might call classical or forward-looking game theory and evolutionary game theory. As the latters name suggests, evolutionary game theory comes much closer to evolutionary economics and, indeed, as we shall stress later, in some respects is even closer to behavioural economics. Classical game theory, on the other hand, falls squarely into neoclassical economics. The individual is assumed to have a clearly defined objective (to obtain the highest payoff for her in the game) and behaves rationally in trying to achieve this objective, in the sense that she chooses the best strategy for obtaining the highest payoff among the set available to her. In much of the rest of neoclassical economics, the choice of objective for the individual, that is, the specification of the function, is central to the problem. The step of deriving the first-order condition is purely mechanical. In game theory, it is the reverse. The analyst defines the payoffs and trivially assumes that the individual wants the highest payoff. The non-trivial part of the analysis comes
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in trying to figure out which strategy is best and in what sense it is best. As in the rest of neoclassical economics, an additional important issue in game theory is whether there exists an equilibrium set of strategies for a game. B. Advantages The great advantage of neoclassical economics is the precision of its predictions. Knowing the cost function of each firm and the demand function for the industry, the analyst can predict what each firms output will be and, thus, what the price of the product will be by assuming that each firm maximizes its profits by choosing, say, output. The consequences of shifts in demand, changes in costs, and changes in the number of firms in the industry can all be predicted with great accuracy. A second important advantage of neoclassical economics is that it is well suited to both positive analysis, as in the example just given, and normative analysis. Having determined the equilibrium price in the industry, the analyst is able to calculate the potential welfare gain from increasing the number of firms in the industry or the level of competition. A beautiful example of the application of neoclassical economics to a normative question is Paul Samuelsons classic article on public goods.5 In a mere four pages, Samuelson uncovers the essential difference between pure public and private goods and illustrates the implications of this difference for the problem of determining the optimal quantity of a public good. It is applications such as this that have helped neoclassical economics take almost full possession of the methodological terrain. C. Disadvantages The more accurate a theorys predictions, the easier it is for it to be rejected by the data. Neoclassical economics Achilles heel is its frequent failure to account for many phenomena that contradict its predictions. Critics of neoclassical economics from the Methodenstreit to the present day have all stressed the seemingly large gap between its predictions and what seems to exist in the real world.
Example one

A large swath of neoclassical economics over the past century has been devoted to proving that demand schedules have negative slopes, first using the assumption of diminishing marginal cardinal utilities, then of diminishing marginal rates of substitution of ordinal utilities, and lastly using axioms of revealed preference. Yet large-scale econometric studies invariably produce estimates implying an awkwardly large fraction of demand schedules with positive slopes.6

Example two

The heart of neoclassical economics is marginal analysis, which follows directly from the assumption that individuals maximize some form of objective function. The rational individual equates the marginal benefits of an

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action to its marginal costs. Starting at least as early as Hall and Hitch, a large number of studies have questioned whether managers of firms set prices by equating marginal revenue and marginal costs.7 Most of these challenges have been empirically based. Observed pricing behaviour does not accord with the prediction of marginal analysis. Most neoclassical economists have simply ignored these sorts of criticisms, but interestingly, those who have tried to defend neoclassical economics against this criticism have usually not sought to do so by presenting counter empirical evidence. Instead, they have usually defended the plausibility of the rationality assumption and have appealed to general economic events that are consistent with neoclassical analysis: price rises following the imposition of a tariff.8
Example three

The development of experimental economics has created a rich body of research testing various assumptions and predictions of neoclassical economics. Much of this literature directly rejects these assumptions and predictions. Two examples will suffice to illustrate this point. A basic tenet in the publicchoice literature is that rational individuals will free ride in situations where contributions to the provision of a public good are voluntary. Countless experiments have demonstrated that they do free ride, but to a far smaller degree than one might have expected. If 100 is the contribution to the public good that produces the optimum quantity of the good for the collective, and 1 is the contribution that is individually optimal, then the typical finding in an experiment testing for freerider behaviour is that the mean contribution of the participants is around 50. Some people do free ride, but many make contributions that are far larger than is individually optimal. In aggregate, the total contributions fall far short of what would be optimal for the group, but far above what pure free-riding behaviour would produce.9 The second set of experiments involves the so-called ultimatum game. A fixed amount of money, say US$20, is to be divided among two players. Player A gets to propose a division, and B can either accept or reject the proposal. If B accepts it, they are paid the amounts proposed by A. If B rejects the proposal, each receives nothing. Rational self-interest on the part of both individuals leads to the prediction that A will propose that she receives most of the money, say US$19, and B will accept the proposed division, because getting US$1 is better than getting nothing. Both predictions are routinely violated by participants in these experiments. Those proposing the division are fairly generous to the other players with mean divisions typically being around two-thirds for A and onethird for B. Bs frequently reject low, but positive shares of the money.10 It is the results of experiments such as these, which have led many economists to seek an alternative to the standard assumptions underlying neoclassical modelling. One such alternative is behavioural economics.

