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Chapter 1: Q 7 (page 15)

Explain, in your own words, the rationality assumption, and contrast it with the assumption of bounded rationality proposed by adherents of behavioral economics.

Short Answer

Expert verified

The rationality assumption states that people take the decision very carefully so as not to incur a loss while the bounded rationality is based on a simple method available to them.

Step by step solution

01

Step 1. Bounded Rational Behavior.

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

Step 2. Assumptions.

Rationality assumptions state that people make their decisions such that they do not incur a loss. On the other hand, bounded rationality do not consider every choice instead they make a choice by a simple method.

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Most popular questions from this chapter

Suppose that the U.S. federal government has borrowed \(500 billion to expand its total spending on goods and services across the entire economy in an effort to boost by \)500 billion the aggregate production by the nation's firms. Would we apply microeconomic or macroeconomic analysis to analyze this policy action?

Under the rationality assumption, could a woman potentially take into account her family's welfare as well as her own when considering having another child? Explain your reasoning.

Why might the rationality assumption explain why even a chicken farmer who has absolutely no humanitarian concern for chickens might seek to maintain very comfortable conditions for the birds?

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?

Recently, a bank was trying to decide what fee to charge for “expedited payments”—payments that the bank would transmit extra-speedily to enable customers to avoid late fees on cable TV bills, electric bills, and the like. To try to determine what fee customers were willing to pay for expedited payments, the bank conducted a survey. It was able to determine that many of the people surveyed already paid fees for expedited payment services that exceeded the maximum fees that they said they were willing to pay. How does the bank’s finding relate to economists’ traditional focus on what people do, rather than what they say they will do?
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