Introduction to Choice Theory

Individual decision-making forms the basis for nearly all of microeconomic analysis. These notes outline the standard economic model of rational choice in decisionmaking. In the standard view, rational choice is defined to mean the process of determining what options are available and then choosing the most preferred one according to some consistent criterion. In a certain sense, this rational choice model is already an optimization-based approach. We will find that by adding one empirically unrestrictive assumption, the problem of rational choice can be represented as one of maximizing a real-valued utility function. The utility maximization approach grew out of a remarkable intellectual convergence that began during the 19th century. On one hand, utilitarian philosophers were seeking an objective criterion for a science of government. If policies were to be decided based on attaining the “greatest good for the greatest number,” they would need to find a utility index that could measure of how beneficial different policies were to different people. On the other hand, thinkers following Adam Smith were trying to refine his ideas about how an economic system based on individual self-interest would work. Perhaps that project, too, could be advanced by developing an index of self-interest, assessing how beneficial various outcomes ∗These notes are an evolving, collaborative product. The first version was by Antonio Rangel in Fall 2000. Those original notes were edited and expanded by Jon Levin in Fall 2001 and 2004, and by Paul Milgrom in Fall 2002 and 2003.