Homo Economicus Why are new year’s resolutions so difficult to maintain and economic models so bad at predicting our behaviour?

Have you ever wondered why it is so difficult to follow through on new year’s resolutions, such as to exercise more or to start saving more money towards retirement? The agent that most traditional economic models are based on would not struggle to keep up these resolutions. These agents are referred to as homo economicus. Homo economicus are hyper rational beings that always seek to optimise their own utility, even at the expense of other people. What this means is that when faced with a decision, a homo economicus will always do what is best for them. If they hear pleasant music being played on the street they will enjoy it but they will not give the musician money. The reason for this is that the music is there, whether or not the homo economicus pays for it. Thus, the money can be better used for something else. To go back to the original example - regular exercise or saving towards retirement has many benefits in the long run. A homo economicus will therefore not struggle to keep up their new year’s resolution, as they want to maximise their utility in the long run.

A popular new year’s resolution is starting to save more money towards retirement. A homo economicus always evaluates all possible scenarios of a decision to arrive at the best one. In this case, saving money for retirement will maximise the long term utility and keeping up the new years resolution is therefore the best decision. However, not perfectly rational people have a hard time arriving at the same conclusions. First of all, calculating every aspect of a decision or outcome is often impossible. Imagine trying to buy ice cream on a hot summer day in a beach town. A person cannot possibly know how much all the different ice creams cost, how long the waiting time is, or which is the most delicious ice cream. However, a homo economicus is expected to know and yet, in reality there is almost always a lack of perfect information. Therefore, making the utility maximising choice can be hard when faced with many options such as what to do with one’s money.

Additionally, the ‘nudge’ research by Richard Thaler suggest that the way choices are presented influence the decisions that people make. A homo economicus, for example, will not be tempted by the chocolate at the checkout counter at a grocery store, but placing chocolate at eye level in an area where individuals do nothing but wait, might tempt non perfectly rational individuals into making a chocolate purchase. This goes to show that the way choices are presented can also impact what kind of decisions are made. In other words, given the reality of how there are many choices to choose between, and some will be presented as more tempting than others, starting to save money for retirement is difficult for non perfectly rational beings.

The new years resolution to exercise more is another resolution many people will aim to uphold starting the 1st of January of a new year. Since exercising every day will maximise one’s long term utility, a homo economicus will keep up this resolution. However, a homo economicus is also devoid of emotion and will always maximise their own well-being. A non perfectly rational person might be swayed by a friend in need to drop their excising schedule and help this friend. Counter to the fictional homo economicus, people may actually place other people’s well being above their own on occasion. Along the same lines, real humans might also donate money to charities although they don’t gain any direct personal benefits. This is something a homo economicus would never do. Furthermore, non perfectly rational people are heavily impacted by their surroundings. For example, individuals can be biased by the decisions of other people. If everyone in one’s friend circle has decided to go spend time together, many people will have a hard time still prioritising their excising schedule.

In other words, a homo economicus has an easy time keeping up their new year’s resolutions as these will maximise their utility in the long run. These choices might make the homo economicus better off, yet most real humans have a very hard time making the same decisions.

A homo economicus is not influenced by their surroundings or the way choices are presented. However, a homo economicus does also not have any inherent biases that influence their decision making. Non perfectly rational beings on the other hand, are swayed by a number of biases. Kahnemann and Tversky found that most people are inherently risk averse. This means for example, that people will forego the option to win more money, for the option to win less money if that second option is more certain than the first. A field known as prospect theory explores this behaviour and analyses why gains and losses are viewed so differently. In summary, real humans have limited information and limited time to make decisions. In addition to this, they are influenced by their own cognitive limitations. The limitations to decision making capabilities are often referred to as bounded rationality. This means that decision making is limited by certain outside factors such as lack of information or cognitive biases. Bounded rationality can explain why most individuals don’t act the way a homo economicus would.

The reason why a homo economicus would keep up their new year’s resolution has been addressed as well as the idea that homo economicus behaves differently from most real humans. Yet, it can still be questioned why it is so hard for most people to start exercising every day or to start saving money towards retirement. The reasons are a combination of the external and internal factors described above. One well documented reason is referred to as hyperbolic discounting. Hyperbolic discounting states that most people will prefer sooner rewards over later rewards, even if the later rewards are bigger. For example, many people will prefer $20 now rather than $40 in a year. The discounting rate is the amount of money an individual will want to be paid to delay their reward. In other words, when people are asked how much they want to be paid instead of $20 to receive the money in a year they will reveal their discounting rate. This of course varies among different people and scenarios. People who have a harder time delaying gratification will have a higher discounting rate.

How does this relate to the new year’s resolution of non-perfectly rational people? As alluded to earlier, most people value the present higher than the future. Therefore, if a real human, subject to bounded rationality, can choose between starting to exercise or continuing to watch a good movie, many people will choose to continue watching the good movie. This holds true even if the real human is aware of the long-term benefits of regular exercise. The problem is simply that the long-term rewards of better health is often less tempting in the moment than the short-term reward of continuing to watch the movie. Hyperbolic discounting not only explains why people have a hard time sticking to their new year’s resolutions but also why they procrastinate or over consume.

It is interesting to ask why the idea of homo economicus is used in economic models to begin with, if they are so far removed from the way humans actually act. The truth is, even though homo economicus do not perfectly model human behaviour they are still very useful. Homo economicus make different economic theories easier to model. Even though these models don’t always account for real human behaviour, they are still crucial in helping to understand economic trends. In other words, a homo economicus provides a good and important foundation for analysing economic decision making.

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