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Where the Rational Choice Model Fails

There are many different models of rational choice each developed to explain different phenomena within microeconomics consumer behavior or decision science.

Basic assumptions

Despite their diversity these models tend to be built on a few simple foundations. When we make decisions we should exhibit inconsistent preferences that follow mathematical rules like transitivity. We should prefer better things to worse things, more money to less and we should take actions to obtain the things we most prefer in order to maximize our overall utility.

Now, the great virtue of rational choice models is simplicity. Their assumptions are so basic that they seem almost tautological: people want more money not less, of course this must be true right?! Let’s examine this single assumption: people want more money not less. This simple statement lies at the core of traditional models. If it were incorrect as unlikely as that might sound then rationality itself would follow the question.

The assumption that people want more money not less implies that people should be motivated by the opportunity to obtain more money. That is money should be an incentive that can shape their behavior. We know that’s true in many circumstances like the labor market for consumer responses to sale prices.

Reward undermining

A traditional rational choice model makes a simple prediction the utility of donating blood should increase and thus more people should donate if money are offered as a motivation. So what happens? You walk around a mostly empty tent puzzled the number of people donating blood has gone down dramatically.

Only about half as many people donate even though they now have an explicit monetary incentive for donating. So the next year you drop the monetary incentive and stop paying people for giving blood and the number of donations increases back to a normal level. This phenomenon is known to economists as reward undermining.

Reward undermining occurs when an external incentive disrupts our internal motivation for some behavior like paying people to give blood. It’s one of the most striking findings of behavioral economics because it calls into question that most basic assumption of rational choice models that people want more money rather than less. On the contrary, in many real-world situations money can actually serve as a disincentive for behavior.

Moral duties

Money is usually a very powerful incentive. Structuring monetary incentives the right way can have very positive effects. If the government wants to encourage people to save for retirement it can create tax breaks on retirement savings. If a company wants to encourage its employees to quit smoking it offers discounts on insurance copayments for non-smokers.

These sorts of incentives do work usually in exactly the ways protected by rational choice models. When the utility of the incentive become sufficiently great people start behaving in a way that is good for themselves and good for society. Creating and tracking the effects of such incentives represents a major thrust of microeconomics, both in academic research and institutional policy.

But monetary incentives don’t always work. They fail when they undermine her sense of moral duty. They fail when they crowd out other sources of motivation. Incentives and rational choice models more generally work some of the time and fail some of the time. And, here’s the important point: the failures of rational choice models are random.