Modern economic theory: network notion is necessary

Greg Fisher:

“Modern economic theory was first set out on a formal basis in the late 19th century. There have certainly been developments since then, but at heart the basic view in economics of how the world operates remains the same. Economics is essentially a theory of how decisions are made by individuals, of what information is gathered and how it is used by the decision maker.

All scientific theories, even quantum physics, are approximations to reality. Theories involve making assumptions, simplifications, to enable us to understand problems better. A key feature of a good theory is that its assumptions are a reasonable description of the real world.

In the early 21st century, just as it did in the late 19th, economics in general makes the assumption that individuals operate autonomously, isolated from the direct influences of others. A person has a fixed set of tastes and preferences. When choosing amongst a set of alternatives, he or she compares the attributes of these alternatives and selects the one which most closely corresponds to his or her preferences.

At first sight, this may seem quite reasonable, indeed even ‘rational,’ as economists choose to describe this theory of behaviour. But there is a serious problem with the assumption that individuals operate in isolation from each other, that their preferences are not affected directly by the decisions of others. If I am interested in buying a product which many people want, the price may go up. So their choices affect me indirectly through the workings of the market. But my preferences remain unaltered.

The social and economic worlds of the 21st century are simply not like this at all. We are far more aware than ever before of the choices, decisions, behaviours and opinions of other people. In 1900, not much more than 10 per cent of the world’s population lived in cities. Now, for the first time in human history, more than half of us live in cities, in close, everyday proximity to large numbers of other people. In the last decade or so, the internet is revolutionising communications in a revolutionary way not experienced since the invention of the printing press in the late 15th century.

The assumption that people make choices in isolation, that they do not adopt different tastes or opinions simply because other people have them, is no longer sustainable. Perhaps – perhaps, and it is a big ‘perhaps’ – over 100 years ago this might not have been a bad assumption to make. But no longer.

The choices which people make, their attitudes, their opinions are influenced directly by other people. The medium across which this influence spreads is social networks. Often, social networks are thought of as purely a web-based phenomenon, sites such as Facebook. These indeed can influence behaviour. But it is real-life social networks, family, friends, colleagues, which are even more important in helping us shape our preferences and beliefs, what we like and what we do not like.

Network effects have in fact been pervasive throughout human history. A crucial feature of human behaviour is our propensity to copy or imitate the behaviours, choices, opinions of others. We can see it in the fashions in pottery in the Middle Eastern Hittite Empire of three and a half millennia ago. And we can see it today in the behaviour of traders on financial markets, where the propensity to follow the herd can lead all too easily to the booms and crashes we have experienced. Scientists such as Robin Dunbar have argued that our anomalously large brain, compared to other mammals, evolved precisely because copying is a very successful strategy to follow from an evolutionary perspective“.

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