Rational Decision Making

Written by Arsen Ashlayev | Proofread by Yasmin Uzykanova

Rationality in economics can be defined as individuals making decisions that provide them with the highest amount of personal utility. Those decisions award consumers with the greatest benefit or satisfaction out of the choices available within their limitations such as a personal budget and income.

For example, while it is likely more financially beneficial for an executive of a firm to stay on at a company rather than retire at an early age, it can still be considered rational behavior for her to seek an early retirement if she feels the benefits of retired life outweigh the utility from the paycheck she receives. The optimal benefit for an individual may involve non-financial returns.

An economic agent’s willingness to take on risk, or oppositely, their aversion to risk, may be considered rational depending on their personal circumstances.

For example, an investor may choose to take on more risk in his own retirement account than in an account designated for his children's college education. Both would be considered rational choices for this investor.

Behavioral economics seeks to explain why people make certain decisions about how much to pay for a cup of coffee or other luxury goods, whether or not to pursue a college education or a healthy lifestyle, and how much to save for retirement, among other decisions that most people have to make at some point in their life.

Business investors may also make decisions primarily based on gut feeling, for example, investing in a company for which the investor has positive feelings, even if financial models suggest the investment is not wise.