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II. Behavioural economics

A. Methodology Neoclassical economics postulates that consumers maximize a utility function defined over the set of consumption goods available to them, and that workers maximize a utility function defined over their income and leisure. The assumption that individuals maximize utility functions follows essentially tautologically from the premise of rational, self-interested behaviour. In this sense, neoclassical economics is also behavioural, but it differs from what I am referring to here as behavioural economics in that it typically assumes that all actors in a particular situation maximize the same objective function, and the postulated objective functions contain a fairly small number of arguments. Workers obtain utility only from money and leisure; managers maximize profits; investors utility functions contain only their wealth, and so on. Other assumptions (for example, that managers pursue other goals than profits) are frequently dismissed as ad hoc. There is nothing inherent in a methodological approach that assumes that individuals maximize an objective function that requires that all people who apply this methodological approach employ the same objective function for all people in all situations, or limit themselves to a small set of objective functions. One branch of behavioural economics (the one discussed in this section) breaks with mainstream neoclassical economics by postulating different objectives for the main actors from those commonly assumed in neoclassical economics, but in other respects follows the same methodology as standard neoclassical economics. Individuals are assumed to be maximizers. A good example of what I refer to here as behavioural economics is Robin Marris Economic Theory of Managerial Capitalism.11 The second chapter of this book contains a long review of sociological and psychological studies which suggest that managers utility is more closely related to the growth of their firm than to its profitability. Marris used this literature from outside of economics to justify the assumption that managers maximize an objective function that includes the growth rate of the firm. Marris theory looks like any other theory in economics replete with first-order and equilibrium conditions. It differs from the standard model of the firm only with respect to what it is that managers are assumed to maximize. Nevertheless, Marris model and the other contributions to the managerialist literature that appeared at that time and assumed that managers pursued goals other than profit maximization were considered heretical by mainstream neoclassical economists. Fritz Machlup, who had led the marginalist counter-attack against non-marginalist theories of pricing, took the occasion of his presidential address to the American Economic Association to defend the assumption of profit maximization against the challenges posed by Marris and the other managerialists.12 In 1986, I took the occasion of my presidential address to the Public Choice Society to recommend a behaviouralist approach to modelling in the public64

Mueller: Models of man: neoclassical, behavioural, and evolutionary

choice field. Public choice is, of course, nothing more than neoclassical economics applied to politics. Every political actor (the voter, the politician, and the bureaucrat) is assumed to be a self-interested, rational actor. This assumption unfortunately leads to the prediction that a self-interested, rational voter will not vote a not very well-supported prediction. To avoid this embarrassing prediction failure, and others such as that regarding free riding discussed in the previous section, I proposed abandoning the strong form of rationality assumption used in neoclassical economics and public choice in favour of assuming that individuals behaviour is conditioned by past rewards and punishments. Such operant conditioning produces patterns of behaviour (often called habits) in which individuals undertake certain actions such as voting because they have been rewarded for undertaking similar actions in the past, or punished for not undertaking them. By relying on behavioural psychology in this way, the social scientist is able to retain the self-interest portion of the rational self-interest postulate. Individuals seek to obtain rewards and to avoid punishment. Only the strong form of rationality assumption must be relaxed, but even here it is not necessary to give up the analytical advantages of assuming maximizing behaviour. Individuals can be assumed to act as if they were maximizing a particular objective function. The observed behaviour of individuals in voluntary-contribution-public-good experiments and ultimatum games, for example, could be modelled by assuming that an individual, i, maximizes an objective function of the following form:
Oi = Ui (i) + qi Uj (Xj)
ji

(1)

