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find it a plausible interpretation, see further, Boland [1986a, Chapter 6].
Neoclassical economics is often thought to need an infusion of social
9 The convexity of the possibilities set is logically provided in the usual
psychology. There are two reasons for this. One is that economics should
Marshallian model by simply assuming that the two production functions are
different and exhibit diminishing marginal returns to all factors and that there be able to recognize the social interaction between individual decision-
are no increasing returns to scale in any production process. makers; the other is that economics should recognize that the nature of an
10 Note that this is a very different alternative from the current arguments against
individual™s utility function is essentially psychological. Both of these
governmental intervention of the Rational Expectations school. Their argument
reasons involve the methodological requirements of the individualism that
is that if you allow for a sufficiently long time period, the government could not
is at the foundations of neoclassical economics. In this short chapter I wish
really change any givens by fooling everyone. In the long run, supposedly,
everyone can learn the true nature of the world [see further, Boland 1982a, to explain why the requirements of individualism do not necessitate an
Chapter 4]. infusion of social psychology.1
11 An alternative would be to recognize non-individualist, non-natural exogenous
variables [see Boland 1982a, Chapter 11].
INDIVIDUALISM VS PSYCHOLOGISM
As I have been insisting in the previous chapters, it is important to avoid
confusing methodological individualism with psychologism. Individualism
is the methodological view that all social events must be explained as the
consequences of choices made by individuals “ things do not choose, only
individuals do. Psychologism is the view that in any explanation
(individualist or otherwise) the only exogenous givens other than natural
© LAWRENCE A. BOLAND
146 Principles of economics Individualism without psychology 147
constraints allowed are those representing psychological states of either bank robber. By asking our friend for an explanation we are asking him to
individuals or groups. As I noted above,2 individualism is distinguished give a description of the logic of his situation. Specifically, we ask him to
from holism and psychologism is distinguished from institutionalism. This give reasons which represent (1) his aims and (2) the constraints that
means that in addition to psychologistic individualism and institutional restrict the achievement of his aims. If he can describe the logic of his
individualism, which I discussed previously, there are two versions of situation such that we would agree that anyone who exactly faced that same
holism: psychologistic holism and institutional holism. Explaining an event situation (aims and constraints) would also rob the bank, then we would
as a case of ˜mass psychology™ would be an instance of psychologistic say that we understand why he robbed the bank. For example, he may tell
holism. Explanations based on such things as ˜class interest™ are examples us that his child needs a very expensive operation and he wants his child to
of institutional holism. have that operation but there is no legal way he could afford it before it
Individualism as a methodological view or doctrine about how social would be too late. Robbing the bank was the only way to achieve his aim.
events and situations are to be explained does not require us to base If his description of the situation is true (i.e. there really is no other way
individualism on psychology. Before I can discuss the social and possible), then given his aim (to save his child) it would be rational for him
psychological aspects of an individual™s choice situation, I need to present to rob the bank “ in fact, it might be considered rational for anyone with
the explanatory problem confronting any methodological individualist. that aim and those constraints.
The logical requirements of an explanation of individual behaviour are
the same whether we are discussing our friend the bank robber or the
INDIVIDUALISM AND THE LEGACY OF EIGHTEENTH
individual consumer choosing to spend his or her money on tomatoes and
CENTURY RATIONALISM
cucumbers. In the case of the individual consumer, the aim is supposedly
There is more to (methodological) individualism than an explicit the maximization of utility obtained from consuming what one has
commitment to individualist explanations. Since the eighteenth century, for purchased while facing the constraints of given prices, given purchasing
any explanation to be acceptable it must be ˜rational™ and thus, as I power (one™s budget or income) and a given utility function. Such utility-
explained in Chapter 6, it must be universal. Being rational means that the maximizing behaviour is rational in the sense that any two individuals with
explanation forms a logically valid argument such that if the premises of the same utility function and same income facing the same prices will
the argument are all true then the conclusions logically derived will also be choose to consume the same quantities of goods so long as each individual
true. By universal, we mean that anyone who accepts the truth of the aims to maximize his or her utility.
