22 Rationality and Self-Interest
What you’ll learn to do: explain the assumption of economic rationality, define marginal analysis, and differentiate between positive and normative reasoning.
This module is about how economists analyze issues and problems, which is sometimes referred to as the “economic way of thinking.” In the previous sections of the module, we explored two common models used by economists to think about economic issues. Now we segue into introducing some specific features of economic thinking: economic rationality, marginal analysis, and positive vs. normative reasoning.
Economists assume that humans make decisions in predictable ways. They believe that, when making choices, people try to avoid costs and maximize benefits to themselves.This is what economists mean by rational decision-making.
Economists recognize that very few choices in the real world are “all or nothing.” Should you study economics for another hour? Economists use the word marginal to mean “additional” or “extra,” and they use the term marginal analysis to describe how people make choices by comparing the benefits and costs of doing a bit more or a bit less.
Economists can make two kinds of arguments. Positive reasoning is scientific reasoning, based on theories and evidence. Policy decisions often employ normative reasoning, which is based on values. For reasons we will see later, it is important to be able to to differentiate between the two.
Learning Objectives
- Define rationality in an economic context
- Provide examples of rational decision-making
If you say that someone is behaving “rationally,” you probably mean that he or she is acting in a thoughtful, clear-headed way (as opposed to irrationally, which suggests that someone is acting emotionally or illogically). In the context of economics, the term rationality has a very specific meaning. It refers to an assumption that economists make about how people behave—remember that this is the starting point of all economics—in the face of scarcity. There simply aren’t enough resources to satisfy all needs and wants. Charlie has only $10, he’s hungry, and he needs to get to work. What will he do? An economist predicts that Charlie will behave in a predictable, rational manner, balancing costs against benefits to arrive at an action that maximizes his personal happiness or utility. As a result, he will choose a certain number of burgers and a certain number of bus tickets.
To put it differently, if an individual acts in an economically rational way, anything that increases the benefits or decreases the costs of some action is likely to increase the probability that the individual will choose that action. Anything that decreases the benefits or increases the costs will likely reduce the probability that the individual will choose that action.
Economists assume that people will make choices in their own self-interest. They will choose those things that provide the greatest personal benefit, and they’ll avoi