What Is Homo Economicus?

Homo economicus is a financial term that some economists use to describe a rational human being. 

Key Takeaways

  • Homo economicus is a model for human behavior, characterized by an infinite capability to make rational decisions.
  • The model is generally used in economics and was first proposed by John Stuart Mill in an 1836 essay defining the characteristics of political economy.
  • Modern research has proved that the theory of an economic man is a flawed model.

Understanding Homo Economicus

Homo economicus, or economic man, is the figurative human being characterized by the infinite ability to make rational decisions.

Certain economic models have traditionally relied on the assumption that humans are rational and will attempt to maximize their utility for both monetary and non-monetary gains. Modern behavioral economists and neuroeconomists, however, have demonstrated that human beings are, in fact, not rational in their decision making, and argue a "more human" subject (that makes somewhat predictable irrational decisions) would provide a more accurate tool for modeling human behavior.

Origins of Homo Economicus

The origins of the economic man lie in an essay about political economy by John Stuart Mill in 1836. The essay, which was titled "On the Definition of Political Economy and on the Method of Investigation Proper to It", attempted to assign characteristics to subjects under consideration for the new field.

Mill's subject was a "being who desires to possess wealth, and who is capable of judging the comparative efficacy of means for obtaining that end." He stated that political economy abstracts other human motives, except for those that help the hypothetical being in his pursuit of wealth.

Luxury is considered part of the being's desires, as well as producing babies. The economic man's tastes and propensities are also passed on from one generation to another, according to Mill. In Mill's model, a parent with a taste for luxury might have children who possess similar tendencies.

Limitations of Homo Economicus

History and various economic crises over the years have proved that the theory of an economic man is a flawed one. Daniel Kahneman, an Israeli-American psychologist and Nobel laureate, and Amos Tversky, a leading expert in judgment and human decision making, founded the field of behavioral economics with their 1979 paper, "Prospect Theory: An Analysis of Decision under Risk."

Kahneman and Tversky researched human risk aversion, finding that people's attitudes regarding risks associated with gains are different from those concerning losses. Homo economicus, and the idea that humans always act rationally, is challenged by risk aversion. Kahneman and Tversky, for example, found that if given a choice between definitely getting $1,000 or having a 50% chance of getting $2,500, people are more likely to accept the $1,000.

Example of Homo Economicus

The most common example provided of homo economicus is that of a businessperson.

The businessperson seeks to eke out profits from each transaction and decision. For example, they may automate operations and lay off workers in order to maximize productivity. Similarly, they might get rid of non-performing parts of their business to focus on the ones that generate profits.

A homo economicus being brings the same rationality to their dealings in other spheres of life. But the theory falls short in explaining the rationale behind some seemingly irrational decisions. For example, rationality should dictate that the rational business person should use profits from their business to live a fairly frugal existence. But that is not always the case. The prevalence of luxury items and philanthropy are direct refutations of the theory.