An individual maximizes a weighted sum of his own utility and that of everyone else. When modelling his behaviour when grocery shopping, it may be reasonable to assume that q is zero; in situations such as public-good experiments, a more reasonable assumption may be that it is positive. In adopting such an approach, the social scientist must make assumptions about both what goes into the utility functions that are implicitly maximized (the Xi and Xj vectors in Equation (1)) and about the q-weight to be placed on the welfare of others. Here, one can either rely on introspection (I get utility from seeing my friends become happier and I assume everyone else does also) or more scientifically by examining the psychology and sociology literatures to see what they can tell us about how individual preferences are formed. Experiments involving the ultimatum game have revealed significant differences across cultures in the sizes of the offers made by the first players and the willingness of the second players to accept these offers.13 These experiments indicate the importance of social conditioning in determining individual behaviour. The salient feature of behavioural economics that differentiates it from mainstream neoclassical economics is that it relies upon concepts and findings from psychology and perhaps other social sciences to inform its assumptions about what it is that individuals maximize, what goes into an individuals utility func65

politics, philosophy & economics 3(1)

tion. Although it has probably had its biggest impact on the finance literature, leading contributors to this growing field have also taken up a variety of other questions.14 B. Advantages The chief advantage of behavioural economics is that by relying upon a more complex and accurate description of individual preferences, it can explain phenomena (even economic phenomena) that are poorly accounted for by the more naive assumptions about individual preferences that characterize much of neoclassical economics.
Example one

Robert Frank presents considerable evidence that wage profiles in firms and other institutions are much flatter than predicted by the marginal productivity theory of wages.15 Citing works from psychology, sociology, and philosophy, Frank develops the argument that people obtain satisfaction from knowing that they are paid relatively more than their peers. Status is an important component of an individuals utility function and thus high-productivity workers are content with smaller increments in pay over the average, whereas low-income workers must be given higher wages than their productivity levels warrant.

Example two

Throughout the 20th century the movement of stock prices has been too large relative to future movements in dividends, if one accepts the hypothesis that the markets expectations about future dividend movements are rational.16 Relying on psychological studies, Robert Shiller accounts for the wide swings in share prices by arguing that investors exhibit herd-like behaviour, and are seized by considerable over-optimism when share prices are rising and exaggerated pessimism when they crash.17 Public-choice scholars invariably assume that citizens vote to advance their narrow self-interest. A voter supports a tax reduction only if she stands to benefit personally from it. Survey evidence continually rejects this assumption. Large fractions of the population support policy changes that harm themselves, but benefit other members of the community.18 One way to account for this kind of behaviour is to assume that citizens maximize an objective function of the type depicted in Equation (1) when they vote with q > 0. John Hudson and Philip Jones have provided a direct confirmation of this explanation.19 They conducted two surveys of voters in Bath, UK. Voters were asked to comment on different policy proposals regarding changes in taxes and expenditure on health, education, and social benefits. Voters first identified their preferred policy, and then stated (1) whether they thought that the policy would benefit themselves personally and (2) whether they thought that the policy would be in the publics

Example three

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interest. From the answers to these questions Hudson and Jones inferred magnitudes of q of 0.66 for the 1988 survey and 0.73 for the 1992 survey. C. Disadvantages Intentionally flying an airplane into the side of a building is not what most people regard as rational behaviour. One could, nevertheless, model such actions assuming that the actor maximized an objective function that was a weighted sum of his utility in this life and his utility in the afterlife. With enough weight placed on the afterlife, the action becomes rational. Ex post, any behaviour can be made consistent with the postulate of rational self-interest by appropriate modification of the objective function to be maximized. The tautological nature of the assumption of utility maximization raises the danger, if one takes too many liberties with what goes into the utility function, of the existence of a plethora of behavioural models, each one designed to explain individual behaviour in a particular situation. Neoclassical economics main advantage of being a unified and relatively simple model of human behaviour that makes powerful predictions is lost. This criticism of behavioural economics is taken up in the concluding section of this article.

