Rational Actor Theory

Let’s go over a simplified example. Imagine you are shopping for a red top. In a store, you find two red tops that you like. Top A is red, a little uncomfortable, and not quite form-fitting. Top B is red, more flattering, more comfortable, but $50 more expensive than top A. 

As a rational actor, you would use the information available to you to evaluate the benefits and costs of each option.

Top A

• Benefits: $50 cheaper
• Costs: Less flattering and comfortable

Top B

• Benefits: Flattering and comfortable.
• Costs: $50 extra

The rational actor will make the decision that aligns with their self-interest. If you value saving money more than comfort and style, you will choose top A. If you value comfort and style more than money, then you will pick top B. 

The rational actor theory assumes that people make decisions logically in order to maximize their personal benefit. There are a few key assumptions the theory follows:

1. People are rational decision-makers. It is assumed that people will use all of the information available to them to make decisions that align with their desired outcomes.
2. People make decisions based on self-interest. People will evaluate options based on their relation to their personal preferences and interests. 
3. People are optimizers. People will make the decision that maximizes utility and benefit. 

Economists and policy makers use rational actor theory to make sense of and predict the way that human beings behave.

The Invisible Hand Theory²: The invisible hand theory is a metaphor for unseen forces that affect the free market economy. The theory suggests that people acting in their own self-interest produces socially beneficial outcomes and advocates for minimal interventions in the market. 

Homo economicus: A hypothetical figure that operates according to unconditional rationality. 

Game theory: A theory that relates economic decisions to the moves players make in a game. It suggests that people make rational decisions based on anticipated decisions by other people.

Maximizers: Individuals that obtain all the necessary information to make a decision that maximizes utility. 

Satisficers: Individuals who make decisions that are satisfactory, rather than optimal. 

Bounded Rationality: A decision-making process through which people make satisfactory decisions rather than optimal ones due to constraints limiting information. 

In the 18th century, Adam Smith, known as the father of modern economics, came up with the Invisible Hand Theory in his essay “An Inquiry into the Nature and Causes of the Wealth of Nations,” to argue for the benefits of a free market. The Invisible Hand Theory suggests that although people make decisions based on self-interest, because we exist in a system of mutual interdependence, those decisions will lead to the best interests of society as a whole. As such, Smith argued that there should be minimal government-imposed policies, as the market will find equilibrium naturally. The idea of people as rational decision-makers acting in self-interest helped to form the basis of the rational actor theory.

In 1944, mathematicians John von Neumann and Oskar Morgenstern extended the concept of rational decision-making through the development of game theory. Neumann and Morgenstern identified a gap in existing mathematical models that could explain the physical sciences, but were not apt to describe how humans behave in a world where there are other actors to factor into decision-making. They saw similarities between economics and games – people anticipate each other’s moves and decisions to inform their own choices. Neumann and Morgenstern also laid the foundation for the expected utility hypothesis, which suggests that when consumers are faced with a level of uncertainty in decision-making, they make decisions based on the expected value of the utility. Game theory makes two important assumptions: that players understand the rules of the game and that they are rational actors. Game theory provided a formal framework for analyzing how individuals, acting in their own self-interest, interact with other individuals acting in their self-interest.³

In the 1950s and 60s, sociologists George Homas, Peter Blau and James Coleman expanded the application of the rational actor to explain social exchange. They stated that social behavior is driven by rational actors who calculate the exchange of benefits and costs to make decisions.⁴

Adam Smith

Well-known as the father of modern economics, Smith laid the foundation for many economic theories still used today. Smith is best known for his theory of the invisible hand, which he used to explain the ties between individuals acting in self-interest and the consequential positive but unintentional impact on society as a whole. Although Smith is primarily known as an economist, he also made significant contributions in philosophy and behavioral science. 

John Von Neumann⁵

Hungarian-born American mathematician well-known for applying mathematical concepts to real-world problems. Neumann is best known for laying the foundation for quantum mechanics and establishing game theory. 

Oskar Morgenstren⁶

German-born American economist, Morgenstren co-developed game theory with John Von Neumann in their 1944 book Theory of Games and Economic Behavior. Later in his career, Morgenstren applied his economic theories to finance

Herbert A. Simon

Simon had a profound impact on economics, behavioral science, psychology, and computer science. He is one of the most important figures of behavioral economics, which adapted classic economic theories to better reflect human behavior. Simon introduced bounded rationality as an adaptation of the rational actor theory, which maintained that people make rational decisions, but only within the context of the information that is available to them, rather than exhibiting perfect rationality. 

The rational actor theory is instrumental in understanding and predicting individual behaviors. By viewing each person as an independent, self-interested agent who makes decisions to maximize their benefit, the theory explains why an individual's decisions are not always aligned with the social or collective good. This knowledge can be leveraged by behavioral scientists and politicians to design behavioral interventions and nudge individuals towards behaviors that will contribute to collective good.

