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What Is Rational Behavior?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 27 September 2014
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    Conjecture Corporation
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In the world of economics, rational behavior is a term used to describe the process of making financial decisions based on which course of action will yield the most benefit. This process is often assumed to be the basis for any type of transaction activity, ranging from the purchase of goods at a local supermarket to opening a business or buying blocks of securities as part of an investment scheme. Rational behavior is also thought to be the foundation for most theories regarding finance, including theories like the law of diminishing marginal utility.

It is important to note that rational behavior is not limited to the realization of monetary benefit alone. While earning a return or profit from a financial decision is often the motivation for the action, there are other forms of satisfaction that may also result from the activity. For example, a consumer may choose to purchase an item because he or she expects to gain greater personal satisfaction from owning a particular brand, even though a similar brand that is less expensive would save money. It is possible to actually lose money but gain some other form of satisfaction, and thus be employing rational behavior.

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At the root of rational behavior is the process of determining just what types of benefits or satisfaction will be achieved by making a specific financial decision versus going with a different decision. Comparing the relative merits of each decision, as well as allowing for potential drawbacks, makes it much easier to settle on a choice that eventually provides the most overall satisfaction. This would be true for someone who was considering early retirement. On the one hand, continuing to work up to the standard retirement age would usually mean a larger retirement nest egg, but the individual may find that more time with loved ones or the opportunity to travel now rather than later outweighs the additional financial resources that would be amassed by working a few more years. Alternatively, the individual may decide that the financial rewards are more important than the benefits that would be gained by retiring early, and decide to remain on the job.

In many situations, rational behavior in economic or financial matters is at least partially subjective. Once all possible benefits are identified, the individual can determine if those advantages are desirable enough to preclude making some other choice. The right decision for one individual may be the wrong move for someone else, making it all the more important to look closely at all types of benefits involved before choosing a course of action.

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