Discussion Paper

No. 2015-40 | June 03, 2015
The Economics of Radical Uncertainty

Abstract

In situations of what we now describe as radical uncertainty, the core model of agent behaviour, of rational autonomous agents with stable preferences, is not useful. Instead, a different principle, in which the decisions of an agent are based directly on the decisions and strategies of other agents, becomes the relevant core model. Preferences are not stable, but evolve. It is not a special case in such circumstances, but the general one.

The author provides empirical evidence to suggest that as a description of behaviour in the modern world, economic rationality is applicable in a declining number of situations. He discusses models drawn from the modern literature on cultural evolution in which imitation of others is the basic strategy, and suggests a heuristic way of classifying situations in which the different models are relevant.

The key point is that in situations where radical uncertainty is present, we require theoretical ‘null’ models of agent behaviour which are different from those of economic rationality. Under uncertainty, fundamentally different behavioural rules are ‘rational’. The author gives an example of a very simple pure sentiment model of the business cycle, in which agents use very simple heuristic decision rules. It is nevertheless capable of approximating a number of deep features of output growth over the cycle.

JEL Classification:

D81, E14, E32

Assessment

  • Downloads: 1508

Links

Cite As

Paul Ormerod (2015). The Economics of Radical Uncertainty. Economics Discussion Papers, No 2015-40, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2015-40


Comments and Questions


Romar Correa - comment on paper by Ormerod
June 05, 2015 - 09:22

Thank you, Paul Ormerod, for your bold essay! My only query is: Is uncertainty only sufficient for the heuristics you propose. Under conditions of ‘simplicity’ and/or perfect information would people not use rules of thumb? I come from old-style macroeconomics, an explanation of aggregative behavior that does not need ...[more]

... to be reduced to microeconomics. Thus, the cycle is always in the background. However, cycles have always been with us, through small menus of options for consumers and firms.
It looks like your microeconomic equations can be collapsed into one macroeconomic equation. Individual output is a function of aggregate sentiment and individual sentiment is a function of aggregate output.


Anonymous - Referee Report 1
June 24, 2015 - 08:33

The basic argument of this paper is that the economic environment is typically so complex that: (1) decision-making must be based on simple heuristics (rules of thumb) rather than rational calculation; and (2) the main source of information must be the behaviour of other people rather than individual experience or ...[more]

... calculation. This argument is supported by a good literature survey and by an illustrative model based on the author’s own work on economic growth. The paper deals with an extremely important topic. It is convincingly argued and clearly written, and provides an accessible overview of the issues. The main lacuna is the absence of any reference to the work of the biological anthropologists Boyd and Richerson (1985). These authors have written extensively on the relationship between individual and social learning (imitation etc.). Ormerod’s paper would be strengthened by some reference to their work which predates most of the articles that he cites.

Reference
Boyd, Robert and Richerson, Peter, J, (1985) Culture and the Evolutionary Process, Chicago, Chicago University Press.


Anonymous - Referee Report 2
September 02, 2015 - 08:31

see attached file