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Chapter 1: Q 11 (page 15)

For each of the following approaches that an economist might follow in examining a decision-making process, identify whether the approach relies on the rationality assumption or on the assumption of bounded rationality:

(a) An economic study of the number of online searches that individuals conduct before selecting a particular item to purchase online presumes that people are interested only in their own satisfaction, pursue their ultimate objectives, and consider every relevant option.

(b) An economist seeking to predict the effect that an increase in a state's sales tax rate will have on consumers' purchases of goods and services resumes that people are limited in their ability to process information about how the sales-tax-rate increase will influence the after-tax prices those consumers will pay.

(c) To evaluate the impact of an increase in the range of choices that an individual confronts when deciding among devices for accessing the Internet, an economic researcher makes the assumption that the individual is unable to take into account every new Internet-access option available to her.

Short Answer

Expert verified

(a) Rationality Assumption.

(b) Bounded Rationality Assumption.

(c) Bounded Rationality Assumption.

Step by step solution

01

Step 1. Bounded Rationality

Bounded rationality behavior explains that people are rational but not completely as they do not examine every possible choice given to them but instead sort among the alternatives.

02

Part (a). Online searches by individuals.

Rationality Assumption.

The individual will consider all the options and also take into consideration self-interest and will the option that is best for him.

03

Part (b). Increase in sales tax.

Bounded Rationality Assumption.

The state's sales tax will limit individuals' spending and they will choose among the alternatives based on their tax rate and this might sometimes not be the best alternative.

04

Part (c). Increase in range of choicees.

Bounded Rationality Assumption.

The individual does not take into account every new Internet access and therefore might not be able to make the choice rationally to the full extent as all alternatives are not considered.

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Most popular questions from this chapter

Could it be the case that chicken farmers who have both humanitarian and profit motives for keeping their chickens comfortable nonetheless are fully "self-interested"? Explain.

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Consider two models for estimating, in advance of an election, the shares of votes that will go to rival candidates. According to one model, pollsters’ surveys of a randomly chosen set of registered voters before an election can be used to forecast the percentage of votes that each candidate will receive. This first model relies on the assumption that unpaid survey respondents will give truthful responses about how they will vote and that they will actually cast a ballot in the election. The other model uses prices of financial assets (legally binding IOUs) issued by the Iowa Electronic Markets, operated by the University of Iowa, to predict electoral outcomes. The final payments received by owners of these assets, which can be bought or sold during the weeks and days preceding an election, depending on the shares of votes the candidates actually end up receiving. This second model assumes that owners of these assets wish to earn the highest possible returns, and it indicates that the market prices of these assets provide an indication of the percentage of votes that each candidate will actually receive on the day of the election.

(a) Which of these two models for forecasting electoral results is more firmly based on the rationality assumption of economics?

(b) How would an economist evaluate which is the better model for forecasting electoral outcomes?

Sebastian is a financial analyst who is convinced that his clients do not always make choices that are consistent with their long-term objectives. He has also determined that his clients do not consider every relevant choice and often fail to act in their own self-interest. Does Sebastian perceive that his clients' behavior accords with the rationality assumption or the assumption of bounded rationality?
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