This document discusses the Rational Choice model and its assumptions about human decision-making. While the model assumes humans make rational decisions to maximize utility, research in behavioral economics has found ways in which human psychology can lead to irrational decisions. Specifically, Daniel Kahneman's research on System 1 and System 2 thinking shows how quick, automatic judgments (System 1) can be biased and lead to errors. However, the document argues that while behavioral findings show limitations, the Rational Choice model still provides a useful framework for understanding aggregate human decision-making when assumptions are not taken as absolute. It should not be abandoned, as it generally predicts outcomes even if some individual decisions depart from strict rationality.

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For numerous past years the purpose of economists’ work was primarily focused on
“mathematical techniques and public discourse orientation” as defined by Wikipedia. Currently,
the discipline of economics has been redirected to communicate certain economic principles in
relation to public policies that affect the lives of the general public, focusing on individual
decisions rather than aggregate decisions and market outcomes. For this reason, economics has
become considerably more concerned with the decision-making processes of individuals in their
daily lives. Traditionally, the Rational Choice model was and is still used to predict how
individuals and firms will make decisions. However, recent studies have dedicated increased
focus to the analysis of the psychology behind an individual’s behavioral tendencies that cause
them to depart from “rational” thinking. There are several assumptions that the Rational Choice
model makes in order to give simplified predictions of how people will act. Yet, multiple
anomalies based on behavioral heuristics raise the question of accuracy in the findings of the
Rational Choice model. Many debate whether or not this model is becoming obsolete based on
these new studies and behavioral heuristics, displaying specific instances when humans depart
from rational thinking. However, the Rational Choice model should not be abandoned despite the
findings of behavioral economists because it still provides economists with a useful tool for
analysis of overall decision-making among the population in general.
Although the Rational Choice model is useful, what are the complaints against it? The
most simplified answer is human psychology. In his book “Thinking, Fast and Slow,” Nobel
Prize-winning cognitive psychologist Daniel Kahneman explains that thought process is
conflicted between two systems. The first, System 1, operates automatically, quickly and almost
completely involuntarily. This system contains the same innate abilities found in animals. It

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gives us the ability to recognize shapes, judge distances, understand simple sentences, detect
emotion, and orient the source of a sound. Humans are naturally equipped to assess and
understand the world around them. Some actions can also become automatic through repeated
practice, such as reading simple sentences on billboards or completing simple addition. System 1
also is responsible for generating reactions and predictions quickly in our minds, depending on
the situation. However, System 1 cannot cope with more difficult complex ideas and this is
where the body must switch gears.
Additionally, the human brain utilizes System 2 in thinking through complex decisions
and ideas. System 2 requires focus and attentiveness, and because of this, it can be easily
distracted which may lead to inaccuracies. As described by Kahneman, “System 2 allocates to
the effortful mental activities that demand it, including complex computations. The operations of
System 2 are often associated with the subjective experience of agency, choice, and
concentrations” (Kahneman 21). System 2 has the ability to overtake the impulses and immediate
suggestions of System 1 and to take over when the first system cannot comprehend or manage a
more complex situation. This system of thinking requires substantially more effort on the
individual in terms of patience and self-control.
This combination of systems in the human mind is highly efficient, allowing people to
quickly recognize, assess, and react to situations that occur. “System one is best described as a
system of short cuts (or heuristics) that allow the mind to jump to intuitive conclusions relatively
easily. Its advantage is its speed; it is also associative, uncontrolled, and essentially automatics,
and these constitute its areas of vulnerability. On the other hand, system two is logical and rule
bound; it is controlled and deliberate,” (Hill/Myatt 22). System 1 is constantly alert and normally

