Directory UMM :Data Elmu:jurnal:J-a:Journal of Economic Behavior And Organization:Vol43.Issue1.Sept2000:

Vol. 43 (2000) 1–34

Bounded rationality, social and cultural norms,

and interdependence via reference groups

Hiroaki Hayakawa (Professor)

∗

Institute of Policy and Planning Sciences, University of Tsukuba, Tsukuba, Ibaraki 305-8573, Japan Received 27 April 1999; received in revised form 1 September 1999; accepted 1 September 1999

Abstract

This paper presents an axiomatic theory of preference orderings similar in abstraction to the stan-dard preference model, but developed for the analysis of bounded rationality where social norms and reference groups serve as sources of low-cost heuristics that can absorb costly deliberation and other limits to rationality. A two-step choice process is proposed, in which physical wants are satisfied sequentially with social want reducing choice indeterminacy. Social want is captured by emulation–avoidance of reference groups, and the serviceabilities of a commodity bundle to it are imputed. The resulting norm-guided behavior is rationalizable in the traditional sense. © 2000 El-sevier Science B.V. All rights reserved.

JEL classification: D0; D1; D8; B4

Keywords: Bounded rationality; Reference groups; Social norms; Social want; Life styles

1. An overview

Whether individual decision makers are homo economicus guided by independent prefer-ences or homo sociologicus guided by social norms has been a matter of defining concerns to both economists and sociologists. In broad terms, most economists have maintained that human behavior, whether in isolation or embedded in social situations, can be explained, with proper modifications if necessary, within the rational choice framework where prefer-ences are treated as given data. Sociologists, on the other hand, have largely maintained that it is social norms and order that shape preferences of individuals and give meaning to their actions. In recent years, the crossing between the two fields has intensified (Coleman, 1990;

∗_{Present address: Nara-Aoyama Danchi 17-101, Aoyama 3-1, Nara 630-8101, Japan. Tel./fax:+81-742-26-2687.}

E-mail address: hirohay@tezukayama-u.ac.jp (H. Hayakawa).

0167-2681/00/$ – see front matter © 2000 Elsevier Science B.V. All rights reserved. PII: S 0 1 6 7 - 2 6 8 1 ( 0 0 ) 0 0 1 0 6 - 2

Baron and Hannan, 1994; Smelser and Swedberg, 1994; Bowles, 1998). Among many ques-tions that have been addressed by both camps is the fundamental one: why do individuals allow their behaviors to be molded by social and cultural norms if they are (assumed to be) capable of making decisions without the help of such norms? In retrospect, the Lucas critique that individuals’ decision rules are constantly altered to reflect the structure of the decision-making environment cannot have been aloof to this question, since human behav-ior in a culturally and socially structured environment is of no exception to this critique (Lucas, 1976).

In dealing with social interactions, economists normally start with preferences that are given and represented by a utility function. Adding social factors to the list of the arguments of this function produces a variety of externalities that have been explored in various models. Thus, economists have been answering the fundamental question essentially by saying, rather circularly, that individuals have preferences over social interactions. Most sociologists would defy such an approach for the very reason that the existence of a fixed mapping from social and other factors into utility would imply that social norms are, after an infinite regress, reduced to preferences of individuals (Hodgson, 1986). To many of them, social order is something that cannot be reduced to self-interested or voluntary actions of individuals (e.g., Smelser, 1990; Tilly, 1991), much less to fixed individualistic preferences, although such a position has met serious challenges from the rational choice approach to sociology (Coleman, 1990, 1994).1

A very promising approach to the fundamental question has been suggested by the economics of bounded rationality à la Simon (1955, 1959) and by the recent develop-ment of the economics of limited cognition that dates back to, e.g., Cyert and March (1963) (see also Conlisk, 1988; Day and Pingle, 1991). The insight that decision makers economize on economizing models is not new (e.g., Schumpeter, 1934; Alchian, 1950), and the idea of habit was an important concept among Western social theorists (Camic, 1986; see also Day, 1987 for the notion of habere). Now the profession recognizes: (1) the decision-making environment including the internal psychology and the cognitive capacity of a decision maker may be significantly short of being perfect; (2) because the time endowment is fixed, every activity including cognition competes for the use of time; (3) information on which decisions are based is almost always incomplete, but information gathering and processing is costly; and (4) many decision making situations are imbued with elements of risk and uncertainty.

If these limitations are serious enough, a decision maker’s motivations would apply not only to choice objects but also to how to handle the limitations without sacrificing too much of his resources. Therefore, what kind of a problem-solving procedure (or mode) is actually adopted to save cognitive efforts and to absorb bounded rationality in general becomes a matter of no trivial importance. In Simon’s words, it is the procedural rationality that matters in understanding human behavior, not the substantive rationality that has pervaded the orthodox economics (Simon, 1978).

1_{One movement which has been gaining momentum in the field of sociology is what is now called the rational} choice sociology, which has been led by Coleman. This approach seeks to explain the nature, the origin, and the reproduction of the social order as consequences of voluntary actions of rational individuals (see Coleman, 1990, 1994).

Thus, it has been suggested that bounded rationality may account for the adoption of simple modes of behavior that take advantage of social and cultural norms and readily available heuristic solutions to complex problems. The implications of such possibilities are far reaching, and we shall explore some of them in this study, particularly ones that relate to the formation of social norm-guided endogenous preferences. If decision makers resort to such modes, there will be non-negligible rigidities in human behavior. Such rigidities often produce adaptive economizing behavior, which may become important sources of dynamic forces that drive the economic system as a whole (Day, 1984, 1986; Conlisk, 1996).

In this regard, Day (1984, 1986) calls attention to the fact that adaptive economizing by way of simple computable steps (analogous to optimizing algorithms in mathemat-ics) activates two types of mechanisms: (1) information, planning and control mecha-nisms in disequilibrium, and (2) inventory-order-price adjustment mechamecha-nisms that mediate transactions in disequilibrium. In such modeling of behavior, economic units are seen to exercise only local rationality or local search within zones of flexible responses in a sequence of recursively connected programs. In his view, agents’ behavior is governed by an information-planning-control system under mental-physiological structures of spe-cialized functions. It is not difficult to understand why agents in such a system might turn to economization of economizing itself. According to Day (1984, 1987), seven basic modes are capable of describing economizing choices: (1) obedience to an authority, (2) imita-tion of others’ modes, (3) habit (unconscious repetiimita-tion of past behavior), (4) unmotivated search, (5) hunch, (6) experimentation (trial and error), and (7) procedural optimizing (see also Pingle and Day, 1996 for an explicit statement). The effectiveness of these modes has been examined experimentally by Pingle (1992) and Pingle and Day (1996) (see also Day, 1967; Day and Tinney, 1968; Shipley, 1974; Naish, 1993 on the near optimality and the convergence of adaptive decisions; Conlisk, 1980 on the coexistence of costly optimizers and cheap imitators; Pingle, 1992 for an experiment of costly optimization). There is no reason for some of these economizing modes not to draw on social and cultural norms as sources of low-cost heuristics to complex problems and as instruments by which to endow human action with social meaning. The mode of imitating what significant others (Miller, 1963) are doing is a good example. Such a mode is expedient because it saves cognitive efforts; at the same time it is socially meaningful because the act of emulating and avoiding certain reference groups by watching what significant others are doing is driven by social motives to seek upper status identification.

