3. Definition
Latin for "economic human". A term used in
economic theories to describe humans as
rational and self-interested beings capable of
making judgments towards subjectively
defined ends (such as accumulation of wealth
and resources). This is used as a basic for the
majority of economic models, where they
assume that all human beings will act like
homo economicus. The validity of this
assumption has been questioned in some
economic circles, with alternative assumptions
proposed.
http://www.businessdictionary.com/definition/homo-economicus.html#ixzz26H7fSQXC
4. Thinking rationally...
Experiment 1
Imagine you are hungry and fancy an apple. The answer is obvious; the
You stroll to the nearest market and find three cheapest. But why?
fruit stands, each selling identical apples. The
●
The apples are identical so
apples and the price being charged are shown each will bring the same
below. benefit (utility)
●
The money is a scarce
Which apple do you buy? resource so the less you
spend of it the better
35p 40p 45p
5. Assumptions
The concept of Homo Economicus relies on the
assumption that people act in their rational self-
interest i.e.they do what is best for them.
Therefore we are assuming that;
●
People know what they want and their priorities
●
People can judge the benefit (or utility) the consumption
of a good will bring
●
People can place a value on the utility (i.e. they know
what they are prepared to pay)
●
People act selfishly i.e. seek to satisfy their own needs
Are these assumptions correct?
6. Thinking rationally...?
Experiment 2
Solution (part two)
Imagine you are given £20. You are allowed
If player B acts rationally they will accept
to keep some of the money on one condition;
as little as 1p. Therefore the rational
you give some away to another person (call
amount to offer is 1p. It is in your self-
them player B). However, player B has the
interest to keep as much money as
choice to reject your offer. If they do, neither
possible.
of you get to keep any money. If they accept
you both keep your share of the money.
Will you offer 1p? If not, why not?
How much do you offer player B?
Solution (part one)
To work out the rational thing to do we
must first think like player B. If player B
This experiment demonstrates that
rejects ANY offer then they will go away
emotions play a part in our decisions
with nothing. Therefore the rational
and that the economically rational
thing to do is to accept ANYTHING that
thing to do is not always how people
is offered, even if it is 1p. behave.
Will player B be likely to accept 1p in
reality? If not, why not?
7. Thinking irrationally...
Experiment 3 – The Prisoner's Dilemma
Two men are arrested.. The police separate the two men, and offer both the same
deal: if one testifies against his partner (betrays), and the other remains silent
(cooperates with his partner), the betrayer goes free and the one that remains silent
gets a one-year sentence. If both remain silent, both are sentenced to only one
month in jail on a minor charge. If each 'rats out' the other, each receives a three-
month sentence. Each prisoner must choose either to betray or remain silent; the
decision of each is kept secret from his partner. What should they do?
The rational thing to do
is to both stay silent.
However, each is fearful of
the much higher jail-term if
they stay silent and the
. other prisoner 'rats'.
Therefore the safest thing
to do is to betray each
other.
Each prisoner will 'choose' the option which leads to a 3 month jail-term. There is an
option which could lead to a shorter jail-term but they do not choose to act in what
appears to be their self-interest
.Source: Wikipedia
8. Thinking irrationally...
Experiment 4 – The Sunk Cost fallacy
You purchase a ticket to the theatre. When
you arrive you realise that the ticket is lost.
There are more tickets on offer.
Do you buy another ticket?
Many people answer by saying that they
cannot bring themselves to pay for
another ticket. In their mind they cannot
let go of the money already 'sunk' into
the purchase. By paying for another
ticket they feel that they would be paying
twice the original cost for the ticket.
Rationally we should behave as we did
when we first purchased a ticket. The
value of the ticket hasn't changed and
the price is the same, therefore the A little more about rational thinking...
decision should still be to buy. The
original cost is sunk whether or not we http://boxonomics.blogspot.co.uk/2012/
buy the new ticket and enjoy the theatre 09/basic-concepts-rational-choice-
production. theory.html#!/2012/09/basic-concepts-
9. Summary
We behave rationally when...
●
We search for the cheapest product available
●
We buy what we most need
●
We seek to maximise our utility with the scarce money we possess
●
We consider the opportunity cost of our decisions
Some economists claim we often don't behave rationally. For example we
may...
●
Be persuaded to make decisions which are not in our self-interest
●
Allow emotions to influence our decisions
●
Take account of sunk costs rather than just the future costs which will be
incurred
●
Follow others rather than thinking for ourselves
●
Make decisions without all the information we need at our disposal
10. Do firms behave rationally?
Economists often apply the idea of rational self-interest to other economic agents (this
means other economic decision makers) such as firms or government.
What are these economic agents trying to achieve? In other words, what is in their
self-interest?
Individuals seek to
maximise their utility
through increasing their
income and consumption
Government seek to
maximise welfare i.e.
society's wellbeing and
wealth
Firms seek to maximise
their profit
