What Is Rational Behavior?
Let me explain rational behavior directly: it's a decision-making process where you make choices that lead to the optimal level of benefit or utility for yourself. You would rather take actions that benefit you than those that are neutral or harmful. Most classical economic theories assume that everyone involved in an activity behaves this way.
Key Takeaways
Rational behavior is about decisions that optimize benefit or utility. Rational choice theory in economics assumes this behavior from individuals. Keep in mind, rational behavior doesn't always mean the most money or material gain; satisfaction can be emotional or non-monetary.
Understanding Rational Behavior
Rational behavior underpins rational choice theory, which posits that you always make decisions yielding the highest personal utility. These choices give you the greatest benefit or satisfaction from what's available. Remember, this might not involve the most financial or material reward, as the utility could be purely emotional.
For instance, if you're an executive, staying at a company might be more financially beneficial, but choosing early retirement is still rational if you value retired life more than the paycheck. Your optimal benefit can include non-monetary aspects.
Your risk tolerance or aversion can also be rational based on your goals. You might take more risk in your own retirement account than in one for your children's education—both are rational for you.
Behavioral Economics
Behavioral economics analyzes economic decisions through psychological lenses, explaining human behavior in those contexts. Rational choice theory sees you as self-controlled and unaffected by emotions, but behavioral economics recognizes you're emotional and distractible, so your actions don't always match economic predictions.
Psychological factors and emotions influence your choices, leading to decisions that aren't entirely rational. This field explains why you decide on coffee prices, education, healthy living, or retirement savings in certain ways.
You might base investment decisions on emotions, like investing in a company you feel positively about, even if models say it's unwise.
Example of Rational Behavior
Consider this example: you might invest in an organic produce company's stock over a conventional one because of your strong beliefs in organic value. You do this regardless of the organic company's lower present value or the conventional one's higher return. That's rational behavior aligned with your personal utility.
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