III. Evolutionary economics

A. Methodology The branch of economics commonly referred to as evolutionary economics can legitimately be said to have been born with the publication of Nelson and Winters An Evolutionary Theory of Economic Change.20 This book presents both a broadside attack on standard neoclassical economics and an alternative methodological approach to that which it criticizes. Nelson and Winter challenge the two fundamental assumptions that underlie neoclassical economic modelling: that individuals are rational in the sense that they maximize well-defined objective functions and that markets and other economic systems are in (or tend toward) equilibrium. They thus propose replacing the first-order conditions that one obtains from the assumption that individuals maximize well-defined objective functions with equations that represent the routines or rules of thumb that people in the real world follow. A mark-up pricing rule is a good example of such a rule of thumb. Herbert Simon was also highly critical of the assumption that individuals consciously maximize specific objective functions.21 Growing out of his work there developed the Carnegie school of economics. A Behavioral Theory of the Firm by Richard Cyert and James March was an early product of this school.22 Cyert and March modelled the behaviour of a specific firm using a computer program which incorporated the various rules of thumb and routines that they observed in the firm. Nelson and Winters approach is very much in line with this earlier work of Simon and Cyert and March. They too rely heavily on computer pro67

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grams in their analysis. The equations embedded in these programs replace the first-order and equilibrium conditions of neoclassical economics. The work of Nelson and Winter differs from the earlier work of the Carnegie school mainly in so far as they are concerned with the dynamic evolution of a firm or industry.23 Headings such as evolutionary economics, evolutionary game theory, and even neoclassical economics itself are sufficiently broad that the kinds of research they delineate covers a range of methodological styles. Not all scholars who call themselves evolutionary economists, for example, go as far as Nelson and Winter in abandoning the concepts of maximizing behaviour and equilibria. The same breadth of styles exists in the general area of evolutionary game theory. Some evolutionary game theory models, such as that of H. Payton Young, can, however, be legitimately called a part of the broader field of evolutionary economics.24 They too relax or entirely abandon the assumption of individual rationality. They too rely on simulation techniques to derive results. Individuals behaviour is often assumed to be adaptive and thus this approach is also often compatible with the behavioural approaches described in the preceding section. Given a choice between two strategies, x and y, individuals will learn to play x if it has been more frequently rewarded with higher payoffs in the past. Here, the contrast with standard game theory is dramatic. Whereas a player in a standard game is only concerned with future payoffs to the game as depicted in the matrix she confronts, players in many evolutionary game models are always looking at the past to see what the highest payoffs were. Evolutionary game theory models have been used to demonstrate how individuals can learn to coordinate on particular pairs of strategies that provide higher long-run payoffs to both players, and more generally how conventions and mores can emerge over time. In this respect, some of the experiments involving the evolution of individual behaviour in repeated games might be classified as part of behavioural economics, for these experiments often reveal how the behaviour of individuals in later rounds of a game is conditioned by their rewards and punishments in earlier rounds.25 Like behavioural economics, therefore, it can fill important lacunae in the set of phenomena that economists have previously been unable to explain.26 Evolutionary economics differs from neoclassical economics both in the techniques that it employs in its analysis and in the questions that it does and can ask. A typical study in evolutionary economics might proceed as follows. First, examine the rules of thumb managers use when making decisions about price, research and development, and so on. Then make reasonable assumptions, perhaps based on empirical analysis, about the relationships among the key variables. How much increase in productivity is it reasonable to expect from a given increase in research and development spending? Build these relationships into a computer program and use it to simulate the course of development of an industry in terms of its level of productivity, prices, industrial concentration, and so on. Evolutionary game theory proceeds in much the same way, but it tends to con68

Mueller: Models of man: neoclassical, behavioural, and evolutionary

fine itself to a much simpler set of relationships. First, a payoff matrix is written down. Second, a rule of thumb is defined for each player choose the strategy that has produced the highest average payoff over the previous 10 plays of the game. Then the game is simulated. Evolutionary game theory differs from many studies in evolutionary economics, however, in so far as it generally involves a search for evolutionary stable strategies and thus for equilibria of sorts. For example, Samuelson concludes in his recent survey of the literature on evolutionary game theory that it provides qualified support for the proposition that when stable strategies emerge in evolutionary games, they take the form of a Nash equilibrium.27 He then goes on to observe:
I view the stability implies Nash result as putting game theory on much the same footing as the rest of economics. We do not believe that markets are always in equilibrium, just as we do not believe that people are always rational or that firms always maximize profits. But the bulk of our attention is devoted to equilibrium models either because we hope that equilibrium behavior is sufficiently persistent and disequilibrium behavior sufficiently transient that behavior that is robust enough to be an object of study is (approximately) equilibrium behavior. . . . Evolutionary game theory thus provides little reason to believe that equilibrium behavior should characterize all games in all circumstances. But it provides reason to hope that behavior that comes into our field of study is likely to be equilibrium behavior. In this sense, we obtain a stronger motivation for Nash equilibrium than provided by rationality-based models.28

