Rational Choice Theory

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What is the 'Rational Choice Theory'

Rational choice theory is an economic principle that states that individuals always make prudent and logical decisions. These decisions provide people with the greatest benefit or satisfaction — given the choices available — and are also in their highest self-interest. Most mainstream academic assumptions and theories are based on rational choice theory.

BREAKING DOWN 'Rational Choice Theory'

Rational choice theory assumes that all people try to actively maximize their advantage in any situation and therefore consistently try to minimize their losses. The theory is based on the idea that all humans base their decisions on rational calculations, act with rationality when choosing, and aim to increase either pleasure or profit. Rational choice theory also stipulates that all complex social phenomena are driven by individual human actions. Therefore, if an economist wants to explain social change or the actions of social institutions, he needs to look at the rational decisions of the individuals that make up the whole.

Arguments Against Rational Choice Theory

However, many economists do not believe in rational choice theory. Dissenters have pointed out that individuals do not always make rational utility-maximizing decisions. For example, the field of behavioral economics is based on the idea that individuals often make irrational decisions and explores why they do so.

Additionally, 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. Further, 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.

An Example Against Rational Choice Theory

While rational choice theory is clean and easy to understand, it is often contradicted in the real world. For example, political factions that were in favor of the Brexit vote held on June 24, 2016, used promotional campaigns that were based on emotion rather than rational analysis. These campaigns led to the semi-shocking and unexpected result of the vote, when the United Kingdom officially decided to leave the European Union. The financial markets then responded in kind with shock, wildly increasing short-term volatility, as measured by the CBOE Volatility Index (VIX).

Further, research conducted by Christopher Simms of Dalhousie University in Halifax, Canada, shows that when people are anxious, they fail to make rational decisions. Stressors that produce anxiety have been shown to actually suppress parts of the brain that aid in rational decision-making.