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Thomas Smith
ENGL 109
November 9, 2016
The Limits of Application of Rational Actor Hypothesis
Summary of Argument
It is argued that we must consider both the ideas that people maximise manifest payoffs, and claims
that people maximise their utility when looking at the rational actor hypothesis. The former version is and
has been falsified. The latter is unfalsifiable, as utility cannot be observed. It is shown that in principle,
utility maximisation can explain any form of behaviour, including the behaviour of amoeba. The
presumably falsifying event of inconsistent behaviour is shown to be impossible to establish without
qualification. Thus this utility-maximising version of rational choice theory is a universal explanation
that can explain any set of events.
1: Selecting and justifying a definition of rationality
As a first definition of rationality we use that people maximize their benefit in any circumstance. Thus
agents should respond to any given incentives. This idea fails to take into account the process by which
the agent comes to their decision. Different interpretations of situations and hence different goals are
never examined. Thus this doing ones best idea of rationality never concerns itself with agent cognition
and goal-formation. Confirmation bias easily finds its way into this model since the best benefit posited
may in fact be undermined by the evidence. This notion of rationality is not entirely vacuous, as it does
point to the need to problem-solve. But it clearly lacks vital details.
To understand the next notion we must define some additional terms. A payoff is a reward in a game that
has a definite expected worth (e.g. money) that is known to both players of a game. Payoff rationality or
payoff maximization is the maximization of such payoffs by players, given the information available to
them plus the assumption that other players are playing to maximize their payoffs. Given these definitions
rationality is clearly consistent. But utility theory cannot imply payoff optimization, unless they each
increase or decrease with each other.
Vernon Smith resolved this potential problem of the absence of such joint growth, also taking into account
utilities unrelated to ones own payoffs, such as taking risks. The players payoffs must be the main factor
in their choices. Smith envisions experiments to test this relation. His precepts involve no player quitting
the game, large rewards, no communication between players, to name a few. But Smith (p. 929) himself
admits that these precepts do not guarantee this relation between observable monetary rewards and
preferences, since they are not directly observable. Indeed, we cannot even know if any of these
precepts has been effectively applied.
While the axioms of payoff rationality clearly imply consistency of behaviour, the converse is false. As
Herbert Gintis (2007; 2009) has explained, one can abandon payoff rationality and still have behaviour is
consistent, even utility-maximizing. Gintis has performed studies showing a Nash equilibrium is almost
never found in an ultimatum game (Henrich et al., 2001; 2004). In an ultimatum game players divide
money between themselves. Given that the second player rejects their amount, neither player gets any
money; otherwise both players get the divided amounts. Assuming that the second player is playing
towards a Nash equilibrium, he will accept the lowest possible positive division, since payoff maximisers
would never accept a zero payoff. We therefore get a subgame perfect Nash equilibrium; it gives the best
expected payoff outcome for both players, given that each is playing to maximize payoff. By definition of
a Nash equilibrium, no player can gain anything by unilaterally changing strategy. But in real life players

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do not always maximize payoffs in this way. Instead, their behaviour is consistent with taking additional,
intangible factors into account, such as honour and fairness, even when they cannot communicate.
While he abandons payoff rationality, Gintis adopts another definition of rationality, consistent behaviour.
Gintis (2006, p. 7) argues that since it is possible to construct a utility function such that behaviour is seen
to be consistent with expected utility maximization, utility maximization is useful in predicting human
behaviour, even if humans are not self-aware.
2: All-encompassing explanation
Gintis fails to see that as utility cannot be measured, decision made to maximize utility does not constitute
evidence for what the person was hoping to achieve. For example, given an experiment showing
consumers take a monetary reward less than the computed outcome, or switch their preferences, we can
always make the evidence mesh with utility maximization, by positing extra hidden variables.
To take a specific example, a subject must choose between $10 guaranteed, and a chance of $1,000 at 2%.
