Decision Making In Business: A Summary
Organizations are involved in decision making process in order to direct their course of action and achieve maximum profit. Individual with the authority and power make rational decision depending on the predetermined organizational goal. They have little or no interference in the process of making decision from the stakeholder, because individual s is expected to apply bounded rationality.
The bounded rationality is where an individual is guided by their knowledge and information they have about the organization, and their cognitive ability about the estimated outcome of each alternative possible solution they have to consider in order to make a decision.
The list of individual preferences and the constraints facing the process are considered when coming up with the best alternative or choosing the course of action. As argues by Miller (1996, p.80), individuals will choose the solution to a problem that maximizes profit for the organization. However, this choice is affected by issues of personal interest among those with the power and therefore only a negotiated choice is taken through the process of problem solving.
The process of decision making is faced with limitation especially in situation where an action is taken before the decision is made. There also have been inconsistencies between the strategic plan and the operation level, the decision of who to involve, where and to what extent leaves out key individuals in the process of making decisions.
Where there is no demarcation of power, the situation is even worse. Therefore, there is need to define how the decisions making process will be, before the time for making decision emerges.
Showing posts with label Choice Theory in Decision Making. Show all posts
Showing posts with label Choice Theory in Decision Making. Show all posts
Wednesday, 31 October 2012
Rational Choice Theory and Business Decision Making
Rational Choice Theory and Business Decision Making
The shareholder of a business enterprise gives manager(s) the mandate to make decisions on their behalf. In any business organization, the management ought to make day to day decisions in order to achieve the predetermined goals/objectives of the business. The manager is expected to have knowledge of the set goals of the business and come up with a strategic plan to achieve them.
The management has to choose how to allocate the scarce resources to the most efficient among the productive processes available. Therefore, awareness of the business environment and the alternatives course of action enable those with the managerial position to make informed decisions for profit maximization.
Rational choice theory
The choice theory is a model that explains how individuals tend to minimize cost so that they can maximize the returns. Individuals will therefore prefer an action that requires less costly activity but maximizes the profit. The theory does not consider the intrinsic cost issues but just the extrinsic cost of preferring this course of action to another by comparing cost and benefits of each action differently. Therefore, the model is based on cost-benefit analysis as manager chooses the best action depending on their individual preference and inherent constrains facing them. These choices cause a pattern of behavior to develop within the society.
In this case the optimal activity may not be undertaken due to the scarcity of economic resources; satisfactory actions are taken out of the given set of individual preferences. Rational decision making could therefore mean choosing the course of action among the given individual preferences. It also includes the action one could take and the estimated outcome of the course of action.
Assumptions of the rational choice decision making model
There are various assumptions that this model is based on.
Preference
According to the choice theory, individuals are rational and normally act as maximizing entrepreneurs, wanting to get the most useful products at the lowest cost possible and therefore will impose judgment on the usefulness of a product compared to other similar product in their preference function. For instance, if P represents the preferred products 1…n, then the set of all products can be defined in the following preference function:
P= [p1, p 2, p3,, ……., pn]
In case p1 is a highly attractive and benefiting product than p2, then p1 is preferred to p2. Where p1 brings more benefit than p3 but it sharply minimizes profits then, p3 will be preferred to p1. This is a value judgment equation and in this case p3 will be preferred to p2.
An individual judges the usefulness or benefits of products or actions by comparing them with similar products or actions respectively. Primarily, the product or action that has the highest returns at minimal cost is chosen.
The preference assumption requires individual to be aware of their preferences in terms of:
The shareholder of a business enterprise gives manager(s) the mandate to make decisions on their behalf. In any business organization, the management ought to make day to day decisions in order to achieve the predetermined goals/objectives of the business. The manager is expected to have knowledge of the set goals of the business and come up with a strategic plan to achieve them.
The management has to choose how to allocate the scarce resources to the most efficient among the productive processes available. Therefore, awareness of the business environment and the alternatives course of action enable those with the managerial position to make informed decisions for profit maximization.