When first conceptualized, the rational actor theory helped economists to understand how various factors, such as income, taxes, and costs affect demand for goods and services. This understanding predicts market behavior and allows us to identify opportunities for adjustments to encourage specific decisions.

While the rational actor theory has its grounds in economics, today, it has a wide-range of applications in diverse fields.

For example, businesses use rational actor theory to employ discounts and loyalty programs, given the fact that people will rationally respond to incentives. If there is greater gain from purchasing a product, people are more likely to do so.

Rational actor theory can also be used to inform policies. If governments are looking to reduce the carbon footprint of a country, they may impose carbon taxes. The taxes would incentivize businesses, who are acting in self-interest to maximize their profit, to reduce carbon-intensive activities to avoid increased costs.

Many economists have disputed the rational factory theory. They believe that humans are not rational decision-makers and do not always make decisions that maximize utility. Instead of following classical economics, these individuals belong in the behavioral economics camp and believe that we need to examine people’s economic decision-making through a psychological lens, understanding that people do not always have enough information available to make rational decisions and can be influenced by other factors such as emotions. Emotions trigger hormones that can cloud your judgment. For example, the impact bias demonstrates how our current emotions impact our perception of the future. If you’re really sad after a breakup, you anticipate that you’ll feel that sadness forever, causing you to get back into the relationship and ignoring the reasons why it ended in the first place. However, emotions can sometimes be useful tools to guide our behavior. If you experience fear, it signals to your central nervous system that something is wrong, and can produce the adrenaline necessary to keep you safe – that’s what the fight or flight response is!

Although behavioral economists don’t believe in humans as perfectly rational beings, they still believe that human behavior is predictable. To assume people are homo economicus suggests that we are capable of being ‘all-seeing’, objective thinkers that can easily differentiate rational from non-rational choices. However, we may be able to assume that people are rational given their context and environmental constraints, and therefore, that we are still reasonable decision-makers.⁷

Herbert A. Simon came up with the notion of bounded rationality to explain this phenomenon. Bounded rationality suggests that we make decisions that are “good enough” instead of the ones that maximize utility. For example – returning to the example of trying to purchase a red dress – bounded rationality suggests that once you found top A, you would purchase it. That is still a rational choice based on the information available to you, but not on all the possible information out there (i.e. knowing that there was another top you’d like better). Bounded rationality assumes people are satisficers rather than maximizers. 

Voter Turnout and the Rational Actor Theory

Voting is an important act of political participation in a democracy. However, voter turnout is an issue in many countries, including the U.S.

Rational actor theory can be used to explain why people choose not to vote. According to the theory, a citizen would decide to vote if the benefits of voting are greater than the costs. 

Many individuals don’t believe that their vote will influence the election outcome—after all, they are only one of hundreds of millions of people eligible to vote. Since the perceived benefit is small, any small cost associated with the act of voting can be enough to deter them. These costs, which in a vacuum seem small, include weather, registering requirements, and distance to the polling place.⁸

By being aware of the rational actor theory, politicians can put sanctions in place to elevate the benefits of voting and diminish the costs—governments need to make it easy to vote to increase turnout. This can be achieved by allowing individuals to vote by mail, early voting so people can choose a time most convenient with their schedule, and making candidate information easily accessible to diminish the work the individual has to do to be informed. 

It has been speculated that early voting and voting by mail is one of the reasons there was a record voter turnout of 62%  in the 2020 presidential election.⁹ Other nudges include mandates for employers to give their employees time off to vote, and setting up more polling stations to reduce the distance someone has to travel to vote.

Rational Addiction

For many, the decision to smoke cigarettes seems irrational. There are both monetary and health-related costs associated with smoking, and seemingly few benefits. With this in mind, is it correct to say that addiction clouds our ability to be rational?

While some people would say yes, the rational addiction theory suggests that people who engage in addictive behaviors are still making rational decisions. The rational actor theory states that people make rational decisions according to their own self-interest. For a smoker, the benefits of having a cigarette outweigh the costs.¹⁰

This is why governments need to emphasize the costs of smoking if they hope to reduce the habit. Some tactics include increasing the price of cigarettes, enforcing age restrictions, and noting the harms of cigarettes in advertisements and on packets. This way smoking seems like a less attractive and rational choice.

Of Canceled Flights and Rationality: It’s All About Context

Many people say that the rational actor theory is too simplistic to explain the way that humans make decisions in their day-to-day lives. In this article, our writer Preeti Kotamarthi analyzes a recent experience of hers familiar to most – a flight delay – to determine whether the actions she took were rational or irrational.

Does Emotion Affect Our Ability To Make Rational Decisions?

The rational actor theory suggests that outcomes are predictable, because people will make the most rational decision when faced with options. However, emotions can often cloud our perception of what is rational. In this article, our writer Tiantian Li explores how emotions impact our decision-making process. 

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