Thus, evolutionary game theory is, in fact, more akin to behavioural economics than it is to the kind of evolutionary economics espoused and practiced by Nelson and Winter and their followers. It abandons the strong-form assumption of forward-looking, ultra-rational behaviour that underlies neoclassical economics and replaces it with assumptions of adaptive or learned behaviour that resemble strong-form rational behaviour, if and when equilibria emerge. Quite unlike evolutionary economics, evolutionary game theory does not abandon the quest for equilibria, but instead searches for, and often claims to find, the same sort of equilibria that form the core of neoclassical theory. B. Advantages The advantage of evolutionary economics is that it can answer questions that standard neoclassical economics is either unable to answer or answers with considerable difficulty. As described above, standard neoclassical economics can give a precise answer to the question of what the structure of an industry will be today, given certain assumptions about firm cost schedules, demand, and so on. It is not well suited, however, to describing how an industrys structure will evolve over time as firms invest and innovate. Describing this sort of industry evolution is the bread and butter of evolutionary modelling. Neoclassical economics is in its own element when it comes to describing the properties of a static equilibrium. Even neoclassical growth models which appear to model economic dynamics, typically describe a form of static equilibrium moving through
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time. Evolutionary economics, in contrast, can describe the dynamics of an industry or of a whole economic system. C. Disadvantages Neoclassical economics at its best can reveal the essence of a problem with a simple analytical model. Consider, for example, the prisoners dilemma game. It contains all of the essential ingredients of a neoclassical economic model. Both players wish to maximize their payoffs. Both choose their best strategies. An equilibrium ensues. Few models of human interaction are simpler, and yet the game provides a great insight into the problems individuals encounter when they interact. All significant contributions to neoclassical economics provide similar insights. Modern neoclassical economics has become highly mathematical, but the truly important contributions today, as in the past, differentiate themselves from ordinary contributions by the insights and intuitions that lie behind the mathematics. Once one understands the logic of the prisoners dilemma or, say, Akerlofs (1970) lemons problem,29 one has an insight to human behaviour that can be applied in one situation after another. Similar insights and intuitions are more difficult to extract from evolutionary models. These models typically consist of so many equations and assumptions that one is unable to discern the main message of the model. Thus, the lasting contributions of many studies in evolutionary economics, for example, that of Nelson and Winter, are not the actual results that were obtained from the application of the methodology, but the exposition of the methodology itself. The bedrock of neoclassical economics is methodological individualism. In much evolutionary modelling, the individual and her motivation almost disappear, however. The individual adopts routines and the aggregation of the carrying out of these routines produces the outcomes of interest. The focus usually is much more on the aggregates (the industry, the system, and so on) than on the individuals who ultimately produce the outcomes. In most evolutionary models, individuals could be replaced by programmed robots without disturbing the underlying logic of the model.30 In a standard application of neoclassical economics, the researcher derives from the first-order condition for profit maximization a relationship for the price cost margin of a firm. The theory can then be tested by comparing actual with predicted pricecost margins. In evolutionary modelling, on the other hand, one replaces the predicted relationship from the maximization exercise with an assumed relationship in the form of a rule of thumb a pricecost margin equation. Often this assumption comes from observing actual pricecost margins. Clearly, in this case, the theory cannot be tested in the same way as a theory derived in neoclassical economics is tested. The proof of the pudding for evolutionary models has to be how well they explain the macro-phenomena of interest, say, the evolution of a system. Should the model not exhibit good
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explanatory power, it is often difficult to discern what part of the model is at fault. The last difficulty with evolutionary economics is that it is devoid of a normative component. However well it describes what it sets out to describe, it lacks any means for judging whether the predicted dynamics of the phenomenon modelled produce good or bad outcomes. To make such judgements one is driven back to the normative toolkit of neoclassical economics (consumers surplus areas or Pareto optimality) as are Nelson and Winter when they revisit the Schumpeterian trade-off.31

IV. Conclusions
Which methodological approach is the best? The answer to this question depends upon both the problems one wishes to study, and upon the person giving the answer. Consider, first, the problem of explaining the actions of specific individuals in certain situations. A social scientist who wishes to explain the behaviour of individuals as consumers, workers, voters, bureaucrats, priests, politicians, stockbrokers, soldiers, and drug addicts has a series of options. At one extreme is what we might call the universal, rational actor model all individuals maximize an objective function (O). The starkest form of such a model would have a single variable in the objective function: all individuals maximize their own personal wealth (W):
O=W (2)