premises of a logically valid argument will also accept the truth of its Rationality assures such universality and uniqueness of choice. The idea
conclusions. The tradition of compounding rationality with individualism is that rationality assures universality is characteristic of eighteenth-century
problematic in two ways which together represent the classic intellectual ˜Rationalism™ and thus is fundamental to the origins of economic theory.
dilemma between unity and diversity [see Agassi 1969]. On the one hand The identification of rationality with utility maximization is a late-
the universality of rationality undermines individualism by making all nineteenth-century perspective and the foundation of neoclassical eco-
individuals identical in a significant way. On the other hand, the nomics. In terms of modern economics, the quantities of goods the indi-
nineteenth-century tendency to view rationality as a psychological process vidual consumes are considered endogenous variables. Only the utility
also undermines individualism by making individuality exogenous and thus function is unambiguously exogenous. Income and prices are treated as
beyond explanation. constraints for the individual but not for the economy as a whole, so
To illustrate these methodological problems, consider the following whether they are endogenous or exogenous depends on the situation we
hypothetical situation. Our closest friend has been caught robbing a bank. choose to model. In neoclassical economics our task is to explain
Demanding an explanation, we ask, ˜Why did you rob the bank?™ Before individual choices in order to explain how prices affect demand so that we
we allow our friend to answer, we must recall that, to be an acceptable can explain how demand influences prices in the market; in other words,
explanation, any explanation given either by us or by our friend must be prices and incomes (which depend on factor prices) are endogenous.
rational and conform to the requirements of methodological individualism. From a logical point of view (and contrary to what some people think
Individualism only precludes choices being made by things. Rationality is [e.g. Mason 1988]), a single individual™s choice is easier to explain than a
established by examining the logic of the situation facing our friend, the market™s demand curve. This is because in consumer theory we can treat
© LAWRENCE A. BOLAND
148 Principles of economics Individualism without psychology 149
the prices and income facing the individual as exogenous variables, leaving ˜criminal mentality™. But such a crude psychologism would seem to be our
only the consumer™s choice as the endogenous variable to explain. Any only recourse if we are to avoid the moral dilemmas involved in the
explanation of a market™s demand curve requires us to explain all explanation based on the logic of the situation. If the robber™s choice to rob
consumers™ choices as well as all the other market prices that these the bank was a rational one, how can we object?
consumers face. Of course, we would also have to explain the supply curve Crude psychologism also avoids an intellectual dilemma. When our
in every market in question. friend (as a bank robber or a consumer) provides an ˜acceptable™
explanation, one which says that anyone facing that position would choose
to do the same thing, the individuality of the situation is revealed to be
UNITY VS DIVERSITY IN METHODOLOGICAL
empty. If any individual would do the same, then there is nothing
INDIVIDUALISM
individualistic about the choice made. Crude psychologism (i.e. the view
Neoclassical economics, nevertheless, claims to explain all prices and the that behaviour is predetermined by exogenously given mentalities) as an
allocation of all fixed resources. How is it possible for one theory to ex- explanation of individual choices may seem to be a way to promote
plain so much? The particular value of prices (or state of resource alloca- psychology. It is not “ it only begs more questions. What determines who
tion) depends, of course, on the nature of each individual™s utility function. gets which mentality? How many different mentalities are there? In the
In this context methodological individualism allows both diversity and extreme, crude psychologism may even lead us to discard psychology in
unity. Diversity is promoted by recognizing that some people will spend favour of sociobiology.
