Articles Behavioural

What is rationality in Economics?

Rationality in economics is described to be a decision-making process of an economic agent that seeks to maximise utility. To best understand the notion of rationality in economics, it is best to compare it to rationality in a more psychological sense: the quality of being able to think sensibly or logically. This comparison highlights that rationality in economics is more concerned with the outcome of the decision whilst, in psychological terms, rationality is greater associated to the process at which one arrives to the outcome.

In economics, maximising utility is referred to in a quantitative sense, where there is an objectively best outcome. In reality, humans’ decisions often take into account emotion and sentiment – abstract concepts that, because they are immeasurable, skew one’s decision-making process and can lead to an economically irrational outcome. Gary Becker exhibits this view of rationality in the case of marriage in The Economic Approach to Human Behaviour (1976), where he expresses the belief that “a person decides to marry when the utility expected from marriage exceeds that expected from remaining single.” Becker believes that emotion and sentimentality prevent a logical and rational approach in coming to a decision. However, Becker dismisses that maximised utility of an individual can also come from emotional fulfilment. If emotion and sentimentality are considered to contribute to the utility of an outcome of a decision, previously irrational outcomes could instead be considered rational as welfare may be maximised.

By considering emotion and sentiment within rationality, the notion of rationality is made much more subjective. However, if economists can construct models that predict the behaviour of economic agents, therein lies an assumption that the rationality behind a decision is consistent and that there is a consistently best outcome. If rational thinking is to consider human emotion, one must also realise that the economic models that predict behaviour are not explicit and therefore cannot be relied upon so heavily.

Moreover, economics describes humans as possessing a “bounded rationality:” humans face factors – information and cognitive limitations, a lack of time to make decisions, emotions, to name a few – that prevent us from being entirely rational in decision-making. Economics describes these factors as preventing a human from being entirely rational, but this contradicts rationality in psychology. This is the case as psychology’s concern with the reasoning behind the decision, even if there are factors that do limit the individual, lead it to say that, nonetheless, the individual is rational with the information and capacity they have. A distinction therefore between rationality in psychology and rationality in economics is that the factors psychology would describe as part of human nature are considered to contribute to rationality whilst, in economics, it, in fact, limits one’s rationality.

The extent of bounded rationality differs amongst economic agents. Humans are said to have the greatest bounded rationality whilst there are fewer factors limiting the rationality of firms and governments; they have access to greater resources.  In this sense, in an economic viewpoint, one could argue that artificial intelligence is more rational than an individual, as artificial intelligence has access to far greater resources than a human, so it should come to a utility-maximising decision. However, if one were to consider rationality as subjective, then the presence of human nature may, in fact, allow an individual to make a decision that is more rational than artificial intelligence as it also considers psychological welfare. This demonstrates that rationality in economics is a highly objective notion, where human nature interferes with the decision-making process. But, as human nature is present in all human decisions, rationality may be highly subjective, therefore the notion of rationality as described in economics may not be entirely rational itself.

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