Cognitive dissonance as a means of explaining economics of irrationality and uncertainty.

INTRODUCTION

Criticizing the standard (neoclassical) optimization model in economics, several years ago Herbert Simon (1978) argued that:

In the past economics has largely ignored the process that rational man uses in reaching his resource allocation. This was possibly an acceptable strategy for explaining rational decision in static, relatively simple problem situations where it might be assumed that additional computational time or power could not change the outcome. The strategy does not work, however, when we are seeking to explain the decision maker's behavior in complex, dynamic circumstances that involve a great deal of uncertainty, and that make demands upon his attention. (p. 14)

Simon then urges economists to give an account of substantive rationality, as well as procedural rationality in light of human cognitive powers and limitations.

While conventional theory assumes that economic agents respond to information perfectly in the sense of always making decisions that maximize expected utility based on their observed information, opponents of the neoclassical optimization theory have argued that real world agents have severe limitations in their ability to process information, which thereby prevents them from perfectly using information without error (Heiner, 1988).

The difficulty that conventional economics has faced in studying the actual behavior of economic agents has been the assumption that any behavior which is not fully rational must be random and not subject to scientific research (Akerlof & Dickens, 1982). For example, Gary Becker (1962) has viewed irrational behavior as random deviations from economic rationality, and thus not subject to scientific investigation. However, recent developments in psychology and other behavioral sciences suggest the existence of a continuum of qualitatively distinct states of partial rationality, or systematic irrationality. These writers have found irrational behavior as predictable, and therefore not totally random. This body of research deals essentially with cognitive dissonance, a psychological concept first discussed by Leon Festinger in 1957. Since 1957, various psychologists and other behavioral scientists have discussed cognitive dissonance and its impact on the processing of available information. It will be demonstrated that these theorists have identified a wide range of cognitive processes which serve to simplify decision maker's perceptions of problems. Since 1965, when Albert Hirschman applied the concept to attitudes toward modernization, various economists have applied cognitive dissonance to economic behavior. In general, a growing number of researchers aim at a better understanding of human action in the face of uncertainty. Simon's concept of satisficing and Schelling's notion of pre-commitment and self control are among alternatives to the standard optimization model in economics (Schelling, 1984).

In spite of Gary Becker's (1976) attempt to apply the economic method to non-economic issues, the above mentioned body of research and its application to economics have proven that economics can learn a great deal from other social sciences. It will be argued that the standard neoclassical approach is too narrow in its scope.

A parallel development has been Ronald Heiner's research since the 1980's. Heiner began by arguing that economic agents must often make decisions in complex environments in which the difficulty of the problem and the complexity of the available information exceed their abilities to decipher this information correctly and in an optimal way. This competence difficulty (C-D) gap, according to Heiner, gives rise to uncertainty, which in turn becomes the basic source of predictable behavior. This will be discussed …