Reconciling Normative and Behavioral Economics: An Application of the “Naturalistic Approach” to the Adaptation Problem

Summary While standard economic theory takes individual preferences as stable and “given”, i.e., independent of situational context, real-world preferences tend to vary with changing opportunity sets. This is exemplified by Aesop’s fable of the fox and the sour grapes. This phenomenon of “adaptive preference formation” poses a vexing problem for normative economics: preferences which constitute the measuring rod for welfare are in turn shaped by the (economic) situation of the individual, leading to problems epitomized by Amartya Sen’s “hopeless beggar” dilemma: The beggar, enduring objectively miserable circumstances, nonetheless claims to have all his preferences satisfied, which would lead orthodox welfare economics to establish a high level of well-being. For those who find this counterintuitive, different solutions for the “adaptation problem” have been proposed in the literature, typically centering on highly demanding rationality and information requirements. We argue that, in order to cope with this and related problems of preference endogeneity, welfare economics rather needs to account for recent psychological insights into the mechanisms that drive preference formation and change. We then use these insights to suggest and apply a procedural criterion of autonomous preference formation.