A slightly more general version of this model would be that all individuals maximize a utility function that includes wealth and one or two additional variables, depending upon the type of decisions being analysed:
O = U (W, X1, X2, . . .) (3)

Moving further away from the strongest version of a universal theory we would have:
O = U (X1, X2, . . .) (4)

All arguments of the utility function are at the analysts discretion. Moving still further, we have the approach suggested above to account for altruistic and similar sorts of behaviour in situations in which this behaviour is anticipated:
Oi = Ui (Xi) +qi Uj (Xj)
ji

(5)

When one takes into account that the analyst is also free to choose the shape of the utility function and a set of constraints and auxiliary conditions under which the maximization process takes place, one sees that an approach to modelling
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human behaviour that is universal in so far as it posits that individuals maximize an objective function can be quite flexible. At the other extreme of the methodological spectrum is a pure inductive approach. The analyst who wishes to explain the behaviour of individuals in the nine contexts listed above constructs nine different models, each one containing the set of variables which best explains the behaviour of the group in question. The choice of variables in each case is determined from an examination of the relevant literatures in sociology and psychology, what has worked in previous studies, or simple trial and error. As one adds more arguments to the objective function, and more auxiliary assumptions, the power of the maximizing assumption is diluted. Furthest removed from the top of the list are those who abandon the maximization assumption entirely, and assume that individuals are guided by rules of thumb, specific mores, or other sorts of prescripts. Where each scholar chooses to place herself along the spectrum running from Equation (2) to a pure inductive model is largely a matter of scientific taste ones willingness to live with weak explanatory power in some situations for the sake of the cleanness and beauty of a simple, elegant model of human behaviour versus ones desire for high explanatory power in all situations at the cost of analytical consistency and clarity. Earlier in this article we discussed several examples of behaviour, such as voting and free riding, which cannot be well explained with a simple version of the selfish, rational actor model. My proposal is to replace this model in these situations with a model in which individuals act as if they were maximizing an objective function that included their own utility and a weighted sum of everyone elses utility. This model could be used to explain human behaviour in all situations, even those in which the traditional rational self-interest model does well, since it allows for the possibility that the weight on other peoples utility is zero. My proposal would constitute a step away from the pure rational actor model, but would retain some of the advantages of this approach by deriving clear predictions from the assumption of as if maximizing behaviour, predictions that are subject to falsification. An experienced researcher would come to know when it is reasonable to assume that an individual is likely to place a zero weight on the utilities of other individuals, and when she is more likely to place a positive, or perhaps sometimes a negative, weight on the welfare of others. Moreover, because these weights are dependent on the past history of an individual, past histories can be used to predict differences in these weights across individuals. Behavioural psychology is somewhat out of vogue now among psychologists, and economists who resort to branches of psychology to enrich their models often build on findings in the area of cognitive dissonance or some other currently more popular field. All researchers working in the area of what I have termed behavioural economics have in common, however, that they refuse to abandon the assumption of maximizing behaviour. Their main focus is to specify better what it is that is being maximized.
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Furthest removed from the pure rational actor model are the evolutionary economics models. These often come close to being purely inductive in that the key assumptions of the models are based on observations of what firms and individuals actually do, as captured in the assumed routines that they follow, and on observed relationships between capital stock and output, research and development and productivity change, and so on. This more inductive approach can be justified by the more complex phenomena that the evolutionary economists wish to describe the evolutionary developments of entire industries or economic systems. The choice among the three methodologies thus depends both upon the questions the researcher wishes to answer and the degree of complexity she wishes to build into her behavioural models. For those who are content studying the traditional questions of economics (the properties of demand functions or the properties of competitive equilibria), the highly simplified and abstract models of modern neoclassical economics will continue to be the methodology of choice. For those who wish to extend the scope of economic modelling to explain the behaviour of voters, politicians, bureaucrats, philanthropists, and so on, the standard behavioural assumptions underlying most of neoclassical economics will prove inadequate. These scholars can be expected to draw upon the rich behavioural literature developed outside of economics to help inform them as to what it is that individuals in these non-market situations maximize, and subject to what constraints. Although these behavioural economists will have to sacrifice some of the pristine simplicity of the traditional neoclassical models to obtain better explanations of human action in different contexts, they do not have to sacrifice the rigour that comes from assuming maximizing behaviour, if they do not want to. Evolutionary economists will, indeed, usually wish to abandon the assumption of maximizing behaviour. Their models must inevitably lack the precision that comes from assuming individuals strive for the maximum that they can obtain, and that economic and political markets reach equilibria. This feature will ensure that many of those trained in the use of maximization models will be repelled by the somewhat inelegant or complicated structure of evolutionary models. But those scientists who are willing to live with such complexity are likely to continue to build their evolutionary models to describe a world which they see as being every bit as complex as their models. It seems clear to me that there is room for all three methodological approaches in the social sciences, and that all have something to offer in the way of increasing our knowledge of human behaviour. The s in the word models in the title of this article seems likely, therefore, to describe accurately the methodologies that will be employed by social scientists for some time in the future.

