Homo economicus

Homo economicus is a model alluding to an imaginary person with interests and preferences aimed at making the best decisions for themselves, staying true to the study of economics— the social science of human behaviour with the interest of optimising preferences. This article explores the meaning and implications of Homo economicus.

In an essay from 1836, Stuart Mill mentions a hypothetical subject who was driven by ‘the desire of wealth’, ‘present enjoyment of costly indulgences’ and ‘aversion to labour’, taking all other motives as abstractions. Consequently, the Latin term ‘Homo economicus’ was introduced for this aforementioned subject by Mill’s critics in the nineteenth century. The name, a hyperbolic take of the term ‘Homo sapiens’, draws a distinction from the common man, often evoking the image of a mechanised, money-making machine. However, like most economic models, the initial assumptions defining Homo economicus are reductionist and meant solely for pragmatic purposes. Homo economicus is a generalisation embodying the common beliefs that we take for granted in everyday transactions — monetary or non-monetary. Taking some examples of where the Homo economicus model can be used in economics:

Maximising Satisfaction

It is assumed that Homo economicus wants to make the most of what they have. They have an income, and after spending this income on regular monthly goods, bill payments, setting aside savings, etc, they want to buy apples and oranges. Homo economicus wants to get the most amount of apples and oranges that each penny can buy, out of this remainder. Not only that, Homo Economicus has different tastes for apples and oranges, so, they would like their transactions to reflect these tastes — not buying a single more of any fruit than they like or less than the number they require.

In economics, indifference curves are used to plot combinations of goods that a person prefers equally. For example, a person likes apples and oranges such that they are indifferent between consuming A (5 apples and 10 oranges) or B (10 oranges and 5 apples) because either combination yields the same amount of satisfaction. Each point on the indifference curve represents the same level of satisfaction gained. The points A and B, representing these choices will thus lie on the same indifference curve. Each point on a higher indifference curve represents a higher level of satisfaction, as compared to the lower curve.

On average, a person (here, Homo economicus) will agree that consuming more of one good and the same amount of another good as before, makes an individual better off. For example, consuming 10 oranges and 10 apples is better than consuming 5 oranges and 10 apples. Graphing these preferences, we get two indifference curves (red and blue in Fig.1). The upward right shift from the red indifference curve to the blue indifference curve indicates an increase in utility (due to an increase in the number of oranges). This is the result of an initial assumption that more quantity consumed brings more satisfaction to Homo economicus.

Fig. 1

How demand works

It was earlier believed that the effort put into producing a good, determined its price and was not affected by demand. This is now considered untrue as price is said to be determined at the level where quantity demanded is equal to the quantity supplied for the good. Demand emerged as a function of utility—the amount of satisfaction projected to be gained from consuming an object. It is assumed that Homo economicus would want to buy a good, at a particular level of income, on the basis of how much satisfaction they presume to gain from it, in addition to whether they can afford it.

A demand curve indicates the number of goods demanded by a person at a particular price level. The demand curve for Homo Economicus is derived from the maximum amount of satisfaction affordable on their indifference curves at different levels of income. Thus, the ideal level of consumption is considered to be at a point where the budget line (ways of fully spending your income) is tangent to indifference curves, reflecting your tastes and preferences — implying the highest indifference curve at the maximum dispensable expenditure.

Fig. 2 (Credit)

Citation: (Read here for further details)

These simple assumptions, characterised as the behaviour of Homo economicus, went a long way in restructuring economic theories.

Critique

The importance of Homo economicus is primarily as a model that shifted the focus of the microeconomic perspective from society and the market as a whole to the individual — a consumer maximising their welfare.

Nevertheless, Homo economicus has faced criticism from multiple quarters. It is a primitive assumption to reason that people are only driven by self-interest. Further, given the debate on whether pure altruism is possible, and whether or not it is linked with long - term gains; Would Homo economicus’ negligence of altruistic traits be uneconomic? Further, how can one calculate whether short-term altruism or long-term altruism is more relevant and which one yields greater returns? Finally, how can one calculate the limits to which altruism does not harm one’s own interests?

By depicting the behavior of a theoretical man, Homo economicus is somewhat opposite to conventional economic behaviour (explained by behavioural economics), where people’s preferences are not divorced from emotions nor unrestricted by the limits of their social reality. Homo Economicus’ belonging to different corners of the world, across geographical boundaries and cultures, would think in different ways. This is because economies in different geographical and social contexts are diverse in economic interests and preferences. Finally, Homo economicus requires perfect information to make the best possible decision. For example, ideally, if Homo economicus were to buy a laptop, they would survey all the markets, all the shopping websites, all the brand-outlets, to make a final decision. But, attaining perfect knowledge is seemingly impossible. Moreover, the efforts would involve high ‘search costs’ constituting both time and money.

Nevertheless, by personifying an imperfect normative, Homo economicus helps us to understand its dissimilarities as compared to positive economics. Positive economics refers to the study of economics in terms of what is, in contrast to normative economics: the study of what ought to be. So then, we are limited in our ability to construct positive economic explanations from Homo economicus. Homo economicus might want to incorporate assumptions drawn from behavioural economics for these studies. One thing is clear: the definition of Homo Economicus would benefit from being more clearly defined.

(Written by Lavanya Goswami and Edited by Anoushka Gehani)