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takes the reins in the thought processes, as System 2 exerts as little effort as possible for most of
the time. System 2 is activated when a situation arises that System 1 cannot handle. However,
System 1 cannot be turned off and it operates on initial perception and impulse. This makes it
susceptible to cognitive biases, which are systematic errors that it has a tendency to make in
specified circumstances. “As we shall see, it sometimes answers easier questions than the one it
was asked, and it has little understanding of logic and statistics” (Kahneman 25). Therefore, the
mind can make mistakes that cause people to depart from rational thinking and make decisions
that fall outside the predictions of the Rational Choice model, due to the cognitive psychology of
the human in that situation.
Furthermore, System 1 uses heuristics in decision-making. A heuristic refers to
experience-based techniques for problem solving, learning, and discovery. Heuristic methods
speed up the process of finding a satisfactory solution via mental shortcuts to ease the cognitive
demands of making a choice. Other names for this method of thinking are rules of thumb,
an estimation, or common sense. Since it is accepted that these methods affect the human thought
process, it is then simple to recognize specific situations in which these shortcomings appear.
“Nevertheless, we are confident – overconfident in fact – of our ability to make judgements,”
(Hill/Myatt 23). This causes further irrational decisions in daily life that do not adhere to the
predictions of the Rational Choice model.
One exhibit of a cognitive bias is the availability heuristic. This is a process by which the
mind judges frequency by the ease with which instances come to mind (Kahneman 129). For
example, “…you wish to estimate the size of a category or the frequency of an event, but you
report an impression of the ease with which instances come to mind” (Kahneman 130). This

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demonstrates the systematic error in which the mind swaps one question by answering another.
Multiple factors present a potential sort of availability heuristic bias. These include: salient
events, dramatic events, and personal experiences, pictures, and vivid examples (Kahneman
130). Firstly, a salient event attracts your attention and can be easily retrieved from memory
because of this. Highly publicized events in the news or media are more likely to stick out in
one’s mind and exaggerate the frequency of similar occurrences. A dramatic event also increases
the availability heuristic. A known case of rape on a college campus is likely to cause people to
worry that the same event has a very strong probability of it happening to them. However, the
statistical chance of experiencing rape may be very slim at the given campus. Finally, personal
experiences, pictures and vivid examples are more available to your cognitive systems than
incidents that have happened to other people (friends, family, in the media, etc.). All of these
factors contribute to just one of the several cognitive biases that can affect human logic and
reasoning.
Additionally, these inaccuracies represented by the Rational Choice model are due to the
fact that certain principles of human psychology are not generally accounted for. “Unlike rational
choice theory, behavioral economics allows human nature to be bounded in three ways: bounded
(or limited) rationality, bounded willpower and bounded selfishness,” (Hill/Myatt 23). Bounded
rationality is exhibited in human error based on framing (one example of a systematic heuristic).
Cognitive biases often take over when the mind is confronted with a certain choice that is framed
in a way to lure in the consumer, even into making a decision that is not in his or her best
interest. This is often used by advertisers in framing a product or service in a way that makes it
more appealing. Bounded willpower is demonstrated through all of the choices that people make

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and then fail to act on. The majority of Americans make New Year’s Resolutions to lose weight
and get in shape. However, most of them do not follow through by changing their diet or going
to the gym with regularity. In regards to bounded selfishness, most people can make irrational
decisions, based on possible financial incentives that have a tendency to crowd out principles
such as altruism (Hill/Myatt 24).
Similarly, advertising and marketing companies can further abuse the cognitive
shortcomings of consumers beyond using the heuristic of framing. Experts in these industries are
also familiar with the Status Quo bias. This simply means that people tend to not change an
established pattern of behavior. “Many organizations in both the private and public sector have
discovered the immense power of default options. Successful businesses certainly have…If
renewal is automatic [for magazine subscriptions], many people will subscribe, for a long time,
to magazines they don’t read (Thaler/Sustein 87). Because cancelling a magazine subscription is
typically an action that requires further effort, consumers will allow themselves to continually be
subscribed to the publication, even if they do not read it. Any rational decision-maker would be
concerned that he or she is losing money by receiving a subscription that is not wanted or used.
Because of this bias, suggestions have been made to make organ donation a default, instead of
asking drivers to elect to become an organ donor when receiving their license. It has been proven
to drastically increase the number of organ donors in other countries who utilize this approach. If
potential drivers had to elect to be removed from a donation list and fill out corresponding
paperwork, it is much more likely that they would forgo this effort and remain with the default
option. Moreover, these biases can be manipulated in specific ways.