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notes

I would like to thank Jonathan Riley and Geoffry Hodgson for comments on an earlier draft of this article. 1. Some, such as Samuel Hollander in his John Stuart Mill on Economic Theory and Method (London: Routledge, 2000), might question just how radical an innovation neoclassical methodology was, but this need not concern us here. My arguments still hold, even if neoclassical economics is regarded as a logical transition of classical economics into the modern age. 2. This statement obviously hinges on ones definition of neoclassical economics, which is taken up in Section I. The most obvious exception to this statement was Herbert Simon, from whom I have stolen the first part of the title of this article. 3. See, for example, Jonathan Riley, Liberal Utilitarianism (Cambridge: Cambridge University Press, 1988); Hal Varian, Equity, Envy, and Efficiency, Journal of Economic Theory 9 (1974): 6391; William J. Baumol, Superfairness: Applications and Theory (Cambridge, MA: MIT Press, 1986) and Ken Binmore, Game Theory and the Social Contract I. Playing Fair (Cambridge, MA: MIT Press, 1994). Richard Posner has applied neoclassical economic reasoning to anthropology in A Theory of Primitive Society, with Special Reference to Law, Journal of Law and Economics 23 (1980): 153. Neoclassical economic reasoning has been applied to biology (a discipline for which there is now even a journal devoted to this methodological approach) by Jack Hirshleifer, Economics from a Biological Viewpoint, Journal of Law and Economics 20 (1977): 152; Janet T. Landa, Bioeconomics of Some Nonhuman and Human Societies: New Institutional Economics Approach, Journal of Bioeconomics 1 (1999): 95113; and Janet T. Landa and Michael T. Ghiselin, The Emerging Discipline of Bioeconomics: Aims and Scope of the Journal of Bioeconomics, Journal of Bioeconomics 1 (1999): 512. James S. Coleman in his Foundations of Social Theory (Cambridge, MA: Harvard University Press, 1990) was a pioneer in introducing neoclassical economic modelling into sociology. Examples from the fields of law and political science are so numerous as to not require specific references. 4. Of course, there may exist several first-order conditions if the model contains several sorts of actors: consumers, firms, regulators, and so on. Second-order conditions can also be useful in some circumstances. 5. Paul Samuelson, The Pure Theory of Public Expenditure, Review of Economics and Statistics 36 (1954): 3879. 6. See, for example, H.S. Houthakker and L.D. Taylor, Consumer Demand in the United States, 2nd edn. (Cambridge, MA: Harvard University Press, 1970). 7. R.L. Hall and C.J. Hitch, Price Theory and Business Behavior, Oxford Economic Papers (May 1939): 1245. 8. See, for example, Fritz Machlup, Marginal Analysis and Empirical Research, American Economic Review 36 (1946): 51954, and for a fuller discussion and additional references, Dennis C. Mueller, The Corporation and the Economist, International Journal of Industrial Organization 10 (1992): 14770; reprinted in D. Hausman (ed.), The Philosophy of Economics: An Anthology, 2nd edn. (Cambridge: Cambridge University Press, 1993).