more of their income on tomatoes than other people do. Unity is promoted If we thus reject crude psychologism, we are then left with our two
by the claim that all individuals are maximizers. This means that all people dilemmas. The moral dilemma (the rationality of one™s choice to commit a
face falling marginal utility curves (a necessary calculus condition for crime) is not easy to overcome and in the end is more a question of
maximization). Does this mean all people are identical and thus deny indi- philosophy than of psychology. The intellectual dilemma is the foundation
viduality? No; so long as everyone faces downward sloping marginal utility of attempts to promote psychology in the development of economic
curves, the absolute position of that curve (relative to other goods) need not explanations of individual behaviour. If we allow ourselves to assume that
be the same for all individuals. For the same amounts of tomatoes and psychologically all individuals are given different exogenous utility
cucumbers, some may get more satisfaction from tomatoes, others get more functions, then individuality will seem to be preserved in our explanations
from cucumbers. Also, some people may have steeper marginal utility of rational choice. However, whenever psychologism is adopted as a means
curves than other people do. We see that on the one hand individuality is of promoting individualism, it is a defeatist methodological stance.
preserved since, even facing the same prices and incomes, two maximizing Individualism is in trouble here only because neoclassical economics
individuals may choose different quantities if their exogenously given util- misleadingly identifies the individual™s aims with the individual™s
ity functions are different. On the other hand, universality is provided by psychologically given utility function. Two individuals facing the same
the common nature of utility functions if it can be shown that as a matter of prices and with the same income will usually choose different consumption
human nature all utility functions exhibit diminishing marginal utility. bundles if they have different utility functions. If our problem as
This is the methodological dilemma of individualist-cum-rationalist economists is to explain a wide diversity of choices made by people in the
economics. If the (equilibrium) values of prices depend only on the same income class, then the psychological reasons for why people have
different utility functions which are exogenously given, then prices are different given utility functions would certainly seem to be a promising line
actually determined outside of economics. Whatever determines the nature of inquiry. But it is not a necessary line of inquiry since one may just as
of the given utility functions ultimately determines prices. Does this mean easily presume that the individual™s utility function is socially determined.
that economics must surrender to psychology as has often been suggested The traditional emphasis on individualism seems to force an excessive
[e.g. Scitovsky 1976]? concern for diversity to the point that economists (as opposed to sociolo-
Identifying the individual with his or her psychologically given utility gists) tend to overlook obvious social circumstances where diversity is
function is a rather sophisticated and subtle type of psychologism. A more more conspicuous by its absence. Specifically, the problem that should be
blunt and obvious use of psychology would be for us (or our friend the of concern to individualist economists is to explain widespread conformity
bank robber) to explain the event by claiming that our friend has a whenever considering consumption patterns. In most cultures, each social
© LAWRENCE A. BOLAND
150 Principles of economics
role is closely associated with a specific consumption pattern. Accountants
11 Methodology and the individual
or lawyers in similar income brackets will usually have consumption
decision-maker
patterns much like their colleagues™. Non-conforming individualism is
more the exception than the rule in organized society. For example, corpor-
ate lawyers tend to dress alike, belong to the same social clubs, acquire the
same ostentatious goods such as expensive automobiles, houses, etc. More-
over, their conspicuous consumption is not a psychological phenomenon
but rather it shows how profoundly one™s preference ordering is dependent
on social structure [cf. Veblen 1899/1934]. In short, one™s consumption
choices may be determined more by one™s social position than by one™s
personal tastes [see Newman 1972; Hayakawa and Venieris 1977].

if a man had sufficient ability to know everything about the market for
UNNECESSARY PSYCHOLOGISM his labour, he would have too much to remain long in a low grade. The
older economists, in constant contact as they were with the actual facts
I do not wish anyone to think from my recognizing that utility functions of business life, must have known this well enough; but partly for
(or, more generally, personal aims) are matters of sociological inquiry that brevity and simplicity, partly because the term ˜free competition™ had
I am thereby rejecting individualism. Such is not the case. As I have become almost a catchword, partly because they had not sufficiently
classified and conditioned their doctrines, they often seemed to imply
already argued in Chapter 8, social situations and institutions are the
that they did assume this perfect knowledge.