Bounded rationality and the ensuing adaptive behavior hold promises to answer Hodgson’s call for a new framework of thinking beyond the methodological individualism (Hodg-son, 1986). Examining the validity of this methodology and Hayek’s (1952) composite

method that runs through much of contemporary economics, he argues that in understanding

human behavior there is no need to fall into the trap of complete voluntaristic individualism nor into the trap of the structural determinism. What is needed is a theoretical framework that allows human behavior to be molded by social and cultural norms while retaining the autonomy of individual decision makers. If bounded-rationality motivates individuals to orient themselves to social and cultural norms, their goals and preferences will be molded or guided by such norms, but the purposefulness of their actions will remain intact.

Simple modes of behavior suggested by Day above are similar to Beckert’s (1996) devices of uncertainty reduction. Expanding on Granovetter’s (1985) notion of the embeddedness

of economic action in situational structures and Simon’s (1976) intended and bounded

rationality that underlies administrative behavior, Beckert has scrutinized the rationality

principle in economics and its limitations. He has asked: if the dominant feature of situational structures in which economic actions are embedded is uncertainty so that the means–end relations on which economic calculations are based are lost, is it not the case that some mechanisms external to the decision maker (be they social and cultural norms, institutions, and social relations) are called in to reduce the choice set of decision makers and to restore

certainty in the means–end relations? Because uncertainty, as distinguished from risk by

Knight (1921), is not reducible to calculable probabilities, it imposes formidable limitations to the rationality of actions in situations characterized as such. If the means–end relations are lost, agents simply cannot decide what is best to do. It is, therefore, argued that the rational choice theory of economics cannot be a reasonable theory about human behavior in circumstances that are conditioned by uncertainty and that this rationality should be replaced with a more practical one that transcends the dichotomy between rational and irrational behavior. Beckert’s argument is reminiscent of Radner’s (1975) point over two decades ago that rationality does not allow an easy definition once cognitive capacities are recognized as limited.

As an alternative to the objective rationality, Beckert introduces the notion of intentional

rationality as one that relies on simple devices as instruments of uncertainty reduction when

all means–end relationships break down. Such devices are comprised of (1) tradition, habit, and routines, (2) norms and institutions, (3) structural predispositions of decisions such as social networks, organizational structures, and past decisions, and (4) power relations (Beckert, 1996, pp. 827–829). The social devices build up rigidities in human behavior, thereby causing it to be adaptive, and more importantly, to be predictable. Beckert’s argu-ment that making use of these devices narrows the choice set of decision makers and make actions predictable shares much with Heiner’s (1983, 1989) insight that the boundedness of the decision-making environment is an important source of predictable behavior as decision makers adopt more inflexible decision rules. It is analogous to Simon’s notion of intended

and bounded rationality (that takes the form of satisficing behavior), which, according to

him, forms the theoretical basis of administrative behavior (Simon, 1976).

Thus, the recognition that human behavior is boundedly rational and that it is embedded in social norms and order has brought to light possible linkages between the adoption of simple modes of behavior and persistent orientation to such norms. Such linkages have made it an important agendum to look into the possibility that human behavior may be better modeled by considering not only the need for simple modes of behavior that can absorb bounded rationality but also the non-functional benefits from orientation to social and cultural norms.

Many views have been put forth on such linkages. For our purposes, the following views are particularly important: (1) The society takes on a bigger meaning than a mere aggregation of the parts, and it should serve as reliable sources of meaningful simplification devices or heuristics to otherwise complex problems. (2) Decision makers will resort to simple modes of behavior and look for heuristic solutions in order to save their cognitive efforts and to absorb other limiting elements of the decision-making environment. (3) If preferences are composite of various needs which are not necessarily commensurate, they may be prioritized and satisfied sequentially with switching from one need to the next being effectuated as soon

as the aspiration level is reached. (4) There are social and cultural norms (social institutions, customs, sanctions, cultural values, etc.) which motivate individuals to behave in ways that endow their actions with social and cultural meaning. To the extent that preferences beyond physical needs are closely related to social and cultural norms, such norms may account for the origin of norm-influenced preferences for social interdependence. (5) More strongly, the formation of ends or preferences itself reflects the desire to act in a socially meaningful fashion when there are serious limits to the objective rationality. Social and cultural norms are, therefore, not just sources of external influences on human behavior, but rather they endow the decision-making environment with a social and cultural structure under which socially meaningful preferences and actions are actively formed and planned to reproduce the structure itself. (6) In acting under a socially structured environment, individuals will be able to exercise only local rationality within their social zones of flexible responses (in Day’s terms), which are determined to a large extent by the history of their past emulation and avoidance efforts and on which social, psychological, economic, communicational, and other principles are working.

In this paper, we propose a theory of choice behavior that takes into account these views, answering by so doing Simon’s call for procedural rationality as well as Hodgson’s call for norm-oriented purposeful behavior. If individual decision makers are in need of simple devices to solve complex problems, such heuristics must be readily available in the society, and there must be, at the same time, a process by which they are continually sustained and renewed. The view we expound is that low-cost heuristics to complex choice problems are sought and found in life styles of social groups. These life styles constitute a form of social capital that is accumulated collectively by members of social groups through their error-learning processes. If the cost of problem solving is too excessive for individuals to bear, it makes sense to invest in this capital collectively with all parties sharing the cost of the required investment. The benefits of the accumulated consumption know-how are then shared by members of social groups. Thus, with accumulation of such capital, the task of selecting the best from the set of feasible alternatives is reduced to an expedient act of referring to what has been tested and approved by members of social groups.

What is so distinctly important about the life styles of social groups is that they are, in Granovetter’s terms, embedded in a cultural-value system so that the act of orienting to them becomes a socially meaningful cultural behavior. It is doubtful that these life styles would ever be developed if identifying with them had no social and cultural value to begin with. The society, therefore, can be viewed as a culturally directed social field (analogous to a magnetic field in physics) in which the life styles of social groups exist as norms of consumption behavior and in which individuals sense the direction for higher status identification. This social field gives rise to social want as a culturally directed social predisposition to orient oneself to relevant social groups (and their life styles) in the process of seeking higher social status levels. Viewed as such, social want is crucially dependent on one’s location in the social field and on his zone of flexible responses, however this zone may be determined.

The rest of the paper is organized as follows: in Section 2, we discuss the nature of bounded rationality and argue that there are genuine needs for simple devices or low-cost heuristics to complex problems. In Section 3, we identify those social and cultural arrange-ments that shape decision makers’ orientation to social groups. These arrangearrange-ments will be

abstracted by way of interdependence via reference groups, in which social status ranking of such groups gives direction to the emulation–avoidance motives. In Section 4, holding that physical and social wants are not commensurate generally, we consider a sequential satisficing decision rule over physical wants as an alternative to the usual utility theory. In Section 5, we discuss properties of a preference relational system that follows from this sequential rule and propose a two-step procedural model of consumer choice where social want appears in the second step as an instrument of indeterminacy reduction. In Section 6, we present a formal model of interdependence via reference groups and define what social want constitutes. We show that a reaction function over relevant social groups and information on the whereabouts of social norms together make it possible to quantify the social want-satisfying property; this quantification eliminates or substantially reduces the indeterminacy of choice that remains in the first step. We show that a norm-oriented choice behavior can be rationalized by a norm-guided ordering of choice objects. In Section 7, we relate our model of interdependence to the work of Duesenberry (1949) and Leibenstein (1950), and Section 8 concludes the paper.

