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Are people rational?

When we study economics, we often make the assumption that people will behave rationally. But what do we mean by rational behaviour? Generally speaking we expect people to make rational choices in their consumption decisions.

For example, if you want to buy a new car, how do you decide which car to buy? You may have a choice between an expensive sports-style car or a cheaper saloon car. The more expensive car will be more exciting to drive and give you more satisfaction, but the saloon car is cheaper. So, the sports car will have a higher opportunity cost; your income is not unlimited, so you will have to give up more other consumption to be able to afford it. Is the higher level of satisfaction enough to persuade you to spend more money?

In making this kind of choice, you are weighing up the costs and benefits of the decision and if the benefits of the sports car are greater than the costs, then you will purchase it. This is how we assume people behave. They make rtional rational decisions by weighing up the costs and benefits of any decision they make. This will apply not just to consumption, but also the choiccie of a job, the choice of leisure pursuits and so on.

We assume also that firms make rational decisions. When making decision like whether to introduce a new range of goods, or whether to produce more of an existing range, they will weigh up the costs and benefits of the decision and decide on that basis.

So all economic agents are generally assumed to be rational decision-makers.

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