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Cognitive biases are experienced by every human; therefore, a simplified model of
decision-making, such as the Rational Choice model, is necessary to give economists a
reasonable method to predict outcomes of choice. Moreover, peoples’ personal biases and
preferences cannot all be accounted for individually because it would be impossible to model and
analyze. The Rational Choice model is only meant to serve as a framework for decision-making.
In using it, economists make several assumptions regarding human behavior. These assumptions
maintain that 1) humans are goal-oriented, 2) humans have an ordered set of preferences, 3)
humans make rational calculations with respect to their preferential hierarchy and the best way to
maximize utility, 4) social phenomena is the result of decisions by rational, utility-maximizing
individuals, and 5) from these phenomena, parameters for subsequent rational decisions are set.
All of these assumptions are made in order to grasp the methods in which humans will make
choices in a generic sense. If looked farther into, it is clear that no equation or model could be
adapted to account for each anomaly in human thinking.
Primarily, humans are considered to be goal-oriented, making decisions as a means to a
desired outcome. However, humans have a certain degree of expected error in decision-making.
In “Nudge” by economist Richard H. Thaler and Law professor Cass R. Sunstein they write,
“The key point here is that for all their virtues, markets often give companies strong incentives to
cater to (and earn a profit from) human frailties, rather than to try to eradicate them or to
minimize their effects” (Thaler/Sunstein 74). Among these human frailties include a lack of self-
control and discipline by human beings in pursuit of their goals. For an example, an individual
may have a goal of living a healthy lifestyle, which would maximize his or her utility by limiting
pain due to health problems, medical bills, and so forth. However, when faced with consuming

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an investment good, such as exercise, flossing, and dieting, humans do not always choose these
because the benefits of these goods are delayed. Not exercising today will make no difference to
an individual at that moment, but rather, if not consumed for months or years at a time, utility
will be decreased as the individual is at risk for obesity, heart disease, high cholesterol and so on.
Similarly, sinful good, such as smoking, alcohol, and unhealthy food, offer the individual
pleasure at the moment, but heavy consequences later (Thaler/Sunstein 75). This idea of instant
gratification and a lack of self-control deter people from their goal-oriented decisions.
Subsequently, two more assumptions are made concerning individuals’ set of
preferences. The Rational Choice model assumes that all preferences are complete and transitive.
The completeness of the set of preferences refers to an individual’s ability to rank all of their
preferences in order from providing the greatest utility to the amount of least utility. This does
not account for the fact that sometimes a person is indifferent between two options or decisions.
Similarly, the idea of transitivity assumes that if action a1 is preferred to a2, and action a2 is
preferred to a3, then a1 is preferred to a3. This does not always hold true. Also, these preferences
are not always considered depending on the degree of difficulty in the situation and the amount
of feedback from actions upon similar preferences in the past. Lastly, some people do not always
know what they like or prefer. This can be demonstrated if an individual is deciding whether or
not to go to a concert during the summer, or spending that day at a waterpark they cannot make
choice aligned with his or her preferences if the music has not been heard before. How can a
person know which opportunity will provide the highest utility if he or she does not know what
option will be preferred?

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Lastly, the assumptions made by the Rational Choice model depend upon consumers
having access to perfect information. This causes problems in most market decisions because
often, companies have an incentive to keep some information from consumers. Additionally,
certain complex decisions that individuals may face require extensive knowledge or training. For
example, an individual often consults with a financial advisor, accountant, or stock broker when
making investment decisions. If an individual cannot gain the necessary information through
other means, utility cannot be maximized because all options and their associated pay-offs are
not known or are not understood. Therefore, these assumptions cannot always hold true because
information is asymmetric.
Conversely, many hold significant arguments supporting the Rational Choice model and
its use. Some argue that the human decision-making tested in a laboratory setting is unrealistic.
British sociologist John Scott argued that in the same way that animals respond to incentives of
food in testing, humans also respond to incentives, but that the incentives provided in these
experiments are not large or important enough. “Humans, however, are motivated by a much
wider range of goals. While pigeons will do almost anything for grain, humans are more likely to
seek approval, recognition, love, or, of course, money. Human consciousness and intelligence
enters the picture only in so far as it makes possible these symbolic rewards” (Scott 2).
According to Scott’s thinking, the individual examined in an experiment may not make the same
decisions that he or she would in real life because there are no consequences to endure after, or
no reward of significance on the line. Therefore, several feel that people will behave more
rationally when they are forced to make an important decision in their own lives and put their
second system of thinking into effect.