2. Bounded rationality and the need for low-cost heuristics

It is now widely recognized that the decision-making environment including the internal psychology of decision makers is short of being perfect. Various elements can account for such imperfection. (1) Decision makers’ cognitive and computational capacities are signif-icantly bounded (Simon, 1955, 1959). (2) The severity of this limitation is compounded by the fact that the time endowment is fixed, so that all activities (including cognitive ones) compete for the use of this endowment (Becker, 1965; Linder, 1970). (3) Decision makers seldom have perfect information about choice alternatives, but information gathering and processing, like any other activity, is costly in time and other resources (Stigler, 1961). (4) Many decision-making situations involve elements of risks, so that the anticipated con-sequences of decisions can only be assessed in probability terms, subjective or objective. (5) If decision-making situations are imbued with uncertainty so that the means–end re-lationships that are necessary for economic calculations break down, the consequences of an action cannot be assessed even in probabilistic terms (Keynes, 1921; Knight, 1921). The total failure of the objective rationality in the face of uncertainty leaves a gap that is beyond the cognitive capacity of decision makers (Beckert, 1996). While various models or apparatuses have been developed to cope with some of these limitations, we focus here on decision makers’ motives to save the resources that would otherwise be required to solve complex choice problems.

In our view, the key to the success of a decision maker in coping with the limitations of the decision-making environment is the availability of cost-absorbing choice mechanisms (or devices) that are rooted in social capital and order. For sure, such mechanisms have to be simple enough to afford a painless adaptation to the decision-making environment; at the same time they should reflect the social structure of this environment. Specifically, what is needed is a socially meaningful choice mechanism that absorbs risk and uncertainty, reflects costs of acquiring and processing information, reduces the pressure of time constraints, and eases the computational pain of problem solving. If one’s cognitive capacity is limited and if

there are limits to decision making costs that can be borne, a resulting decision mechanism will be of a simple kind.

Assume, for a moment, that there are neuron locations in human brains to process in-formation and that two kinds of inin-formation occupy such locations: (a) decision rules and transformation, and (b) data about choice objects and internal states of a decision maker. Naturally, an economizing problem arises over such locations. The more complex are the problem-solving algorithms, the less room is available for data, and the more complete are the data, the less room is available for complex algorithms. The total computational capacity has an upper limit that is short of global optimization. Given costs of obtaining data and given time constraints on how long is permitted to solve a problem, further limits are placed on the complexity of problem solving. After all, the costs of decision making should not exceed the net value of choices made.

Once costs of reaching a decision are taken into account, the need for a simple-choice mechanism that relies on low-cost heuristics cannot be ignored. Given social capital that has been accumulated in the form of life styles and given social and cultural order that has transformed the environment into a well-directed social field (so that socially desirable ends and means can be identified), it is only natural for individuals to search for low-cost heuristics in the life styles of their relevant social groups.

Viewing the consumer choice process as one of utilizing low-cost heuristics is not an escape from the conventional rationality hypothesis. Rather, it is best viewed as an extension of this hypothesis when the decision-making environment is imperfect. The central issue is still one of cutting costs of problem solving as we focus on the use of socially desirable, cost-saving means (see Vriend, 1996 for a much broader interpretation of rationality as pursuance of self-interest). What is novel of this view is that it interprets the life styles of social groups as social capital that has been accumulated through error-learning processes and relates this capital to human behavior of bounded rationality.

3. Social capital as sources of low-cost heuristics

Choice decisions made by an individual depend crucially on the organization of his perceptions of choice objects. To the extent that such perceptions are affected by social and cultural elements, they cannot be independent of a particular social and cultural environment in which decisions are made. An individual participates in the economy not simply as an economic abstract with idiosyncratic tastes but as a whole person with a variety of legitimate social and cultural concerns and motivations that are very much part of his economic choices. For this reason, it is important to deal with the full complexity of choice behavior.

An individual occupies certain positions and plays certain roles in a society in which he lives. He also takes part in the life-worlds of social groups through many activities. This entails that his behavior reflects a web of reciprocal role expectations and obligations as well as social sanctions (positive or negative) of various kinds and strengths (see Parsons and Shils, 1951 for the notion of double contingency of social action or order). It, therefore, follows that human behavior is, to a large extent, a social behavior. Culture then provides a framework of value orientation shared by the majority of the society, without which

reciprocal expectations on the responses of different individuals would break down, and coherent perceptions of choice objects in the context of a social environment would not emerge. Among many functions that society performs, we pay attention to its function as the provider of socially desirable heuristics to complex choice problems through clusters of activities that mediate life styles of social groups and through commonly shared cultural values that make adoption of such heuristics a socially desirable act to follow. Thus, the totality of life styles developed by social groups can be viewed as social capital, and a commonly shared cultural value orientation that guides the use of this capital can be viewed as social order.

There are at least four aspects to this capital: economic, psychological, social, and cultural. If a decision maker in a social setting makes use of this capital, we need to know, on top of his usual budget constraint, his psychological motives, the social sanctions (pressures for conformity and sanctions against deviations) that are at work on his choices, and the cultural values shared by members of his society. These aspects are not independent of one another as, e.g., the success-oriented cultural values will give rise to the psychological motives to gain upper status identification as a moral claim to success.

Economists often say that choice theory is or should be independent (in explanatory power) of choice objects. It is the same regardless of what individuals want. It is, therefore, often concluded that a decision maker’s motivations are irrelevant to choice theory. This would be the case if it were true that his motivations applied only to the goods bundle’s constituent list of commodities. However, the matter of motivation may apply to the safety of a choice as of neighborhood or brand of car, to the status gains, to the costs of han-dling uncertainty, to the appropriateness of a chosen list of goods to life style activities, or to the handing of high information costs. To the extent that these motivations may play important roles in decision making, they should not be swept aside and branded as irrelevant.

To summarize, social and cultural arrangements of the decision-making environment affect an individual’s organization of his perceptions of choice objects, therefore, his choice behavior. The society is not simply a collection of isolated individuals acting on their own idiosyncratic preferences with little interdependence among themselves. It is best viewed as a coherent whole organized around social norms and cultural values that constitute social capital and order of powerful economic significance. An individual’s behavior is then part of his entire living in this totality of socio-economic realities.

With this general view, we note that the modern society places high moral values on achievement and success. Moreover, the structure of differentiated social roles and positions is integrated around a system of pecuniary rewards and social prestige based on these values. Therefore, it makes up a very significant part of an individual’s motivation to be regarded as a winner and to be respected as worthwhile in his society. Such motivation normally manifests itself in status seeking and emulation of higher status groups. It seizes upon consumption behavior for an obvious reason that it is the best, impersonal way of demonstrating to the society the extent of one’s success as a moral claim to the social prestige.

Such an idea is not new in economics. Veblen (1899), writing on the theme of human proclivity to emulation, expounded the notion of pecuniary emulation and conspicuous consumption as a means to an invidious comparison. He writes:

The accepted standard of expenditure in the community or in the class to which a person belongs largely determines what his standard of living will be. It does this directly by commending itself to his common sense as right and good, through his habitually con-templating it and assimilating the scheme of life in which it belongs; but it does so also indirectly as a matter of propriety, under pain of disesteem and ostracism. To accept and praise the standard of living which is vogue is both agreeable and expedient, commonly to the point of being indispensable to personal comfort and to success in life. The standard of living of any class, so far as concerns the element of conspicuous waste, is commonly as high as the earning capacity of the class will permit — with a constant tendency to go higher. . . (Veblen, 1899, pp. 111–112).