Let the $10 option be chosen. Naively, this may seem to contradict utility but we must keep in mind that a
risk-averse actor can maximize utility without maximizing monetary outcome through the introduction of
an additional variable such as risk. Critics may inquire whether inconsistent behaviour will falsify utility
maximization. The problem here is only thinking of inconsistent behaviour in empirical terms, since as
already noted utility is unobservable.
As a possible objection one may argue that assuming preferences are stable, evidence on revealed
preference would reveal inconsistent preferences based on measurable variables. But this line of argument
cannot get around the reality that utility may always depend on unaccounted for factors in the
environment. Let the utility function be U = f(X, E), with X a vector of consumption inputs and E a vector
of environmental factors. For preference reversal to contradict utility theory the function U must be
stable. But E can never be strictly held constant, as some part of the environment, will inevitably alter in
time. Hence, in practice, switching of the elements of vector X alone would not indicate preference
reversal because some elements in the vector E would also have changed. Even intuitively, the
environment is an ever changing sea of conditions. Consequently, since the environment is never
repeatable, X alone can never falsify the assumption of fixed preferences.
Therefore the utility-maximization assumption is unfalsifiable, but it is not a tautology in the logical sense
because it is conceivably false. Logical tautologies such as a triangle has three sides are true by
definition. By contrast, individuals may not be maximizing any quantity.
Clearly then, the rational actor hypothesis is rather broad. For example, Gordon Tullock has shown that
creatures from amoeba to whales fall under the framework of the utility function of microeconomics.
Therefore we can now call everything in evolution from the amoeba onwards rational. Therefore these
assumptions tell us very little specifics of human nature, a basis for the enterprise in the first place.
Arguably, human societies are unique in terms of institutions. The authors cited in the preceding
paragraph thus show that these individual elements are removed from the utility picture of a rational
person. Consequently this rational person has no influences from a specific institution. Human
psychology is also ignored. There is no substantial theory of human action underlying the utility theory.
The non-falsifiability of utility-maximization is only an critique of the degree of its validity. One must
furthermore consider the theoretical limitations. Here utility-maximisation fails as it bypasses the question
of how people develop dispositions, for example, Gintis claims that there is an evolutionary basis for
utility maximization ( Gintis, 2006, p. 17). By now it is clearly insufficient to show mere consistency of

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the behavioural outcomes of evolution with some utility function, as one can always find a function that
fits. One must demonstrate that utility maximization can causally produce a specific behaviour. This is
clearly an issue, as it seems contradictory to say that evolution makes individuals that both maximize
utility and show altruism.
3: Review and Responses to Defenses of the Rational Hypothesis
Proponents of utility theory assume an in-born fixed preference function. Human development is then the
process of updating and finding underlying preferences. Clearly, this is an unworkable causal account
however. Despite many in-born biological factors, further development from birth is based on a network
of neural connections, which themselves are reliant on environmental factors (Marcus,2004).
This assumption of in-born fixed preference appears in game theory, but here it is used beyond all
reasonable limits of logic. Agents do not merely act rational, but also that they consider the rationality of
others, and act as if others respond rationally with such common knowledge (etc.) all without any
assumptions about the causes of their behaviour. Keeping a preference argument in this context requires
the treatment of individuals as logic super-calculators, never worrying about the practical problems of
such a view.
While Colin F. Camerer et. al. (2005, pp. 54-55) present evidence that neuroscience supports utility
theory, it only relates to simple decisions only, not the abstract, long-term payoffs which are the
traditional province of economic and game theory. Utility function may therefore function at a formal
level to sort preferences. It therefore is a shortcut for modelling but fails to give an understanding of
human motivation and therefore prediction, its stated purpose.
4: Conclusion
In summary, utility theory does not lack empirical evidence, but it is such a broad explanation that every
possible causal mechanism underlying a given choice may fall under its purview. Nevertheless, some
important causal links may be excluded by considering specifics of all decision situations. Once this is
decided upon we then turn to claims of explanation and realize the deficiencies of the model and the
rational actor hypothesis. In situations of interest such as games or decision making it fails the biggest test
of a hypothesis; to make unique predictions whose effects may easily isolated from the environment and
tested.