Rational Choice Theory
Rational Choice Theory
A Significant theory to me will be the Rational Choice theory. This theory explains how people make decisions by seeking the most cost-effective means to achieve a specific goal without reflecting on the worthiness of that goal; to maximize personal advantage by weighing costs against benefits without moral or ethical values. It is a popular theory as it is an efficient system that explains and predicts a behavior of a person, and to larger extent, a collective group of people. Understanding this theory would allow a person to understand quickly how decisions are made, and the impact of the decisions on a society — how it functions and performs economically. Based on this theory, people’s measured decisions are often calculated based on financial benefits and costs. Singapore, by and large, has functioned on this theory, which has benefited from this tool of measurement and prospered since the days of nation building. However, this theory will work perfectly only if everyone in the society shares the same values, had perfect information, and the ability to make the most rational decisions at any point in time. People living in a society with homogenous values, such as Singapore, have similar behavioural patterns, which enable this theory to work. However, on a global scale, this theory will no longer work as peoples’ values are varied and culturally diverse.
The most rational choice for one man might be an irrational choice for another. And when this occurs, there will be unpredictability and the results that follow can be disastrous. The Great Financial Crisis is a good example of the rational choice theory gone awry. Financial institutions’ goal is to maximize profits. To maximize profits, financial institutions have to find ways to create profits. One of these methods was to get creative with offering mortgage to people who wanted to own homes. Credit terms were made easy and the securities in place to safeguard the process were ignored. These consolidated loans were sold to big investment banks which resold them as securities offering high returns. Credit agencies working for these investment banks told investors’ that securities were safe. Selling a financial product based on a large group on loans was supposed to limit the risk if a few loans went bad. However, a large number of loans, later known as toxic, were borrowed by individuals with no financial means. Furthermore, many of these loans were offered in the form of adjustable rate mortgage, which started out with an initial period of low interest rate, and later ballooned up to three times the initial rate. All these borrowers were saddled with a monthly mortgage payment way beyond their monthly income. To make matters worse, the sprint to own a house on such easy terms had created a housing bubble, causing house prices to escalate astronomically. This phenomenon further pushed people to borrow way beyond their means. Consequently, millions of homeowners were unable to repay their mortgage loans. The financial institutions disregarded moral and ethical values to draw up shady credit schemes. Consolidated mortgages were bundled in with the toxic ones and resold for profits. Individuals felt the need to buy a house simply because everyone else was buying a house without the discretion of affordability and the hyper-inflated housing prices. Each acted on imperfect knowledge to maximize personal benefits and disregard moral and ethical values. Rational choice theory can be an efficient method as a decision-making tool to attain goals, but it is definitely too simple an application on a macro context. To make a good decision, one has to balance cost-benefit analysis with moral and cultural factors.