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Summary - rational decision making
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A summary of my own personal notes on rational decision making and economically irrational behaviours. Includes definitions and examples.
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Micro EW NotesRational Decision Making
Economic Agents - Producers, Consumers, Workers, Governments, Special Interest Groups
- When analysing markets, a range of assumptions are made about the rationality of economic
agents involved in the transactions
- In Classical Economics, the word ‘rational’ means that economic agents are able to consider
the outcome of their choices and recognise the net bene ts of each one.
- Consumers are assumed to act rationally. They do this by maximising their utility
↳ Utility - The satisfaction gained from a good or service
- Producers are assumed to act rationally. They do this by selling goods/services in a way
that maximises their pro ts.
- Governments are assumed to act rationally. They do this by placing the interests of the
people they serve rst in order to maximise their welfare.
- The assumption of Rational Decision Making is awed.
- Consumers don’t purchase something based on a rational computation of net bene ts
- ↳ They purchase based on emotional decisions
Economically Irrational Behaviours
- Can be seen where consumers may not react to a price change
↳ Due to people displaying ‘habitual behaviour’ → persistence, even if this is costly
Habitual Behaviour - where consumers persist in acting a particular way even when conditions
have changed
↳ E.g Gym Membership - good intentions of remaining t however, they cannot be bothered to
go to the gym and have other things to do and yet, they still pay the gym membership.
Individual consumers may exhibit herding
↳ where people take decisions based on the actions of others, rather than on a rational
evaluation of the situation that they face
Bounded Rationality - a situation in which people’s ability to make rational decisions is bounded
by a lack of information or an inability to interpret the information that is available, perhaps
because of a weakness of computation.
Nudge Theory - analysis that suggests that people’s behaviour can be in uenced by making
desirable decisions easy to be made.
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