Microeconomics:
Behavior, Institutions, and Evolution

Samuel Bowles

Princeton University Press 2004
A book review by Danny Yee © 2011 http://dannyreviews.com/
Microeconomics: Behavior, Institutions, and Evolution is by far the best microeconomics text I have found. Though it preserves the standard approach of a textbook, building up a toolkit of modeling methods and concepts, it goes beyond that in its ambitions, attempting a survey of modern microeconomics as a work in progress. ("Our understanding of microeconomics is fundamentally in flux. Little is settled. Nothing is complete.")

The subtitle gives an idea of the ways in which Bowles' approach differs from most microeconomics texts. He incorporates ideas and results from behavioural and experimental economics, not just as add-ons but foundationally. He understands the importance of institutions for providing frameworks within which individuals act, and which themselves change. And he takes a historical and evolutionary perspective, using game theory and replicator dynamics as well as equilibrium analyses.

Bowles avoids fetishization of the mathematics, emphasizing qualitative features, not getting hung up on analytic results, and being prepared to use simulations. His models are elegant and powerful and general, but their assumptions and limitations are always carefully considered; he is historically and sociologically aware, keeping the complexity of reality in view even as he collapses it. And he illustrates his theory with interesting and diverse examples, from Ibn Battuta to slime moulds and lobster fishermen.

Part one presents tools and ideas of quite general application for understanding social interactions.

Starting with the basics of coordination and conflict, Bowles introduces the Tragedy of the Fishers (a simple prisoner's dilemma) and the Assurance Game. This is also a rapid introduction to game theory and concepts such as Nash equilibria and Pareto-efficiency.

Turning to the possibilities of self-organisation, Bowles introduces the idea of an evolutionary social science based on replicator dynamics, with an example of residential segregation. He then introduces evolutionary stable states and builds a model for the evolution of property rights, suggesting that these could have evolved spontaneously. Stepping back a little, he considers how much of actual historical processes such models may capture, and how well replication-selection works in finding optima — in this case, efficient institutions.

Conventional theory gets from preferences to behavior by the maximisation of expected utility. If "extended to cover risk and intertemporal choice" this approach appears quite general, but empirical studies reveal some major problems. Preferences are situation dependent, individuals are adaptive agents with limited cognitive powers, and social experiments reveal that self-interest doesn't always prevail. Attempts to improve our models using prospect theory, or by incorporating inequality-aversion and reciprocity, are still works in progress.

Looking at coordination failures, Bowles models the Tragedy of the Fishers and Team Production problems. This leads to a general taxonomy of coordination problems, with three approaches to solutions: imposition of a "binding participation constraint" with allocation at a Pareto optimum, modification of the underlying interaction (perhaps by Pigouvian taxes) so that prices capture all interaction information, or enabling of social preferences as a substitute for complete contracting. Differences between the players can assist solutions but can also impede cooperation.

Dividing the gains from cooperation involves bargaining. The Nash solution here is not realistic ("Nash wanted to characterize a good bargaining outcome; he did not intend the model to illuminate real world bargaining processes") and an "alternating offers" model, with endogenous bargaining powers, has its own shortcomings. Bowles lookes at work on rent seeking, bargaining inefficiencies, and bargaining breakdowns induced by conflicts of interest. He suggests better models will need to recognise that: "bargaining behavior is influenced by the bargainers' fairness concerns and other distributional norms ... we need to explain bargaining power rather than assume it ... bargainers typically have very incomplete information about the preferences and other aspects of their opponents".

Part two considers aspects of competition and cooperation in the context of the institutions of capitalism.

Bowles starts with "Utopian Capitalism", with the Fundamental Theorem of Welfare Economics and the Coase theorem. These model abstract, utopian limiting cases and though they have often been taken as normal their assumptions are not approximated in real economies. But "the fact that Walrasian general equilibrium theory has not adequately modeled a decentralized process of competition does not detract from its central contribution to clarifying the conditions under which Smith's invisible hand reasoning might be at least approximately correct".

When it comes to exchange, "contractual incompleteness is the rule rather than the exception". Bowles explores how norms develop and are maintained, using game theory to model retaliation and repetition (tit-for-tat), segmentation, and reputation. He also considers asymmetric information and principal-agent relationships, and evidence from experimental studies for the relationship between incomplete contracts and behaviour. More abstractly: "The underlying process jointly determines the distribution of contracts and the distribution of behavioral norms in the population, a dynamic sometimes termed the coevolution of institutions and preferences."

