Basic assumptions of Economics

Economists have generally looked for some’ fundamental assumption” about human behavior from which most of the principles of economics can be ultimately deduced. Every decision-maker in an economic system-whether he is a consumer or producer, whether it is a house hold or a firm- is assumed to have in a rational manner and go in for maximum gain. Economic rationality presupposes that every person knows his interest and selects that course of action, which promises him the greatest amount of satisfaction.

The economists have, generally assumed that human beings are rational and that they are influenced by the ‘maximization principle’. For example, every consumer is said to maximize his satisfaction with a given amount of expenditure, every producer maximizes his output and minimizes his cost; every seller minimizes his profit, as so on.

But rationality and maximization principles are based on the further assumption of perfect knowledge. Every rational consumer, for example, knows the different possible alternatives open to him and will choose that alternative that promises maximum satisfaction. However, rationality is conditioned and influenced by habits and social customs. Habits acquired over a number of years influence the consumers in the choice of goods. Likewise, social customs influence guide and modify economic behavior of individuals.

The assumption of economic rationality does not carry any moral or ethical implication. Rationality implies that in a period of acute shortage, producers and distributors would raise the price and secure higher profit margins. Such a behavior may be condemned from the social point of view, but economically it is justified. At the same time, it is necessary to distinguish between individual rationality and social rationality.

An individual entrepreneur may like to set up his workshop in or around Bombay as he can get his inputs easily and dispose of his output profitably; rational behavior indicates that he set up