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9. The pioneering contributions to this strand of the literature were by Gerald Marwell and Ruth E. Ames. See Gerald Marwell and Ruth E. Ames, Experiments on the Provision of Public Goods I: Resources, Interest, Group Size, and the Free Rider Problem, American Journal of Sociology 84 (1979): 133560; Experiments on the Provision of Public Goods II: Provision Points, Stakes, Experience and the Free Rider Problem, American Journal of Sociology 85 (1980): 92637. 10. See, for example, Georg Kirchsteiger, The Role of Envy in Ultimatum Games, Journal of Economic Behavior and Organization 25 (1994): 37389. This article also contains additional references. 11. Robin Marris, The Economic Theory of Managerial Capitalism (New York: Free Press, 1964). 12. Fritz Machlup, Theories of the Firm: Marginalist, Behavioral, Managerial, American Economic Review 57 (1967): 133. 13. See the discussion and references to the literature in Theodore C. Bergstrom, Evolution of Social Behavior: Individual and Group Selection, Journal of Economic Perspectives 16 (2002): 6788. 14. For a recent survey of the behavioural finance literature, see Robert J. Shiller, From Efficient Markets Theory to Behavioral Finance, Journal of Economic Perspectives 17 (winter 2003): 83104. Other important contributors include George Akerlof, The Economic Consequences of Cognitive Dissonance, American Economic Review 72 (1982): 30719; Robert H. Frank, Choosing the Right Pond (New York: Oxford University Press, 1985); Robert H. Frank, Passions with Reason: The Strategic Role of the Emotions (New York: Norton, 1988); Richard Thaler, Quasi Rational Economics (New York: Russell Sage Foundation, 1991). 15. Frank, Choosing the Right Pond. 16. Robert J. Schiller, Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?, American Economic Review 71 (1981): 42136. 17. Robert J. Shiller, Irrational Exuberance (Princeton, NJ: Princeton University Press, 2000). 18. Jeffrey W. Smith, A Clear Test of Rational Voting, Public Choice 23 (fall 1975): 5567; Paul N. Courant, Edward M. Gramlich and Daniel L. Rubinfeld, Why Voters Support Tax Limitations Amendments: The Michigan Case, National Tax Journal 33 (1980): 120. 19. John Hudson and Philip R. Jones, The Importance of the Ethical Voter: An Estimate of Altruism, European Journal of Political Economy 10 (1994): 499509. 20. Richard Nelson and Sidney G. Winter, An Evolutionary Theory of Economic Change (Cambridge, MA: Harvard University Press, 1982). As my discussant at the workshop where this article was first presented, Geoffrey M. Hodgson, correctly pointed out that Thorstein Veblen might well be thought of as the inventor of evolutionary economics. Veblens contributions to economics are largely ignored today, however, by both those working in the mainstream and those in evolutionary economics. See Thorstein B. Veblen, The Theory of the Leisure Class: An Economic Study of the Evolution of Institutions (New York: Macmillan, 1899); The Place of Science in Modern Civilization and Other Essays (New York: Huebsch, 1919).

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21. Herbert A. Simon, Models of Man (New York: Wiley, 1957). 22. Richard M. Cyert and James G. March, A Behavioral Theory of the Firm (Englewood Cliffs, NJ: Prentice Hall, 1963). 23. For a recent survey of the literature on evolutionary economics that focuses on the evolution of firms and industries, see Richard R. Nelson and Sidney G. Winter, Evolutionary Theorizing in Economics, Journal of Economic Perspectives 16 (2002): 2346. 24. H. Peyton Young, The Evolution of Conventions, Econometrica 61 (1993): 5784. 25. See, for example, Raymond Battalio, Larry Samuelson and John van Huyck, Optimization Incentives and Coordination Failure in Laboratory Stag Hunt Games, Econometrica 69 (2001): 74964. See also the discussion in Larry Samuelson, Evolution and Game Theory, Journal of Economic Perspectives 16 (2002): 4766. 26. See, for example, Robert Sugden, The Evolution of Rights, Cooperation and Welfare (New York: Basil Blackwell, 1986); Karl Warneryd, Conventions, Constitutional Political Economy 1 (1990): 83107; Michihiro Kandori, George Mailath and Rafael Rob, Learning, Mutation, and Long Run Equilibria in Games, Econometrica 61 (1993): 2956; Young, The Evolution of Conventions. 27. Samuelson, Evolution and Game Theory. 28. Ibid., pp. 589. 29. George Akerlof, The Market for Lemons, Quarterly Journal of Economics 84 (1970): 488500. 30. Some critics of neoclassical economics might argue that homo economicus also behaves like a robot. 31. Nelson and Winter, An Evolutionary Theory of Economic Change, Ch. 14.

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