1.2.1 Rational Decision Making

Question 1

Explain the (Neo-classical theory)

Answer 1

. Developed from the 1870s

. Microeconomics is predominantly based on this theory

. Key assumption from neo - classical is that economic agents make decisions in a rational way and maximise their benefits

Question 2

Define [rationality / acting in a rational way] in the ‘neo-classical theory’

Answer 2

.ranking the order of different outcomes from an action in terms of net benefits

. then acting in way that maximises these net benefits.

. Neo - classical economists assume that consumers and other economic agents acting in a rational way

Question 3

Define utility

Answer 3

the satisfaction received from consuming a good or service

Question 4

Explain maximisation in regards to consumers (Neo-classical theory)

Answer 4

consumers try to maximise their economic welfare measured by utility.

They have to make choices by comparing the utility to be gained from consuming an extra unit of a product with its opportunity cost

Question 5

Explain maximisation in regards to governments (Neo-classical theory)

Answer 5

Assumed they want to maximise the welfare of citizens. Thy take decisions that will lead to increased welfare for the country as a whole

Question 6

Explain maximisation in regards to firms (Neo-classical theory)

Answer 6

Assume that owners of the firm want to maximise their reward from ownership.

This means that firms will aim to maximise their profits to keep shareholders happy

Question 7

Explain maximisation in regards to workers (Neo-classical theory)

Answer 7

Assumed to want to maximise their own welfare at work. Important factors for them to consider: pay, job security, commute work, job satisfaction

Question 8

Define economic welfare

Answer 8

the level of well - being or prosperity or living standards of an individual or group of individuals such as a country

Question 9

Name three limitations to Neo - classical theory and rational decision making

Answer 9

1. ) Governments tend to maximise citizen welfare. However, some governments around the world are corrupt as they will take decisions that will benefit members of the government instead of their citizens. They may also reward their own supporters at the expense of other citizens. It could be argued that in democracy there’s little point in taking decisions that will reward core voters of other parties
2. ) Firms tend not to be run by owners or shareholders but by managers. Managers may take decisions that will benefit themselves rather the shareholders who employed them
3. ) Neo - classical theory recognises that not every decision will be made in a rational way. However, these economists argue their theories will be correct as long as most economic agents act in a rational way most of the time

Question 10

Define irrational behaviour

Answer 10

. Irrational behaviour is when people make choices and decisions that go against the assumption of rational utility-maximising behaviour.