Pigou was also among the first to point out the importance of this achievement-oriented moral value as reflected in consumers’ constant quest for reputation and distinction bearing goods. He writes:

. . . the essential matter is that people do, in fact, desire many things, not merely for their own sake, but, in the main, on account of the reputation or distinction which the possession of them confers.. . . The quantity of a distinction-bearing article that anyone demands at a given price depends, not merely on the price, but also on the extent to which it is “the thing” to buy that article, and thus, indirectly upon the quantity that people in general are buying. . . ..

. . . In fact, however, distinction is usually to be found, not in being in the swim in general, nor yet in being out of the swim in general, but in a combination of resemblance to certain persons and of difference from certain other persons.. . . Furthermore, both among the persons whom a man wishes to resemble, and among those from whom he wishes to separate himself, some are usually much more important to him than others. . . . (Pigou, 1913, pp. 20–24).

Thus, given the human proclivity to emulation and avoidance and given a social status scale that has evolved over time with success-oriented moral values, people of higher or equal social statuses tend to have positive effects and those of lower statuses negative effects on one’s consumption behavior. Since an individual emulates or avoids behavior of other individuals to the extent they are representative of the social classes or groups of their orientation, Veblen and Pigou’s insight can be best abstracted in terms of interdependence

via reference groups (Hayakawa and Venieris, 1977).

More precisely, an individual orients his behavior to a number of his reference groups. People in them constitute what social psychologist Miller (1963) calls significant others; they are usually friends, neighbors, or associates. Some of them exert positive effects and others negative effects. Both among those groups to be emulated and among those to be avoided, some have stronger positive or negative effects than others. Moreover, under a commonly shared cultural value orientation, it would be possible to rank these groups in terms of their social statuses. It is conceivable that there may be more than one criterion for this ranking. If the ranking of social groups is comprehensive enough, the essential feature of the interdependence via emulation and avoidance of reference groups may be captured by the notion of a reaction function defined on a set of well-ordered social reference groups.

This formalization of social interdependence is to be distinguished from various models of social interdependence or consumption externalities that have been presented in the literature

to this day.2 Most of such models have remained within the confine of interdependence via

individuals or at the level of Millers’ significant others without considering social groups in

the background. This is understandable in the light of the fact that the hedonistic creature of the traditional utilitarian individualism has dominated economic theorizing. But, it is useful to go beyond the individualistic level of social interdependence and to address the fundamental reason for it. In our view, an individual is affected by significant others because they are representative of his reference groups targeted for emulation and avoidance along the social-status scale. Furthermore, if the social and cultural proclivities of human behavior are to be linked to bounded rationality of attempting to reduce the cost of complex problem solving in an imperfect decision-making environment, social interdependence ought to be abstracted by a scheme of interdependence via reference groups. For, after all, it is social groups, not individuals, that possess cost-saving heuristics for complex problems.

Some observations are in order: first, which social groups an individual targets in an invidious system is not random, but is very much guided by other groups’ social statuses. Therefore, two individuals of different social statuses will orient their behaviors to dif-ferent social groups. Yet, to the extent that the same principles (psychological, economic, sociological, and communicational) are likely to be operating within a given society, the general characteristics of emulation and avoidance patterns, hence, the general shape of a reaction function will be similar among most individuals. In fact, it is this fact that supports the notion of social order (an orderly pattern of social orientation) in an invidious system. Moreover, a reaction function is best viewed as a (net) summary of (a) psychological mo-tives to seek higher social statuses, (b) social pressures for conformity to group norms and sanctions against deviations from such norms, (c) the amount of useful factual information about consumption patterns of different groups across society, and (d) the economic cost of

2_{There have been many attempts to capture consumption externalities. Some old examples include: Leibenstein’s} bandwagon, snob, and Veblen effects (Leibenstein, 1950); Duesenberry’s relative income hypothesis (Duesenberry, 1949; Clower, 1951/52; Johnson, 1952); Veblenian conspicuous consumption through prices or real income as separate arguments in the utility function (Kalman, 1968; Allingham and Morishima, 1973; Hayakawa, 1976); interdependence via reference groups based on emulation–avoidance motives (Hayakawa and Venieris, 1977); dynamic modeling of consumer interdependence by way of a system of interdependent linear difference demand equations (Gaertner, 1973; Krelle, 1973); Becker’s (1974) theory of social interactions in which characteristics of other persons enter the production functions of the basic wants or commodities; Pollak’s (1976) model of interdependent preferences via consumption of all individuals in the utility function; Frank’s (1984) model of wage differentials based on income hierarchies yielding within-group status, and his model (Frank, 1985) of the effect of Hirsch’s (1976) positional goods on the demand for non-positional goods; Granovetter and Soong’s (1986) threshold models of interpersonal effects in consumer demand. An interdependence model via reference groups by Hayakawa and Venieris (1977) differs from these other models as it tries to derive indifference curves axiomatically from a life style hypothesis. The notion of social reference groups consisting of significant others is also applied in Kapteyn (1980).

More recently, the literature has witnessed a resurgence of interest in social interactions as sources of promising answers to some intriguing questions. Among them are the equity premium puzzle (see Mehra and Prescott, 1985; Abel, 1990; Gali, 1994; Kocherlakota, 1996), the convexity of the utility function in the controversy between the New Keynesian and the New Classical economics (Mankiw et al., 1985; Hall, 1988; Ikeda, 1994), and the concave–convex–concave utility function (Robson, 1992; Coelho and McClure, 1998). Furthermore, with growing interest in new growth theory, some attempts have been made to relate status seeking and consumption externalities to capital and wealth accumulation, economic growth and dynamics, and economic performance in general (Cole et al., 1992; Fershtman and Weiss, 1993; Futagami and Shibata, 1995; Hof, 1997).

gathering information and experimenting something new (at the risk of disturbing the com-plementarities among activities and goods that mediate particular life styles) (Ray, 1973, pp. 284–288).

Second, wants are not distributed randomly or evenly throughout the entire society. Most likely they exist in clusters associated with different social groups. To the extent that indi-viduals select certain social groups as their reference groups, social wants of indiindi-viduals will reflect such clusters. Heuristically, there are islands of clustered wants of different social groups, which may be disjoint or overlapped. These clusters are then learned and acquired by individuals through interactions with significant others. In this process, individuals acquire a collection of wants at a time lest their complementarities be lost.

One further observation: the notion of a life style introduces a parallelism between com-plementarities among goods and particular life styles. Some clusters of goods are better than others in serving a particular life style. In this context, a social group can be thought of as having borne the cost of testing various consumption technologies and associated clus-ters of goods for their serviceabilities to its life style. Such testing may be understood as follows: suppose that members of a social group are in continual contact with one another, sharing common ideas, values, standards, information, etc., and learning from experiences of one another. Then, simple learning will set off an elementary hill-climbing process of incremental adjustments of a life style and a cluster of goods serving that life style, and of similar adjustments of consumption technologies that mediate properties, activities, and goods (Day, 1967; Day and Tinney, 1968). What comes out over time, therefore, is a well-defined life style and an efficient cluster of goods to live that life style. The latter is called complementary because of the interconnections among goods that are established by virtue of life style activities and related consumption technologies.

