They made the assumption, that all individual firms are logical and rational, and based on those assumptions all of the following theories are based. They also assumed that preferences are consistent.
Definition: Economic theory where individuals make decisions aimed at
- Max their utility based on
- Rational choices, consistent preferences and full info
Key assumptions
- Rational behavior
- Aims to max utility and satisfaction
- Decision making: logical and consistent
- Stable and Transitive preference
- Pref are stable over time: e.g. if A is preferred over B and B is preferred over C then A is preferred over C
- Full information
- Individuals have full info while making purchasing decisions
- Marginal Analysis
- Comparing additional benefits and costs (when purchasing something else, “What do I get if I substitute this good with another”)
Applications
- Consumer Choice theory
- How individuals allocate their income to max ultity
- Graph: budget constraints and indifference curves
- Production theory
- How firms decide on the combination of inputs to maximize output
- Cost min and profit max
- Graphs: iso quants etc
Examples
- Consumer behavior: If a student is deciding how to allocate his budget, between textbooks, food and entertainment
- Business decisions: A bakery is deciding how many loaves of bread to bake each day to balance costs and revenue
- Market Dynamics: Fluctuation of gasoline prices by the changes in supply and demand
Criticisms and limitations
- Behavorial economics
- Challenges assumption of complete rationality
- Cognitive biases and emotions