Economy

When Reality Questions the Notion of Rationality

The assumption that human beings are rational creatures was one of the most celebrated propositions in the realm of economic thought, especially popularised by the neoclassical economists. The idea of rationality, as propounded by the neo-classicists, categorise humans as individuals who always maximise their wants or utility. Thus, an individual always makes choices that maximises one’s utility or at least an achievement of an optimal level of utility. In this regard, the assumption implicitly considers that individuals have complete information or perfect information about market or their necessary scenario of operation. This notion of information symmetry implies that individuals possess complete and true information about the market or market conditions like price, quality, quantity and other demand-supply aspects. The neoclassical economists ignored the possibility of any manipulation, moral hazard or adverse selection problems arising from the information asymmetry, which is again an unrealistic assumption.

Let it be any individual or a firm, it always tries to achieve the maximum potential, maximum utility in the case of an individual or maximum profit in the case of a firm. Another aspect of the assumption on information symmetry is that it also considers the preferences or choices of the individuals in line with the concepts of consistency, transitivity and preferences. These assumptions have attracted immense set of criticisms and contradicting arguments from other economists and other schools of thought.

It is thus very much imperative to test whether the notion of rationality actually holds well in reality. On considering the assumption of rationality, it is necessary to examine various real life situations to check whether the rationality assumption is valid, i.e. whether the individuals are perfectly aware of the situations they live in. For example, while making various choices about buying goods or services, the definition of rationality comes into picture. Thus, the idea of rational choices for one individual may not be the same for another person. The idea of utility is thus different for a rich person and for a poor person. We can, therefore, assume that rational decision may be explained as a situation where a person pursues to achieve maximum utility given the necessary financial and social conditions.

Various other disciplines like gender economics and behavioural economics raise huge criticisms against this notion stating that human beings are not always rational. The emotional and social conditions of a person also influence the decision making process. Behavioural economists, through various psychological tools, have given empirical evidences to prove that human beings are not rational. For example, in the study “Sports Sentiment and Stock Returns” conducted by Edman, Gracia and Norli in 2007, it was found that FIFA World Cup results have an impact on the stock returns of the participating countries. Thus, a defeat in the match translates to negative stock returns and a win in the match results in positive stock returns. This is proves the failure of the rationality assumption. Also, the behaviour of individuals during an offer or discount sale is another situation where the advertisement and incentives impact the human decisions.

Further, the rationality assumptions state that individuals are consistent in their performance. That is in a given situation the choice made by the consumer will be the same as in another situation. The transitivity element of this notion states that if an individual chooses a product A to product B and product B over product C, then in another scenario the individual choose product A over product C. However, in real situation these assumptions do not hold good as the preferences or the choices of the individuals may change depending on the context. Above all, the notion of rationality is questionable especially in the case of domestic scenario. The household expenditure decisions are largely influenced by emotions, attachment and desires of other family members. Various empirical studies have proven that women are more altruistic in nature and even less competitive comparative to men. Also, the decision of women to stay back at home looking after the kids involve very high opportunity cost in terms of outside work options. Thus, human beings are largely a product of their circumstances and various factors like social, economic, political and emotional elements influence the decision making ability. Therefore, an individual cannot make rational decisions always.

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