Bowles constructs a fairly standard model of the employment relationship in a single firm. He goes on to look at general equilibrium with multiple firms, bargained Pareto improvements, why firms don't sell jobs, and some empirical evidence about labour discipline and incentives.

Wealth has qualitative and not just quantitative effects on the operation of markets.

"The most obvious reason why wealth influences contractual form is that only those with sufficient wealth can undertake projects on their own account. Those with sufficient wealth to do this can assign to themselves full rights both of residual claimancy and control over the relevant assets. They thereby eliminate costly incentive problems."

Bowles models credit and constraints on credit, and their implications for risk aversion, ownership and allocative efficiency. There is the possibility here that "government mandated transfers of property may implement efficiency improvements that would not have come about by voluntary exchange".

A look at the history of cooperatives leads in to four candidate explanations for why control rights in firms tend to be held by suppliers of capital rather than suppliers of labour — why capital hires labour rather than vice versa — but it remains unclear exactly "why control rights confer power". Exploring representations of power and models for the distribution of wealth and contracts, Bowles hints at extending the theory of incomplete contracts to provide a microeconomic foundation for the concept of class.

"Given the benefits of specialization and economies of scale, economic activity is necessarily social rather than individual, and the types of institutional arrangements governing production and exchange reflect the fact that the conflicts of interest among the participants are governed by incomplete contracts. The combined effect of incomplete contracts and conflicts of interest is that the determination of outcomes depends on who exercises power in the transaction. Power is generally exercised by those who hold the residual rights of control, meaning the right to determine what is not specified contractually."

Part three turns towards models for the coevolution of preferences and institutions.

"Economic institutions impose characteristic patterns of interaction on the people who make up a society, affecting who meets whom, on what terms, to perform which tasks, and with what expectations of rewards. These allocation rules and cultural transmission processes influence the way people update their behaviors, affecting personality, tastes, identities, values, and beliefs."

Bowles builds a replicator model, with both within-group and between-group selection, for competing Hobbesian and Rousseauian equilibria in mobile foraging bands. This is then extended to modeling "the first property rights revolution", which he suggests was driven by technological changes associated with the shift to agriculture.

To consider change in institutions more generally, Bowles uses stochastic evolutionary game theory, with random non-best (idiosyncratic) play and the possibility of shifting equilibria. This allows the possibility of collective, intentional "non-best response" in an attempt to change equilibria, with "a model of the coordination problem posed by collective action, nested in the larger population game representing institutional evolution".

Modelling the coevolution of institutions such as resource-sharing and segmentation, Bowles develops a moderately complex multi-agent simulation which incorporates between-group conflicts, multi-level selection, and migration. He considers how such a model may capture something of the dynamics of human history and the empirical evidence for its features. (These three chapters are the starting point for Bowles' more recent book A Cooperative Species: Human Reciprocity and Its Evolution.)

A final chapter considers the implications for economic governance of an evolutionary social science (dynamics and coevolution) rather than Walrasian approaches (methodological individualism and equilibrium analyses). When it comes to implementation, Bowles emphasizes finding the right balance between communities, markets and states in different contexts. He concludes with some speculation that "the information-intensive economy of the future may more closely resemble the economy of the mobile foraging band in human prehistory rather than the economy of grain and steel that displaced it".

There are thirty pages of problems at the end of Behavior, Institutions, and Evolution. These are fairly complex multi-part scenarios, designed to make one think about core ideas, rather than simple applications of results.

Microeconomics is not hugely technical, using only simple calculus, but what mathematics it does use is presented succinctly, with ideas introduced at a brisk pace and at a high level of abstraction. It could be read by undergraduates or lay readers, but it really assumes some previous exposure to formal microeconomic thinking — and familiarity with game theory or evolutionary models would also help. Bowles writes in his introduction that it is "intended for use in graduate-level microeconomics courses". The problem is that by that point economics students in many institutions are likely either to have been indoctrinated into Walrasian orthodoxy or to have given up on economics and switched to biology or engineering.

November 2011

External links:
- buy from Amazon.com or Amazon.co.uk
Related reviews:
- Samuel Bowles - A Cooperative Species: Human Reciprocity and Its Evolution
- Samuel Bowles - Meritocracy and Economic Inequality
- books about economics + finance
- books published by Princeton University Press
- other "best book" selections
%T Microeconomics
%S Behavior, Institutions, and Evolution
%A Bowles, Samuel
%I Princeton University Press
%D 2004
%O paperback, problems, references, index
%G ISBN 0691126380
%P 584pp