Rational Self Interest (Economics) - Explained
Whare is a Rational Self Interst?
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What is a Rational Self-interest?
Rational Self-Interest is a behavioral assumption that economists make about how people act under different economic conditions. Acting in an economically rational way entails taking actions that reduce costs and increase benefits for the individual. Acting conversely renders actions economically irrational.
How does Rational Self Interest Work?
People making active choices to serve their own Self-Interest is the assumption that economists make to predict economic behavior. Individuals choosing actions that prove optimally beneficial to them while avoiding situations that would further harm their economic condition, or not provide the best value for their time, money, or efforts, is the sum total of Rational Self-Interest. For example, John needs to stretch the last $20 he has for the last week of the month. He needs to be able to feed himself while also commuting to work by bus everyday. Economists predict that Rational Self-Interest is the reason why John buys ramen in bulk to last a week for $10, and spends the rest buying a bus pass to commute for the next 7 days. Thus he maximises the $20 he had to ensure all his needs are covered within his limited resources, arriving at an optimal outcome. Conversely, spending his last $20 for a coffee and donut at Starbucks would make for a very bad decision. Rational Self-Interest doesnt imply selfish behavior. The word Rational qualifies the Self-Interest as beneficial rather than greedy. Self-Interest can also entail making others happy. Saving income to buy gifts, or spending on family, is also an act of Rational Self-Interest that encompasses making others happy. Its a simplified view of rationality that economists rely on to explain the process of human decision making.
Rationality in Commerce
This theory of rational behavior is applied in the field of commerce to understand consumer behavior and answer the question, What do consumers want?. The simple answer being maximum benefits at minimal costs. For e.g., what would bring the consumer to the movie theatre in the era of Netflix? What would induce a customer to spend more money to watch a single movie instead of spending a small amount to have access to thousands of movies? The answers to these questions will shape customer strategies adopted by movie studios to fill in movie hall seats. The benefits of rational decisions arent limited to minimising costs, they also include a satisfaction component that makes consumers spend more for experiences that make them happy even if the expenditure isnt optimal.
Rationality in Business
Unlike consumers, businesses do not have a satisfaction or happiness angle. Hence their Rational Self-Interest is guided by behavior that maximizes profits and minimizes operational costs. Thus, economists will base their predictions about businesses on the basis of their profit margin goals. If the minimum wage was to be increased in the U.S., companies might strive to reduce operational costs by outsourcing menial jobs to countries with lower wage requirements. This is just a prediction based on the Rational Self-Interest theory and might not always be 100% accurate, although the underlying assumption that companies will make a move towards reducing operational costs in salaries stands true. Both businesses and consumers are making rational choices that will serve their self-interests, whichever way they lie.
- Total Utility (Economics)
- Efficiency Principle
- Indifference Curve
- Time Preference Theory of Interest
- Diminishing Marginal Utility
- Sunk Costs
- Production Possibilities Frontier
- Law of Diminishing Returns
- Economic Efficiency
- Efficiency Theory
- Productive Efficiency
- Capacity Utilization Rate
- Pareto Efficient
- Comparative Advantage
- Criticisms of the Economic Approach
- Behavioral Economics
- Normative Economics
- Positive Economics
- Invisible Hand
- Sunk cost