Minimizing missed opportunities: a new model of choice?

Author:Oleinik, Anton
Position:Neoclassical theory

Key axioms of the "hard core" of neoclassical theory suggest that there is a solid link between the model of rational choice and the existence of unique, stable and Pareto-efficient market equilibrium. The task of this article consists of differentiating two potential sources of sub-optimal outcomes; the first refers to the nature of individual choice, and the second--to interactions between agents, with special emphasis on the latter.

Power relationships produce an asymmetrical situation: one side, Principal, tries to realize his or her agenda, whereas the other side, Agent, chooses between sub-optimal outcomes. One of the strategies for imposing Principal's will, domination by virtue of a constellation of interests in the market, is the subject of the present analysis. Max Weber, who first introduced the concept (1968, 943-946), does not explore it in depth--he just mentions that this type of domination is more oppressive to Agent than the will Principal imposed by legitimizing it.

Monopoly power illustrates this form of domination. Neoclassical economists show how monopoly leads to sub-optimal outcomes at the macro level. Nevertheless, they appear less interested in modifications in the model of individual choice induced by monopoly and in the interactive side of relationships between Principal (monopolist) and Agent.

Part I is devoted to differentiating the two sources of sub-optimal outcomes. Power is considered as one of the coordination mechanisms. A special case of power, domination by virtue of a constellation of interests (DVCI), is discussed in Part II. It involves minimizing Agent's missed opportunities. Empirical examples considered in Part III illustrate the idea of DVCI. They refer to recent tendencies in emerging markets in post-Soviet countries.

Sources of Sub-optimal Outcomes: Individual Decision Making versus Interactions

Particularities of approaches developed, on one hand by the majority of economists, and, on the other by game theorists and advocates of the old institutionalism, facilitate the task of differentiating sources of sub-optimality. The former group focuses attention on individual decision making, whereas the latter questions the premise of methodological individualism and examines interactions.

With the help of the model of bounded rationality, mainstream economists (Simon 1978) indicate that limited cognitive capacities and high transaction costs prevent the agent from finding and implementing an optimal solution. Uncertainty, or unawareness of all possible "states of nature," further complicate the task of finding the optimum (Langlois 1986, 228). Socio-economists introduce values into analysis. The eventual conflict between values and rational considerations calls for ordering preferences. Values, as second-order preferences, can "overrule" first-order preferences referring to the model of rational choice and lead to sub-optimal--in terms of technical expedience--outcomes (Jonge 2005).

Models of rational choice remain focused on individual decision-making. In spite of the existence of various institutionalist interpretations of bounded rationality, they just add constraints under which an individual attempts to maximize his/her utility (Figure 1).


The search for an alternative source of sub-optimal outcomes involves shifting the unit of analysis "from commodities and individuals to transactions" (Commons 1931, 652). Sub-optimality due to coordination failures takes manifest forms if in order to achieve desired outcomes, everyone needs to adjust their behavior to that of their counterparts--yet fails to interpret correctly their intentions and to send them an easily decipherable signal about his or her own intentions (Schelling 1960, Ch. 3; Schotter 1981, 22-23). For example, each of two motorists on a narrow road depends on the counterpart's choice to achieve the ultimate goal of avoiding a collision.

Even if individuals manage to find common references and coordinate their behavior, there is no guarantee against falling into sub-optimality. Common references are embedded in institutions that 'are adapted to past circumstances, and are therefore never in full accord with the requirements of the present' (Veblen 1934, 191; see also Sugden 1989).

Power relationships emerge as one of the tools that help solve coordination problems: instead of trying to predict the counterpart's choice, the individual transfers the right to control his/her actions to the former who then becomes Principal. Principal decides for Agent how to behave and what actions the latter has to undertake when confronted with unforeseen contingencies (Coleman 1990, 66-67; Kreps 1990a, 92-93). Principal's decisions do not necessarily refer to the past; hence, in conditions of uncertainty coordination through power relationships has greater potential than spontaneous coordination embedded in institutions. The terms Principal and Agent are employed here exclusively in the context of power relationship. Such interactions represent a subset of a larger set of relationships in which one person, an agent, 'is employed to do an act on behalf of another called the principal, so that as a rule the principal himself becomes bound' (Munro 1987, 966).


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