Rational choice theory
The choice theory is a model that explains how individuals tend to minimize cost so that they can maximize the returns. Individuals will therefore prefer an action that requires less costly activity but maximizes the profit. The theory does not consider the intrinsic cost issues but just the extrinsic cost of preferring this course of action to another by comparing cost and benefits of each action differently. Therefore, the model is based on cost-benefit analysis as manager chooses the best action depending on their individual preference and inherent constrains facing them. These choices cause a pattern of behavior to develop within the society.
In this case the optimal activity may not be undertaken due to the scarcity of economic resources; satisfactory actions are taken out of the given set of individual preferences. Rational decision making could therefore mean choosing the course of action among the given individual preferences. It also includes the action one could take and the estimated outcome of the course of action.
Assumptions of the rational choice decision making model
There are various assumptions that this model is based on.
Preference
According to the choice theory, individuals are rational and normally act as maximizing entrepreneurs, wanting to get the most useful products at the lowest cost possible and therefore will impose judgment on the usefulness of a product compared to other similar product in their preference function. For instance, if P represents the preferred products 1…n, then the set of all products can be defined in the following preference function:
P= [p1, p 2, p3,, ……., pn]
In case p1 is a highly attractive and benefiting product than p2, then p1 is preferred to p2. Where p1 brings more benefit than p3 but it sharply minimizes profits then, p3 will be preferred to p1. This is a value judgment equation and in this case p3 will be preferred to p2.
An individual judges the usefulness or benefits of products or actions by comparing them with similar products or actions respectively. Primarily, the product or action that has the highest returns at minimal cost is chosen.
The preference assumption requires individual to be aware of their preferences in terms of:
Rational Choice Theory in Business Decision Making
Rational Choice Theory in Business Decision Making 2
The rational choice theory’s preference assumption requires individual to be aware of their preferences in terms of:
Completeness of preferences.
For any two course of action or action, one should at least be more preferred than the other. Two actions may be equally good and the managers may be indifference between taking action A and doing away with action B. However, some small level of differences should be seen by the manager and rank the two actions or products that are equal.
From preference function above, if a manager preference between dealing with products p2 and pn, he should be able to rank them in an order of preference, that is p2 ≤ pn, where pn is at least preferred to p2.
Transitivity of preferences.
In the example above, p1 is preferred to p2 while p3 is preferred to p1. Therefore, due to transitive nature of preferences, p3 is preferred to p2.
Reflexive and monotonicity of preferences.
If by undertaking two courses of action gives returns just slightly higher than undertaking one of the actions, then undertaking one of the actions is better. This is the reflexive nature of preferences.
Sometimes when comparing actions or products, one may have more or both of the products, or might only have more of one product due to monotonic preferences. In the previous example it may be challenging comparing products p1 and p3 since both are profitable.
Perfect knowledge
The theory assumes decision makers have perfect information concerning the outcome as a result of the choice made. It is worth noting that depend on chance or probability to describe the expected outcome.
Cognitive ability
This premise is about the cognitive ability of the decision makers of the business organization. Individuals are presumed to have time to scrutinize each choice with reference to other choices and the ability to understand what each option requires. One is also expected to have read and understood the goals of the organization.
The rational choice theory’s preference assumption requires individual to be aware of their preferences in terms of:
Completeness of preferences.
For any two course of action or action, one should at least be more preferred than the other. Two actions may be equally good and the managers may be indifference between taking action A and doing away with action B. However, some small level of differences should be seen by the manager and rank the two actions or products that are equal.
From preference function above, if a manager preference between dealing with products p2 and pn, he should be able to rank them in an order of preference, that is p2 ≤ pn, where pn is at least preferred to p2.
Transitivity of preferences.
In the example above, p1 is preferred to p2 while p3 is preferred to p1. Therefore, due to transitive nature of preferences, p3 is preferred to p2.
Reflexive and monotonicity of preferences.
