Key Assumptions in Classical Economics and Their Application

ECONOMICS FOR MANAGERS
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Question 1
A key assumption in classical economics is the rational actor paradigm. According to this,
people would act rationally and aim to maximise their self-interest by making optimal
decisions. This assumption is critical as it leads to pattern of behaviour which can be
predicted by the economists leading to theories (Arnold, 2017).
An example of this is highlighted with regards to hiring decisions of labour. Here the
incremental revenue (also called marginal revenue) that can be derived from the hiring of a
particular labour would be equivalent of the product of unit price and marginal product. This
needs to be compared with the incremental cost (also called marginal cost). The hiring of the
incremental labour makes sense only if the marginal revenue is higher than the marginal cost.
This is based on the assumption that the given individual would be driven by the intent to
maximise profits (Mankiw, 2014). It may be possible that in reality a person may hire an
extra labour owing to inclination towards providing employment rather than aim for profit
maximisation. However, such a possibility is against the rational actor paradigm.
Another example where the use of this paradigm is highlighted relates to pricing decisions
made by firms operating in a given market structure. A central assumption which is pivotal
here is that the buyers and sellers both behave rationally. However, in reality this is rarely the
case. But the economic theory does not consider this as focusing on human behaviour which
is not driven by rationality would make prediction difficult and thereby limit the utility of
economics as a useful social science (Arnold, 2017).
References
Arnold, A.R. (2017) Microeconomics. 9th edn. Sydney: Cengage Learning, pp. 34-35
Mankiw, G. (2014) Microeconomics. 6th edn. London: Worth Publishers, 54-55