what is rational choice theory 
rational choice theory states that individuals use rational calculations to make choices and achieve outcomes that are aligned with their own personal objectives these results are also associated with maximizing an individual s self interest using rational choice theory is expected to result in outcomes that provide people with the greatest benefit and satisfaction given the limited options they have available understanding rational choice theorymany mainstream economic assumptions and theories are based on rational choice theory rational choice theory is associated with the concepts of rational actors self interest and the invisible hand rational choice theory is based on the assumption of involvement from rational actors rational actors are the individuals in an economy who make rational choices based on calculations and the information that is available to them rational actors form the basis of rational choice theory rational choice theory assumes that individuals or rational actors try to actively maximize their advantage in any situation and therefore consistently try to minimize their losses economists may use this assumption of rationality as part of broader studies seeking to understand certain behaviors of society as a whole self interest and the invisible handadam smith was one of the first economists to develop the underlying principles of the rational choice theory smith elaborated on his studies of self interest and the invisible hand theory in his book an inquiry into the nature and causes of the wealth of nations which was published in 1776 1the invisible hand itself is a metaphor for the unseen forces that influence a free market economy first and foremost the invisible hand theory assumes self interest both this theory and further developments in the rational choice theory refute any negative misconceptions associated with self interest instead these concepts suggest that rational actors acting with their own self interest in mind can actually create benefits for the economy at large according to the invisible hand theory individuals driven by self interest and rationality will make decisions that lead to positive benefits for the whole economy through the freedom of production as well as consumption the best interests of society are fulfilled the constant interplay of individual pressures on market supply and demand causes the natural movement of prices and the flow of trade economists who believe in the invisible hand theory lobby for less government intervention and more free market exchange opportunities 2advantages and disadvantages of rational choice theorythere are many economists who dispute the veracity of the rational choice theory and the invisible hand theory dissenters have pointed out that individuals do not always make rational utility maximizing decisions the field of behavioral economics is a more recent intervention into the problem of explaining the economic decision making processes of individuals and institutions behavioral economics attempts to explain from a psychological perspective why individual actors sometimes make irrational decisions and why and how their behavior does not always follow the predictions of economic models critics of rational choice theory say that of course in an ideal world people would always make optimal decisions that provide them with the greatest benefit and satisfaction however we don t live in a perfect world in reality people are often moved by emotions and external factors the nobel laureate herbert simon who rejected the assumption of perfect rationality in mainstream economics proposed the theory of bounded rationality instead this theory says that people are not always able to obtain all the information they would need to make the best possible decision simon argued that knowledge of all alternatives or all consequences that follow from each alternative is realistically impossible for most decisions that humans make 3similarly the economist richard thaler pointed out further limitations of the assumption that humans operate as rational actors thaler s idea of mental accounting shows how people place greater value on some dollars than others even though all dollars have the same value 4 they might drive to another store to save 10 on a 20 purchase but they would not drive to another store to save 10 on a 1 000 purchase like all theories one of the benefits of rational choice theory is that it can be helpful in explaining individual and collective behaviors all theories attempt to give meaning to the things we observe in the world rational choice theory can explain why people groups and society as a whole make certain choices based on specific costs and rewards rational choice theory also helps to explain behavior that seems irrational because a central premise of rational choice theory is that all behavior is rational any action can be scrutinized for its underlying rational motivations helpful in explaining individual and collective behaviorsall theories attempt to give meaning to the things we observe in the worldcan help to explain behavior that seems irrationalindividuals do not always make rational decisionsin reality people are often moved by external factors that are not rational such as emotionsindividuals do not have perfect access to the information they would need to make the most rational decision every timepeople value some dollars more than othersexamples of rational choice theoryaccording to rational choice theory rational investors are those investors that will quickly buy any stocks that are priced too low and short sell any stocks that are priced too high an example of a rational consumer would be a person choosing between two cars car b is cheaper than car a so the consumer purchases car b while rational choice theory is logical and easy to understand it is often contradicted in the real world for example political factions that were in favor of the brexit vote held on june 23 2016 used promotional campaigns that were based on emotion rather than rational analysis 5 these campaigns led to the semi shocking and unexpected result of the vote the united kingdom officially decided to leave the european union the financial markets then responded in kind with shock wildly increasing short term volatility as measured by the cboe volatility index vix 6rational behavior may not involve receiving the most monetary or material benefit the benefit of a particular choice could be purely emotional or non monetary for example while it is likely more financially beneficial for an executive to stay on at a company rather than take time off to care for their new newborn child it is still considered rational behavior for them to take time off if they feel that the benefits of the time spent with their child outweigh the utility from the paycheck they receive 