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How Do Markets Work ?

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How Do Markets Work ?

Explain what is implied by the assumption that decision-makers are
rational. To what extent is it sensible to think of decisions about
marriage and divorce as rational decisions ?

Economic theory has a tough job. It is essentially trying to distil
the complexities of thousands of thought processes, all types of
transactions and other various decisions we make every day that are
all effected by innumerable variables, into easy to understand, bite
sized pieces of individual theory. Surely it can be forgiven then, for
eliminating one small variable, namely the rationality of the
decision-maker, that you and I take for granted every day. This much
is true, that very little economic theory does not take the rational
behaviour of the consumer as a given and even less would be able to
function effectively without this being so. The question here
challenges us to explore the validity of the claim of unquestionable
consumer rationality and what it actually means when we take for
granted that everyone would always act in a rational manner. What are
the implications for the applicability of economic theory, should the
assumption of economists prove to be incorrect, or indeed if it is
completely true ? I will attempt to explore the implications of this
assumption using examples of where it is a key part of the workings of
economic theory, where a point in the mechanics of a theory arises
when the truth or otherwise of the assumption of consumer rationality.
An example that the question suggests is that of marriage, and if it
is appropriate to claim that such a step can be considered rational
course of action given the factors influencing the decision and surely
in this context, the economic consequences in addition to this.

It follows then that the implications of the assumption that all
decision-makers are rational are multiple for economic theory. Basic
supply and demand, and the subsequent equilibrium that characterises
market economics has at its heart, consumers making rational
decisions. The theory suggests that the price of goods tend to
equilibrium because consumers act rationally. If the price of a good
is below its equilibrium price, it is likely that many consumers will
decide that they will derive more utils from the consumption of that
good than from the consumption of any other good they could buy at the
same price. They would derive more satisfaction from that good than
the opportunity cost buying it. Conversely, should the price be above
the equilibrium, supply and demand is telling us that this is because
consumers are rationally asserting that the opportunity cost of
purchase is more than the satisfaction to be gained from it. Should
decision-makers act in a random fashion when choosing goods, such a
theory would be inconsequential. Therefore one could say that one
implication of the assumption the question refers to is that it allows
basic economic theory to appear scientific, and therefore to hold
intellectual weight. Laying aside the fact that it is a necessity for
its existence that economics takes this as given, is it really
reasonable to make such assumptions ? It could be argued that in fact,
not all economic decisions are made in a rational manner, indeed that
they are influenced by purely arbitrary factors. Take for example, so
called 'goods of ostentation', to which economic theorists themselves
assign a different demand curve than more 'conventional' goods. An
example of such a good would be a product with 'snob appeal' such as a
very expensive car. As the price increases past a certain point
further increases in its price make the good more heavily demanded, in
effect more people want to buy it as it gets more expensive. A
secondary assumption being made in most economic theory that
facilitates rational decision making is that all consumers are
equipped with 'perfect knowledge', they know exactly where the goods
the wish to buy can be bought at the cheapest prices, as well as being
able to buy them just as freely anywhere happen to be. It could be
argued that although not strictly accurate representations of the
state of things per se, as both assumptions have obvious exceptions,
generally they can be accepted as a reasonable summarising for the
purposes they serve.

A non-economic interpretation of the question would take a slightly
different view of things. Rationality can be thought of in a number of
ways, and whether a decision is rational depends on what view of
rationality one might be taking. For example, I think view people
would argue that as far as short-term gratification is concerned, if
an individual is in possession of all their faculties, the
implications of any decision are rationally considered. This is not to
say that long-term considerations are always ignored, but neither is
it to say that they are always taken into account either. For example,
somebody deciding or not they should buy sandwich, will certainly
consider the immediate satisfaction of their hunger, yet it is
dependant on the individual how much importance they would assign to
the fact that they wouldn't be able to get the bus back home later
that night and would catch a cold from returning on foot, resulting in
days off work and subsequent loss of income. It could be said that by
popular consent, the anyone who bought the sandwich would be
considered 'irrational'. The assumption that one is always in
possession of all their faculties is a dangerous one to make. It can
hardly be asserted that the decision of anyone already very drunk on a
night out to buy another alcoholic beverage to be rational .They know
that it will result in their being violently sick and lead to them
regretting the purchase in the morning, yet this does occur as their
intoxicated state has robbed them of the power of 'rational' thought.
The same can be said of other conditions such as stress and being in
love. If we have previously asserted that an emotionally overwhelming
attraction to another human being is a condition that can lead to
loosing of any innate 'rational', is it at all valid to consider the
decision to 'tie the knot' as being a rational one.

Looking at a hypothetical couple, who are very much in love and feel
everything associated with that term, what are the thought processes
behind wanting to get married, and are they rational. A commonly cited
reason for marriage is that it is the most public way of expressing
the love a couple feel for one another, and this is certainly true. It
allows others to clearly understand the nature of an individual
relationship and of course many marry for religious reasons. If these
are things that two individuals value highly, and have clearly thought
about the opportunity cost of getting married, then it is difficult to
argue that it is in any sense 'irrational'. However, this couple is in
love, and although it is certainly true that many couples can and do
see getting married as a rational decision, who is to say that this
couples decision has been, they are do not posses all of their
faculties at this particular moment and have not necessarily consider
everything relating to such a decision. How important does the
statistic that 1 in 3 marriages end in divorce, and all the financial
and emotional nastiness that this entails, seem to a couple in love as
they are in the process of the making the decision to go ahead with it
? A marriages, assumption the absence of a prior agreement, makes all
the assets of both parties a single legal entity, meaning that in the
future, when circumstances can and do change and they possibly
divorce, one party is liable to lose a proportion of their personal
wealth. However it is necessary to point out also that currently
marriage in this country gives partners a certain legal status,
entitling them to certain allowances and inheritance rights which they
would not otherwise have and this could conceivably be taken into
account by some couple, perhaps making it seem more 'rational' in an
economic sense. It can be argued then, that on an individual basis it
is perfectly sensible to assume that the decision of marriage is a
rational and well thought out one. However it would be very naive to
assume that this held true for all marriages, as the statistics show
that divorce is prevalent in the sphere of marriage, and rational
people simply do not want to go through something of that nature.

Economics assumes the rationality of the individual in all cases, yet
we have seen here that this assumption is not correct in all cases.
Outside influences colour and cloud our judgement, and this is
accepted as a facet of human nature by most people. However it is fair
to say that the majority also consider people to act 'rationally' most
of the time, certainly in an economic sense of maximising utility from
given resources. So perhaps it could be argued that seeing as this
assumption could be considered reasonable, the implication of it that
economic theory can exist could also be considered reasonable, which
it goes without saying is extremely important for the economic
discipline. Marriage, is can be said, is a special case can be grouped
with other situations that find an individual without all of their
faculties, and unable to act rationally. This is not to say that
individual marriages have not been entered into for rational,
economically rational reasons, simply that it is impossible say that
marriage decision making follows a general pattern and therefore it
must be viewed as in a sense, as outside of the realm of economic
theory.

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