consequences of individual choices. All that I am arguing here is that there
It is therefore specially important to insist that we do not assume
is no necessity to see deviations from narrow-minded neoclassical the members of any industrial group to be endowed with more ability
economics as expressions of irrationality and hence a demonstration of a and forethought, or to be governed by motives other than those which
need to study the psychology of the individual. Irrationality is easily are in fact normal to, and would be attributed by every well-informed
person to, the members of that group; account being taken of the
interpreted as merely an expression of the incompleteness of the descrip-
general conditions of time and place.
tion of the logic of the situation facing the individual [pace Stigler and
Alfred Marshall [1920/49, p. 449]
Becker 1977]. Perhaps a more complete description might involve
psychology but psychology is not a necessity here. An individual whose there is something fundamentally wrong with an approach which
utility function is completely determined by social conventions is no less habitually disregards an essential part of the phenomena with which
capable of making a rational decision than the individual whose utility we have to deal: the unavoidable imperfection of man™s knowledge
and the consequent need for a process by which knowledge is
function is psychologically given. In summary, a successful methodologi-
constantly communicated and acquired.
cal individualist explanation of the behaviour of a rational decision-maker
Friedrich Hayek [1945/48, p. 91]
is a matter of establishing the logical completeness of the decision-maker™s
objective situation. It is not necessarily a matter requiring the recognition
of a possible role for the decision-maker™s psychological predisposition. While it is one thing to recognize the role of knowledge in a neoclassical
explanation, those few who do will usually fail to deal with how the
knowledge is acquired. Unfortunately, almost all neoclassical models
NOTES
which do recognize the state of the decision-maker™s knowledge either
1 Peter Earl invited my comment on some papers he was publishing about ignore the decision-maker™s methodology or implicitly adopt Inductivism,
˜psychological economics™ [Earl 1988]. This chapter is based on my contribu- a methodology that was refuted two centuries ago. What is missing in
tion [Boland 1988]. Those parts repeated here are copyrighted by Kluwer
neoclassical models which do recognize the state of the decision-maker™s
Academic Publishers and reprinted with their permission.
knowledge is an explicit discussion of the decision-maker™s methodology
2 See Chapter 8, note 14.
for learning or otherwise acquiring knowledge.
Traditionally, methodology has been of interest primarily to historians
© LAWRENCE A. BOLAND
154 Principles of economics Methodology and the individual decision-maker 155
of economic thought or to those few economic theorists who view no significant role in the economic process because this economic process
methodology as an instrument to help them explain their theories to other is concerned with economic problems which arise from changes in such
economists. In effect, we might say that methodology has always been things as tastes. If tastes continue as before, there are no allocation
˜meta-theoretical™. This instrumental view is in contrast to that which I problems to be solved. In the absence of new problems, there would be no
wish to present in this chapter. Here I argue for a necessary theoretical role need to make new decisions or thus to learn anything new. For Hayek,
for methodology, a role implied to a certain extent in some of Hayek™s scientific knowledge is knowledge of general rules and thus is inherently
papers. To be more general, we could say that any economic theory which static. In effect, scientific knowledge is irrelevant “ particularly when it is
recognizes a need for knowledge in decision-making must in some way considered true and certain. Thus, the recognition of possibly false practical
imply a role for methodology because, as Hayek explicitly said, to explain knowledge is essential if we want to understand the competitive market
any decision the economist must also explain the ˜acquisition™ of the process.
knowledge needed to make that decision. In my 1982 book and elsewhere I This leads Lachmann to conclude that, if knowledge is to play an
have argued that while we must recognize the importance of knowledge explicit role, Hayek™s two types of knowledge must be clearly recognized.
