An Analysis of the Rational Choice Model and Utility Theory

Categories: Economics

In this synopsis I intend to analyse the rational choice model and its relevance in economic theory, using the utility theory as an example. Firstly I will define and explain rational choice and then introduce utility theory. From there I will move on to outlining some of the major criticisms of the rational choice model.

Rational choice is a psychological model directed at testing and analysing the rationality of individuals decisions. It was introduced to economics by John Mill, who adapted Bentham’s pleasurepain principle.

For an individual to behave rationally, he would have to ‘attempt to obtain the greatest possible satisfaction from the money resources he has available when making a purchase’. Rational choice is therefore ‘not a goal but a means to reach goals’. When deciding which action to take, an economic agent only has to consider the expected benefit from this action. H. A. Simon argued that the rational man of economics is a maximiser who will settle for nothing less but the best’.

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The best way to show rational choice is by using an example. Assume agent A has a choice of two CDs, X and Y, but can only buy one of them, due to restricted monetary resources. As he prefers Y over X, he will therefore buy Y. This example shows that rational choice is about maximising satisfaction from actions taken.

Rationality as an attempt to maximise satisfaction has close ties with utility theory.

Utility is defined as the satisfaction or pleasure that an individual derives from the consumption of a good or service’.

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It is often argued that individuals are utility maximisers, meaning that they are trying to maximise their utility from a fixed limited income. In a two good world, the point of utility maximisation can be described as:

Marginal utility of X/ Price of X = Marginal utility of Y/ Price of Y.

As said, individuals want to maximise utility, therefore a rational choice would be the one that maximises utility.

Looking back it seems that individuals want to act rational because of self interest. It is argued by Alchian (1950) and Friedman (1953), that people who do not act rationally, will be eliminated by the natural selection. According to this Darwinian view, ‘the social environment tolerates rationality only and thus individuals are forced to act rational.

Dawkins (1982) argues that this principle should not be drawn too far, since the biological concept ‘is not all that clear in that science’.

There are very obvious exceptions to the Darwinian concept. Take for example companies in a competitive market and you will see that not all companies act rational in terms of utility maximisation, but some simply copy competitors’ behaviour and do still survive. This does not only give an exception to the Darwinian view, but also shows that not all behaviour is strictly rational.

Sen (1982) argues that the traditional theory of utility, which relates to rational choice ‘has too little structure’. An individual is given one set of preferences, which is supposed to reflect his interests, summarise his ideas and describe his actual choices. A single set of preferences cannot reflect all these though. Sen continues with saying that a person described as rational in terms of not showing any inconsistencies in his choices, has not use for distinctions between different social concepts. Thus, ‘the purely economic man is indeed close to being a social moron’. Sen argues that a more elaborate structure is needed and suggests John Harsanyi’s distinction between ethical and personal preferences. This distinction allows us to distinguish between what an individual thinks is good from a social point of view (ethical) and what is best in his own interest (personal).

Dow (2002) argues the point that rational choice in terns of utility maximisation is impossible. She asks in what sense behaviour can be classed as rational, and states that saying ‘rationally optimising when making a decision’ is not sufficient.

Before we can make a rational decision we need a complete set of preferences in terms of goods and services as well as the utility yielded from each. This implies perfect knowledge, which does not exist; a consumer will never know the amount of utility each action available yields. According to Dow, rational choices can never be made, and if they were made, we as the ones analysing the choice, would not know that they were rational, due to the lack of perfect knowledge.

Mundell (1968) says that there is no scientific way of proving that other people make irrational choices’. Observations of other individuals presumably making irrational choices ‘merely reflect our judgement about what makes other people satisfied’. This is the same as saying that the entire discussion about rational choice is pointless, as when deciding about other people’s choice decisions we make value judgements. Thus, for different people the question whether a certain action is rational, has different answers; some might think that an action is rational, while others think that the same action under the same circumstances is completely irrational.

Mundell continues by saying that ‘trial and error [in our decisions] help us to discover those things that help us maximise profits … . But as long as we think changes can be made for the better, we will in fact make these changes’. This means that we do not necessarily always make the ideal – rational in terms of utility maximisation – decision, but we will continuously seek to improve our decisions by changing the actions we take.

Even though the rational choice theory has several weaknesses it is still a very important economic concept and theory which can be applied to all social sciences. Mundell (1968) states in his book that ‘optimisation is a fundamental principle of economics and a basic ingredient of all action’. Thus, if we want to understand and analyse human actions we need some sort of perfect case scenario, similar to the perfect competition model, in order to judge any given decision.

In my opinion the rational choice model, in combination with the utility theory, is fairly valid in economics, as it provides us with a benchmark on which we can measure the rationality of individuals’ decisions.

Yes, there is considerable criticism to the theory but I do believe there is not a single criticism-free theory in any of the social sciences. When using the rational choice model though, one always has to remember that it is not a perfect model and that there are several exceptions to the theory.

Bibliography

  1. Alchian, Arman A., (1950) Uncertainty, evolution and economic theory, Journal of political economy, 58: 211-221
  2. Allingham, Michael, (1999) Rational choice, MacMillan Press Ltd.: London
  3. Backhouse, Roger E., Hausman, Daniel M., Mki, Uskali., and Salanti, Andrea., (1998) Economics and Methodology – crossing boundaries, MacMillan Press Ltd.: London
  4. Boudon, Raymond., (1989) A critical dictionary of sociology, Routledge: London
  5. Brown, C. W., (1970) Economics Principles applied, Martin Robertson & Company Ltd: London
  6. Coleman, James S. and Fararo, Thomas J., (1992) Rational choice theory: advocacy and critique, Sage Publications: Thousand Oaks (Ca, USA)
  7. Davis, John B., Hands, D. Wade, and Mki, Uskali., (1998) The handbook of economic methodology, Edward Elgar Publishing: Bodmin
  8. Dawkins, Robbin., (1982) The extended phenotype, Clarendon Press: Oxford
  9. Eatwell, John., Milgate, Murray and Newman, Peter., (1998) The new Palgrave, a dictionary of economics; volume 4, MacMillan: London
  10. Edgeworth, F. Y., (1981) Mathematical Psychics, C. Kegan Paul & Co.: London

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An Analysis of the Rational Choice Model and Utility Theory. (2021, Sep 21). Retrieved from https://studymoose.com/an-analysis-of-the-rational-choice-model-and-utility-theory-essay

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