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A second argument advocating the rational model defends the idea that it creates a trade-
off between realism and simplicity. To use another model example, microeconomics often
examines market behavior in relation to a perfectly competitive equilibrium. However, no market
is truly perfectly competitive, and it can be said that one does not truly exist because competition
always provides producers with an incentive to differentiate their product from others in their
industry. Still, the perfectly competitive model gives fairly accurate representations of what
shifts in supply and/or demand will cause in terms of the price and quantity of a good supplied
and demanded. This is the same with the rational choice model. It offers simplicity because using
this model often yield results that are aligned with the actions that people take. Behavioral
economics, which discusses all of the human anomalies described, focuses on the reasoning
behind peoples’ decision-making process emphasizing the psychological aspects. In other
branches of economics, the outcomes of decisions in the overall markets are determined to be
rational or irrational, and in most cases, the results indicate rationality.
Finally, it is thought that, although there are numerous “irrational” decision-makers in
every market, rational individuals will put pressure on others to make rational choices. Using the
stock market as an example, if one broker is acting rationally and receiving the expected pay-offs
for these decisions, it makes intuitive sense that others will try to learn from this broker in order
to experience success as well. This could start a trend that moves the majority of brokers towards
making consistently rational decisions as a result of learning from their peers. Even word of
mouth can cause people to learn from others’ mistakes or fortune, which would help consumers
shift away from those decisions that would be considered irrational and towards those that would
give them a higher utility.

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Despite all these discrepancies presented against the accuracy of the Rational Choice
model, it still should not be abandon in the study of economics or the analysis of human
behavior. To convey why this is, let us examine the purpose of learning the patterns of supply
and demand through the lens of a perfectly competitive market. In reality, almost no perfectly
competitive markets exist because most products or services produced by different firms are
differentiated in one way or another to create brand loyalty and encourage consumption of that
particular product. Also, there is almost always some sort of barriers to entry in a market.
Finally, as discussed, perfect information is not always provided to the consumer. Yet, we still
use the perfectly competitive model to analyze market fluctuations. This is because it still yields
accurate overall predictions of market outcomes in general. Just as this model is still a good
indicator of market trends, the Rational Choice model is still a good predictor of human decision.
In several cases, even after humans consider their biases, and all other assumptions are accounted
for, the rational choices are still the ones often made. As previously stated, there is no formula
that can account for every bias, misinformation, and preference possessed by each individual. A
generalized model is the only way to predict consumer behavior on a larger, impersonal scale.
Moreover, behavioral economic analysis is important to understand more specified human
decision-making, but the Rational Choice model will always be a necessary stepping-stone in
understanding rational behavior and logical decision-making.

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Bibliography
Green, Steven L. "Rational Choice Theory: An Overview." Diss. Baylor University,
2002.Rational Choice Theory: An Overview. Baylor University Faculty Development, May
2002. Web. 12 Apr. 2013.
Hill, Rod, and Tony Myatt. The Economics Anti-Textbook:A Critical Thinker's Guide to
Microeconomics. Black Point: Fernwood, 2010. Print.
Kahneman, Daniel. Thinking, Fast and Slow. New York: Farrar, Straus, and Giroux, 2011.
Print.
Scott, John. Understanding Contemporary Society: Theories of the Present. London: SAGE
Publications, 2000. Print.

12. Rational Choice Theory: Real-World Application Ability
By Brianna Martinez
May 16, 2013
Intermediate Microeconomics/Behavioral Economics
Final Research Paper
Prof. John Deal