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Economy and the rational choice HOW THE RATIONAL CHOICE THEORY WORKS Rational choice theory comes from economics, where predicting human actions is as important as anything. In economics, rational choice theory is used to “smooth out” data and come to logical conclusions based on the behavior of illogical monkeys (humans). For example, proponents of the theory assume that all people try to maximize their advantage and overall utility in any given situation – at any given time. According to rational choice theory, the only goal of an individual is to maximize his or her individual pleasure or profit. This means that on the micro level, all humans behave according to careful self-analysis. On the macro level, the rational choice theory says that all social phenomena are caused by individual humans interacting with one another. Therefore, on the scale of the national economy, proponents of rational choice theory believe that social trends should mirror the decisions of individuals that make up the whole – i.e. if people are rational on the micro level, then we should see things on the macro level (like financial markets) move in rational ways, too. WHAT IS THE RATIONAL CHOICE THEORY ? Rational choice theory refers to a set of guidelines that help understand economic and social behaviour. The theory originated in the eighteenth century and can be traced back to political economist and philosopher, Adam Smith.The theory postulates that an individual will perform a cost-benefit analysis to determine whether an option is right for them.It also suggests that an individual's self-driven rational actions will help better the overall economy. Rational choice theory looks at three concepts: rational actors, self interest and the invisible hand. Rational choice in criminology & economy It’s disturbing that even though rational choice theory seems so obviously wrong, it’s used as the basis for some of our largest political and social initiatives. In fact, much of the established guard in finance, economics, and public safety believe to some extent in the rational choice theory. It should come as no surprise, then, that many of our public policies and discourse result in systems that break down at the macro level. This can cause a lot of problems, both in economics and public safety. In economics, our financial markets are built on the assumption that people act rationally. But we’ve seen time and time again that this isn’t true. In public safety, people use the rational choice theory to assume that all criminals act out of pleasure. As long as the cost-benefit is there, a criminal will take action. What’s more, public safety officials often believe that criminals freely choose their behavior. Now, if you’ve ever met a criminal, or if you’ve ever had criminal impulses before, you know that these people and these impulses are far from rational. In fact, it seems that the more heinous a crime is, the more irrational the criminal’s actions. RATIONAL CHOICE THEORY ECONOMICS EXAMPLE Many economists believe that humans are always trying to maximize their utility, which is to either maximize their pleasure or profit. For example, if you have money in the stock market and the market goes down, what does the rational theory say that you’ll do? Well, according to the theory, rational thought says that if you believe in the investment then you buy the dips. So even if you’re losing money as you’re buying, you should do it anyway because it maximizes your long-term potential profits. How to use the theory to your advantage The key is to understand that humans are irrational and not rational.For example, understanding that the rational choice theory is false, it would be easy to see that as soon as the price of Bitcoin started to decline, it would begin to decline exponentially. Why? Well, because a lot of laymen were investing in Bitcoin without any real knowledge, and when prices started to drop, it scared these non-savvy investors, causing them to sell and exit their position (creating more supply than demand and further pushing down the price).nal, and then use that knowledge to spot trends. CONCLUSION The rational choice theory is a nice idea, but it has many problems. Still, this doesn’t mean that the rational choice theory isn’t useful. In fact, if you know that the opposite is true, that humans are irrational, you can use it to your advantage by spotting irrational trends and positioning yourself to succeed. The majority of classical economic theories are based on the assumptions of rational choice theory: individuals make choices that result in the optimal level of benefit or utility for them. Although many criticisms of rational choice theory exist—because people are emotional and easily distracted, and therefore, their behavior does not always follow the predictions of economic models THANKS FOR PAYING ATTENTION
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