Stochastic learning theory, 242. — Probability matching: an example, 244. — The model, 247. — Alternative states of the market: a monopoly model, 252. — A simple market model, 254. — Further properties of the single-firm model, 256. — The dynamics of adjustment, 258. — The firm in disequilibrium, 261. — A final note: rules of thumb, 264.
elasticity of demand is less than one is entirely correct. It may be only a quibble, but it seems to me to be more appropriate to consider the rate of exchange between total profit, 7x, and the total waste, W, rather than the rate of exchange between Xr and the rate of inefficiency, X, as does Jaffee. It is a little misleading for Jaffee to maintain that the relationship between wastage and profit is a simple one to derive, and then follow up with a comparison of X7 and X: a different function entirely. My selection of W instead of X was not made inadvertently, but reflected my tendency to think along the lines of Williamson's emoluments, for which W (total emoluments) is surely the more relevant variable.' In a way, I suppose this remains a matter of taste since one can conceive of a managerial utility function with the rate of inefficiency used as an index of management comfort. Even so, I would expect the discomfort associated with reductions in X to vary positively with volume, and this leads back to W as the proper measure.
The Review of Economics and Statistics197961(2), 190
T HE purpose of this paper is to suggest that the contemporary microeconomic model of the could be adapted to incorporate a more realistic description of ordinary human behavior. For many years economists have tolerated the amalgam of good sense and bad psychology that characterizes microeconomic theory because of the empirical plausibility of its predictions. There is growing pressure to expand the limits of this theory, however, and it is becoming more common for empirical regularities to be explained in terms of variables which never have had a secure place in the theory, or which even may be in open conflict with it. This is exemplified by Houthakker's and Taylor's (1970) use of a consumer's stock of habits a variable in their demand equations, and by Katona's (1960) appeal to low levels of consumer confidence in his explanation of the observation that saving rates tend to increase in times of unusual inflation. It is possible that these are merely cases in which economists have taken unconventional lines on situations in which orthodox models still might work were one to introduce such addenda information costs and lags, expectations formation, transactions costs and the like. Nevertheless, it is intriguing to find that behavior which does not correspond to the simplest traditional models is frequently explained, not with these modifications, but instead with propositions of a psychological or quasipsychological character. There are a great many psychological theories that appear to hold promise for application to economics. Indeed, some cognitive theories of behavior have, at least in appearance, points in common with traditional maximization theory, although they are rarely meant to be taken literally economists are prone to take them. In many cases, it is difficult to apply these models to economic problenas (particularly in the case of cognitive models) because there does not seem to be any means for making their exogenous variables endogenous to economic environments. There are other psychological theories for which this difficulty is not evident, however, and the purpose of this paper is to investigate one of the simplest: stochastic learning theory it would apply to behavior. The work of James Duesenberry (1952) has already brought the relevance of learning processes to the attention of economists concerned with the nature of the consumption function, although his work antedates the development of most of the quantitative models of learning that now exist. An additional impetus for this research comes from compelling demonstrations of the practical relevance of learning theory to experimental economic settings in a series of studies performed by psychologists working in the area of simple reinforcement learning (i.e., reward-induced learning), an aspect of behavior which psychologists have subjected to extensive experimental study. One of the remarkable features of these studies is the complete absence of any characterization of the a rational, maximizing decision-maker, although the experimental results often correspond closely to what would have been expected on the basis of traditional economic theory. For example, in carefully controlled experiments in artificial (token) economies, Ayllon and Azrin (1966) were able to demonstrate downward-sloping demand curves, upward-sloping supply curves (including the suggestion of a backward-bending supply curve), supply-demand equilibrium prices, and even the purchase of franchises. Often, such results are interpreted empirical support for the positivistic proposition that individuals behave as if they were utility maximizers. It is often the case, however, that learning experiments turn up phenomena that are quite difficult to reconcile with the maximization model. One such example occurs in Ayllon's and Azrin's work on the impact of advertising on consumption decisions. Their experimental procedure was to provide free samples: small quantities of those goods or services that were to be advertised. For a wide variety of items, the provision of these free samples was found to Received for publication August 31, 1977. Revision accepted for publication May 4, 1978. * University of Michigan. The author would like to thank John Fitts, Robert S. Holbrook and Sidney G. Winter for their comments upon earlier drafts of this paper.