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Topic 1: The concept of rational choice is a frontier of economic theory. A fundamental assumption for economic analysis is that economic agents, a household, and a firm, tend to make the best choices from among viable alternatives, given the available resources at their disposal (money, time, etc.) and information.

The rational economic choice implies that people are driven by the rational pursuit of self-interest, and engaged in economic decisions to maximize this rational self-interest. Self-interest is an individual’s economic decisions that are made to fulfill the individual’s best interests. On the other hand, social interest indicates choices that are made to benefit society as a whole. Economists argue that social interest can be attained by individual decision makers acting in their own self-interest. This process is what Adam Smith called the invisible hand, which is the foundation of the theory of the market economy.

• Give an example illustrating how a firm acting out of self-interest to maximize its profits by offering goods or services in economic markets benefits consumers – even if it does not care about them. In other words, how does self-interest help achieve society’s economic goals?
• Give an example illustrating how a firm acting out of self-interest can have deleterious effects on consumers. Why might consumers allow firms to behave in this way? Are there ways in which a firm acting out of self-interest might be harmful to society?
• What is the relationship between self-interest and social interest in the economic decision (economic choice) process? Is there a conflict between the two in the economic world?
• Do people always make rational decisions? What are the factors that lead to bounded rationality? What are the factors that lead to irrational economic decisions?

Do the discussion first do then do the response posted down below.

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Class,

Individual choice can, and often does, benefit society as a whole; usually coincidentally and not intentionally. Individuals acting in their own self-interest can benefit society when they are properly incentivized to do so. For example, a research immunologist may be working on a vaccine because they want to be famous for perfecting it or rich for patenting it first; but that doesn’t matter to the millions that will benefit from being healthier and safer when it is developed. The key to understanding this economic principle is understanding that capitalism is not a zero-sum game, as what benefits one can benefit all as well and benefit is not necessarily “taken” from another.

Adam Smith may have called this the Invisible Hand, but it absolutely has visible and measurable impacts on the world today. Perhaps the most clear example is that, in the same time period that the innovation and wealth brought from capitalism has drastically increased, the world’s population has significantly decreased in the percentage that live in absolute poverty (World Vision, n.d.). This is a result of many factors of innovation that have helped raise people out of this level of poverty, but those that invented the technology to do so and invested in the companies that developed it were likely motivated by their own greed. While it is an uncomfortable fact to many, greed has propelled many out of poverty and disease. While people do not always make rational decisions, greedy decision-making is rational; as it is motivating an individual to do better for themselves and often accidentally results in global good.

Posted 2

The invisible hand theory is the idea that competition leads the individual pursuit of self-interest to maximize public good (Ulrich van Suntum, 2005). “Self-interest, awakened and guided by the competitive market system, is what induces responses appropriate to the changes in society’s wants.” (CITE BOOK). The emergence of the e-commerce industry is a good example of this. Amazon burst onto the e-commerce scene, dominating the market by offering free two-day shipping to Amazon Prime members. Nearly 82% of U.S. households are prime members and 70% of U.S. consumers choose retailers based on shipping options (Bloch, 2020). To stay competitive, other retailers had to create similar shipping policies and incentives for consumers to purchase. Target now offers free two-day shipping when a customer spends $35 or more, Nordstrom offers standard free shipping on all orders, and Home Depot offers same-day delivery and free in-store pick-up. To stay competitive with Amazon, retailers created policies that not only benefit their economic and financial goals but also the consumers.

Self-interest can motivate action and lead to innovation, but it can also lead to corruption, cutting corners, or doing business unethically (Kenton, 2021). Corporations want to stay competitive so the naturally tend towards behaviors that increase profits, sometimes regardless of the outcome (Federal Reserve Bank of St. Louis, 2020).

If there are no economic regulations in place, self-interest can have negative effects on consumers. An example of this is monopolies, where consumer choice is limited, prices increase, and quality decreases (Manuel, 2019). It is hard to believe that consumers would allow firms to behave in such a way, but in a monopolistic economy there is not much of a choice.

Firms acting out of self-interest can have harmful effects on society. For example, in a monopolized market there might be little innovation or adaptations to changing societies if the market is dominated by a single product. If there are no competitors, there is no need for product differentiation. Additionally, the labor force might be restricted or smaller in a monopolized industry since there are fewer competitors. This effects a person’s ability to attain employment and provide for themselves (Manuel, 2019)

Self-interest is an individual making decisions in their own best interest; social interest is an individual making decisions that benefit all of society. Self-interest and social interest are closely related in the economic decisions process. An individual acting in self-interest will go to work and spend their paycheck at the grocery store, to pay bills, or on entertainment. At the same time, they are bettering society by doing their job and spending their paycheck in ways that allows others the opportunity for employment while stimulating spending in the economy. The two interests work in tandem.

Generally self-interest and social interest are positively correlated in the economic world. However, some examples of these two interests conflicting are monopolies (only self-interest) or non-profit entities (only social interest).

Economists have studied rational self-interest and the associated behaviors that suggest “most people will act in an economically rational way when faced with behavioral decisions affecting their own personal income and well-being.” (Kenton, 2021). There are many factors that impact the decision-making process, so people and businesses do not always make rational decisions.

The factors that lead to bounded rationality, the theory that consumers have limited rational decision-making, are cognitive ability, available information, and time constraints (Graham, 2020).

Decisions may not be rational if there are time constraints (an immediate decision is needed), or if the information is inaccurate or incomplete. Irrational decisions are often made in haste and long-term outcomes are not considered. Different types of irrational economic behavior include cognitive bias, making decisions based on faulty or mistaken assumptions; present bias, focusing on the short-term and ignoring long-term costs; and, irrational exuberance, getting carried away with an asset bubble (Pettinger, 2017). Greed, poor-planning, long-held biases, and faulty information can all influence irrational economic decisions.

Bloch, G. (2020, March 23). Council post: How can retailers compete with Amazon? Forbes. Retrieved September 19, 2021, from https://www.forbes.com/sites/forbestechcouncil/2020/03/23/how-can-retailers-compete-with-amazon/?sh=972088f6eeae.