POS Rational Choice Theory CH7

Question 1

What is rational choice theory a combination of?

Answer 1

Individualism and explaining

Question 2

Individualism in rational choice theory

Answer 2

• causal accounts of social phenomena provide an explanation of how they originate from the actions and motivations of individual agents
• does not allow for trait-based differences across individuals, thus differences are not based on traits; all observed behavioral differences are explained situationally through incentives. This means they do not stem from the actors

Question 3

Explanatory model in rational choice theory

Answer 3

• to explain behavior and social level outcomes (e.g. institutions) from rational choices of individual agents
• aimed at discovering rules or laws that generalize towards other comparable situations

Question 4

Assumptions to explain social phenomena in accordance with the rational choice theory

Answer 4

1. methodological individualism:
2. Individuals are perfectly rational (all options considered, transitivity (order of options), all knowledge)
3. Agents are fully self-interested

Dual ambitions: both positive (explaining) and normative (justificatory)

Question 5

What is methodological individualism?

Answer 5

Ontological individualism:
- only individual natural person really exists
- social phenomena do not really exists (they are aggregate outcomes of the actions and behaviors of individuals
Methodological individualism:
- social phenomena (rules, structures, institutions) really exist, but we can explain them only from the actions and behaviors of individual human beings.
–> contrast with the functional and systems explanation that explains social phenomena from from other social phenomena (Durkheim)

Question 6

Two ways of an individual to be rational

Answer 6

Parametric rationality

Strategic rationality

Question 7

Parametric rationality

Answer 7

• assumption is that the choices of others are known in advance (given parameters for a decision)

Question 8

Strategic rationality

Answer 8

• additionally to parametric rationality takes into consideration the rational choices of other agents, who in turn take into consideration and try to anticipate your actions

–> the situation is one of interdependent choices

Question 9

Popper and the rational choice theory

Answer 9

• it is a bad theory because it does not contain any empirical content.
• if you only look at it from your own point of view, you cannot exclude anything

Question 10

Positive theory and world fit

Answer 10

• says something about what the world is like

- if there is a difference between the actual world and the theory then the theory needs to be adjusted.

Question 11

Normative theory and world fit

Answer 11

• says something about what the world should be like
• if there is a difference btw. theory and world the world needs to be adjusted.
• we should follow a theory and act accordingly

Question 12

metering problem

Answer 12

hard for any principle to monitor the agent’s actions to gather the necessary information

Question 13

adverse selection

Answer 13

Adverse selection is when sellers have information that buyers do not have, or vice versa, about some aspect of product quality.

Question 14

Moral hazard

Answer 14

• when agents take on mare risk than they should, because the costs are carried by the principal and not by the agent

Question 15

Holdup

Answer 15

the agent and principle could work a lot more efficiently together if they would cooperate.

Question 16

Bonding costs

Answer 16

Furthermore, an agent may commit to contractual obligations that limit or restrict the agent’s activity.

Question 17

Residual loss

Answer 17

“residual loss,” occurs whenever the actions that would promote the self-interest of the principal differ from those that would promote the self-interest of the agent

Question 18

Double hermeneutics and managers

Answer 18

managers start to act selfish because the payment structure imposed on them

Question 19

Hermeneutics

Answer 19

In sociology, hermeneutics is the interpretation and understanding of social events through analysis of their meanings for the human participants in the events.

Question 20

Are game theory and agency theory part of rational choice theory?

Answer 20

Yes they are both

Question 21

Two problems when using Game Theory

Answer 21

• coordination problems

- motivation problems

Question 22

pay-off matrix (game theory)

Answer 22

• explains the interactive strategic decision making process between two persons

Question 23

4 assumptions for the pay-off matrix

Answer 23

1. Action is reaction: one person’s actions can lead to the others reaction
2. Only partial control (of the individuals on the outcome)
3. Gain seeking
4. Empathy (ability of players to put themselves into the other’s shoes)

Question 24

Points of critique regarding the rational choice theory

Answer 24

• humans are not fully rational

- double-hermeneutics leading to people being more selfish

Question 25

risk sharing problem (agency theory)

Answer 25

when cooperating parties have different attitudes

–> 1. unaligned goals 2. monitoring costs

Question 26

Which two types of contracts can help minimize the agency problem?

Answer 26

1. Behavior-oriented contracts (salaries, hierarchical governance)
2. Outcome-oriented contracts (commission, stock options..)

Question 27

positivist agency stream

Answer 27

• most concerned with identifying situations in which agent and principal are most likely to conflict
• -> tries to describe governance mechanisms that solve the agency problem (outcome based contract; principal should have information to verify agent behavior)

Question 28

principal-agent stream

Answer 28

• concerned with finding a general principal agent relationship (mathematician and abstract)
• at the core is the trade-off btw. costs of measuring the outcome and transferring risk to the agent
  programmability (extent to which you program a job) solves moral hazard and adverse selection
• best way of addressing the problem depends on the situation
• the most efficient contract should be chosen if there is no tested evidence
  -efficiency is measured by the programmability and outcome uncertainty
• results indicate whether an outcome based or behavior based contract is suitable

Question 29

What does Game Theory explain?

Answer 29

• explains patterns of behavior and institutions from interdepend rational choices

Question 30

Nash equilibrium

Answer 30

• (in economics and game theory) a stable state of a system involving the interaction of different participants, in which no participant can gain by a unilateral change of strategy if the strategies of the others remain unchanged.

–> mostly worst condition

Question 31

Pareto optimal

Answer 31

relating to or denoting a distribution of wealth such that any redistribution or other change beneficial to one individual is detrimental to one or more others.

–> best choice for the system( both players)