Rational decision-making

Rational decision-making

Courses Info

Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes 

Rational Decision-Making

Traditional neo-classical economists believe that consumers act rationally by making decisions that maximise their utility. They also believe firms act rationally to maximise their profits.

However, many economists have challenged this school of thought with another called behavioural economics

What is Utility?

Utility is the satisfaction a consumer gets from the consumption of a product or service.

Behavioural Economics

Behavioural economists believe that consumers and producers make decisions using the process of psychology e.g. emotions and habits

Additional Content – AQA Spec

Bounded Rationality Model – The Administrative Man

This model was devised as Herbert Simon recognised the limitations of the decision making model proposed a developed model known as the ‘Bounded Rationality Model’

Assumptions of the Model:

  • The first option which is satisfactory is selected
  • The world is perceived as ‘simple’ by the decision maker
  • The decision maker needs to be comfortable making decisions without worrying about other alternatives
  • Decisions could be made by heuristics

Consumers are able to exercise self-control with some decisions, as per the theory of Bounded Self-Control

Law of Diminishing Returns – in some circumstances – for example food – some consumers will choose to consume more food regardless of the fact that it wont increase the optimal benefit

Short Term vs Long Term view – some consumers will go by a choice which will provide them will a short term gain, rather than thinking long-term and acting accordingly

Biases in Decision Making

Homo Economius – a consumer who acts rationally by making rational decisions and maximising utility

Heuristics – encourage a rational decision to be made through a simplified process; they are shortcuts to avoid lengthy decision making processes and also prevent the problem of having imperfect information

Social Norms

People’s decisions are often influenced by the behaviour of others. Social pressure from a third party encourages consumers to pick choices which they may not necessarily choose otherwise.

Consumers are reluctant to change certain habits even if they will benefit society, as they would rather ‘stick with the crowd’


Humans tend to rely on the first piece of information given and causes biasness towards any subsequent information they are provided with


This is bias created towards events that were recent, personal or memorable – this is because they are overestimated and can cause emotional responses

The importance of altruism and perceptions of fairness

Altruism – the act of being selfless, considering the interests of others

The Ultimatum Game

This game is used to describe altruism and explain the importance of fairness.

There are two players: the proposer and the responder. The proposer chooses a specific amount of money to offer to the responder, in which they can either accept or decline the offer.

The sum of the money is divided if the responder accepts the money. However both will receive nothing if the responder declines the offer

The perception of fairness is highlighted through the proposer usually offering a range of 40% – 50% of the total sum

Responders do not usually accept values below 25% of the total sum

IAL Spec – Additional Content

Reasons why may not aim to maximise utility


The idea that individuals have a tendency to remain in the same situation, without wanting to change a habit or try something else


Individuals decide to follow each other and imitate group behaviours instead of acting independently. The behaviour of others influences their own

Poor computational skills

Consumers struggle to calculate the probability of an outcome occurring when making purchasing decisions – hence their decisions are dominated by computational weakness

Framing and bias

This suggests that the way information is presented affects the likelihood of a consumer following it. If information is presented in a way that exercises a gain to a consumer, they are more likely to listen to it



Quick Fire Question – Knowledge Check

1. Explain the two Neo-classical assumptions of Rational Decision-Making (4 marks)

2. Define ‘Utility’ (2 marks)

3. Explain what is meant by ‘Behavioural Economics’ (2 marks)


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