Rational choice theory

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Rational choice theory, also known as choice theory or rational action theory, is a framework for understanding and often formally modeling social and economic behavior. The basic premise of rational choice theory is that aggregate social behavior results from the behavior of individual actors, each of whom is making their individual decisions. The theory also focuses on the determinants of the individual choices (methodological individualism). 

 

Rational choice theory then assumes that an individual has preferences among the available choice alternatives that allow them to state which option they prefer. These preferences are assumed to be complete (the person can always say which of two alternatives they consider preferable or that neither is preferred to the other) and transitive (if option A is preferred over option B and option B is preferred over option C, then A is preferred over C). The rational agent is assumed to take account of available information, probabilities of events, and potential costs and benefits in determining preferences, and to act consistently in choosing the self-determined best choice of action.

Rationality is widely used as an assumption of the behavior of individuals in microeconomic models and analyses and appears in almost all economics textbook treatments of human decision-making. It is also used in political science, sociology, and philosophy. A particular version of rationality is instrumental rationality, which involves seeking the most cost-effective means to achieve a specific goal without reflecting on the worthiness of that goal. Gary Becker was an early proponent of applying rational actor models more widely. Becker won the 1992 Nobel Memorial Prize in Economic Sciences for his studies of discrimination, crime, and human capital.

Definition and scope

The concept of rationality used in rational choice theory is different from the colloquial and most philosophical use of the word. Colloquially, "rational" behaviour typically means "sensible", "predictable", or "in a thoughtful, clear-headed manner." Rational choice theory uses a narrower definition of rationality. At its most basic level, behavior is rational if it is goal-oriented, reflective (evaluative), and consistent (across time and different choice situations). This contrasts with behavior that is random, impulsive, conditioned, or adopted by (unevaluative) imitation.

Early neoclassical economists writing about rational choice, including William Stanley Jevons, assumed that agents make consumption choices so as to maximize their happiness, or utility. Contemporary theory bases rational choice on a set of choice axioms that need to be satisfied, and typically does not specify where the goal (preferences, desires) comes from. It mandates just a consistent ranking of the alternatives. Individuals choose the best action according to their personal preferences and the constraints facing them. E.g., there is nothing irrational in preferring fish to meat the first time, but there is something irrational in preferring fish to meat in one instant and preferring meat to fish in another, without anything else having changed. 

Rational choice theorists do not claim that the theory describes the choice process, but rather that it predicts the outcome and pattern of choices. An assumption often added to the rational choice paradigm is that individual preferences are self-interested, in which case the individual can be referred to as a homo economicus. Such an individual acts as if balancing costs against benefits to arrive at action that maximizes personal advantage. Proponents of such models, particularly those associated with the Chicago school of economics, do not claim that a model's assumptions are an accurate description of reality, only that they help formulate clear and falsifiable hypotheses. In this view, the only way to judge the success of a hypothesis is empirical tests. To use an example from Milton Friedman, if a theory that says that the behavior of the leaves of a tree is explained by their rationality passes the empirical test, it is seen as successful. 

Without specifying the individual's goal or preferences it may not be possible to empirically test, or falsify, the rationality assumption. However, the predictions made by a specific version of the theory are testable. In recent years, the most prevalent version of rational choice theory, expected utility theory, has been challenged by the experimental results of behavioral economics. Economists are learning from other fields, such as psychology, and are enriching their theories of choice in order to get a more accurate view of human decision-making. For example, the behavioral economist and experimental psychologist Daniel Kahneman won the Nobel Memorial Prize in Economic Sciences in 2002 for his work in this field. 

Rational choice theory has become increasingly employed in social sciences other than economics, such as sociology, evolutionary theory and political science in recent decades. It has had far-reaching impacts on the study of political science, especially in fields like the study of interest groups, elections, behaviour in legislatures, coalitions, and bureaucracy. In these fields, the use of the rational choice paradigm to explain broad social phenomena is the subject of active controversy.

