PPT Week 40 Flashcards
Rational choice theory
Rational choice theory models people’s Choices. It’s goal is to predict people’s behavior
Rational agent - a theoretical invention (a fictitious person). The agent always strives to maximize their utility
Prospects: the alternatives from which the agent can choose
Utility: the value a prospect has to the agent (a subjective quantity). Cardinal: expressed in absolute number. Ordinal: expressed in a relative number
Rationality
The agent always maximize his or her utility
Is rational choice theory falsifiable?
No, rational choice theory is a set of definitions that is used for scientific research. Since it’s a definition(analytic statement), it’s not falsifiable
The agency problem
Example with the Ice cream shop
Someone is doing something on behalf of someone and has different interests in mind
The agent has a different utility function than the principle
Solution: changing utility function for the agent (I.e. giving ice cream manager a % of the profit)
Game theory
Game theory is an extension of rational choice theory where more than 1 agents are involved
Example with lemonade stand
The most well known example is the Prisoner’s dilemma
In the prisoner’s dilemma the rational choices of the individual sends lead to an irrational outcome
Comparable situation: climate change. An individual gets more utility from pollution than from sustainable behavior but if we coordinate we can achieve a more rational outcome for everyone’s future
Criticism of rational choice theory
Bounded rationality: it’s not possible to evaluate all choices. It’s rational to be only partially rational in the choices you make
Behavioral economics
Combination of empirical approach and mathematic models
Risk aversion: preferring 100 euros with certainty to 50-50% chance of €0/€200
Loss aversion: preferring a 50-50% change of €0/€200 to loosing €100 with certainty
Framing effect: listerine kills 97% of bacteria vs 3% of bacteria survive listerine
Homo economicus
An assumption based on rational choice theory :
Utility = wealth + measure
People are selfish
