Newswise — TROY, N.Y. — A new theory of economic decision-making from Mina Mahmoudi, a lecturer in the Department of Economics at Rensselaer Polytechnic Institute, offers an explanation as to why humans, in general, make decisions that are simply adequate, not optimal.
In research published today in the Review of Behavioral Economics, Dr. Mahmoudi theorizes an aspect of relative thinking explaining people may use ratios in their decision-making when they should only use absolute differences. The inverse is also possible.
“Effectively solving some economic problems requires one to think in terms of differences while others require one to think in terms of ratios,” Dr. Mahmoudi said. “Because both types of thinking are necessary, it is reasonable to think people develop and apply both types. However, it is also reasonable to expect that people misapply the two types of thinking, especially when less experienced with the context.”
“Understanding how the cognitive and motivational characteristics of human beings and the operating procedures of organizations influence the working of economic systems is of critical importance,” Dr. Mahmoudi said. “Many economic behaviors such as imitation occur and many economic institutions like inventories exist because people cannot maximize or because markets are not in equilibrium. Our model provides an example of a behavior that occurs because people cannot maximize.”
This model can be applied to a variety of behavioral economic experiments in the gambling industry and financial markets among others.
The paper, “A Ratio-Difference Theory of Choice,” was co-authored by Mark Pingle from the University of Nevada-Reno and Rattaphon Wuthisatian from Southern Oregon University.
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Journal Link: Review of Behavioral Economics, Vol 9, Issue 2