Thus, the society is best viewed as a social space in which various styles of living and consumption technologies have been tested and accumulated with their benefits being shared by members of social groups and in which there is movement from one style of living to another as one seeks higher social prestige and status. The accumulated life styles constitute social capital, and the cultural value orientation that drives upper social status seeking defines social order. Our scheme of social interdependence via reference groups is based crucially on the existence of such capital and order. Faced with an imperfect decision-making environment, it is natural for individuals to turn to social capital as sources of low-cost heuristics that not only save the cost of problem-solving but also meet their social needs, and to turn to social order for orientation of their emulation–avoidance behavior.

The question is, how do the social capital and order help reduce problem-solving costs borne by individuals? In our view, they do so by sending to individuals signals or directions as to which reference groups ought to be emulated and which reference groups ought to be avoided, all as a function of their social statuses (i.e., as a function of their positions in the social field). Once their reference groups are identified, their attention turns to such non-functional attributes of choice objects as how popular they are among members of such groups, hence how the acquisition of them helps achieve a desired social status identification. Each commodity bundle, therefore, comes with a set of non-functional attributes, some of which are based on its popularity across the reference groups. If an individual seeks to emulate a particular group, those goods that are in vogue with that group have, in their vectors of non-functional attributes, a component which gives him a sense of belonging

to that group and of having attained the social status of that group. Hence, given a set of socially ranked reference groups and a vector of non-functional attributes of goods, one may be able to contrive a measure that indicates to what extent any given commodity bundle satisfies one’s social want by taking the convolution of a reaction function and vectors of non-functional attributes. The social want-satisfying property measured this way makes up an important part of the total serviceabilities of a commodity bundle. Thus, the social capital and order we have identified reduce the burden of complex problem solving by substituting, in place of utilitarian psychologizing, learning of social norms called life styles and by directing individuals to make use of these norms in the quest for higher social status identification.

4. A sequential satisficing of wants

The traditional approach to consumer behavior assumes that rationality is global and that wants are commensurable (i.e., reducible to utility) regardless of their origins. It ignores the possibility that the internal physiology of a decision maker may not allow a common mea-surement of all different physiological needs. Moreover, as we argue, if the limited cognitive capacity and other limiting conditions are the dominating features of the decision-making environment, individuals may be significantly motivated to economize on economizing by searching for low-cost heuristics to otherwise complex choice problems and to turn to social and cultural norms (i.e., life styles of social groups and a commonly shared system of cul-tural value orientation) as real sources of these heuristics and direction to guide emulation and avoidance motives. Embedded in a system of cultural value orientation, such motives give rise to some well-structured social want, which, by its very nature, is distinctly different from any of the physical needs. If human wants, physical or social, differ so much in nature to make them practically non-commensurate, it makes sense to model consumer choice as one of assigning priorities to differing wants and satisficing with respect to their relative satiation levels.

For this reason, we take an approach based on Georgescu-Roegen’s (1954) hierarchical nature of human wants, Simon’s (1955, 1959) principle of satisficing (see also Radner, 1975; Radner and Rothschild, 1975), and Day’s (1987) prioritization of multiple ends. We assume (1) that wants are specific and not commensurable, (2) that they are prioritized and satisfied sequentially under the principle of satisficing with respect to their aspiration levels (relative satiation levels), and (3) that wants of physical nature are bounded by their aspiration levels whereas no such restriction is placed a priori on want of social nature because this want is inherently relative to social norms. The primary physiological needs are assigned higher priorities, to be followed by less basic ones and eventually by want of social nature.

Reviewing the literature, we find that the view that the decision maker’s actual choice process is sequential is at least as old as Menger and Jevons. They write:

An isolated farmer, after a rich harvest, has more than 200 hundred bushels of wheat at his disposal. A portion of this secures him the maintenance of his own and his family’s lives until the next harvest, and another portion the preservation of health; a third portion assures him seed-grain for the next seeding; a fourth portion may be employed for the production of beer, whiskey, and other luxuries; a fifth portion may be used for the

fattening of his cattle. Several remaining bushels, which he cannot use further for these more important satisfactions, he allots to the feeding of pets in order to make the balance of his grain in some way useful.

· · · ·

We have seen that the efforts of men are directed toward fully satisfying their needs, and where this is impossible, toward satisfying them as completely as possible. If a quantity of goods stands opposite needs of varying importance to men, they will first satisfy, or provide for, those needs whose satisfaction has the greatest importance to them. If there are any goods remaining, they will direct them to the satisfaction of needs that are next in degree of importance to those already satisfied. Any further remainder will be applied consecutively to the satisfaction of needs that come next in degree of importance (Menger, 1950, pp. 129–131).

. . . Nor, when we consider the matter closely, can we say that all portions of the same commodity possess equal utility. Water, for instance, may be roughly described as the most useful of all substances. A quart of water per day has the high utility of saving a person from dying in a most distressing manner. Several gallons a day may possess much utility for such purposes as cooking and washing; but after an adequate supply is secured for these uses, any additional quantity is a matter of comparative indifference. All that we can say, then, is that water, up to a certain quantity, is indispensable; that further quantities will have various degrees of utility; but that beyond a certain quantity the utility sinks gradually to zero; it may even become negative, that is to say, further supplies of the same substance may become inconvenient and hurtful (Jevons, 1957, pp. 43–44).

As seen in these quotations, three principles run through Menger’s and Jevons’s views on human wants: (1) wants are specific and qualitatively different; (2) in the process of satisfying them, they are prioritized; and (3) they are bounded by their relative satiation levels. In the subsequent development of economists’ choice theory, however, it has been assumed that wants of all origins are reducible to a common measurement called utility. This utility theory then has expounded that it is only ordering of choice objects that matters in consumer choice. Thus, the fact that wants are prioritized has become replaced with the principle of the diminishing marginal utility, or, more generally, with that of the diminishing marginal rate of substitution. As we shall show below, a sensible ordering of choice objects is equally possible with non-commensurable and prioritized wants. It is this possibility that legitimizes a two-step choice process we propose below.

A couple of observations are in order. First, it has often been pointed out that human wants are dynamic in nature in the sense that the satisfaction of lower, more primary wants awakens higher wants so that wants themselves are destined to grow in number over time. This aspect of wants has been dubbed as the principle of the subordination of wants or the

principle of the growth of wants (see Menger, 1950, pp. 82–83; Marshall, 1920, pp. 86–91).

While wants grow dynamically over time, they may be taken to be finite in number at a given point in time.

Second, one’s priority ordering of wants and setting of their aspiration levels are likely to be socially and culturally influenced. Hence, it would not be surprising if individuals who belong to the same society and share an identical cultural value orientation exhibited similar priorities and aspiration levels of wants. Different societies and cultures attach

different values to human activities, and individuals’ orderings of wants are likely to reflect such social and cultural differences.

Third, the fact that social want is placed at the end of an ordering does not imply that social considerations are of the least importance when one’s budgetary resources are too limited to satisfy many of the basic needs. Even in such situations, multiple means are likely to be available, and this multiplicity often calls for social considerations for further guidance. This may account that even in a less affluent society, where individuals are still struggling for the basic needs, social pressures for conformity can coerce individuals to choose, among many alternatives, those that invite less social sanctions. In an affluent society on which our attention is focused, most of the primary needs are satisfied and social considerations occupy the mind of most individuals as they seek constantly higher social status identification. In such a society, social considerations do play a crucial role as an instrument of indeterminacy reduction on the choice set. It is this fact that supports our assumption that the satisficing feasibility set (i.e., the set of those choice objects that are feasible and meet all of the physical needs to their aspiration levels) is non-empty.

