Bounded Rationality

Rational Decision Making and Economic Rationality

Many social sciences behavioral models assume human “rationality.” Rational deliberations are described by rational choice theory, used by practitioners in economics, management, philosophy, psychology, and other behavioral science fields. The theory explains deliberations among alternative courses of action, assuming motivation by the pursuit of individual usefulness or happiness—that is, utility. Rationality suggests that decision makers select optimal options—the best possible or most preferred alternatives for each agent, given their resource constraints and knowledge of their environment. Decision [Page 187]makers maximize personal utility by carefully quantifying, weighing, and comparing all relevant information.

Rational decision making has been studied extensively in neoclassical economic theory under the theories of (1) the consumer and (2) the producer. Decision agents—households and firms—are conceptualized as rational actors maximizing subjective (expected) utility via the “self-interest standard.” Given their knowledge of utilities, alternatives, and outcomes, they calculate the alternative yielding the greatest subjective utility for the costs incurred.

The neoclassical (microeconomic) theory of the firm studies individual business choices. Business organizations face the profit maximization problem, deciding which price and output alternatives maximize earnings.

The neoclassical theory of consumption (consumer decision making) analyzes individual consumer choices regarding quantities of various products (goods and services) to be purchased at particular prices. Consumers derive needs and wants satisfaction (utility) from the consumption of products. They face the utility maximization problem: how to maximize satisfaction by spending their scarce money. Buyers possess omniscient rationality— they make highly informed optimal decisions based on self-interested economic calculations, maximizing their expected utility per dollar spent.

This theory proposes a utility function providing a mathematical representation of an individual's preferences over alternative bundles (market baskets) of commodities purchased during some discrete time period. Personal preferences are defined to be rational and can be represented by a utility function if they are (1) complete (any two bundles can be compared, and all combinations of goods can be ranked), (2) transitive (logically consistent), (3) reflexive (more utility is preferred to less), and (4) stable(unchanging over a particular time period).

Two applications emerge. First, observers can normatively describe optimal economic behavior by explaining what the best decision should be in a given situation. Second, they can explain and predict what actual economic behavior will be.

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