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Rational Behavior

A decision-making process that results in the optimal level of benefit, or the maximum amount of utility

What is Rational Behavior?

Rational behavior is used to describe a decision-making process that results in the optimal level of benefit, or alternatively, the maximum amount of utility. Individuals who exhibit rational behavior make decisions that provide them with the highest amount of personal satisfaction.

 

Summary

  • Rational behavior reflects a decision-making process that results in the maximum amount of utility for the decision-maker.
  • An individual who exhibits rational behavior considers all available information and evaluates its costs and benefits and takes sufficient time to make a utility-maximizing decision.
  • Behavioral economists have argued that individuals cannot exhibit fully rational behavior due to real-world limitations, such as the lack of full information and the time limitation in decisions.

 

Understanding Rational Behavior

Rational behavior is the underlying assumption of the rational choice theory, which is an economic theory stating that individuals make decisions that provide the highest amount of benefit and satisfaction. An individual who exhibits rational behavior uses all available information, evaluates each information by its costs and benefits, and takes sufficient time to make a utility-maximizing decision.

Rational behavior does not simply involve choosing a decision that maximizes monetary benefit, rather, choosing a decision that maximizes satisfaction/utility, which could entail non-monetary benefits.

For example, an individual could be exhibiting rational behavior if she is retiring early rather than staying at the company and earning a paycheck if she feels the utility gained from retiring early exceeds that of the paycheck. In such a scenario, the maximum satisfaction for this individual would entail choosing a decision that provides non-monetary benefits.

 

Practical Example

Background Information: John is invited by his company to attend a Christmas party. However, he is introverted and is reluctant to attend for fear of acting or saying the wrong things in front of his co-workers in a social setting. Despite not wanting to go, John ultimately decides to attend.

Question: How does John exhibit rational behavior by deciding to attend the Christmas party even though he does not want to go?

Answer: John is faced with costs and benefits. The costs of not attending the Christmas party can be: (1) an adverse impact on future promotion chances and/or (2) social ostracization in the workplace. The benefits of not attending can be the ability to relax at home and spend time with his loved ones.

Under the assumption of rational behavior, John considered the costs and benefits and felt the costs of not attending outweighed the benefits, hence his decision to attend.

 

Challenges to Rational Behavior

The following are some challenges to the idea of rational behavior:

  • Individuals have limited capacity to accurately calculate the costs and benefits of a decision.
  • individuals may choose a decision that is not optimal due to social norms.
  • Individuals do not always act in their own pure self-interest.
  • Individuals tend to satisfice rather than maximize decision outcomes.
  • Individuals tend to have a strong bias towards maintaining the status quo.
  • Individuals may exhibit emotional states, impacting the decision that they make at that time.
  • Individuals may lack self-control and seek immediate satisfaction.

 

Bounded Rationality

The concept of rational behavior has been meticulously argued in economics, with behavioral economists noting that individuals cannot exhibit fully rational behavior due to a number of real-world limitations, such as the lack of full information, the time limitation in decisions, and the inability to consider every single possible decision.

The idea of bounded rationality seeks to convey that individuals do not exhibit fully rational behavior when making decisions, rather, they satisfice. It means that, given real-world constraints, individuals seek to reach a suitable/acceptable decision rather than a utility-maximizing decision.

 

Additional Resources

Thank you for reading CFI’s guide to Rational Behavior. To keep advancing your career, the additional CFI resources below will be useful:

  • Asymmetric Information
  • Nash Equilibrium
  • Utility Theory
  • Behavioral Finance Course
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