Summary - Rational Choice Theory (6442RK14Y)

Rationality and preferences
 RC (rational choice) is more an approach than one theory:
o Social choice theory
o Public choice theory
o Expected utility theory
o Game theory
o Smaller theories
 RC uses a deductive method = theory  predictions  experiment
 RC is based on two main assumptions:
o 1: methodological individualism (about people as individuals)
o 2: rational behaviour (= utility maximalization)
 Methodological individualism
o Unit of analysis is the individual person  even group actions are explained by actions of
individuals
o Other than theories that focus on groups
o Focus of RC is on individuals and individual actors
o Institutions can be explained by the individuals in it
o Society is the sum of individuals
o Society does not shape individuals, individuals are shaped independently of the social structure
o Every analysis must begin with the individuals, deal with individual choices and experiences,
with collectives formed as aggregates
o = bottum up
 Rational behaviour = utility maximalization
o Rationality  individuals have goals or desires; individuals act according to those goals and
desires = preferences (goals and desires = preferences)
o If you don’t act according to your preferences, you are irrational + if you act according to those
preferences, you are rational
o Where do preferences come from?  survival, reproduction, socially acquired, etc.
o RC does not care about where preferences come from and why people want certain things
o Preferences of individuals are given, and they don’t change much (on short term)
o We don’t know the preferences of others, just our own, however we make assumptions about
the preferences of others
 Self-interest vs. selfish
o If an individual has preferences and acts according to them, we call the individual rational and
self-interested
o People pursue what they find important, this can include empathy for friends and family,
animals, environment, etc.
o Self-interest does not equal selfish, it can be, but doesn’t have to be
 Complication of rationality  thick vs. thin
o Thin version  we do not make any assumptions about an individual’s goal, we only know
they have goals
o Thick version  we make more explicit assumptions about the goals of individuals
o Some theories use thin version, some use thick version
 To put it more formal
o i = term for individual = one person
o x, y, z = preferences that individual has (= options for preferences) = choice set
o x Pi y means i prefers option x over y
o x Ii y means individual is indifferent between option x and y
 You chose the action that leads to the most preferred option
 To be able to order your preferences two assumptions are of importance:
o 1: comparability/completeness
o 2: transitivity
 Comparability/completeness
o A rational choice must be complete
o All alternatives in the choice set must be comparable in terms of preferences
 Transitivity
o A strict preference relation is said to be transitive if for any of the possibilities:
 x Pi y Pi z = x Pi y + x Pi z  rational

,  Problems with completeness: if the comparison does not make sense for the individual
 Problems with transitivity
o Requires consistency
o It gets complicated when stakes are very low and/or uncertainty is very high
 3 options is 3 options in formula, so x Pi y Pi z not x Pi y and y Pi z, otherwise you can’t know if the
person is rational. You need to know the complete preferences ordering = completeness
 Check for “circle” in preferences  if so = problem with transitivity
 Rational decision often involves cost-benefit analysis
 A rational individua will pursue aa goal if the benefits out weight the costs
 Cost and benefits can change, preferences not (on short term)
 Miscalculations of costs and benefits can happen

Expected utility theory
 Individuals rarely get to choose outcomes directly, often you can only choose a course of action you
believe leads to the most preferred outcome
 A rational individual chooses an action s/he believes will lead to the most preferred outcome
o Belief = a probability statement relating the effectiveness of a specific action (or instrument)
for various outcomes
o They come from different sources and can change
 Relationship: action and outcomes
o 3 options: certainty, risk, and uncertainty
o Certainty = the relationship between action and outcome is clear
o Risk = the relationship between action and outcome is unclear, but it is possible to link its
probabilities
o Uncertainty = the relationship between action and outcome is imprecise and entirely unclear
o Making a rational decision on the conditions of risk and uncertainty is difficult but not always
impossible, for this we need to work with utility
 Risk and utility
o Utility = the “benefit” the individual derives from the outcome
o There are two kinds of utility
 Ordinal utility
 Cardinal utility
 Ordinal utility
o A rational preference ordering means that we can order outcomes from most preferred to least
preferred and it is logically consistent (complete and transitive)
o We can therefore assign a number to each outcome to denote its rank in the individual’s
preference order, this is ordinal utility
o Ordinal utility only captures the ranking of preferences
o However, problem:
 The results of some actions may be risky or uncertain
 Furthermore, actions often entail costs
o We need to know more than the ordinal utility of preference orderings
 Cardinal utility
o Cardinal utility tells us how much an individual prefers one outcome to another
o Cardinal utility expresses the intensity of preferences for a given outcome
o This intensity is relative to:
 1: the individual
 2: the set of outcomes
o We cannot compare the cardinal utilities of two people
o We cannot make interpersonal comparisons
 Important  a preference relation can be represented by a utility function only if it is rational
 Cardinal and ordinal utility can be found in many political settings, most prominent voting
 Expected utility
o Individuals make choices under conditions of uncertainty
o We can assign probabilities to outcomes
o Individuals’ preference ordering can be ranked in terms of cardinal utility
o Using probabilities and cardinal utility, we can treat actions as lotteries en derive Expected
Utility (EU) of each course of action (lottery)