The Paradox of Economic rationality

Abstract

Rationality is a very vital assumption in micro economics theory of choice. Behavioral economics advocates that behavior of economic agents deviates systematically from rationality axioms. Rationality axioms are evaluated on the basis of experimental games, where agents are subject of a controlled environment to follow certain instructions. Ultimatum Game is used to test the axiom of monotonicity. In this study we have examined the power of Ultimatum Game by analyzing expected returns in transferable income and proposer’s behavior when asked to offer a part of their earned income. We have also examined computational ability of subjects through Beauty Contest. The results obtained in this study explain that rationality axioms don’t hold in real settings which put a question mark on the predictive power of microeconomic models. We have concluded that although more study is needed for betterment of these microeconomic models but if we keep on making policies on these models which assume rationality, it can have drastic implications for the economy.