5. Sequential satisficing of wants

Sequential satisficing of wants reviewed above is based on three premises: (1) All wants, physical or social, are prioritized, and social want appears at the end of this ordering. (2) Each physical want is bounded by its aspiration level whereas no such bound is imposed a priori on social want because this want is determined by social norms. (3) It is social interdependence via reference groups (embedded in a cultural value orientation) that structures social want such that it serves as an instrument of indeterminacy reduction in choice decision making. In the sequel, we derive an ordering (of choice objects) from the prioritization of differing wants and show that behavior based thereon is perfectly rational. As a matter of our strategy, we first deal with prioritization of physical wants and get an ensuing ordering of choice objects, which is incomplete to the extent that the satisficing feasibility set is non-empty. We then combine this ordering with another ordering based solely on social want considerations. We show that this composite ordering is well defined and that the resulting choice behavior is rationalizable.

Suppose, we have a fixed number of physical wants. Let want i be denoted bywi and

the property that satisfies want i by xi. A greater value ofwi and xi indicates, respectively,

a greater degree of satisfaction of want i and a greater capacity to satisfy want i. We start with the following postulates:

Postulate 1. An individual has a finite number, say m, of physical (functional) wants,

denotedw1, w2, . . . , wm. LetW ≡ {w1, w2, . . . , wm}. W is individual-specific.

Postulate 2. An individual has a strong orderingRwon the set W, i.e.,Rwsatisfies:

1. Transitivity:wiRwwj and wjRwwk imply wiRwwk for any wi, wj, and wkinW.

2. Asymmetry:wiRwwj implies not wjRwwi for any wi and wj in W.

Postulate 3. Each want,wi, has its aspiration (or relative satiation) level, denoted wi∗.

This is equivalent to assuming that the corresponding want-satisfying property (or quality)

xihas its aspiration levelxi∗.

Postulate 2 implies that any subset of W has a unique maximal element. Postulate 3 implies satisficing, i.e., that physical wants are only satisfied to their (relative) satiation levels. These postulates give a sequential satisficing decision rule: an individual first prioritizes physical wants, and satisfies them sequentially, each to its aspiration level. Without loss of generality, let the elements of set W be arranged according to the priority ordering, so thatwiRwwj

holds if and only if i<j.

The space of goods is the non-negative orthant of an n-dimensional Euclidean space, denoted

G= {y :y ∈Rn and y ≥0},

and the space of the want-satisfying properties (qualities) is the non-negative orthant of an

m-dimensional Euclidean space, denoted

X= {x :x ∈Rm and x≥0}.

Assume that there is a (perceived, hence basically subjective) transformation functionΦ : G→X, which reflects the amount of information that an individual possesses, his cognitive limitations, and the way he perceives the merits of choice objects. Since information and cognition are not free, the perceived transformation reflects the cost of both information gathering and cognition. Given such a transformation function, a commodity bundle yi is

transformed to a bundle of physical want-satisfying properties: xi ≡(x₁i, x₂i, . . . , x_mi)=Φ(yi)≡[Φ1(yi), Φ2(yi), . . . , Φm(yi)],

whereΦj(yi) is the jth component ofΦ(yi). Let the vector of the aspiration levels of m

want-satisfying properties be x∗≡(x1∗, x2∗, . . . , xm∗).

The transformation functionΦ:G→Xinduces an ordering of objects in G, which we call a preference relation. This relation is more general than the usual one that underlies the traditional utility theory for the reason that it is affected, among other things, by the aspiration levels, experiences, and information in possession, which are not independent of social and psychological predispositions of the decision maker, the cost of cognition, and the cost of information gathering and processing.

Postulate 4. An individual has a preference relation≻on the space of goods G, which is defined as follows: for any two commodity bundles, yi _{and y}j_{, in G,y}i _≻yj_{if and only if}

any one of the following conditions holds: 1. xj₁< x1∗andx₁i > x₁j.

2. xi₁=x₁j < x1∗, x₂j < x2∗, andx₂i > x₂j.

3. xi₁> x1∗, x₁j > x1∗, x₂j < x2∗, andx₂i > xj₂and so on up to the mth want-satisfying property, wherexi ≡(x₁i, x₂i, . . . , x_mi )=Φ(yi)andxj ≡(x₁j, x₂j, . . . , xmj)=Φ(yj).

In determining preferences between any given two commodity bundles, yi and yj, an individual first examines the extent to which they satisfy the want of the first priority. If the two bundles satisfy this want either to the same extent or in excess of its aspiration level, then his attention shifts to the want of the second priority. This will be repeated sequentially. A preference relation of this kind is in general not complete for the following reason: to be able to state that eitheryi ≻yj oryj ≻yi holds for any two alternatives, one needs some decisive relation at the margin. But, after all preceding ones have failed to make preferences determinate one way or the other, even the last (the mth) property may still fail to do so because this property is again satisfied either to the same extent or in excess of its aspiration level. It is this incompleteness or the indeterminacy that, in our view, motivates individuals to seek further guidance in social and cultural norms, which will be discussed in detail in the next section.

The space of goods, G, together with this preference relation, constitutes a relational system denoted (G,≻). Because≻is asymmetric and negatively transitive (i.e., notyi ≻ yj and notyj ≻yk imply notyi ≻yk), this is a weak order system. Also, given≻on G, an indifference relation, denoted∼, can be defined by the absence of preferences one way or the other. That is, for any two bundles, yiand yj, in G,yi ∼yj (yiis indifferent to yj) if and only if neither one is preferred to the other. Then, combining≻with∼, we may form a composite relation RG, on G, defined by yiRGyjif and only if eitheryi ≻yj oryi ∼yj.

For any two bundles in G, it is always the case that either one is preferred to the other or there are no definite preferences between the two. Therefore, the composite relation RGis

reflexive and complete. It is also transitive. Thus, an induced relational system (G, RG) is

a preference-ordering system. Let these results be summarized as follows.

Proposition 1. A preference relational system (G,≻), where≻is defined as in Postulate

4, is a weak-order system (i.e.,≻is asymmetric and negatively transitive).

Proposition 2. An induced relational system (G, RG), where∼is defined by the absence

of definite preferences, is a preference-ordering system (i.e., RGis reflexive, transitive, and

complete).

Moreover, if the relation≻ is weakly complete (i.e., for any two bundles, yi and yj (yi6=yj), in G, eitheryi ≻yj oryj ≻yi), the composite relation RG, defined by yiRGyj

if and only if eitheryi ≻yj oryi ∼yj, becomes a chain. The only way that≻becomes weakly complete in the context of a sequentially satisficing decision rule is by being able to come up, at the margin, with some want-satisfying property that makes preferences determinate one way or the other. Notice that by the asymmetry of≻and by the definition of∼, yiRGyjand yjRGyimust imply that yiis indifferent to yj; but if the weak completeness

is met, yiis indifferent to yj if and only if yi is identical to yj. Thus, if the axiom of weak completeness is satisfied, our composite relation RGsatisfies the property of antisymmetry

(i.e., for any two bundles, yi and yj, in G, yiRGyj and yjRGyi imply yi=yj). This is the

case taken up by Georgescu-Roegen (1954) to demonstrate that lexicographic preferences are not measurable.

