Question

Question One a) State the Axioms of rational choice and show how they affect indifference curves where possible. b) If 2 goods, good X and good Y, draw an indifference curve such that good X is a normal good and good Y is an economic bad. c) Given two goods, good K and good T. If the price of good K is K2 per unit and good is K3 per unit for purchases less than 5 and K1 for purchases more than 5. Draw a budget line for Moses who has an income of K30 If Moses utility function is given by find his optimal combination of the two goods if the price of K is K2, the price of T is K1 and his income is 10. What is his utility?

Answer 1

1. Rational Choice Theory

Rational choice theory is also known as rational action theory or choice theory states that individuals make rational decisions using rational estimations. Using these rational calculations they attain their objectives which are compassionate to their personal choices. With the available information individuals make right predictions regarding their future life events, through this they may attain greatest benefits and satisfaction. Following are the main axioms or assumptions of rational choice theory.

Axioms

1. Rational actors.

The involvement of rational actors is necessary for making rational choices using rational calculations and rationally available information. Rational actors are the basis of rational choice theory and they make effective rational choices. Rational actors’ means their objective will be maximise their advantages.

2. Rationality assumption

With the involvement of rational actors, an economy seeks to analyse certain behaviours of the society as a whole. The rationality assumption states that the individuals in an economy are expected to be rational actors making rational decisions using rational calculations and information in order to gain the utmost advantages which are alienated with their interests.

3. Self-interest and Invisible hand

The ideas of rational choice theory are mainly derived from the contributions of Adam Smith such as the concepts of self-interest and invisible hand theory. Both the invisible hand theory and the rational choice theory both criticise the misconceptions that may be related out self-interests. Refuting adaptive expectation hypothesis, these two theories are giving more importance to the concept of self-interest which is necessary for rational actors can actually result in benefits for the economy as a whole. The invisible hand theory is progressed through the ideas of self-interest, rationality and rational choice theory. The invisible hand theory is defined as individuals are driven by self-interests and rationality to take decisions and ultimately lead to positive results for the economy at large.

4. Consistency

Rational actors are always appeared as consisting agents with unchanged preferences and choices. That means, if agents are superior, inferior or indifferent among their preferences, they will not change their preferences in any situations. Even if their choices are either risky or uncertain, still they reflect consistency.

Effect of Rational Choice Theory on Indifference Curve.

            Indifference curve is defined as the combination of two commodities that provide equal level of satisfaction within given level of income. The importance of indifference curve is that as we know the basic economic unit is consumer they determine which commodity has to be produced and purchased and in what quantities. A rational consumer will take right choice of goods and services through which they maximise their level of satisfaction. Therefore, the indifference curve is construct based of the idea of rationality assumption where, a rational individual select right combination of commodities that can be purchased with his available income to maintain their level of satisfaction as constant. Through this rational choice, he will attain highest indifference curve which maximise his level of satisfaction.