Rational Behavior

Last Updated :

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Blog Author :

Aswathi Jayachandran

Edited by :

Raisa Ali

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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What Is Rational Behavior?

Rational behavior is a personality trait demonstrated by individuals who make sensible choices based on reasoning. Such choices are well-considered and typically yield an optimized outcome compared to other options. This type of behavior is often referred to as "economic behavior."

Rational Behavior

In economic theory, it is a fundamental assumption that entities engage in rational thinking when making decisions. Rational behavior enables individuals to make optimal choices from a set of options, which may not always yield the best possible materialistic outcomes. Moreover, this type of decision-making aims to produce the highest quality benefits, whether financial or non-financial, for the decision-maker.

Table of contents
  • Rational behavior in economics refers to the process by which individuals choose the most rational and desirable option among a set of choices.
  • Economists assume that entities in economic theory make rational decisions. Rational behavior allows individuals to make optimal decisions, even if the outcomes are not always financially rewarding.
  • Factors such as income, resources, and physical or intellectual abilities also constrain economic or rational decisions. 
  • Emotional intelligence, lack of self-control, societal conventions, selflessness, resistance to change, and other factors may limit an individual's decision-making ability.

Rational Behavior In Economics Explained

Rational behavior in economics implies the idea that an individual selects the most rational and desirable choice among the given options. In economics, rationality refers to a person's decision to take advantage of the opportunity set they see as having the most favorable possibilities given their preferences. Here, opportunities are characterized by considering all potential costs and advantages, particularly the costs of knowledge, decision-making, and transactions. Prospective opportunities are made up of perceived potential acts and perceived results. The economic theory works on the idea that the participants can make a desirable, reasonable choice.

According to the theory of rational behavior, economic or rational decisions are subject to certain limitations. This includes constraints on income, resources, or physical or intellectual capacities. In addition, the emotional quotient, lack of self-control, societal conventions, selflessness, resistance to change, and other factors may also limit an individual's decision-making ability.

Another factor that can influence choices, as per the theory of rational behavior, is "time". Furthermore, one of the most important factors in the rationality economic model is "knowledge or information". People involved, or elements of economic theory, evaluate their options using existing knowledge. The knowledge may be pre-existing or recently acquired.

The neoclassical approach typically assumes that the rational economic actors have "perfect information," which further leads to the assumption that rational action is behavior optimization. People might gather information until the perceived costs outweigh the perceived benefits. There is, however, no way to ensure that individuals will have the necessary knowledge to perform the "cost or benefit" analysis (i.e., to decide when to stop gathering information). Or that, once they stop gathering information, they will have the necessary knowledge to make an ideal or even a good decision.

Examples

Check out these examples to get a better idea:

Example #1

Daisy has two job offers, one from a multinational company in a big city that offers a handsome salary and another from a not so well known company with a decent amount of pay. She could choose the decent paying company that offers no scope for career growth and lead a relaxed life.

On the other hand, a big company comes with a huge salary, good exposure, good benefits, etc., but it comes with job stress. Since Daisy is from a poor background and needs money for survival, she keeps that as her priority; she chooses the job at the MNC.

Example #2

Dan goes shopping and sees the sign of buy two get one free offer on a laundry detergent. He is stocked for the month and doesn't need any. However, laundry detergents have a larger shelf life and need not be used immediately. His initial budget did not have room for the new offer. However, he decides to cut out the soft drink packs in the list to accommodate the detergent. According to rational behavior economics, this is a rational choice, as he saves money on the detergent and saves his health by not drinking sugary soft drinks.

Rational Behavior vs Irrational Behavior

Key differencesRational BehaviorIrrational Behavior
MeaningRational behavior is a trait of an individual whose decisions are based on sensible reasoning.Irrational behavior is the behavior of an individual who favors emotion and disregards logic and reasoning.
Long-term consequencesRationally behaving involves considering options and weighing their cost and benefit. While considering the option, the long-term consequences are evaluated.Irrational behavior disregards any long-term consequences and is mostly focused on short-term gains.
Evaluation of factsRational thinking and behavior consist of evaluating the current reality or situation. The facts that accompany these relationships are also taken into consideration.Irrational behavior, however, is focused on momentary perceptions and does not focus on the facts of reality. As a result, they are unsupported by the known facts.
Element of logicWhen facts and figures accompany reality, it is said to be the outcome of rational behavior.Irrational behaviors result from emotional choices and may lack any logical aspects. As a result, they are not founded on logic or reasoning.
OutcomeRational thinking may result mostly in positive outcomes.Irrational behavior may almost always result in negative outcomes. For example, it may hinder the growth of an individual and act as a barrier to both monetary and non-monetary aspects of their life.

Frequently Asked Questions (FAQs)

1. What is rational behavior therapy?

Rational-emotional behavior therapy (REBT), also known as rational therapy, rational emotive therapy, or rational behavior therapy, is a psychotherapeutic approach aimed at helping individuals change negative and irrational thought patterns to improve their emotional well-being and lead more fulfilling lives. While it is not directly related to making economic decisions, it may help individuals make better decisions overall.

2. Do consumers exhibit rational behavior?

Consumers exhibit rational behavior when making logical decisions based on the information available. This includes weighing the costs and benefits of their choices and selecting the option that best meets their needs and preferences. However, consumers may also exhibit irrational behavior due to emotional or other factors that can influence their decision-making process.

3. What are the disadvantages of rational behavior?

One disadvantage of solely relying on rational behavior is that it may not account for emotional factors that could impact decision-making. Additionally, rational behavior can be time-consuming and may not always lead to the most innovative or creative solutions.