Rational Choice Theory

Rational Choice theory is an economic theory that assumes that individuals always make prudent and logical decisions that provide them with the greatest benefit or satisfaction and that are in the best self- interest. Most mainstream economics and theories are based rational choice theory. Rational Choice theorists believe that most human decisions are based on maximizing a person’s own benefits, while minimizing that which can hurt the individual. Small business owners should consider adapting the theory of rational choice into their business models as it can help predict and explain future consumer spending decisions.

Rational choice theory is a framework for understanding and often formally modeling social and economic behavior. It is the paradigm in the currently dominant school of microeconomics. Rationality is widely used as an assumption of the behavior of individuals in micro economic models and analysis which appears in almost all economics dealing with decision- making. The rationality described by rational choice theory is different from the colloquial uses of the word. For most people rationality means sane, in a thoughtful clear- headed manner or knowing and doing what’s healthy in the long term.

Rational choice theory uses a specific and narrower definition of rationality, simply to mean that an individual acts as if balancing costs against benefits to arrive at action that maximizes personal advantage. In rational choice theory, the costs are only extrinsic or external to the individual rather than being intrinsic or internal.

Assumptions and individuals preferences

Rational choice theory makes two assumptions about individual’s preferences for actions: completeness in all actions that can be ranked in an order of preference and transitivity- if action A is preferred to B, and action B is preferred to C and action C is preferred to D.

An individual’s preferences can also take forms: strict preference occurs when an individual prefers A, B, C or D. In some models though, indifference occurs when an individual does not prefer A to B or B to A.

Other assumptions include an individual has full or perfect information about exactly what will occur due to any choice made. An individual has the cognitive ability and time to weigh every choice against every other choice.

Benefits

While there may be many reasons for a rational choice theory approach, two are important for the social sciences. First assuming humans make decisions in rational rather than a stochastic manner implies that their model can be modeled and thus predictions can be made about future actions.

Questions:

• What is Rational Choice Theory?
• What are the assumptions and preferences of the rational choice theory?