Irrational Behaviour

Satisfactory Essays
Rational Decision Making

In economics, a rational person is one who makes decisions by comparing the marginal benefits to the marginal costs. If the marginal benefit of buying an item (say a cup of coffee) is equal to or greater than the marginal cost, then the person will make the purchase. They are making a perfectly rational decision.

However, a new area of economics (called Behaviour Economics) explores the idea on whether economic agents (i.e. consumers) are always rational when making decisions.

In a book by Belsky and Gilovich, they find that people are not always rational, especially when it comes to investing money. I have included some common “irrational” behaviour that they found in their research.

Irrational Behaviour

“Why Smart People make Big Money Mistakes and How to Correct Them”

Gary Belsky and Thomas Gilovich – Behaviour Economists

Measuring Costs and Benefits as Proportions rather than Absolute Values

Lamp – Store #1: $100 Lamp – Store #2: $75 25% savings
Would you walk 3 blocks to save $25? Most people said yes.

Dining Room Set (free delivery in both cases)
Store #1: $ 2,000 – Store #2: $1,975 1.25% savings
Would you walk 3 blocks to save $25? Most people said no!

Other examples

Stereo for your car: $1,000 from a dealer or $500 from an after market store such as ABC Sound

We would go to ABC Sound (50% savings)

Yet, if we were to buy a new car for say $30,000, many people will include the better stereo for $1,000 because it is only 3.3% of the car – totally irrational to think like this.

Failure to Ignore Sunk Costs

Many people will hold on to a loser stock only to try to get their money back. Totally irrational since there might be better stocks elsewhere.

Paying too much tax so that you get a big tax return.
Irrational behaviour because you're lending the money to the government - interest free.

Tipping – It is irrational to tip a server who you will never see again. Also it would make

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