Actions, assumptions, and individual preferences

The premise of rational choice theory as a social science methodology is that the aggregate behavior in society reflects the sum of the choices made by individuals. Each individual, in turn, makes their choice based on their own preferences and the constraints (or choice set) they face. 

At the individual level, rational choice theory stipulates that the agent chooses the action (or outcome) they most prefer. In the case where actions (or outcomes) can be evaluated in terms of costs and benefits, a rational individual chooses the action (or outcome) that provides the maximum net benefit, i.e., the maximum benefit minus cost. 

The theory applies to more general settings than those identified by costs and benefit. In general, rational decision making entails choosing among all available alternatives the alternative that the individual most prefers. The "alternatives" can be a set of actions ("what to do?") or a set of objects ("what to choose/buy"). In the case of actions, what the individual really cares about are the outcomes that results from each possible action. Actions, in this case, are only an instrument for obtaining a particular outcome.

Formal statement

The available alternatives are often expressed as a set of objects, for example a set of j exhaustive and exclusive actions:

${\displaystyle A=\{a_{1},\ldots ,a_{i},\ldots ,a_{j}\}}$

For example, if a person can choose to vote for either Roger or Sara or to abstain, their set of possible alternatives is:

${\displaystyle A=\{{\text{Vote for Roger, Vote for Sara, Abstain}}\}}$

The theory makes two technical assumptions about individuals' preferences over alternatives:

1. Completeness – for any two alternatives a_i and a_j in the set, either a_i is preferred to a_j, or a_j is preferred to a_i, or the individual is indifferent between a_i and a_j. In other words, all pairs of alternatives can be compared with each other.
2. Transitivity – if alternative a₁ is preferred to a₂, and alternative a₂ is preferred to a₃, then a₁ is preferred to a₃.

Together these two assumptions imply that given a set of exhaustive and exclusive actions to choose from, an individual can rank the elements of this set in terms of his preferences in an internally consistent way (the ranking constitutes a partial ordering), and the set has at least one maximal element. 

The preferences between two alternatives can be:

• Strict preference occurs when an individual prefers a₁ to a₂ and does not view them as equally preferred.
• Weak preference implies that individual either strictly prefers a₁ over a₂ or is indifferent between them.
• Indifference occurs when an individual neither prefers a₁ to a₂, nor a₂ to a₁. Since (by completeness) the individual does not refuse a comparison, they must therefore be indifferent in this case.

Research that took off in the 1980s sought to develop models which drop these assumptions and argue that such behaviour could still be rational, Anand (1993). This work, often conducted by economic theorists and analytical philosophers, suggests ultimately that the assumptions or axioms above are not completely general and might at best be regarded as approximations.

Additional assumptions

• Perfect information: The simple rational choice model above assumes that the individual has full or perfect information about the alternatives, i.e., the ranking between two alternatives involves no uncertainty.
• Choice under uncertainty: In a richer model that involves uncertainty about the how choices (actions) lead to eventual outcomes, the individual effectively chooses between lotteries, where each lottery induces a different probability distribution over outcomes. The additional assumption of independence of irrelevant alternatives then leads to expected utility theory.
• Inter-temporal choice: when decisions affect choices (such as consumption) at different points in time, the standard method for evaluating alternatives across time involves discounting future payoffs.
• Limited cognitive ability: identifying and weighing each alternative against every other may take time, effort, and mental capacity. Recognising the cost that these impose or cognitive limitations of individuals gives rise to theories of bounded rationality.

Alternative theories of human action include such components as Amos Tversky and Daniel Kahneman's prospect theory, which reflects the empirical finding that, contrary to standard preferences assumed under neoclassical economics, individuals attach extra value to items that they already own compared to similar items owned by others. Under standard preferences, the amount that an individual is willing to pay for an item (such as a drinking mug) is assumed to equal the amount he or she is willing to be paid in order to part with it. In experiments, the latter price is sometimes significantly higher than the former (but see Plott and Zeiler 2005, Plott and Zeiler 2007 and Klass and Zeiler, 2013). Tversky and Kahneman do not characterize loss aversion as irrational. Behavioral economics includes a large number of other amendments to its picture of human behavior that go against neoclassical assumptions.

