Rational Choice Theory

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What Is Rational Choice Theory?

Rational choice theory states that individuals use rational calculations to make rational choices and achieve outcomes that are aligned with their own personal objectives. These results are also associated with an individual’s best, self-interests. Using rational choice theory is expected to result in outcomes that provide people with the greatest benefit and satisfaction given the choices they have available.  https://content.jwplatform.com/players/Co0E9gxg-yJSCzke2.html

Understanding Rational Choice Theory

Many mainstream economic assumptions and theories are based on rational choice theory. Rational choice theory is often discussed and associated with the concepts of rational actors, the rationality assumption, self-interest, and the invisible hand.

Rational choice theory is based on the assumption of involvement from rational actors which are the individuals in an economy making rational choices based on rational calculations and rationally available information. Rational actors form the basis of rational choice theory and are what make rational choice theory effective. Rational choice theory assumes that individuals are rational actors using rational information to try to actively maximize their advantage in any situation and therefore consistently trying to minimize their losses.

Economists may use the rationality assumption as part of broader studies seeking to understand certain behaviors of society as a whole. The rationality assumption assumes that all individuals under consideration are expected to be rational actors making rational choices based on rational choice theory to achieve the very best results for themselves and their own self-interests.

Key Takeaways

  • Rational choice theory states that individuals rely on rational calculations to make rational choices that result in outcomes aligned with their own best interests.
  • Rational choice theory is often associated with the concepts of rational actors, the rationality assumption, self-interest, and the invisible hand.
  • Many economists believe that the factors associated with rational choice theory are beneficial to the economy as a whole.
  • Rational choice theory is often dominate across behavioral economics but there are many economists who also study irrational choices.

Self-Interest and the Invisible Hand

Adam Smith was one of the first economists to develop the ideas of rational choice theory through his studies of self-interest and the invisible hand theory. Smith discusses the invisible hand theory in his book “An Inquiry into the Nature and Causes of the Wealth of Nations,” published in 1776.

The invisible hand theory is first built on the actions of self-interest. The invisible hand theory and later developments in the rational choice theory both refute negative misconceptions that may be associated with self-interest. Instead, these concepts suggest that rational actors acting with their own self-interests in mind can actually create benefits for the economy at large.

The invisible hand theory is based on self-interest, rationality, and the rational choice theory. The invisible hand theory states that individuals driven by self-interest and rationality will make decisions that lead to positive benefits for the whole economy. Therefore, economists who believe in the invisible hand theory lobby for less government intervention and more free-market exchange opportunities.

Arguments Against Rational Choice Theory

There are many economists who do not believe in the rational choice theory and are not proponents of the invisible hand theory. Dissenters have pointed out that individuals do not always make rational utility-maximizing decisions. Therefore, across the field of behavioral economics economists can study both the processes and results of rational and irrational decision making.

Nobel laureate Herbert Simon proposed the theory of bounded rationality, which says that people are not always able to obtain all the information they would need to make the best possible decision. Moreover, economist Richard Thaler’s idea of mental accounting shows how people behave irrationally by placing greater value on some dollars than others, even though all dollars have the same value. They might drive to another store to save $10 on a $20 purchase but they would not drive to another store to save $10 on a $1,000 purchase.

An Example Against Rational Choice Theory

While rational choice theory is logical and easy to understand, it is often contradicted in the real world. For example, political factions that were in favor of the Brexit vote held on June 24, 2016, used promotional campaigns that were based on emotion rather than rational analysis. These campaigns led to the semi-shocking and unexpected result of the vote, when the United Kingdom officially decided to leave the European Union. The financial markets then responded in kind with shock, wildly increasing short-term volatility, as measured by the CBOE Volatility Index (VIX).

Further, research conducted by Christopher Simms of Dalhousie University in Halifax, Canada, shows that when people are anxious, they fail to make rational decisions. Stressors that produce anxiety have been shown to actually suppress parts of the brain that aid in rational decision making.

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