Rationality versus Irrationality

Abstract

Any introductory textbook on economics always starts with the fundamental assumption of rationality. The rationality axiom guarantees that given scarce resources, a consumer always tries to maximise utility.

The maximisation of utility however is a function of manifold environments. The certainty or the uncertainty issue often brings the decision making process fuzzy as pointed out by Friedrich von Hayek. He asserts that the achievements or a decision is often poorly understood when configured by a different perspective on the role of socioeconomic institutions, behavioural and cultural norms encapsulated in the “knowledge, the idiosyncratic, dispersed bits of understanding of “circumstances of time and place.” This deviation in the decision making process due to uncertainty has changed the landscape of the conventional economics and given birth to new frontier of behavioural economics or empirical economics.When you look into the behavioural finance, you will observe a set of paradoxes and thus need to goad to ascertain the delicacy in the paradoxes and get a solution that satisfies the irrationality in this decision making process. The most important paradoxes are “St. Petersburg Paradox. Mean -Variance Paradox in the selection of portfolio of assets and Maurice Allais Paradox. Now the financial economics has two branches; Classical and Behavioural. Behavioural finance is more related to situation that deals with human psychology and thus often lukewarm in relation to its first cousin, classical counterpart. Donwload the PDF to read more