Normative vs Descriptive Theory
Normative and descriptive economic theory are two branches of economics that get intertwined in debates and discussions. One tells a story of how people should act if they make rational choices, while the latter discusses how people actually behave. Understanding the difference between the two is essential in discussing any economic topic, despite the differences between the two being quite subtle.
If John has 10 dollars and wants to buy two different bundles of goods, how do we maximize his utility? This is a classic textbook problem that most economics majors have encountered at some point. Unfortunately, in real life, most people do not think in terms of bundles of goods and utility. The distinction between textbook and real life scenarios is very important when predicting people's behavior. In many cases, people are not able to justify their economic choices rationally. Rational choices and thinking are under the umbrella of normative economic theory, but the descriptive theory is exactly what it sounds like with tested and proven behavior among real people. Descriptive theory can more accurately tell us a story about our choices because it highlights our irrational consistencies.
One common example of an irrational human behavior is the inability to be “Time Consistent”. Time consistency is “When someone makes a commitment to take an action in the future, the incentive to keep the commitment is the same as the incentive to make the commitment” (Kling) An easy example is the inability to hold a diet. You can tell yourself you will eat healthy for a week because you want to live a healthy life, but if you are unable to keep this commitment by the end of the week, it is because you are time inconsistent and were not able to actually make the commitment. The utility of living a long and happy life is definitely much higher than the utility of eating unhealthy food and staying inactive. However, because we are not time consistent, the utility of being unhealthy in the moment is much higher than the future utility of being healthy. This is irrational, but unfortunately something most people battle with fairly often.
A study by Wei Kang Wong proved that this inconsistency in utility is prevalent in more than just holding a diet. Students are also prone to time inconsistency in their studies even if they are aware of it. Maybe we do not need an economic study to prove this, as it is an issue most students know far too well, but students do not stick to their study schedules and do not commit to studying as much as they would like. The study also showed that time-inconsistent behavior is so prevalent among students that “Only seven percent of my sample of 158 students behaved time-consistently” (Wong, 2). Most students make plans to study, and even though they are aware of the fact that they need to continue studying or study more, they do not. A time-consistent person makes a study schedule and always sticks to it. The other 93 percent were not consistent in the study plans they had made, and even when they were reminded of their goals, they still did not study as they had originally intended. A rational person would make a plan and stick to it, keeping their long-term goals in mind and not giving in to distractions. However, the present utility of slacking off and ignoring our schoolwork is much higher than the future utility of good grades at that particular moment, so most of us are prone to slacking off despite being aware of the consequences.
These examples lead to another interesting instance of how descriptive theory varies from normative theory. Humans experience the disappointment of a loss more than the satisfaction of a gain. Loss aversion is the “Apparent fact that people dislike losses more than they like commensurate gains” (Agner, 54). A person who gains fifty dollars will most likely be happier than a person who gained seventy but lost twenty, despite the fact that in the net gain of both of those people is the same. This is in part because their reference point is different. A person who has gained fifty dollars is ecstatic about the gain because they went from 0 to 50. However, a person who has gained 70 was excited at first and then expected to keep the seventy. Their reference point was having 70 dollars, which went down to fifty. This leads us to the endowment effect, which is when peoples’ preferences depend on what they already possess.
People value what they do have much more than what they do not have. This seems contradictory, as loss aversion makes it seem like people will value what they do not have. However, the endowment effect is more centralized on the fact that losing a good that we own is much more painful than not owning that particular good in the first place. Loss aversion states a similar point, but explains that gaining and losing a similar amount will generate different amounts of discomfort and happiness. What you currently possess and what the people around you possess is called your reference point. Understanding people’s reference points is useful in figuring out the utility of a good. For example, a person with less money will value a steak dinner more than a person who is well off. This serves as a more efficient way to calculate utility for many people.
Descriptive theory tends to be more useful in deciding what people will do and how they will act, while normative theory focuses on people’s optimal behavior. Understanding both is essential in understanding key components of economics, and making sense of our own irrational behaviors.
Angner, Erik. A Course in Behavioral Economics. Palgrave Macmillan, 2016.
Kling, Arnold. “Time Consistency.” Mill, On Liberty, Chapter 1 | Library of Economics and Liberty, 5 Apr. 2018, www.econlib.org/archives/2009/12/time_consistenc.html.
Wong, Wei-Kang. How Much Time-Inconsistency Is There and Does It Matter? Evidence on Self-Awareness, Size, and Effects. 2006, courses.nus.edu.sg/course/ecswong/research/wkwong9.pdf.