1.2.1 Rational Decision Making

• When making economic decisions, consumers aim to maximise their utility and firms aim to maximise profits.
• A consumer’s utility is the total satisifaction they get from consuming a good or service.
• Daniel Kahneman first system on decision making is based on common sense and estimates the emotion responses to the choice made. It uses short cuts and quick decisions.

  It is a dominant system but its biased nature and potential for error can lead to irrational decisions.
• Daniel Kahneman’s second system on decision making uses thoughts and reflections.

  It avoids biases and errors, but because of how easy the system is manipulated the decisions can be harmful.
• A firm or individual can make decision using intuition or rationality.
• Businesses use intuition when they do not have access to facts or when making difficult decisions.
• Stages of making a rational decision

  1. Identify the problem.
  2. Find and identify the decision criteria
  3. Rank the criteria
  4. Generate alternatives
  5. Evaluate alternative options.
  6. Choose best alternative
  7. Carry out decision
  8. Evaluate decision
• Disadvantages of Rational Decision Making Model

  1. Not always the most realistic way to make a decision.
  2. Despite being fairer than intuition, it takes longer.
  3. Not practical under strict time constraints.
• Herbert Simon recognised the limitations of the ratIonal decision making model and devised the bounded rationality model, also known as the administrative man theory.
• Assumptions of The Bounded Rationality Model

  1. First satisfactory alternative is selected.
  2. Decision maker recognises that they perceive the world as simple.
  3. Decision maker recognises the need to be comfortable making decisions without considering every alternative.
  4. Decisions could be made by heuristics.