Rational Choice Theory

Loading the player...

What is the 'Rational Choice Theory'

An economic principle that assumes that individuals always make prudent and logical decisions that provide them with the greatest benefit or satisfaction and that are in their highest self-interest. Most mainstream economic assumptions and theories are based on rational choice theory.

BREAKING DOWN 'Rational Choice Theory'

Dissenters have pointed out that individuals do not always make rational, utility-maximizing decisions:

- The field of behavioral economics is based on the idea that individuals often make irrational decisions and explores why they do so.

- 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.

-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.

RELATED TERMS
  1. Rational Expectations Theory

    An economic idea that the people in the economy make choices ...
  2. Rational Behavior

    A decision-making process that is based on making choices that ...
  3. Mainstream Economics

    A term used to describe schools of economic thought considered ...
  4. Herbert A. Simon

    An American economist and social scientist who won the Nobel ...
  5. Rationing

    The artificial restriction of raw materials, goods or services. ...
  6. Paradox of Rationality

    The irony that rational decision-making in game theory situations ...
Related Articles
  1. Trading

    Understanding Rational Choice Theory

    Rational choice theory assumes an individual will always make prudent and logical decisions that yield the most benefits.
  2. Trading

    Explaining Rational Behavior

    Rational behavior guides the decision-making process toward choices that maximize an individual’s benefit.
  3. Trading

    7 Controversial Investing Theories

    We take a closer look at the theories that attempt to explain and influence the market.
  4. Trading

    Modern Portfolio Theory vs. Behavioral Finance

    Modern portfolio theory and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Perhaps the easiest way to think about their arguments and positions ...
  5. Trading

    Understanding Investor Behavior

    Discover how some strange human tendencies can play out in the market, posing the question: are we really rational?
  6. Trading

    Behavioral Finance: Background

    By Albert PhungBefore we go over the specific concepts behind behavioral finance, let's take a more general look at this branch of finance. In this section, we'll examine how it compares to conventional ...
  7. Trading

    Behavioral Finance: Introduction

    By Albert PhungAccording to conventional financial theory, the world and its participants are, for the most part, rational "wealth maximizers". However, there are many instances where emotion ...
  8. Managing Wealth

    The Science of Making Better Investment Decisions

    Neuroeconomics attempts to bridge neuroscience, cognitive psychology and economics in order to understand the mechanisms underlying economic decision making.
  9. Managing Wealth

    Richard Thaler: The Founding Father of Behavioral Finance

    How one of the founding behavioral economists is helping individuals earn more on their portfolios and triple their savings for retirement.
  10. Trading

    Behavioral Finance

    Learn the science behind irrational decision making and how you can avoid it.
RELATED FAQS
  1. What is the homo economicus?

    Homo economicus or "economic man" is the characterization of man in some economic theories as a rational person who pursues ... Read Answer >>
  2. What's the difference between agency theory and stakeholder theory?

    Learn how agency theory and stakeholder theory are used in business to understand common business communication problems ... Read Answer >>
  3. How does behavioral economics treat risk aversion?

    Learn about the relationship between decision-making and risk, as described by one of the foundational theories in behavioral ... Read Answer >>
  4. How do stockholders use agency theory to affect management?

    Explore the intricacies of agency theory that places stockholders and management in a unique relationship where both parties ... Read Answer >>
  5. Why is Game Theory useful in business?

    Game theory was once hailed as a revolutionary interdisciplinary phenomenon bringing together psychology, mathematics, philosophy ... Read Answer >>
  6. Is a good's production cost related to its value?

    Learn about the history and debate regarding the metrics used to determine the value of a good and which theories place emphasis ... Read Answer >>
Hot Definitions
  1. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  2. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  3. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  4. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  5. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
  6. Security

    A financial instrument that represents an ownership position in a publicly-traded corporation (stock), a creditor relationship ...
Trading Center