If you are rational, you will choose the available option that leads to the outcome you most prefer. But is the outcome you most prefer always the same as the one that gives you the best possible economic payoff? No. It can be entirely rational to choose an option that gives you a worse economic payoff because you care about something other than the size of the economic payoff. There are three principal reasons why people might prefer a worse economic payoff: concerns about fairness, bounded rationality, and risk aversion.

Concerns About Fairness In social situations, people often care about fairness as well as about the economic payoff to themselves. For example, no law requires you to tip a waiter or waitress. But concern for fairness leads most people to leave a tip (unless they’ve had outrageously bad service) because a tip is seen as fair compensation for good service according to society’s norms. Tippers are reducing their own economic payoff in order to be fair to waiters and waitresses. A related behavior is gift-giving: if you care about another person’s welfare, it’s rational for you to lower your own economic payoff in order to give that person a gift.

Bounded Rationality Being an economic computing machine—choosing the option that gives you the best economic payoff—can require a fair amount of work: sizing up the options, computing the opportunity costs, calculating the marginal amounts, and so on. The mental effort required has its own opportunity cost. This realization led economists to the concept of bounded rationality—making a choice that is close to but not exactly the one that leads to the highest possible profit because the effort of finding the best payoff is too costly. In other words, bounded rationality is the “good enough” method of decision making.

Retailers are particularly good at exploiting their customers’ tendency to engage in bounded rationality. For example, pricing items in units ending in 99¢ takes advantage of shoppers’ tendency to interpret an item that costs, say, $2.99 as significantly cheaper than one that costs $3.00. Bounded rationality leads them to give more weight to the $2 part of the price (the first number they see) than the 99¢ part. And retailers also make use of shoppers’ tendency to engage in what social scientists call anchoring, making decisions according to some perceived benchmark or reference point. For example, retailers attempt to influence shoppers’ belief about whether they are getting a good deal by showing both the full price (the anchor) and the discounted price.

Risk Aversion Because life is uncertain and the future unknown, sometimes a choice comes with significant risk. Although you may receive a high payoff if things turn out well, the possibility also exists that things may turn out badly and leave you worse off.

So even if you think a choice will give you the best payoff of all your available options, you may forgo it because you find the possibility that things could turn out badly too, well, risky. This is called risk aversion—the willingness to sacrifice some potential economic payoff in order to avoid a potential loss. (We’ll discuss risk in detail in Chapter 20.) Because risk makes most people uncomfortable, it’s rational for them to give up some potential economic gain in order to avoid it. In fact, if it weren’t for risk aversion, there would be no such thing as insurance.