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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

Under what circumstances might people appear to use rules of thumb, as suggested by the assumption of bounded rationality, even though they really were behaving in a manner suggested by the rationality assumption?

Define economics. Explain briefly how the economic way of thinking鈥攊n terms of rational, self-interested people responding to incentives鈥攔elates to each of the following situations.

(a) A student deciding whether to purchase a textbook for a particular class.

(b) Government officials seeking more funding for mass transit through higher taxes.

(c) A municipality taxing hotel guests to obtain funding for a new sports stadium.

In a single sentence, contrast microeconomics and macroeconomics. Next, categorize each of the following issues as either a microeconomic issue, a macroeconomic issue, or not an economic issue.

(a) The national unemployment rate.

(b) The decision of a worker to work overtime or not.

(c) A family鈥檚 choice to have a baby.

(d) The rate of growth of the money supply.

(e) The national government鈥檚 budget deficit.

(f) A student鈥檚 allocation of study time across two subjects.

Consider the following statements, based on a positive economic analysis that assumes that all other things remain constant. For each, list one other thing that might change and thus offset the outcome stated.

(a) Increased demand for laptop computers will drive up their price.

(b) Falling gasoline prices will result in additional vacation travel.

(c) A reduction of income tax rates will result in more people working.

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) To make predictions about how many apps a person will download onto her tablet device, an economist presumes that the individual faces limitations that make it impossible for her to examine every possible choice among relevant apps.

(b) In evaluating the price that an individual will be willing to pay for a given quantity of a particular type of healthcare service, a researcher assumes that the person considers all relevant health care options in pursuit of his own long-term satisfaction with resulting health outcomes.

(c) To determine the amount of time that a person will decide to devote to watching online videos each week, an economist makes the assumption that the individual will feel overwhelmed by the sheer volume of videos available online and will respond by using a rule of thumb.
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