acquisition, or learning, we must also avoid predisposing our conception of Moreover, we need to see that what the Austrians were saying is that
knowledge and its acquisition in favour of only one view of learning ˜practical knowledge™ (or ˜knowledge how™) is what must be explicitly
methodology “ namely, inductive learning.1 My plan for this chapter is to recognized in the explanation of an individual™s decision process.
begin by presenting Hayek™s views, which, though they are often employed According to Lachmann, logicians only recognize knowledge when it is
in recent literature, are frequently misunderstood. I will end by presenting certain. Thus, he argues, whenever ˜strict logicians™ analyze the decision-
my alternative view.2 making of market participants they miss the point because, according to
Hayek, the market overcomes the problems of (potentially) uncertain
practical knowledge.
EPISTEMICS IN HAYEK™S ECONOMICS
Ludwig Lachmann [1982] has argued that one of the neglected contribu-
The importance of the Hayek“Lachmann knowledge distinction
tions of the Austrian School was their view that ˜the dissemination of
knowledge plays a prominent part in the process of competition™ [p. 636]. Recognition that any individual™s knowledge can be false is central to
Hayek™s [1937/48] argument in favour of capitalist competition depended Hayek™s argument in favour of focusing on market-disseminated
on the assertion that this competition only requires a minimum amount of knowledge that is potentially uncertain rather than on certain scientific
knowledge consisting primarily of easily available private knowledge (of knowledge. For Hayek, scientific knowledge is irrelevant to our
one™s personal aims and limitations) and augmented only by the public understanding of the market economy. Whenever an individual™s
knowledge disseminated by the market. This view later led Hayek knowledge is false, the empirical evidence generated in the market by
[1945/48] to argue that adequate private knowledge is obtainable in prac- actions based on false knowledge actually leads towards the truth about the
tice; but ˜scientific™ knowledge, even if available, is usually inadequate market. For example, over-estimating market supply at the current price
without the individual decision-makers™ private knowledge. Specifically, leads to some individuals having to bid the price up and thereby
the virtue of making decisions based on market-disseminated information inadvertently to reduce the shortage. That is, acting upon false
arises because even though the day-to-day information from the market can (˜disequilibrium™) prices unintentionally leads to the creation of true
be wrong (e.g. disequilibrium prices), the process that leads to an equilib- (equilibrium) prices which can be the basis for realizable plans to
rium necessarily generates the correct information. Hayek thus distin- maximize profits or utility. A competitive market economy thus creates its
guished between possibly false practical knowledge (Lachmann™s ˜know- own adequate practical knowledge. Still, this view of the adequacy of
ledge how™) and true ˜scientific knowledge™ (Lachmann™s ˜knowledge that™ market-generated information presumes that all markets are inherently
or ˜propositional knowledge™). stable. I shall argue that it is the presumption of stability as well as the
Hayek complained that practical knowledge has always been considered presumption of the necessity of induction for certain knowledge that gives
inferior relative to scientific knowledge. More important, Hayek implied ˜scientific™ knowledge a less significant role than practical knowledge.
that if scientific knowledge were actually true and certain it would still play To understand the importance of Hayek™s claim consider two possible
© LAWRENCE A. BOLAND
156 Principles of economics Methodology and the individual decision-maker 157
states of one market from the perspective of contrasting the acquisition of and thus a viable (equilibrium) price will be provided only if someone
˜certain™ knowledge with the process of ˜learning by doing™ which, as (such as an auctioneer) can acquire certain knowledge.
