-
7/31/2019 Lecture 1 Instrumental Rationality
1/5
The Psychology of Economic and BusinessDecisions
1. Introduction
2. Instrumental Rationality in Economics
Lecture 1Revisiting Instrumental Rationality
3. Components of Rationality
4. Anomalies
-
7/31/2019 Lecture 1 Instrumental Rationality
2/5
The Psychology of Economic and BusinessDecisions
1. Introduction
Economics is the science which studies human behaviour asa
relationship between ends and scarce means which havealternative
uses (Robbins)
The concept ofchoice underpins economics - a trade-off
between alternatives
Economists study behaviour in order to explain and predict -able
to prescribe policies to government
Economists use models, which comprises of variables
andassumptions, e.g. behaviour = f (ends, means)
Variables: what we study, e.g. behaviour, ends, means
Assumption underlying economic theory: behaviour or choiceis
rational
-
7/31/2019 Lecture 1 Instrumental Rationality
3/5
The Psychology of Economic and BusinessDecisions
2. Instrumental Rationality
Rational choice theory - when faced with severalcourses of
action, people usually do what theybelieve is likely to have the
best overall outcome(Elster 1989)
,individual has a set of preferences and will choosethe action
that he correctly calculates to be themost instrumental in
satisfying his preferences (i.e.that maximises his utility)
The economic man (homo economicus) is assumedto be
instrumentally-rational
-
7/31/2019 Lecture 1 Instrumental Rationality
4/5
The Psychology of Economic and BusinessDecisions
Action
A choice betweenalternative coursesof action
3. Components of Rationality
Elster 1989:
Beliefs
Evidence
Preferences
Goals, desires, aims,wants (which give utility)
Probabilities,expectations
Information, data
Reason is slave to thepassions (David Hume)
Axioms: e.g. Complete, Transitive
-
7/31/2019 Lecture 1 Instrumental Rationality
5/5
The Psychology of Economic and BusinessDecisions
4. Anomalies
People do not alwaystake the mostrational action
Preferences do not obey axioms, beliefs are not formedcorrectly,
and optimal decisions based on preferences andinformation are not
always taken, e.g. actions influenced bycontext, framing, order of
presentation etc. (Lecs 3, 4)
There is empirical (real world) evidence that people do not
conformto the predictions of instrumental rationality when making
economicdecisions
People are notalways self-interested
People demonstrate pro-social preferences even though
thisadversely affects their material welfare, e.g. giving
toothers/charity; being fair; being reciprocal (Lecs 5, 9)
Culture affectsdecisions
People from different cultures behave differently under thesame
economic circumstances, e.g. Americans are more fairthan Peruvian
hunter gatherers (Lec 6)
Individual differencesaffect decisions
Different people behave differently under the same
economiccircumstances, e.g. females more risk averse than males
(Lec7)
Wealth Happiness Greater material welfare is not strongly
associated withgreater subjective well being/happiness across
individuals,within individuals and across nations (Lec 8)