Proposition 3. An induced relational system, (G, RG), of Proposition 2 becomes a chain

Now, let B(P, M) be a consumer’s budget set corresponding to a price vector P and income

M; i.e., B(P, M)≡{y: y∈G and P·y≤M}. Also, let A(x∗) be his satisficing set; i.e., A(x∗)≡{y: y∈G andΦ(y)≥x∗}(Φ(y)≥x∗meansΦi(y)≥xi∗for all i=1, 2,. . ., m).

We next postulate that the intersection of the budget set and the satisficing set is non-empty. Call this intersection the satisficing feasibility set. The idea is that basic physical needs are within the feasibility of the budget set.

Postulate 5. A consumer’s satisficing feasibility set is non-empty, i.e., A(x∗)∩B(P , M)6= ∅.

Whether the satisficing feasibility set is non-empty or not, or, more importantly, how large this set is, depends on to what extent the aspiration levels of wants are adjusted dynamically when choice decisions are repeated. For instance, depending on the type of want, the aspiration level may be adjusted upward or downward, all according to the degree of easiness or difficulty experienced in day-to-day choices. Overall, however, to the extent that many of the functional wants arise from physical needs, it would not be too unrealistic to assume that they are more or less satisfied. In an affluent society, a typical middle-class individual’s total expenditure most likely exceeds what his basic needs require (see Baxter and Moosa, 1996 for a basic need hypothesis on consumption behavior).

If the satisficing feasibility set is large, it begs a question as to how to reduce the size of this set and where to turn for effective guidance. We argue that it is social want that serves as an instrument of indeterminacy reduction through a well-directed orientation to social and cultural norms. The fact that social want is distinctly different from physical ones and the fact that the satisficing feasibility set is most likely to be non-empty in an affluent society suggests that a typical individual may be solving his choice problems in two steps. In the first step, the satisficing feasibility set (i.e., the set of all RG-maximal elements in the

budget set) is identified. That is, physical wants are arranged by their priorities so as to have them satisfied sequentially to their aspiration levels. In the second step, his attention shifts to social want, whose structure, combined with the whereabouts of social norms, leads to determinate choices by identifying those objects (in the satisficing feasibility set) that yield the highest social gratification.

A two-step procedural choice process: In the first step, identify the satisficing feasibility

setA(x∗)∩B(P , M); i.e., select all RG-maximal elements from the budget set B(P, M). In the

second step, select those elements of this set that yield the highest satisfaction of social want. If income is too low to yield a non-empty satisficing feasibility set, the first step will suffice to make determinate decisions. With the rise of income, the attention shifts to higher (less primary) functional wants and eventually to social considerations. As the satisficing feasibility set becomes non-empty, how best to meet social want acquires the status of an im-portant criterion for selection of desirable objects. In an affluent society, such non-functional aspects of decision making cannot be ignored. Decisions are therefore eventually guided by such considerations as how fit choice objects are to present life styles, how effective they are for status identification and seeking, how fashionable they are to current modes of tastes, etc. Thus, social want, as it is embedded in social capital and order, motivates individuals to select their most socially desirable objects with resources that are typically not enough to catch up with ever increasing social needs and expectations.

This two-step procedure should be contrasted with one suggested by Kornai (1971), in which a single element is chosen from the set of eligible alternatives at the final stage of an elementary process with no deterministic decision rules for this selection. Final choices are randomly made with a decision distribution being defined on the set of eligible alternatives. In our model, the criterion of how best to meet social want narrows the choices from the satisficing feasibility set.

6. Interdependence via reference groups and social want

With the role of social want made explicit, we next turn to the modeling of interdependence via reference groups that endows social want with a useful structure to decision making at the final stage. Since an individual guides his behavior by perceiving, in a bundle of goods, certain properties (or qualities) that contribute to the satisfaction of his social want, we need to measure such properties somehow. Recall that our scheme of social interdependence had three features (Section 3): (1) an individual belongs to a social group and takes a number of social groups as his reference groups in the process of seeking upper status identification; (2) some of these groups are to be emulated (positive orientation) and others are to be avoided (negative orientation); and (3) these reference groups are ordered in terms of their social statuses. These features were then consolidated into the notion of a reaction function defined on a set of well-ordered reference groups. This scheme associates each bundle of goods with a vector of non-functional attributes derived from its popularity across social groups. Therefore, to what extent a given bundle of goods meets social want can be measured, to a first approximation, by convoluting a reaction function with vectors of such non-functional attributes. To formalize this measurement, we start with the following postulates.

Postulate 6. There are a finite number of social groups in the society,Sˆ ≡ {g1, g2, . . . , gn}.

An individual is oriented to a subset of these groups, S≡ {g1, g2, . . . , gk} ⊂ ˆS.

Groups in S are referred to as the individual’s relevant social groups or reference groups. S is individual-specific and depends largely on his position in the social field. The individual belongs to at least one group in S.

Postulate 7. The set of relevant social groups, S, is divided into two disjoint subsets, S1 and S2(S=S1∪S2, S1∩S2=∅):

S1= {gi :gi ∈S and gi is a group of positive orientation},

S2= {gj :gj ∈S and gj is a group of negative orientation}.

That is, gi∈S1is a group to be emulated, and gj∈S2is a group to be avoided.

Postulate 8. An individual has orderings, R1on S1and R2on S2, defined as follows: 1. For any two groups, gi and gj, in S1, giR1gj if and only if gi has emulation effects

2. For any two groups, gi and gj, in S2, giR2gj if and only if gi has avoidance effects

stronger than or equal to gj.

We assume that there is a continuum of social status levels over the range [0, h] (alter-natively, one may assume that there are only a finite number of such levels). It is important that there exists a social-status ranking function that is accepted by most members of the society, so that the status disparity between any two groups can be measured with little personal biases.

Postulate 9. There exists a social-status ranking functionr:Sˆ →[0, h] which satisfies 1. r(gi)>r(gj) if and only if gi is higher than gjin social status, and

2. r(gi)=r(gj) if and only if gi and gj are identical in social status, whereSˆ is the set of

all social groups.

This social-status ranking function makes it possible to measure the social status disparity between any two groups.

Definition 1. A social-status disparity function is a real-valued functiond :Sˆ× ˆS → R that associates each pair(gi, gj)∈ ˆS× ˆSwith a real number

d(gi, gj)=r(gi)−r(gj).

The absolute value |d(gi, gj)| is referred to as the social distance.

A social-status disparity function is analogous to a distance function (a metric) in math-ematics, but it differs in that it is allowed to take both positive and negative values. If the function takes a positive (negative) value for a pair of groups, the first is ranked higher (lower) than the second in social status. If there is little risk of confusion, we shall use

social status disparity and social distance interchangeably.

An individual’s orientation to social groups (for emulation or avoidance) is in general limited to a subsetS⊂ ˆS. Without loss of generality, let it be assumed that the elements of

S are ordered by the social-status ranking function with the larger subscript indicating the

higher social status, so that r (gi)>r (gj) if and only if i>j. We assume that no two groups in

S have an identical social status rank. With this convention, g1takes the lowest value r(g1) and gkthe highest value r (gk) among all gi∈S.

Suppose that group gm∈S is a group of an individual’s current belonging; the case of

multiple group belonging is excluded. From the vantage point of gm, the above disparity

function, when restricted to his relevant set S, takes its maximum value at some social group and its minimum value at some other group with all other groups taking their values in between.

