Rational choice theory is a framework that models economic behavior based on the assumption that agents act rationally. Rational agents are goal-oriented, reflective, and consistent in their decision making. Consumers maximize utility, workers maximize welfare, firms maximize profit, and governments maximize citizen welfare. Rational consumers try to maximize total utility subject to their budget constraint. Utility is the satisfaction from consumption, with diminishing marginal utility as consumption increases. Similarly, firms maximize total profit by producing at the point where marginal revenue equals marginal cost.

1. Rational
Decision
Making
Lower 6th Micro
How Markets Work

2. Intro to Rational
Decision Making
Rational Decision Making
Mr O’Grady

3. Rational Decision Making
Rational choice theory: a framework for understanding and often formally modelling
social and economic behaviour based on the assumption that economic agents act
rationally
Rational: in accordance with reason or logic
Net benefit: The sum of all the benefits of an outcome minus all the costs. Each
economic agent maximises a different net benefit.
Consumers: Maximise their economic welfare or utility (the satisfaction from consuming goods and
services).
Workers: Maximise their own welfare at work. E.g. pay, job security, commute time, fulfilment etc.
Firms: Maximise their profit.
Governments: Maximise the welfare of their citizens.
Rational consumers: try to maximise their total utility (constrained by income)
Behaviour is rational if it is goal-oriented, reflective (evaluative), and consistent (across time and
different choice situations)
Homo Economicus: Rational choice theory uses a hypothetical model of humans who are
infinitely rational and immensely intelligent, an emotionless being who can do cost-
benefit analyses instantly, and is never (ever) wrong.

4. Rational
Choice Theory
& Utility
Rational Decision Making
Mr O’Grady

5. Utility
Utility: the satisfaction derived from the use of a good or service
Unit of utility: util (see extension content for more)
Total utility: the total satisfaction an economic agent gains from
all the units of a commodity consumed within a given time period
Marginal utility: the additional satisfaction gained from
consuming one extra unit within a given time period
Shapes of the TU an MU curves
Thought experiment: you have 10 slices of pizza, how does your
TU & MU change as you drink eat one by one in an hour?
Diminishing Marginal Utility: as more units of a good are
consumed, additional units will provide less additional
satisfaction than previous units.
Eventually consumption of additional units will be detrimental to total
utility, negative marginal utility!
Max. TU: where MU = 0, any more consumption and TU will start to fall
Relationship between MU and TU: MU gives the change in TU
for each unit. The change in TU with each additional unit is the
same as the gradient of the TU curve. The MU curve is the
gradient function of the TU curve. MU is the differential of TU. 𝑀𝑈 =
𝑑𝑇𝑈
𝑑𝑄

6. Rational
Choice Theory
& Profits
Rational Decision Making
Mr O’Grady

7. Profits
Rational Firm’s Objective: In a similar vein of thought to individuals seeking to
maximise utility, rational firms will seek to maximise profits.
Total Profit: The remains of a firm’s revenue after the deduction of all costs.
Total profit = total revenue – total costs
TP = TR - TC
Marginal Profit: The addition to profit a firm makes when it sells an additional unit
of output.
It is equal to the extra revenue generated by the unit’s sale (marginal revenue) minus the
additional costs of producing the unit (marginal costs).
MP = MR - MC
Max. Profit: If total utility is maximised when marginal utility is equal to zero, total
profit is also maximised when marginal profits are equal to zero
MP = 0
MR - MC = 0
MR = MC
This is the profit maximising condition (more on this in U6th Micro content)

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