If by undertaking two courses of action gives returns just slightly higher than undertaking one of the actions, then undertaking one of the actions is better. This is the reflexive nature of preferences.
Sometimes when comparing actions or products, one may have more or both of the products, or might only have more of one product due to monotonic preferences. In the previous example it may be challenging comparing products p1 and p3 since both are profitable.
Perfect knowledge
The theory assumes decision makers have perfect information concerning the outcome as a result of the choice made. It is worth noting that depend on chance or probability to describe the expected outcome.
Cognitive ability
This premise is about the cognitive ability of the decision makers of the business organization. Individuals are presumed to have time to scrutinize each choice with reference to other choices and the ability to understand what each option requires. One is also expected to have read and understood the goals of the organization.
Choice theory and managerial decision making
Choice theory and managerial decision making
Choice theory and managerial decision making
From the rational choice theory, several conclusions can be made concerning the decision making by the management of business organization.
Individualized decision making.
The management of an organization has autonomy in making decision that will lead to maximum profit for the organization on behalf of the shareholders. Individuals make decision according to their understanding of the situation in reference to the available choices. Therefore, the decision making can be affected by individual decision maker as some attempt to include their personal interest without their knowledge when making choices.
The rational theory of choice is based on this individualized model where one makes choices according to their personal understanding of the action that maximizes profit for the organization. This choice or the decision made is based on individual preference, the information one has and the cognitive ability of each individual in a single decision making unit of an organization.
Collective decision.
Managers tend to consider their self- interest and are viewed as cynical especially when responding to the organization’s environmental incentives. Their self interest has been seen to take a precedent consideration before the shareholders interest in the course of action. To ensure collective decision making, those formulating and implementing the policy of the organization should ensure the incentives they include are in line with institution organizational which are correct in order for the right code of conduct and behavior to automatically develop among all those involved in the decision making of the organization.
The incentive given shapes the decision making environment by influencing the managers to make optimal choices if those incentives are in consistence with their self-interest. The owner of the business should therefore ensure a specific behavior is created within the business environment to enhance collective decision making.
Anticipating the outcome.
Managerial decision maker are presented with alternative course of action and they must choose the course of action that brings most returns to them. An individual should therefore anticipate and estimate the outcome of each alternative course of action and choose the one that result to the greatest utility.
Organization goals and the attainable goals.
It is logical that all organization goals may not be possible to attain. As individuals make choices in relation to the organization goals and the means of attaining them, the interaction between the individual preference and constraints are seen from the rational theory of choice as the ingredients of attaining those goals.
The choice theorists define attainable goals as those organizational goals that express the preferences of individual decision maker. They are motivated by those goals and therefore, they will act under the conditions which are the constraints and the knowledge of the organization they have.
Competition in the market.
Competition in the market encourages decision makers to make choices that will lead to increased returns and have time to scrutinize each choice with reference to other choices and have perfect information about the outcome of each choice they have made. As argued by Alchian, 1946, entrepreneurs are known to be keen in maximizing profits in order to survive in the market.
Choice theory and managerial decision making
From the rational choice theory, several conclusions can be made concerning the decision making by the management of business organization.
Individualized decision making.
The management of an organization has autonomy in making decision that will lead to maximum profit for the organization on behalf of the shareholders. Individuals make decision according to their understanding of the situation in reference to the available choices. Therefore, the decision making can be affected by individual decision maker as some attempt to include their personal interest without their knowledge when making choices.
The rational theory of choice is based on this individualized model where one makes choices according to their personal understanding of the action that maximizes profit for the organization. This choice or the decision made is based on individual preference, the information one has and the cognitive ability of each individual in a single decision making unit of an organization.
Collective decision.
Managers tend to consider their self- interest and are viewed as cynical especially when responding to the organization’s environmental incentives. Their self interest has been seen to take a precedent consideration before the shareholders interest in the course of action. To ensure collective decision making, those formulating and implementing the policy of the organization should ensure the incentives they include are in line with institution organizational which are correct in order for the right code of conduct and behavior to automatically develop among all those involved in the decision making of the organization.
