A General Framework of Flawed Decision Making

University essay from Lunds universitet/Nationalekonomiska institutionen

Abstract: Ubiquitous empirical evidence suggests that economic agents strive towards but often fail to maximize utility. Yet there is no consensus on how to best model deviations from optimal behaviour. This paper reviews and analyses the foundation of the utility maximization model and proposes a more general framework that is consistent with – but also allows for deviations from – utility maximization. The framework assumes a complete, reflexive, transitive and continuous binary preference relation, guaranteeing the existence of a utility function. This approach provides a clear theoretical perspective on behaviour that appears to be inconsistent with utility maximization. When applied to a standard supply-demand schedule, the framework implies that market clearing quantities are inefficiently low, even when agents make optimal decisions on average but deviate from optimal decisions in general.

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