1.2.1 Rational decision making

When analysing markets what assumptions?

A range of assumptions are made about the rationality of economic agents involved in transactions

What does rational mean?

• Means that economic agents are able to consider the outcome of their choices and recognise the net benefits of each one.

• National agents will select the choice which presents the highest benefits.

Are consumers assumed to work rationally? why?

Yes

They do this by maximising their utility-

Are producers assumed to work rationally? how?

Yes,

They do this by selling goods/services in a way that maximises profits

Are workers assumed to work rationally? how?

Yes,

they do this by balancing welfare at work with consideration of both pay and benefits

Are governments assumed to work rationally? why?

Yes,

they do this by placing the interests of the people they serve first in order to maximise their welfare

Is the assumption of rational decision making flawed?

Yes for example, consumers are often more influenced by emotional purchasing decisions than a rational computation of net benefits

Why are people willing to pay less ad they buy more and more

The ‘utility’ (or satisfaction) you obtain from consuming the good (e.g water) falls with each bottle you consume. i.e you experience ‘diminishing marginal utility’ - this is normative

Draw a diagram for this example. (Number of water bottles and marginal utility)

What is utility in economics?

MEASURE OF SATISFATION FROM CONSUMPTION

• utility refers to the satisfaction, well-being, or value that an individual derives from consuming goods and services.

What is marginal utility?

refers to the additional satisfaction or utility gained from consuming one more unit of good or service

What is the law of diminishing marginal utility state?

It states that as a person consumes more units of a particular good or service while keeping the consumption of other goods constant (ceteris paribus), the additional satisfaction or marginal utility will decrease