Violations Of The Rational Maximizing Assumption

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Discussion of potential violations of the standard, rational, utility-maximing consumer from introductory microeconomics

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Violations Of The Rational Maximizing Assumption

  1. 1. Violations of rational utility-maximization: Where standard economics breaks down<br />
  2. 2. Assumptions of the Standard Economic Model of Consumer Behavior<br />People have known preferences. <br />People act with full information. <br />People choose rationally so as to maximize utility.<br />Full Internal Knowledge<br />Full External Knowledge<br />Maximizing Choices<br />
  3. 3. It is relatively easy to adjust models for violations of assumption 2<br />People have known preferences. <br />People act with full information. <br />People choose rationally so as to maximize utility.<br />Full Internal Knowledge<br />Full External Knowledge<br />Maximizing Choices<br />The first two are simple informational deficiencies. <br />Correct information (experimentation, education) cures the deficiency.<br />
  4. 4. Violating rational choice to maximize utility is the problem<br />People have known preferences. <br />People act with full information. <br />People choose rationally so as to maximize utility.<br />Full Internal Knowledge<br />Full External Knowledge<br />Maximizing Choices<br />There is no easy “cure” when this assumption is wrong. The model just doesn’t work in those cases.<br />
  5. 5. Let’s look at some examples<br />We will look at some examples of different people.<br />Think about whether or not the person is acting rationally to maximize his or her utility (well-being; happiness; satisfaction).<br />I’ll ask your opinion at the end of each.<br />
  6. 6. Example 1<br />http://www.youtube.com/watch?v=AkvdEoM4Uqs<br />from 5:05 to end <br />
  7. 7. Rationally maximizing utility?<br />Do you think the previous person was acting rationally to maximize her utility?<br />Yes<br />Probably<br />I have no idea<br />Probably not<br />Definitely not<br />
  8. 8. Example 2<br />http://www.youtube.com/watch?v=_7ltjqBn8K4<br />
  9. 9. Rationally maximizing utility?<br />Do you think the previous person was acting rationally to maximize her utility?<br />Yes<br />Probably<br />I have no idea<br />Probably not<br />Definitely not<br />
  10. 10. Example 3<br />http://www.youtube.com/watch?v=OswtLmGX9bw<br />
  11. 11. Rationally maximizing utility?<br />Do you think the previous person was acting rationally to maximize his or her utility?<br />Yes<br />Probably<br />I have no idea<br />Probably not<br />Definitely not<br />
  12. 12. Example 4<br />First 1:50 of <br />http://www.youtube.com/watch?v=kOPOK24g9Cc<br />
  13. 13. Rationally maximizing utility?<br />Do you think the previous people were acting rationally to maximize their utility?<br />Yes<br />Probably<br />I have no idea<br />Probably not<br />Definitely not<br />
  14. 14. The impact of these examples<br />While these examples may seem extreme, consider the associated societal problems …<br />Obesity<br />Addiction<br />HIV/STDs<br />Violence<br />Do you see how these “exceptions” to the rule are not minor issues?<br />
  15. 15. Beyond opinion: A fundamental conflict<br />In the previous examples, you may or may not have agreed with the idea the people were behaving rationally so as to maximize their happiness.<br /><ul><li> Perhaps they simply lacked information?
  16. 16. Perhaps the choice was maximizing for them, even if it would not be for you?</li></li></ul><li>A fundamental economic law<br />If people rationally maximize utility <br />Then, with full information, more choices are always better (or at least no worse)<br />If new options are not better than current options, I simply won’t choose them<br />≤<br />
  17. 17. Costly choice removal<br />Will people willingly paying more money <br />to remove an option?<br />$1,000<br />$500<br />
  18. 18. Costly choice removal<br />Do people checking into a drug rehab program know that the drug will not be available?<br />
  19. 19. Costly choice removal<br />Do people attending a weight loss camp know that their favorite foods will not be available?<br />
  20. 20. Costly choice removal<br />Will people fighting alcoholism pay money to take Antabuse (disulfiram), a drug that causes alcohol to be nauseating?<br />
  21. 21. Costly choice removal<br />Do people ever choose to drive the longer way home in order to avoid being tempted?<br />
  22. 22. Costly choice removal<br />Or the person would not make utility maximizing choices in the presence of this option. <br />Either this choice is not utility maximizing<br />$1,000<br />$500<br />≤<br />
  23. 23. Costly choice removal contradicts simple rational utility maximization<br />If I would make rational choices in the presence of the option<br />Then paying for choice removal is an irrational act<br />It is because I would NOT make rational choices in the presence of the option<br />If paying for choice removal is NOT an irrational act<br />
  24. 24. Homo Economicus <br />v. <br />Homer Economicus<br />“The falseassumption is that people always make choices that are in their best interest. This claim is either tautological, and therefore uninteresting, or testable. We claim that it is testable and false—indeed, obviously false.”<br />Thaler, R. (U. Chicago), & Sunstein, C. (U. Chicago), 2003, Behavioral economics, public policy, and paternalism: libertarian paternalism. The American Economic Review, 93(2), 175–179.<br />
  25. 25. Conclusion<br />Most people understand that we do not always make rational choices that are utility maximizing.<br />The widespread presence of costly choice removal is a specific example indicating that people often do not make rational utility-maximizing choices.<br />
  26. 26. Slides by: <br />Russell James III, J.D., Ph.D., CFP®<br />Associate Professor <br />Division of Personal Financial Planning <br />Texas Tech University<br />russell.james@ttu.edu<br />Please use these slides! <br />If you think you might use anything here in a classroom, please CLICK HEREto let me know. Thanks!<br />The outline for this behavioral economics series is at <br />http://www.slideshare.net/rnja8c/outline-for-behavioral-economics-course-component <br />

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