Individual Decisions and Complex Economies
Every day, all across the world, people make billions of choices, such as how much they are willing to pay for vegetables, how much time they should spend fixing their car, or whether they will keep their Netflix subscription or switch to another streaming service. At the individual level, you might call these personal preferences, but when you add them all up, you have an economy.
The field of behavioral economics attempts to predict big economic trends by first trying to understand the individual preferences that serve as the building blocks of group behavioral trends. Peter Caradonna, a new assistant professor of economics in the Division of the Humanities and Social Sciences, is working to build better tools for studying these individual preferences. We recently talked to him about his research and what excites him most in his field.
What is the relationship between what you study and what the average person thinks of as economics?
Things like the state of the nation's economy, or the stock market, or phenomena like business cycles are really complicated and have lots of moving parts. One of the ways that we try to better understand these tremendously complex systems is through the use of simplified models. But we want these models to be "micro-founded." What this means is that underneath all the other bells and whistles, the models should be built on a foundation of individual, rational actors trying to do whatever they think is in their self-interest.
Now to specify things like what we mean by self-interest, we need to be able to describe, in a stylized way, the ways people act, make decisions, and evaluate different kinds of trade-offs. And this is where what I study comes in. Ideally, we'd like to know how good our assumptions about individual behavior are, really to be able to compare competing sets of assumptions, and see how well they perform in practice. Because if these basic assumptions are off base, it is going to bleed into every other type of analysis we could hope to conduct. But this turns out to be a very difficult exercise. So I'm very interested in developing new, and better-performing tools to try and really test and select amongst these models of how people behave.
You used the phrase, "rational actor." I think a lot of folks would say, "People are not always rational." How much of a challenge for your field is it that people can be irrational?
When I said "rational actor," I was accidentally slipping into some technical jargon. When economists use the phrase "rational," we mean it in a slightly different way, I think, than a layperson might interpret it.
For us, all rationality means is that a person has an internally consistent ranking in their head of the relative desirability of different outcomes, or consequences of their actions. Rationality doesn't necessarily mean that I'm all cool, calm, and collected. Likewise, irrationality doesn't mean that I'm acting a little crazy. It also doesn't necessarily mean that I'm a sociopath who only cares for myself at the expense of others.
To economists, all rationality means is that an individual has this basic, consistent ordering called a preference that says, "I like this more than that." Anyone who satisfies that basic property, we call a rational actor.
What does an experiment in economics look like? Can you paint a picture for me?
One of the hardest parts of studying these models of individual decision making is that preference orderings—these things which we view as driving all individual behavior—are unobservable. So if I have a theory that says "people prefer to hold assets with a certain kind of risk pattern over another," it's hard to test because I can't just see these preferences directly. Instead, I have to indirectly infer them by observing people's behavior. This makes having access to a lab environment really valuable. Oftentimes, experiments involve presenting subjects, in a carefully incentivized way, with specific sets of things to choose between. If I just wanted to test something very simple, like whether or not a subject was rational, that is, has some consistent preference, I could provide them with a collection of different prizes—an apple, a banana, and a cantaloupe, for example.
I could first say, "Here's an apple, and here's a banana. Tell me which one you like more." Then I could do the same thing with the banana and a cantaloupe. So maybe they choose an apple instead of a banana and chose a banana instead of a cantaloupe. From that, I'd infer that these choices reflect their hidden preference.
Now, if I wanted to test if there is any kind of basic ranking that could describe the agent's preferences more generally, I could then say, "Here's an apple, and here's a cantaloupe." Now, if you already told me you like an apple more than a banana, and you like a banana more than a cantaloupe, you ought to like an apple more than a cantaloupe, at least if you're rational. If their choices reflect that, great! But if not, then you get into very interesting waters trying to quantify the magnitude of their irrationality.
More generally, we like to try and build up these little artificial encounters that are able to reveal things about how the agent is thinking and what tradeoffs they consider when making decisions. Maybe the agent is given some budget of money that they're allowed to spend in the lab on bundles of different amounts of food and drink. Maybe they're choosing different portfolios of financial assets with uncertain returns, or rewards being delivered at different points in time. Maybe they have to choose how they allocate time between more or less computationally complex tasks.
These choice-type experiments are often very revealing about the drivers of the decision-making process. One thing my research touches on is studying what types of questions we can ask subjects to obtain the most revealing data, and developing new statistical tools to better analyze it.
Are there any trends in your field right now that are especially exciting to you?
There's a whole host of very interesting new work being done on these kind of problems, both from theoretical and empirical perspectives. If I had to pick one thing, lately there's been some very interesting work using modern machine-learning techniques to see how good a model is at predicting behavior that I'm interested in learning more about.
More generally, one of the things that I find particularly appealing is that there really isn't any kind of broad consensus on the "best" way to study these models. At a technical level, there's lots of very interesting innovation going on using a whole range of mathematical and statistical tools, some of which are only just starting to be put to use in economics more broadly. So it's a very exciting time.
When did you decide that economics was the field for you, and what was it about economics that was interesting?
When I was first entering college, I really wanted to be a diplomat, which in hindsight would've been a terrible fit for me. I got interested in economics originally because it seemed at the time to be getting at the cogs and wheels behind lots of international affairs questions I found interesting. I thought that a lot of times, the various incentives faced by actors on the global stage boiled down into economic considerations.
When I was an undergraduate, I took a math class over the summer as a requirement for my major, and I had this instructor who had just finished his PhD and was going off to a postdoc position in the fall. He was young, and he was exciting, and he was cool, which I had never seen in anyone who did math before.
I just remember sitting in his class—it was multivariable calculus—with eyes like saucers for the entire eight weeks. I was so smitten, I declared as a math/econ major immediately that fall. And as time went on, I got more interested in the technical, theory side of economics, originally because of the mathematical tools involved.
These days, one of the most appealing parts of economics to me is that, in its modern form, it's so young compared to, say, the natural sciences. There are so many basic questions that we as a field just aren't that close to satisfactorily answering yet, and that makes it this kind of wonderful intellectual melting pot, where all kinds of tools and ideas from a whole host of different fields are being combined in new and exciting ways.
How do you like to spend your free time when you are not working?
One of the things I really enjoyed doing when I was younger was hiking. I did a whole lot of hiking in the Adirondack Mountains—I was born on the East Coast—growing up. But the kind of mountains we have back East are nothing like what there is out here. I'm really looking forward to exploring some of the wilderness out around Pasadena and the Los Angeles area more generally. This past weekend, I hiked Mt. Baldy with one of my colleagues, which is the highest mountain in L.A. County, and while it was some steep hiking, it was just gorgeous. I'm really excited to get out more around here, and hopefully this spring to do some hiking out in the national parks!