Multiple Equilibria, Bounded Rationality, and the Indeterminacy of Economic Outcomes: Closing the System with Institutional Parameters

The tenth in a series of excerpts from Minds, Models and Milieux: Commemorating the Centennial of the Birth of Herbert Simon.

Morris Altman

A critical point made by behavioral economists from a wide set of methodological perspectives is that individuals typically do not make decisions that are consistent with conventional economic theoretical norms of rational behavior. This is true of those building on the errors and biases or heuristics and biases approach derived from the research of Kahneman and Tversky (Kahneman, 2003, 2011; Thaler and Sunstein, 2008), and those building upon the bounded rationality approach introduced by Herbert Simon (1978, 1979, 1987; Altman, 1999; Gigerenzer, 2007; Smith, 2003). Such ‘irrational’ behavior form the perspective of the mainstream is considered to be inefficient or sub-optimal. And sub-optimal outcomes should not be able to survive—it would fail the test of the survival of the fittest. However, various and different socio-economic outcomes or solutions for the same specific decision problems appear to be consistent with the survival on the market place. This is even true of economic outcomes, when firms are not maximizing productivity. Both low and high productivity firms can survive simultaneously on in the market. Moreover, ethical or socially considerate firms, and other-giving and empathic individuals can also survive and persist, even if such behavior is often considered to be sub-optimal and irrational from the perspective of the conventional economic wisdom.

It was just such apparent anomalies that Herbert Simon attempts to address through the concept of multiple equilibria, set in contrast with the more mainstream focus on convergence towards some optimal and unique equilibrium. From this perspective, both inefficient and efficient economic entities can persist over time in equilibrium. Therefore, survival and existence need not be in any way indicative or proof of uniqueness or optimality or efficiency in outcomes or decision making processes.

It is important to note that conventional and dominant economic methodology that deduces optimality and efficiency and even uniqueness from survival and existence is derived from the methodological paradigm articulated by Milton Friedman (1953; see also, Alchain, 1950). He maintained that survival is proof of optimality and efficiency of both outcomes and decision-making processes. One can deduce from outcomes—from survival—that individuals or economic agents behave in a particular and unique fashion—optimally and efficiently.