Rational Choice Theory

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DEFINITION of '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.

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