What is a model? A model is a simplification of reality. It is NOT reality. Rather it represents reality. Hence, the model, whatever model, is wrong in that reality is different. What a model is used for is to explain or understand reality.
Theories on the Nature of Man (Largely from The Natures of Man--Michael Jensen)Without knowing how the participants will react to various situations and contracts we are severely hampered in our efforts to examine the actions and possible meanings of those in the financial system. Thus, we need a starting point, an encompassing theory that can be used to predict behavior across a wide variety of situations.
Jensen identifies 5 alternative models to describe human behavior
- Economic (Money-maximizing) Model---humans are short run money maximizers. They are only concerned with money. Are not willing to trade money for other things. Example:
- Sociological (Social Victim) Model--Humans are viewed as a product of their environment. They are conformists whose behavior is determined by tradition and customs.
- Psychological (Hierarchy of Needs) Model (most famous is Maslow's hierarchy of needs)
- Political (Perfect agent) Model--Humans are seen as perfect agents "seeking to maximize the 'public good' rather than his or her own welfare." This view is often behind governmental agencies whose staffs are supposed to act as perfect agents and only concerned with overall good. Similar to altruistic view except this is more encompassing, for example may be looking out for environment and not just people.
- Altruistic Model: Humans gain utility from helping others. Here people select a cause (and not just maximizing total good) and work for the attainment of that goal. Example Mother Theresa.
- Resourceful, Evaluative, Maximizing Model (REMM)
Often used in Marxism and socialism
Certain needs must be met before individual is willing to give up any of that item…Maslow did back off of this extreme view (ie with no substitution)
Postulate 1 Every individual is an evaluator-cares about everything and is willing to make tradeoffs and substitutions.
Postulate 2 Each individual's wants are unlimited…that is they can not be satiated
Postulate 3 Each individual is a maximizer. People want the highest utility possible.
Postulate 4 The individual is resourceful. They are creative and respond to changes in their environment.
In other words, people will look around their environment and do what they feel is in their own best interests. This is the central tenant to our study of human nature. It is not cynical, although people often interpret it as such, it is merely the view that we all must look out for ourselves. It does not mean that people will not derive benefits (utility) from helping others, rather that the reason people are willing to help others is because it also helps them by increasing their utility.
The ability to adapt to a changing environment is important. It is fascinating to see how this impacts human behavior. For example paying CEOs for growth will result in growth, paying them for stockholder returns will likely result in higher stockholder returns. (As evidence watch how fast behaviors change with the advent of a new tax loophole!).
Implications of REMM model:
No "needs"--always willing to substitute a large enough amount of X for Y
How we pay people matters
People will find ways around laws
Assuming that managers are people, managers will look out for themselves
Stockholders will interpret the actions of managers in light of REMM model
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