Rationality and rules of thumb
Economists often write of behavior’ , in which consumers maximize utility and Finns maximize profits. But i•.•the world. people resources and are to make decisions on the basis of incomplete or analysis. Searching for the absolute maximum of profits or utility would take too much time. Consumers cannot spend all day the had of a firm cannot spend millions of dollars cliometricians to study the price elasticity for one of Its . Instead. as Nobel Prut economist Herbert Simon has emphasized. Finns or consumers often exhibit bounded rationality.
This means that they usually strive to make a than waste resources hunts”l for the “absolutely be,” decision. In some situations the use of a or simplified decision rule an economical choice. For example. it Is common practice for companies especially ones in imperfectly competitive markets-to ~ prices on a “Scorpius-markup” bu Is. This Ii how It works: Inst Nd of setting prices by an MR and Me comparison. companies take the calculated ~ cost of a product and mark It up by adding a fixed appendage-say. 20 percent of the average cost.
This cost-plus-markup ruffian then becomes the price. ~ that If all p!S as planned. the’ price will coverall direct and earn the firm a solid profit. – Does markup pricing Indicate that firms do not maximize profits To some extent, yes. But a better nation would be that markup prim, is a useful rule of thumb that economizes 011 scarce managerial resources In a world of bounded rationality. Managers hive many,woks other than setting prices. So while markup prang does not maximize profits to the last decimal point. It may come reasonably close to maximum profits & the other demands ,on management time.
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