The Theory of

Rational Choice
The Theory of Rational Choice
A rational decision-maker chooses the best
action according to her preferences, among
the actions available to her.

Set of available actions
Preferences
Complete
Consistent (transitive)

Rational Selfish
The Theory of Rational Choice
Payoff function: associates a number with
each action in such a way that actions with
the higher number are preferred.

a and b A

u(a) > u(b) if and only if the decision-maker
prefers a to b

The Theory of Rational Choice
Example:
A = {Coke, Pepsi, Sprite} = {C, P, S}
Decision-maker prefers C to P and P to S
1. u(C)=3, u(P)=2, u(S)=1
Or
2. u(C)=10, u(P)=0, u(S)=-2

The Theory of Rational Choice
Preferences Ordinal information

v is another payoff function that represents
the same preferences as u if

v(c) > v(p) u(c) > u(p)

Any monotonically increasing function of u
represents the same preferences
The Theory of Rational Choice
Example:
u(C)=3, u(P)=2, u(S)=1
u(C)=3 > u(P)=2 > u(S)=1

f(x)=2*x
v(x) = f(u(x))
v(C) = f(u(C)) = f(3)=6, v(P)=4, v(S)=2
v(C)=6 > v(P)=4 > v(S)=2

The Theory of Rational Choice
The action chosen by a decision-maker is at least as
good, according to her preferences, as every other
available action.
Example:
If A={P,C} and she always chooses C
If A={P,C,S} and she chooses P
Inconsistent with the Theory of Rational Choice
To be consistent she must choose C or S
- See the Weak Axiom of Revealed Preference
(WARP)