1.2.1 Rational Decision Making

Question 1

What is neo-classical theory?

Answer 1

A theory of economics that typically starts with the assumption that economic agents will maximise their benefits and act rationally.
It develops how resources will be allocated and at what price through the forces of supply and demand. The margin is a key concept in neo-classical theory.

Question 2

A key assumption of neo-classical theory is that economic agents act in a way that will maximise their net benefits.

Answer 2

> Consumers aim to maximise utility (economic welfare). Utility is the satisfaction gained from consuming a good or service. A rational consumer is one that makes decisions by choosing the decision that gives them the most satisfaction.
Firms aim to maximise profit. It is assumed that firms are run for their owners who want to maximise their rewards.
Governments aim to maximise social welfare. Governments are voted in to work for the public, so should try to maximise their satisfaction.
Workers aim to maximise their own welfare at work, e.g pay, job security, travel, etc.

Question 3

Limitations of the assumption of rational decision-making:

Answer 3

It can be simplistic. E.g. firms may be run by senior managers, governments could be corrupt, etc.
Economic agents also do not always have the information necessary to act rationally and consumers don’t always make calculated decisions.