What is Homo Economicus?
Homo economicus is a theoretical abstraction that portrays humans as rational and full of self-interest, and who pursue their well-being to the fullest in all transactions. The economic man is described as one who uses rational judgment to avoid unnecessary work. The rationality described in homo economicus is considered the cornerstone of many neoclassical economic theories.
Some theories traditionally rely on the assumption that man maximizes his utility optimally in addition to being a rational agent. The homo economicus concept’s triggered controversies with the opposing behavioral economists questioning its premise. According to studies on financial behaviors, humans tend to be irrational in the decision-making process, and that behavior is more important for economic modeling.
- Homo economicus is a belief that humans pursue economic goals based on self-interest and attempt to maximize utility.
- Homo economicus is central to economic theories and assumes that people act rationally with full knowledge of what is relevant for their interests and desire for wealth.
- In the neoclassical theories, the homo economicus concept bears three basic assumptions to the effect that companies maximize profits and people maximize utility, people make decisions based on full and available information, and people have a rational choice regarding outcomes.
Origin and Ethnology of Homo Economicus
The homo economicus theory was first advanced in 1836 by English civil servant, philosopher, and political economist John Stuart Mill in his famous essays, “On the Definition of Political Economy and of the Method of Investigation Proper to It.” Mill’s hypothetical subject describes an economic man with the propensity to make rational decisions. He defined the economic man as one with four distinct interests embedded in pursuit of wealth, including an underlying drive for accumulation, passion for leisure, interest in luxury, and desire for procreation.
The essence of the economic man lies in his rational approach for making choices and not on what he selects. The economic man would face no alternative but to work all day, regardless of the compensation, were it not for the modest psychological complexity associated with the homo economicus assumption. According to Mill, such a workaholic would behave in the same way in any institutional environment.
Contributions to Homo Economicus
Mill further reasoned that numerous economic behaviors could be observed across epochs, countries, and industries. A majority of such behavior could be traced to various economic institutions.
The political economist also asserted that the political economy erodes a portion of human desires, except those used for wealth accumulation – such as aversion to labor and the costly desires for present enjoyment. Therefore, the homo economicus argument’s primary objective is to regard humans as agents with interest in economic gain and rational ability to evaluate means to this end.
The idea that man is characterized by economic self-interest, as well as seeking to maximize pleasure, is attributed to the views of other philosophers and economies, such as David Ricardo and Adam Smith. They described the man as rational with underlying self-interest in pursuit of wealth, and that the process of goods or services reflects the invested labor in their production.
The renewed version of the homo economicus model is called the Rational Expectation Theory, and it was advanced by John F. Muth (1961) and Robert Lucas (1972). The theory posits that the current market expectations of an economy are equivalent to its future state.
Homo Economicus in Modern Economics
The homo economicus is presently a prevailing approach in the form of neoclassical economics, especially in microeconomics. The idea that humans are selfish creatures also influences microeconomics, either in combination with Keynesian economics or alone.
Neoclassical economics focuses on determining income distributions, prices, and outputs in markets using demand and supply. They are portrayed in forms of companies’ cost-constrained utility and individuals’ maximization of income-constrained utility.
Generally, neoclassical economics bears the following three assumptions:
- People demonstrate a rational preference among outcomes: Humans usually respond to a conscious self-interest, regardless of their interests, which evaluates results with a certain degree of value.
- Humans act independently based on relevant and full information: Under this assumption, people can make a rational calculation, which facilitates the assessment of a choice that would maximize utility.
- Companies maximize profits and individuals maximize utility: Companies attempt to maximize profits by recruiting the labor force until a point where the value of the output balances the additional cost of hiring. Also, from a demand’s standpoint, buyers attempt to maximize utility up to the point that what they are willing to pay for the goods and services balances the satisfaction gained from an extra unit.
Criticisms of Homo Economicus
The homo economicus model dominated different classical economics classes for a long period until criticisms arose from experimental economists and other social science disciplines. One of the criticisms against the model focuses on man’s rationality aspect, leveled by prominent economists, such as John Maynard Keynes.
They argued that human behaviors are not typical of the economic man. Instead, Keynes argued that economic actors neither act based on self-interest nor are they fully informed during economic decision-making. Regardless, the theory remains an essential underpinning of economic thought.
CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: