How to Use the Rational Choice Theory to Your Advantage

Rational choice theory is a principle that says that people act rationally in any given situation. The theory assumes that all humans are “rational actors” and that everyone freely chooses behaviors based on rational calculations that maximize utility. Most mainstream economic and even criminal ideologies are based on the rational choice theory, meaning that most of our policies and thinking in the areas of finance and public safety are based on the “fact” that all people act rationally.

However, there are many who don’t believe in rational choice theory, myself being one of them. And yet still, the theory drives much of our discourse and action regarding human behavior. Which is a problem, seeing as almost no human is rational. I’ve still yet to meet one. In this article, we discuss the rational choice theory, how its taken hold on society, and how we as individuals can use it to our competitive advantage.

How the Rational Choice Theory Works

Rational choice theory comes from economics, where predicting human actions is as important as anything. In economics, rational choice theory is used to “smooth out” data and come to logical conclusions based on the behavior of illogical monkeys (humans). For example, proponents of the theory assume that all people try to maximize their advantage and overall utility in any given situation – at any given time. According to rational choice theory, the only goal of an individual is to maximize his or her individual pleasure or profit.

What’s more, rational choice theory assumes that all humans have “agency” (meaning they take action) and that all action is based on careful calculation. Finally, the theory states that the calculations driving these rational actions consist of cost-benefit analyses, and if the benefit is seen to outweigh the costs, then a person will commit that action or behavior.

This means that on the micro level, all humans behave according to careful self-analysis. On the macro level, the rational choice theory says that all social phenomena are caused by individual humans interacting with one another. Therefore, on the scale of the national economy, proponents of rational choice theory believe that social trends should mirror the decisions of individuals that make up the whole – i.e. if people are rational on the micro level, then we should see things on the macro level (like financial markets) move in rational ways, too.

But are humans rational? No, I don’t think so. In fact, I would almost say that by definition, we aren’t. Meaning that both the micro and therefore the macro act unpredictably. So then, why do most of our high-level decisions related to economics and criminology often assume the rational choice theory to be true? And if this continues to be the case, how can we as individuals spot irrational trends before they happen and position ourselves to take advantage?

Rational Choice Theory in Criminology & Economics

It’s disturbing to me that even though rational choice theory seems so obviously wrong, it’s used as the basis for some of our largest political and social initiatives. In fact, much of the established guard in finance, economics, and public safety believe to some extent in the rational choice theory. It should come as no surprise, then, that many of our public policies and discourse result in systems that break down at the macro level.

What’s more, this means that the rational choice theory first breaks down on the micro level. We can’t even use the theory to inform our personal lives, meaning that we can’t use the theory to our advantage. And what does that leave us with? A theory that can’t be used by individuals when making decisions, thus causing our macro social and economic movements to be largely irrational.

This can cause a lot of problems, both in economics and public safety. In economics, our financial markets are built on the assumption that people act rationally. But we’ve seen time and time again that this isn’t true. Yet we continue to prop up an old an ailing system with bailouts because if the rational choice theory isn’t working, it’s the humans’ fault for not acting rationally and not the other way around.

In public safety, people use the rational choice theory to assume that all criminals act out of pleasure. As long as the cost-benefit is there, a criminal will take action. What’s more, public safety officials often believe that criminals freely choose their behavior. Now, if you’ve ever met a criminal, or if you’ve ever had criminal impulses before, you know that these people and these impulses are far from rational. In fact, it seems that the more heinous a crime is, the more irrational the criminal’s actions.

Lets now take a look at two examples of the rational choice theory and how it breaks down:

Rational Choice Theory Economics Example

Many economists believe that humans are always trying to maximize their utility, which is to either maximize their pleasure or profit. For example, if you have money in the stock market and the market goes down, what does the rational theory say that you’ll do? Well, according to the theory, rational thought says that if you believe in the investment then you buy the dips. So even if you’re losing money as you’re buying, you should do it anyway because it maximizes your long-term potential profits.

But how many of us actually do that? By a show of hands, how many people invested in Bitcoin thinking it was the next “thing,” only to pull out a few months later when its value took a nose dive? I’ll raise mine. According to the rational choice theory, this is irrational. If you believe that Bitcoin is a good investment over the next five years, it should be as good an investment today as it is three years from now. So, if you were a rational human, you would’ve bought more throughout its decline…except you probably didn’t.

The funny thing is that experiments have already been run with monkeys and money proving that primates act irrationally when it comes to economics. One in particular, conducted by Laurie Santos and others, showed that chimpanzees would not, in fact, try to maximize their profits when given coins that could be exchanged for food.

Instead, they held grudges against handlers who would give them less food over time, even if the net amount was more than other handlers. The study found that in no way were the chimps trying to maximize their utility, even though they understood the value of each coin and how it could benefit them. In fact, some studies found that the monkeys even used the coins to barter for prostitution and gamble. If that isn’t chillingly close to home then I don’t know what is.

The examples could go on, because unfortunately, much of our macroeconomic policies rely on the rational choice theory. The 2008 financial crisis would be another example of when the theory broke down. Luckily it wasn’t that big of a deal…oh, wait.

Rational Choice Theory Criminology Example

With criminology, the rational choice theory not only tries to explain how and why humans act, but what public safety and law enforcement can do to detour criminal action. According to criminology and rationality, humans aren’t only rational, but their choices can be controlled through the perception or understanding of pain or displeasure as a result of their action.

For example, rational choice theory as it relates to criminals states that all criminals act rationally after careful planning and thought, which some do. A bank robbery, for example, might be a rational action based on foresight. To combat bank robberies, law enforcement might increase the punishment for robbing a financial institution (mandatory minimums, anyone?).

But how about the crimes that aren’t based on rational thought at all? Because there are many. Crimes of passion, for example, don’t seem to be very rational. In fact, crimes that happen in the moment, by definition, can’t have foresight at all. What’s more, these crimes (and others) are often committed by criminals who throw caution into the wind. For example, if you catch your lover cheating on you, how much would you care if murder resulted in life in prison? Chances are that you might act irrationally.

As a result, much of our judicial system is based around the belief that criminals are committing crimes under their own volition. This may be true, but it often seems like it’s a gray area. Wouldn’t it be better to assume that all criminals were irrational and then go from there? This would not only help us with crime but help us rehabilitate those who get caught.

Obvious Fallacies with the Rational Choice Theory

I think the fallacies with the rational choice theory are obvious by now, but let me spell it out for you to be sure. Humans aren’t rational. Period. Yet we still assume that they are, and then go about creating laws, policies, and initiatives that fail as soon as someone starts acting irrationally. The result of this is that things break down both at the micro and macro level.

Of course, what this means is that people can’t use the rational choice theory at all. It doesn’t work on the individual because individuals aren’t rational, and then if the larger whole is made up of irrational individuals, the larger whole, by definition, becomes irrational. But what if we could use the rational choice theory to our advantage? What if we could use it to spot variability and irrationality, and position ourselves to succeed because of irrational thinking, and not in spite of it.

How to Use the Theory to Your Advantage

The key is to understand that humans are irrational and not rational, and then use that knowledge to spot trends. For example, understanding that the rational choice theory is false, it would be easy to see that as soon as the price of Bitcoin started to decline, it would begin to decline exponentially. Why? Well, because a lot of laymen were investing in Bitcoin without any real knowledge, and when prices started to drop, it scared these non-savvy investors, causing them to sell and exit their position (creating more supply than demand and further pushing down the price).

If you were using the rational choice theory in the way it was intended, you might’ve assumed that people would hold onto their positions and that the decline in Bitcoin prices would be short-lived as people continued to buy low. Not the case. Instead, Bitcoin has been in a freefall of late, as more and more people freak out and act irrationally.

If you had spotted this trend of irrationality, you could’ve shorted Bitcoin, profiting off of variability. If, however, you stuck to your guys and believed the rational choice theory, chances are you would’ve held on too long until there was little chance to recoup your losses. So, what are you going to believe? That humans are rational, or that they aren’t? Well, whatever it is, act accordingly.

Conclusion

The rational choice theory is a nice idea, but it has many problems. Still, this doesn’t mean that the rational choice theory isn’t useful. In fact, if you know that the opposite is true, that humans are irrational, you can use it to your advantage by spotting irrational trends and positioning yourself to succeed.