Utility maximization

Often preferences are described by their utility function or payoff function. This is an ordinal number that an individual assigns over the available actions, such as:

${\displaystyle u\left(a_{i}\right)>u\left(a_{j}\right).}$

The individual's preferences are then expressed as the relation between these ordinal assignments. For example, if an individual prefers the candidate Sara over Roger over abstaining, their preferences would have the relation:

${\displaystyle u\left({\text{Sara}}\right)>u\left({\text{Roger}}\right)>u\left({\text{abstain}}\right).}$

A preference relation that as above satisfies completeness, transitivity, and, in addition, continuity, can be equivalently represented by a utility function.

Criticism

Daniel Kahneman

Both the assumptions and the behavioral predictions of rational choice theory have sparked criticism from various camps. As mentioned above, some economists have developed models of bounded rationality, which hope to be more psychologically plausible without completely abandoning the idea that reason underlies decision-making processes. Other economists have developed more theories of human decision-making that allow for the roles of uncertainty, institutions, and determination of individual tastes by their socioeconomic environment (cf. Fernandez-Huerga, 2008). 

Martin Hollis and Edward J. Nell's 1975 book offers both a philosophical critique of neo-classical economics and an innovation in the field of economic methodology. Further they outlined an alternative vision to neo-classicism based on a rationalist theory of knowledge. Within neo-classicism, the authors addressed consumer behaviour (in the form of indifference curves and simple versions of revealed preference theory) and marginalist producer behaviour in both product and factor markets. Both are based on rational optimizing behaviour. They consider imperfect as well as perfect markets since neo-classical thinking embraces many market varieties and disposes of a whole system for their classification. However, the authors believe that the issues arising from basic maximizing models have extensive implications for econometric methodology (Hollis and Nell, 1975, p. 2). In particular it is this class of models – rational behavior as maximizing behaviour – which provide support for specification and identification. And this, they argue, is where the flaw is to be found. Hollis and Nell (1975) argued that positivism (broadly conceived) has provided neo-classicism with important support, which they then show to be unfounded. They base their critique of neo-classicism not only on their critique of positivism but also on the alternative they propose, rationalism. Indeed, they argue that rationality is central to neo-classical economics – as rational choice – and that this conception of rationality is misused. Demands are made of it that it cannot fulfill.

In their 1994 work, Pathologies of Rational Choice Theory, Donald P. Green and Ian Shapiro argue that the empirical outputs of rational choice theory have been limited. They contend that much of the applicable literature, at least in political science, was done with weak statistical methods and that when corrected many of the empirical outcomes no longer hold. When taken in this perspective, rational choice theory has provided very little to the overall understanding of political interaction - and is an amount certainly disproportionately weak relative to its appearance in the literature. Yet, they concede that cutting edge research, by scholars well-versed in the general scholarship of their fields (such as work on the U.S. Congress by Keith Krehbiel, Gary Cox, and Mat McCubbins) has generated valuable scientific progress.

Duncan K. Foley (2003, p. 1) has also provided an important criticism of the concept of rationality and its role in economics. He argued that

“Rationality” has played a central role in shaping and establishing the hegemony of contemporary mainstream economics. As the specific claims of robust neoclassicism fade into the history of economic thought, an orientation toward situating explanations of economic phenomena in relation to rationality has increasingly become the touchstone by which mainstream economists identify themselves and recognize each other. This is not so much a question of adherence to any particular conception of rationality, but of taking rationality of individual behavior as the unquestioned starting point of economic analysis.

