• Antal Ertl

Having More and Having Enough – The Theory of Satisficing Utility

Oftentimes when we think of economics, the first thing that comes to our mind is utility. Although hedonistic utilitarianism (i.e. Bentham’s formulation of maximizing pleasure and minimizing pain) can be traced back to the XVIII century, it is still widely considered to be the best measurement of well-being coming from any sort of economic transaction. In Kenneth Arrow’s words: “The implicit ethical basis of economic policy judgement is some version of utilitarianism” (Arrow, 1973, pp.246).

The basic idea of utility has already been studied by David Hume, Adam Smith, and many other renowned economists, who agreed that, in general, actions, certain deeds, or the acquisition of goods can cause a feeling of pleasure, which can be used as a powerful encouragement. In their turn, Pareto and Slutsky stated that individuals are prone to rank their decision options, thus giving a greater role to preferences in decision-making. Developing this theory further, Daniel Bernoulli – and later von Neumann and Morgenstern (1944) – argued that individuals tend to maximize their utility while dealing with risk and uncertainty. But what if economic agents are not looking to extensively maximize their “utility functions”?

The Argument of Herbert A. Simon

Simon (1958) criticized the idea of maximizing utility in a number of ways, including:

- considering imperfect market conditions, utility maximization in such an environment is an   “ambiguous goal”,

 - in utility maximization, there may be a number of factors other than financial income (which he calls “psychic income” – although if we include this in the model, the definition of profit-maximization becomes equivocal),

 - and most importantly, what if our economic agent just wants to realize a decent return, and does not want to maximize it?

The latter point brings us to an interesting argument: our economic agents only want to reach a certain utilitarian reference point, which is below the theoretical maximum. Psychologists have been conducting extensive research on the effort that agents make in order to reach certain goals. Results show that if one’s performance does not succeed in reaching one’s desired goal, agents tend to make two distinct actions:

  (a) they increase their performance (or effort), in order to get closer to the reference point (this can be done by the so-called “search behaviour”, where other alternative actions are considered), and/or

  (b)  they start to diminish their goal; it can be argued that this is a natural mechanism to minimize our feelings of failure and frustration that come with it.

If our performance and our goal do not come into balance in the long run, a certain cognitive dissonance comes into play: the “rational, adaptive behaviour” gets replaced by actions driven by emotions, such as insensitivity, aggression, or envy.

Let’s say that your goal is to earn $1000 every month. On the 21st day of the month, you realize that you will only earn $900 because you’ve been sick for a couple of days. In this case, (a) you increase your effort (by working late in the office, thus getting some of that desired overtime payment), and/or (b) you lower your expectations to, say, $950.

This argument can be further used in the business world – companies don’t carefully calculate what their maximum expected profit by each product and service could be. In reality, it appears to be the other way around: first, they set out a somewhat realistic goal to achieve (based on market and shareholder expectations), and then they make plans and strategies to achieve them.

Consequently, the role of a reference point is very important. Your reference point can be linked to the payment of other people, or it can be an “internal reference point” – say, your previous payments. An argument can be made that the latter is better for your mental health: constantly comparing yourself to others can bring on the feelings of envy, which, in the long run, can decrease your ability to think and decide rationally.

Business Implications

The business applications of the satisficing theory are far-reaching due to the fundamental insights it provides concerning human behaviour. One prominent example is in the context of negotiations: during negotiations, parties, after identifying the best offer that the corresponding party will accept, form reference points which dictate the direction of the negotiations. Accordingly, communicating higher expected offers prior to the negotiations can increase the offered amount. Inevitably, there are other factors in play, such as the bargaining power (if you have the relative advantage) or intimidation. However, the implications of satisficing are most significant in the realm of consumer behaviour. For instance, even if a perfect product exists, consumers will not seek to continue the search for that product, once another “good enough” substitute is found. Therefore, for consumers, an approximation to the needs replaces exact satisfaction in reaching a decision. 

Further Readings:

Arrow, K.J. 1973. Some ordinalist-utilitarian notes on Rawls’s theory of justice. Journal of Philosophy 70: 245–263.

Festinger, L. (1954): A Theory of Social Comparison Processes Human Relations Vol 7, Issue 2, pp. 117 – 140.

Hoffman, P. J., Festinger, L., and Lawrence, D. H.(1954): Tendencies Toward Comparabi-lity in Competitive Bargaining, Human Relations,1954, 7, 2.

Kahneman, D, Tversky, A. (1979) Prospect Theory: An Analysis of Decision under Risk. Econometrica, Vol. 47, No. 2. 263-291.

Schelling, T. (1956). An Essay on Bargaining. The American Economic Review, 46(3), 281-306.

Simon, H. A. (1959): Theories of Decision-Making in Economics and Behavioral Sciences. American Economic.Review., vol. 49, pp.253-83.

von Neumann, J.& Morgenstern, O. (1947) Theory of Games and Economic Behavior Prin-ceton, NJ: Princeton University Press, 194.

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