Homo Economicus

Homo Economicus is a term used to describe the rationalism of human beings, also known as economic human economicus, showing an ability of a human being to make rational economic decisions in their day-to-day life, fulfilling their wants, desires, and needs in an optimal manner, which is required since various economic theories assume that the person is a rational individual.

Homo economicus assumptions state that a human being would always take decisions that would give them both monetary and non-monetary gains. John Stuart Mill first introduced this theory in an essay on political economy. In this theory, an individual’s self-interest takes precedence over their thought, action, and behavior.

• Homo Economicus, also known as economic man, represents the concept of human rationality in economic decision-making.
• It assumes that individuals can make logical and optimal financial choices to satisfy their needs and desires. This assumption is foundational in many economic theories.
• According to the Homo Economicus model, people consistently act in their self-interest, making choices that maximize their financial and non-financial benefits. This idea was initially outlined by John Stuart Mill in a political economy article, emphasizing that self-interest guides human thoughts, actions, and behaviors.

The term homo economicus considers a human in social science, particularly in economicus, capable of making rational decisions for themselves, seeking their best interest in every particular aspect like bargaining, consumption, saving, purchasing, selling, making investment decisions, etc.

Sociologists, psychologists, behavioral economists, etc., play a very important role in the concept of homo economicus. They help a person make rational decisions in case of certain critical circumstances.

The origin of an economic man has been discussed in a book where the author states that the political economy usually abstracts human motives. The author further explains that if the parent prefers a high-quality life, the next generation will most probably have the same preference. At the same time, the taste and propensities of the individual are passed on from one generation to another.

The idea of homo economic might change due to a change in risk aversion, thus, if the person is highly risk-averse, even though it is rational to act in a particular way, they might not act in that same manner.

It is very clear that this theory has proved so many theories that can help theories reach a particular conclusion. Further, the concept of home economicus has been criticized by many economists so far, which may be considered while making a particular decision. On the other hand, this theory forms the very basis of economicus and cannot be ignored completely.

Let us understand the homo economicus behavior in depth with the help of a couple of examples.

Example #1

Suppose there are two markets in a particular location. In both, a particular market product is getting sold. In market 1, the product is sold at $500 while the same product is sold in market 2 at $700. If that economic theory is true, the person will always choose to buy the product from market 1. When a person buys a product in market one, there is a next saving of $200. It is known as a rational decision.

Example #2

Let us assume that the two markets are in different locations and one is located in another state. In contrast, the market is located in the same state as the customer. Transportation cost from market 1 to the customer's home is $ 300. In this situation, the customer would buy the product from the market instead of the market one since the overall cost of purchasing the product from the market is $800, including the transportation charges, which will make him incur a loss of $100 instead of making a net saving of $200.

Let us understand the advantages of homo economicus assumptions and how it helps investors, citizens, and leaders of the economy understand consumer behavior and beyond.

• The concept of homo economicus is widely used as an assumption in various theories of economicus. This concept helps various economists prove their concepts better and helps make various decisions of the economy like demand and price, consumption habits of the people, etc.
• The concept of the national economy has been used in the theory of demand to protect the demand based on various price levels. Hence it helps to use the linear demand curve, i.e., a higher price may reduce the demand to the lower level.
• The model of a perfectly competitive market assumes a rational man and that the demand of the same is maximum at a given level of price and will highly respond to a change in price.

As mentioned above, the theory has its own flaws. Let us understand the disadvantages of a homo economicus behavior through the points below.

• People's attitudes towards a particular product may change due to connected losses regardless of the risk and gains involved. Hence the theory of economic man or homo economicus may be disadvantageous to use
• The theory of rationalism would be of no use in a situation of luxury items. Even though it costs more to a person, luxury items make a person make irrational decisions.
• Homo Economicus may prove to be a theoretical concept or theory. This theory says that humans are self-interested and have perfect knowledge about various markets. They know what they want and how they want, which is not purely possible in practical life.

Let us understand the limitations of the homo economicus assumptions which have received criticisms from multiple economists. The discussion below would help us understand the concept in depth.

• It may be such that people are not always self-centered. People may make decisions not for their benefit, not for making maximum benefits for themselves. Hence there are circumstances where decisions are taken based on social preferences instead of our own, even though it is not incurred by minimizing the costs.
• Sometimes, decisions are taken under uncertain circumstances. Also, certain decisions are taken without proper or incomplete knowledge. In that case, the decisions taken by a person may be irrational. Hence homo economic definition does not get proved in those circumstances.
• It may happen that certain situations make a person lose self-control, making them make wrong or irrational decisions.
• The taste and preference of a person tend to change over time. Hence a change in a person's preference makes them decide, which they might not have taken before.
• Hence, the homo economic definition might prove to be a limited concept due to changes in the preference of human beings.
• Gift-giving has always been a very important part of social interactions. We offer them to people with an expectation of better welfare, fame, and relations.

This has been a guide to Homo Economicus & its definition. Here we explain examples of Homo Economicus along with advantages, disadvantages, & limitations. You can learn more about finance from the following articles –

• Open Market Operations
• Equity in Economics
• Consumption Function
• Mixed Economic System
• Formulas in Economics