Definition 2. Let an individual belong to a group gm∈S. For his relevant set of social groups,

S, define

δmin≡min{d(gi, gm):gi ∈S, i=1, . . . , k; gm is fixed},

δmax≡max{d(gi, gm):gi ∈S, i=1, . . . , k; gm is fixed}, and

Ω ≡ {d(gi, gm):gi ∈S, i=1, . . . , k; gm is fixed}.

are a solution under a given set of current and expected incomes and initial asset holdings

of all individuals (given also current and expected interest rates), then these consumption

values multiplied by a common positive factor are also a solution if all the income and

asset quantities in the set are multiplied by the same factor. This property follows directly

from the fact that the individuals’ utility functions are homogeneous of degree zero in

own consumption and assets over the planning horizon and current consumption of all

interdependent individuals (see Clower, 1951/52 for more general conditions).

While this homogeneity property describes consumer behavior in steadily growing

sit-uations, consumers in recessions do not easily retreat from the standards of living that the

preceding booms made possible. This reluctance causes consumption to be irreversible in

time with the saving–income ratio declining during recessions. Hence, over time one

ob-serves an upward drift of living standards, which gives rise to ratchet effects in the aggregate

consumption function.

The way our reaction function shifts over different phases of business cycles offers a

new perspective to such ratchet effects. Recall the economic principle underlying a reaction

function, which captures both the cost (risk) of trying something new and the cost of

gathering information about life styles of other social groups. These costs, as argued then,

increase symmetrically as functions of social distance. Call their composite the economic

cost function.

Changes in the position of the economic cost function affects the shape of a reaction

function, hence the degrees to which different statuses are sought or avoided. If the

econ-omy is steadily growing with rising current and expected incomes and asset positions, the

economic cost pressures will ease to allow more vigorous emulation of higher status groups.

Accordingly, an individual’s reaction function will have a wider spread and tilt more toward

higher status groups.

When a recession sets in, there will be contractions in current and expected incomes

and asset positions. Deviations from a current life style become costlier, and so does to

gather information on the life styles of various social groups. Such increased cost pressures

cause an individual’s reaction function to have a narrower spread with its hump centered

around the zero social status disparity. In a recession, therefore, an individual becomes less

aggressive at emulation and clings to what has already been achieved. As the economy

regains its normal growth, the cost pressures ease again to restore the reaction function to

its original position favoring a more vigorous emulation of higher status groups.

To explain Duesenberry’s ratchet effects, we combine this shifting of reaction functions

with the fact that an affluent society has an important pair of hierarchies ordered by social

prestige, status, or even cost. One is on goods, commanding that socially more prestigious

goods be costlier than less prestigious ones. The other is on income with higher income

commanding higher social prestige and status. Given these hierarchies, the income level of

an individual places him at a certain position in the income hierarchy, and he will choose

to live a life style fit to its social status. Where he is in the income hierarchy then dictates

the average prestige or costliness of goods to be consumed and the average committed

expenditure to live the chosen life-style.

As an individual climbs up the income ladder in booms, his reaction function shifts in

favor of more vigorous emulation of higher status groups, therefore, in favor of the life styles

that demand more prestigious goods. This raises both the average costliness of goods to be

consumed and the average committed expenditure required of new life styles. As income

declines in a recession, an individual’s reaction function slides back to its conservative

position, and there will be a tendency to adhere to the life style that has already been

achieved. This life style has a certain social prestige, requiring accordingly a certain level of

committed expenditures to sustain it. Thus, such shifting of an individual’s reaction function

over different phases of a business cycle, combined with the pair of hierarchies on goods and

income, can explain Duesenberry’s ratchet effects in the aggregate consumption function.

Other principles underlying the reaction function also contribute to such effects. For

instance, in a steadily growing full employment economy, one’s neighbors, friends, and

associates will be trying new commodities more frequently than in recessions. Therefore,

the amount of useful factual information passed on to individuals will increase. Moreover,

with more frequent attempts at something new, social sanctions against deviant behavior

will ease, which creates a more conducive environment to upper status seeking. Thus, the

communicational and sociological principles tend to reinforce the economic principle in the

shifting of the reaction function over business cycles. The ratchet effects, therefore, become

all the more plausible when the four principles are jointly considered.

8. Conclusion

We have attempted to characterize human behavior from three perspectives: bounded

rationality, the presence of social and cultural norms, and the formation of norm-guided

preferences. If decision makers are seriously bounded in their rationality, they will be

moti-vated to economize on economizing by turning to low-cost heuristics to otherwise complex

choice problems. In a society that features reference-group taking and success-oriented

cultural values, individuals are motivated to climb the social status ladder by making use

of the low-cost heuristics that are found in the life styles of their reference groups. We have

consolidated such social motives into a reaction function over relevant social groups and

discussed its underlying principles in terms of economic costs, social pressures, psychic

satisfactions, and communicational advantages that are involved in emulating and avoiding

of social groups. Convoluting this function with information about the whereabouts of

so-cial norms makes it possible to order choice objects by their overall serviceabilities to the

satisfaction of social want. When this ordering is combined with one based on the priorities

of physical wants, a comprehensive ordering of choice objects emerges that rationalizes

human behavior under bounded rationality.

In our view, preferences that are invariant to social and cultural structures of the

decision-making environment and which are independent of the boundedness of the decision maker’s

rationality are too restrictive to account for human behavior that features social orientation

and economization of economizing. If preferences were entirely idiosyncratic in nature,

social norms would not reproduce themselves. If individuals were assumed to possess

utility functions that favored certain social interactions, social norms might be explained,

after an infinite regress, as resulting from voluntary choices based on such functions, but in

that case the preference formation itself would remain independent of social and cultural

norms with the causation running from fixed preferences to social norms. The utility theory

of social norm formation, therefore, cannot account for the interaction between social norms

and the formation of norm-guided preferences, nor can it account for possible mechanisms

by which social and cultural norms are internalized into preferences of individuals.

We argue that the shaping of preferences that favor social orientation and the reproduction

of social norms reinforce each other through the formation of norm-guided preferences, and

that bounded rationality is instrumental to the formation of such endogenous preferences.

The traditional utilitarian individualism provides a micro-foundation of human behavior

that abstracts basically from social and cultural elements of decision making. Our view

that individuals internalize social and cultural norms into their preferences provides both

a macro- and a micro-foundation of human behavior in a socially and culturally structured

decision-making environment. The autonomy in decision making as well as in formation

of consistent preferences is retained at a micro-level while macro-phenomena of social and

cultural norms feed back into the formation of preferences that can account for the presence

and evolution of social norms. With such internalization, individual decision makers behave

in the middle ground between the complete voluntaristic individualism on the one extreme

and the structural determinism on the other — a view that answers Hodgson’s (1986) call

for a new theory of human behavior.

Acknowledgements

Many ex-professors, friends, and colleagues have helped me shape my thought on this

topic. I am particularly thankful to Paul H. Ray, with whom I exchanged views on many

oc-casions during period 1973–1974 at the University of Michigan. This exchange contributed

greatly to my first conceptualization of possible connections between social

interdepen-dence and bounded rationality (Hayakawa, 1973), which has evolved to take its present

form with the help of the present enormous literature on related subjects. I am also grateful

to Lester D. Taylor, W.H. Locke Anderson, Michael Manove, Suezo Ishizawa, Vai-Lum

Mui, Allan G. Sleeman, Hajime Miyazaki, John T. Sjöström, Koichi Futagami and many

others for their insightful comments and suggestions at various stages of the development. I

would also like to thank an anonymous referee of this journal for his suggestions. Needless

to say, all remaining shortcomings reflect only my own limitations.

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