Foley (2003, p. 9) went on to argue that

The concept of rationality, to use Hegelian language, represents the relations of modern capitalist society one-sidedly. The burden of rational-actor theory is the assertion that ‘naturally’ constituted individuals facing existential conflicts over scarce resources would rationally impose on themselves the institutional structures of modern capitalist society, or something approximating them. But this way of looking at matters systematically neglects the ways in which modern capitalist society and its social relations in fact constitute the ‘rational’, calculating individual. The well-known limitations of rational-actor theory, its static quality, its logical antinomies, its vulnerability to arguments of infinite regress, its failure to develop a progressive concrete research program, can all be traced to this starting-point.

Schram and Caterino (2006) contains a fundamental methodological criticism of rational choice theory for promoting the view that the natural science model is the only appropriate methodology in social science and that political science should follow this model, with its emphasis on quantification and mathematization. Schram and Caterino argue instead for methodological pluralism. The same argument is made by William E. Connolly, who in his work Neuropolitics shows that advances in neuroscience further illuminate some of the problematic practices of rational choice theory.

More recently Edward J. Nell and Karim Errouaki (2011, Ch. 1) argued that:

The DNA of neoclassical economics is defective. Neither the induction problem nor the problems of methodological individualism can be solved within the framework of neoclassical assumptions. The neoclassical approach is to call on rational economic man to solve both. Economic relationships that reflect rational choice should be ‘projectible’. But that attributes a deductive power to ‘rational’ that it cannot have consistently with positivist (or even pragmatist) assumptions (which require deductions to be simply analytic). To make rational calculations projectible, the agents may be assumed to have idealized abilities, especially foresight; but then the induction problem is out of reach because the agents of the world do not resemble those of the model. The agents of the model can be abstract, but they cannot be endowed with powers actual agents could not have. This also undermines methodological individualism; if behaviour cannot be reliably predicted on the basis of the ‘rational choices of agents’, a social order cannot reliably follow from the choices of agents.

Furthermore, Pierre Bourdieu fiercely opposed rational choice theory as grounded in a misunderstanding of how social agents operate. Bourdieu argued that social agents do not continuously calculate according to explicit rational and economic criteria. According to Bourdieu, social agents operate according to an implicit practical logic—a practical sense—and bodily dispositions. Social agents act according to their "feel for the game" (the "feel" being, roughly, habitus, and the "game" being the field).

Other social scientists, inspired in part by Bourdieu's thinking have expressed concern about the inappropriate use of economic metaphors in other contexts, suggesting that this may have political implications. The argument they make is that by treating everything as a kind of "economy" they make a particular vision of the way an economy works seem more natural. Thus, they suggest, rational choice is as much ideological as it is scientific, which does not in and of itself negate its scientific utility.

An evolutionary psychology perspective is that many of the seeming contradictions and biases regarding rational choice can be explained as being rational in the context of maximizing biological fitness in the ancestral environment but not necessarily in the current one. Thus, when living at subsistence level where a reduction of resources may have meant death it may have been rational to place a greater value on losses than on gains. Proponents argue it may also explain differences between groups.

Benefits

The rational choice approach allows preferences to be represented as real-valued utility functions. Economic decision making then becomes a problem of maximizing this utility function, subject to constraints (e.g. a budget). This has many advantages. It provides a compact theory that makes empirical predictions with a relatively sparse model - just a description of the agent's objectives and constraints. Furthermore, optimization theory is a well-developed field of mathematics. These two factors make rational choice models tractable compared to other approaches to choice. Most importantly, this approach is strikingly general. It has been used to analyze not only personal and household choices about traditional economic matters like consumption and savings, but also choices about education, marriage, child-bearing, migration, crime and so on, as well as business decisions about output, investment, hiring, entry, exit, etc. with varying degrees of success.

Despite the empirical shortcomings of rational choice theory, the flexibility and tractability of rational choice models (and the lack of equally powerful alternatives) lead to them still being widely used.