Economics and Cognitive Science

I The neo-classical approach to analyzing the performance of an economy assumes that in the face of pervasive scarcity individuals make choices reflecting a set of desires, wants or preferences. The theory is derived from the aggregation of those preferences in the context of fixed resources, private goods, and given technology. (Schofield, 1995, p 192) The result has been a powerful set of tools to analyze resource allocation at a moment of time in developed economies under the assumption that the markets being modeled were governed by impersonal forces of supply and demand. The competitive model enshrined in general equilibrium theory makes a major contribution by demonstrating that a decentralized system of market forces would generate an efficient system of resource allocation. In this context beliefs played no role in decision making. But valuable as this model has been for the development of an elegant body of theory it is a very imperfect tool for solving economic problems both at a moment of time but particularly over time. Frictions--read transaction costs--arise from imperfect information and imperfect enforcement of agreements and markets are the creatures of political forces. In the real world of of imperfectly competitive markets beliefs determine the choices of the actors.Their motivation of isderived from their private information and expectations about price movements. Moreover since some goods are public goods--not only the traditional ones of national defense and public security--but in particular property rights and the rule of law they are traditionally created through the political system which entails not only knowledge about the preferences for such goods , but the incentives to produce them, given peoples beliefs about others' willingness to pay for them. Preference based models of either markets or elections are relatively simple. Beliefs, on the other hand, are anything but simple since they involve some description of how people learn, update, and model the world they live in. And it is modeling beliefs that is at the heart of all theorizing in the social sciences. Let us begin by modeling situations in which the substantive rationality assumption of the economist works well: consider choices in competitive posted-price markets.The chooser need only choose the quantity to buy or sell as the competitive environment so structures the situation that price can effectively be viewed as a parameter and only the quantity need be chosen. But as soon as we move away from this simple competitive model and the price depends on the behavior of other buyers and sellers the complexity of the decision increases. Indeed, the interesting issue that require resolution come from the interaction of human beings in economic, political and social markets. Knowledge of other people's actions and beliefs is an essential prerequisite to constructing useful models. But so too is a knowledge of their preferences since it is some melding of preferences and beliefs that determine choices. The strategic interaction of