The incentive given shapes the decision making environment by influencing the managers to make optimal choices if those incentives are in consistence with their self-interest. The owner of the business should therefore ensure a specific behavior is created within the business environment to enhance collective decision making.
Anticipating the outcome.
Managerial decision maker are presented with alternative course of action and they must choose the course of action that brings most returns to them. An individual should therefore anticipate and estimate the outcome of each alternative course of action and choose the one that result to the greatest utility.
Organization goals and the attainable goals.
It is logical that all organization goals may not be possible to attain. As individuals make choices in relation to the organization goals and the means of attaining them, the interaction between the individual preference and constraints are seen from the rational theory of choice as the ingredients of attaining those goals.
The choice theorists define attainable goals as those organizational goals that express the preferences of individual decision maker. They are motivated by those goals and therefore, they will act under the conditions which are the constraints and the knowledge of the organization they have.
Competition in the market.
Competition in the market encourages decision makers to make choices that will lead to increased returns and have time to scrutinize each choice with reference to other choices and have perfect information about the outcome of each choice they have made. As argued by Alchian, 1946, entrepreneurs are known to be keen in maximizing profits in order to survive in the market.
References| Citations for Choice Theory in Decision Making
Resource Citations for Choice Theory in decision making
Choice Theory in decision making,
Individual decision makers do not have perfect information concerning the expected outcome of each choice they are making. Therefore, choices are made on the basis of chance since individual present inability to calculate the expected outcome of each alternative course of action. On the other hand manager may not have full knowledge of their preference and therefore may have constant indifferences when choosing which preference ranks higher than the other.
There are constraints facing the organization decision making process such as finances, high costs of deliberation, simultaneous economic action requiring decision and decisions about how and when to decide. These limit the application of this model especially when it comes to optimization. Managers are left with the option of choosing a satisfactory course of action instead of an optimal one.
References and Resources Cited- bibliography-citation
Becker, G. S. (1976). The Economic Approach to Human Behaviour. Chicago: University of Chicago Press.
Browning, G., Halcli, A. & Webster, F. (Ed). (2000). Rational Choice Theory. United States : Sage publication.
Delanty, G. (1997). Social Science: Beyond Constructivism and Realism. Buckingham: Open University Press.
Russell, C. S. (Ed). (1979). Collective Decision Making: Applications from Public Choice Theory. Baltimore : Resources for the Future.
Shapira, Z. (Ed). (2002). Organizational decision making. New York: Cambridge University Press.
Zey, M. (1998). Rational choice theory and organizational theory: a critique. USA: Sage publications.
Choice Theory in decision making,
Individual decision makers do not have perfect information concerning the expected outcome of each choice they are making. Therefore, choices are made on the basis of chance since individual present inability to calculate the expected outcome of each alternative course of action. On the other hand manager may not have full knowledge of their preference and therefore may have constant indifferences when choosing which preference ranks higher than the other.
There are constraints facing the organization decision making process such as finances, high costs of deliberation, simultaneous economic action requiring decision and decisions about how and when to decide. These limit the application of this model especially when it comes to optimization. Managers are left with the option of choosing a satisfactory course of action instead of an optimal one.
References and Resources Cited- bibliography-citation
Becker, G. S. (1976). The Economic Approach to Human Behaviour. Chicago: University of Chicago Press.
Browning, G., Halcli, A. & Webster, F. (Ed). (2000). Rational Choice Theory. United States : Sage publication.
Delanty, G. (1997). Social Science: Beyond Constructivism and Realism. Buckingham: Open University Press.
Russell, C. S. (Ed). (1979). Collective Decision Making: Applications from Public Choice Theory. Baltimore : Resources for the Future.
Shapira, Z. (Ed). (2002). Organizational decision making. New York: Cambridge University Press.
Zey, M. (1998). Rational choice theory and organizational theory: a critique. USA: Sage publications.
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