Lachmann notes, underlies Hayek™s viewpoint. Let the market be charac-
terized by quantity discount selling. That is, both the supply and the
The methodological problem of the Hayek“Lachmann distinction
demand curves are downward sloping. Following the traditional
assumption of Walrasian market behaviour, excess demand at a quoted It is all too easy to criticize neoclassical economics for confusing practical
price always leads at least one buyer either to offer a higher price to attract with propositional knowledge. Nevertheless, we still need to appreciate a
more of the scarce supply or to give up trying to maximize his or her utility major difficulty with this Hayek“Lachmann distinction. This distinction is
for the quoted price. Whenever the supply curve is steeper than the demand based on a mistake about ˜scientific™ or propositional knowledge. This type
curve, the usual conception of the competitive process logically leads to the of knowledge cannot be distinguished from everyday practical knowledge.
elimination of the false (disequilibrium) quoted prices. In this Walrasian Both ˜types of knowledge™ can be true or false. It is necessary to recognize
stable world, Hayek™s practical knowledge is provided coincidentally with the role of methodology in decision-making precisely because the
the convergence to an equilibrium. However, whenever the demand curve knowledge of the individual decision-maker “ whether it is scientific or
is steeper than the supply curve, Walrasian price competition would only otherwise “ can be false.
aggravate the situation. Whenever there is excess demand, raising the price If one is not careful, the Hayek“Lachmann distinction between practical
causes an even greater excess demand. Nevertheless, if an auctioneer in and propositional knowledge can be used to perpetuate reliance on a false
theory of knowledge “ Inductivism.3 For example, Hayek™s claim that
charge of the market could ˜scientifically™ calculate the respective demand
and supply curves and thereby ˜scientifically™ calculate the price at which certain scientific knowledge will always be unattainable (or be otherwise
they intersect, then he or she could simply start the transactions at the inter- inadequate) presumes that for anyone™s knowledge to be true it must have
section where demand equals supply. Thus, even though the market might been acquired by some inductive process. That is, there is the presumption
embody an inherently unstable Walrasian competitive process, all plans that since the knowledge needed by an individual decision-maker is more
would still be realized “ that is, everyone could maximize their utility or intimate and less general, it can be more certain. Both Hayek and
their profit whenever the price was correctly set in advance. (Note that I Lachmann have implicitly recognized that, simply stated, knowledge can
could have presented all this with upward sloping demand and supply be false and that, in the absence of induction, there is no need to consider
curves or with excess supply situations.) ˜scientific knowledge™ any more reliable than private knowledge. But such
This example suggests that Hayek™s [1945/48] view meant that true a recognition need not imply an endorsement of Inductivism.
scientific knowledge (when attainable) was like the knowledge that the Today, few would so easily espouse any obvious uses of induction.
successful Walrasian auctioneer would require. While capable of achieving Rather, most would argue that we can make do with a watered-down
an equilibrium, true and certain scientific knowledge is unnecessary if the approach that replaces inductive proofs or inductive learning with
market is stable. In a stable market, piecemeal or trial-and-error bidding knowledge based on convenient acceptability criteria such as those found
will always tend towards the equilibrium and never away from it. That is, if in econometric practice. The problem of knowledge acquisition which
the market is stable, then the participants will always learn correctly from Hayek discussed in 1937 can be too easily transformed into a standard
Conventionalist theory-choice problem. 4 Specifically, it is tempting to
their mistakes. As my example shows, Hayek must be presuming the
market to be stable “ which it would be whenever the demand curve is think that all individuals participating in the market are Conventionalists
downward sloping and the supply curve is upward sloping. Furthermore, who are able to participate simply through adopting adequate criteria to
given the common presupposition that the only method for acquiring the determine the equilibrium price so that they can proceed to maximize as
certain knowledge which the auctioneer needs to set the correct price usual. That is, even with insufficient evidence all successful decision-
would involve induction, such certainty requires too many observations to makers have supposedly employed adequate criteria to choose correctly
be a realistic view of any economy whenever there is the potential of an between imperfect theories. This Conventionalist theory of knowledge is
unstable market. In short, either the market is inherently stable, in which only a marginal improvement over the older Inductivism. Appealing as
case in Hayek™s view adequate practical knowledge is provided in the choice-theory may be to economists, it would be a mistake to think that
progress of the competitive process, or the market is inherently unstable only one theory of knowledge would ever be chosen at any point in time
© LAWRENCE A. BOLAND

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