Rational consumer choice

3 assumptions of rational consumer choice

• consumer rationality

• utility maximisation

• perfect information

consumer rationality

• consumers are able to rank goods according to their preferences

• preferences among alternative choices are consistent

• consumer always prefers more of a good to less

utility maximisation

they make utility as large as possible by buying the combination of goods and services that results in the greatest amount of utility for a given amount of money

perfect information

consumers have at their disposal perfect information about all their alternatives so that there is no uncertainty

Bias

refers to systematic errors in thinking or evaluating

biases that affect consumer choices:

• rule of thumb

• anchoring

• framing

• availability

• bounded rationality

• bounded self control

• bounded selfishness

• imperfect information

rule of thumb

simple guidelines based on experience and common sense, simplifying complicated decisions that would have to be based on the complex consideration of every possible choice

anchoring

involves use of irrelevant information to make decisions, which often occurs due to its being the first piece of info that the consumer happens to come accross

framing

refers to how the presentation or wording of information can significantly influence people's choices or judgments

availability

refers to info that is most recently available, which people tend to rely on more heavily, though there’s no reason to expect that this info is any more reliable than other info that was available before.

bounded rationality

the idea that consumers are rational only within limits, as consumer rationality is limited by consumers’ insufficient info, costliness of obtaining info, and the limitations of the human mind to process large amounts of info.

bounded self control

refers to idea that people in reality exercise self control only within limits. they often do not have the self control that would be required of them to make rational decisions.

bounded selfishness

recognises that individuals do things for others without a direct reward

imperfect information

people make decisions based on limited information meaning they may not make the best choice

nudge theory

a method designed to influence consumers’ choices in a predictable way, without offering financial incentives or imposing sanctions, and without limiting choice

choice architecture

the design of particular ways or environments in which people make choices; it’s based on the idea that consumers make decisions in a particular context and that choices of decision makers are influenced by how options are presented to them.

default choice

• Occurs when an individual is automatically signed up to a particular choice

• This reduces choice as it means a decision is already made even if no action has been taken

• Research has shown that individuals rarely change from the default choice

restricted choice

Occurs when the choices available to individuals are limited which helps individuals make more rational decisions

mandated choice

a choice between alternatives that is made mandatory by the government or other authority

Potential advantages of behavioural economics

• a relatively simple and low cost way to influence people’s behaviour to act in socially desirable ways

• the methods of choice architecture and nudging may have numerous possible applications in areas that are unexplored

• it generally offers freedom of choice to consumers and citizens, without restricting their choices

• may be able to overcome the weakness of theory of consumer behaviour

• policy development is based on trials, indicating the use of a flexible trial-and-error method of discovering policy measures

potential disadvantages of behavioural economics

• body of knowledge being developed is not based on any understanding of human behaviour, therefore cannot lead to a unifying theory of how consumers behave

• unsystematic approach may not be valid over time or across all income groups, social groups

• risks of using psychological principles to manipulate consumers

• nudges and architecture may successfully affect people’s choices, but these choices may not be a reflection of their true preferences

profit maximisation

determining the level of output that the firm should produce to make profit as large as possible

corporate social responsibility

involved conducting business activity in an ethical way and balancing the interests of shareholders with those of the wider community

market share

refers to the percentage of total sales in a market that is earned by a single firm

growth maximisation

• growing firm can achieve economies of scale and lower its average costs

• a growing firm can diversify into production of different products

• larger firm has greater market power and increased ability to influence price

revenue maximisation

firm managers who are hired by the owners to perform management tasks may be more interested in increasing sales and maximising the revenues that arise from larger quantities sold

satisficing

refers to the pursuit of satisfactory or acceptable outcomes rather than profit maximisation

• It is a decision-making approach where businesses aim to meet a minimum threshold or standard of performance rather than striving for the absolute best outcome