CH7 Rational decision making Flashcards
what does neoclassical economic theory assume?
it assumes that economic actors are rational
What are consumers, workers, firms and governments assumed to maximise?
they are assumed to maximise:
-consumers: their utility
-workers: their rewards for working
-firms: their profit
-governments: the welfare of citizens
in neoclassical economic theory, economic actors make decisions at what?
at the margin
What is neo-classical economic theory?
it is a body of economics that was developed from the 1870s onwards
what is one of the key assumptions of neo-classical theory?
it is that economic agents make decisions in a rational way
what is the precise meaning of rational in neo-classical theory?
it is that economic agents are able to rank the order of different outcomes from an action in terms of their net benefits to them.
-they then act in a way that will maximise these net benefits.
what is another key assumption in neo-classical theory? (not the rational assumption)
another key assumption in neo-classical theory is that economic agents act in a way that will maximise their net benefits
what are consumers assumed to maximise?
-consumers are assumed to maximise their economic welfare, sometimes referred to, or measured by utility or satisfaction from consuming goods
-in a world where their resources are scare, they have to make choices. So they have to compare the utility to be gained from consuming an extra unit of a product with its opportunity cost. If there is £2 to be spent, would it best be spent on chocolate, a magazine or a gift to charity, for example
what are workers assumed to maximise in neo-classical theory?
-workers are assumed to want to maximise their own welfare at work.
-workers take a number of different considerations into account when deciding where to work and how long to work.
-pay is usually a key consideration. But other factors, such as job security, how long it takes to commute to work, and the cost of looking for alternative employment, are all important too.
what are firms assumed to maximise?
-neoclassical theory assumes that the owners of firms want to maximise their reward from ownership.
-this means that firms will aim to maximise their profits
what are governments assumed to want to maximise?
-govs are assumed to want to maximise the welfare of citizens. They take decisions that will lead to increased welfare for the country as a whole
what does neo-classical theory recognise about these assumptions of the goals of economic actors?
-neoclassical theory recognises that these assumptions about the goals of economic actors can be simplistic.
-e.g. large firms tend to be run not by their owners, the shareholders, but by managers. Not surprisingly, managers can often take decisions that will benefit themselves rather than the shareholders who have employed them
-governments around the world may be corrupt. They then take decisions that will tend to benefit the members of the government rather than the citizens. Equally, govs tend to reward their own supporters at the expense of other citizens. In a democracy, there is little point in taking decisions that will reward the core voters of other parties. Rather, decisions are taken which will benefit your own core voters and those who might vote for you in an election
what does neo-classical theory also recognise?
-it also recognises that not every decision will be made in a rational way
-however, neoclassical economists would argue that their theories will be correct so long as most economic agents act in a rational way most of the time
what is one of the key elements of neo-classical economic theory?
one of the key elements of neo-classical economic theory is that it is much simpler to assume that decisions are taken at the margin.
-for example, when you decide whether or not you want to buy a packet of crisps now, you dont review all your spending decisions. What you do, according to neo-classical economists, is that you look at the one decision in isolation. What will give the greatest utility: to buy a packet of crisps now, or not to buy?
-for a firm, it may investigate whether to take on an extra worker. The firm doesn’t review all its spending decisions when making this one decision. Instead, it considers whether or not profit will be increased by taking on the extra worker
