What is Rational Choice Decision Making?
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Last updated 14 Jul 2023
Rational decision-making can be described as a process of selecting the best option or course of action based on a careful and logical evaluation of the costs, benefits, and risks associated with each potential choice.
Rational decision-making is based on the assumption that people have well-defined goals and that they are able to calculate and compare the potential costs and benefits of different options in order to choose the one that is most likely to achieve their goals. It is a logical and systematic process that is designed to minimize risk and maximize the chances of success.
Rational decision-making is often contrasted with bounded rationality, which refers to the idea that people's ability to process information and make decisions is limited by their cognitive abilities and the time and resources available to them. As a result, people do not always make fully rational decisions and may rely on rules of thumb, heuristics, and other mental shortcuts to simplify complex problems.
Here are four examples of rational choice:
- Choosing the most cost-effective mobile phone plan: A consumer might compare the costs, coverage, and features of different cell phone plans in order to choose the one that offers the best value for their needs.
- Choosing the best investment option: An investor might consider the potential returns, risks, and fees associated with different investment options in order to choose the one that is most likely to achieve their financial goals.
- Choosing the most efficient production process: A firm might analyze the costs and benefits of different production processes in order to choose the one that is most efficient and cost-effective.
- Choosing the best healthcare plan: An individual might compare the costs, coverage, and quality of different healthcare plans in order to choose the one that offers the best value for their needs.
When might people move away from rational choice?
There are a number of factors that can lead people to deviate from rational choice, or to make decisions that are not fully rational. These factors can include cognitive biases, emotional factors, and external constraints on decision-making.
Cognitive biases are systematic patterns of thinking that can lead people to deviate from rational choice. For example, people may be influenced by confirmation bias, which means that they are more likely to seek out and believe information that supports their existing beliefs, or by the sunk cost fallacy, which means that they are more likely to continue pursuing a course of action even if it is no longer in their best interests because they have already invested time or resources in it.
Emotional factors can also influence decision-making and lead people to deviate from rational choice. For example, people may make decisions based on their feelings of fear, anxiety, or hope, rather than on a logical evaluation of the costs and benefits of different options.
External constraints on rational choice
External constraints on decision-making, such as time or resource limitations, can also lead people to deviate from rational choice. For example, people may not have the time or resources to fully research and evaluate all of the options available to them and may instead rely on heuristics, or mental shortcuts, to simplify the decision-making process.
Examples of people following heuristics
Here are examples of people following heuristics:
- The availability heuristic: People may rely on information that is readily available to them, even if it is not necessarily the most accurate or relevant. For example, a person may make a decision about the safety of a particular type of car based on news reports of accidents involving that type of car, even if the actual accident rate is low.
- The representativeness heuristic: People may rely on stereotypes or assumptions about the likelihood of an event based on its similarity to other events. For example, a person may assume that a particular stock is a good investment because it has performed well in the past, even if there are no guarantees that it will continue to perform well in the future.
- The anchoring and adjustment heuristic: People may make decisions based on an initial reference point, or anchor, and then adjust their judgment based on additional information. For example, a person may make a low initial offer when negotiating the price of a car, and then adjust their offer based on the seller's counteroffer.
Why is rational choice a default assumption in many economic models?
Rational choice is often assumed in many economic models because it allows economists to build models that are simple and easy to analyze and understand. By assuming that people are rational and that they make decisions based on a careful and logical evaluation of the costs, benefits, and risks associated with each potential choice, economists can build models that are based on clear and consistent assumptions about how people behave.
Economists who have challenged rational choice
Some of the economists who have challenged the assumption of rational choice include:
- Daniel Kahneman and Amos Tversky: These two psychologists conducted a series of influential experiments in the 1970s and 1980s that demonstrated the existence of cognitive biases, or systematic patterns of thinking that can lead people to deviate from rational choice. Their work laid the foundation for the field of behavioral economics, which studies how people's decision-making is influenced by psychological, emotional, and social factors.
- Herbert Simon: This economist argued that people's decision-making is often bounded by their cognitive abilities and the time and resources available to them, and that as a result, people do not always make fully rational choices. Simon's work on bounded rationality influenced the development of behavioral economics and has had a significant impact on our understanding of how people make decisions.
- Richard Thaler: This economist has conducted extensive research on behavioral economics and has argued that people often deviate from rational choice due to the influence of psychological and social factors. Thaler has developed a number of ideas and concepts, such as nudges and choice architecture, which seek to understand how people's decision-making can be influenced by the way that options are presented to them.
Overall, these economists and others have challenged the assumption of rational choice and have contributed to our understanding of how people's decision-making is influenced by a variety of factors.
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