When building supply and demand models we make assumptions about consumers and producers as economic agents who seek to maximise their utility (satisfaction). Consumers aim to maximise the utility they get from purchasing goods or services and firms aim to maximise their utility by selling goods and services for the maximum possible profit. 

• Rational consumers will choose the lowest priced product when choosing between two identical (homogenous) products. 

• Rational firms aim to maximise profits. 

Reasons why consumers may not maximise their benefits

1. Consideration of the influence of other people’s behaviour One key behavioural bias observed in individuals is herding behaviour. We are greatly influenced by consumption norms within the relevant group. For example, if we see our friends drinking alcohol, we are more likely to do so, too. Even housing market booms can be caused by this effect: some people start investing in houses so others think this is a good idea, too. We seem to be particularly influenced by what other people do when making our consumption decisions. 

2. The importance of habitual behaviour. The ‘status quo’ bias is the tendency which individuals have of just sticking with their current situation. We observe this in the weekly shop of most families at the supermarket, and in the tendency to stay with the same bank even though others may be offering a higher interest rate. This is often linked to individuals wanting to ‘play safe’, not wanting to risk a change which might make them worse off (loss aversion). This bias can cause consumers to lose out on possible utility gains.

 3. Consumer weakness at computation. Humans are particularly bad at mathematical computation. For example, we find it really hard to understand probabilities and to make forecasts about how we will feel in the future. In Richard Layard’s book Happiness: Lessons from a new science, he states that people tend to exaggerate small probabilities into their thinking. This is often observed in how individuals react to ‘health scare’ stories in the media. Articles on how we triple our chance of getting some horrible illness can overly swing consumers into avoiding certain foods. The purchase of super foods may also soar despite the fact that its effect on reducing our real risk of a disease may be mathematically almost negligible. Layard also points out that individuals find it hard to forecast future feelings. Individuals always think their purchasing decision, e.g. whether to buy a new car, will give them happiness for a longer time than it does in reality. ‘If only I had the latest iPhone …’ Products which have an addictive element also cause particular problems for individuals. They have a tendency to underestimate the future problems of trying to stop once they start and instead overly base their decision to buy cigarettes on the immediate gratification they receive. Individuals also have an unrealistic optimism, despite statistical data, and so overestimate their personal immunity from harm. 

Reasons why producers may not maximise profits

In large businesses, not all decisions are made by the owner. The owner will delegate day-to-day decisions to managers. Managers have different objectives to owners. Owners want to maximise profits (in order to earn high dividends) but managers aim to maximise their own salary (assuming they do not own shares in the business). Therefore, businesses might try to incentivise managers by maximising revenue or sales (for example, managers can be paid a commission – the more they sell, the higher the pay). Maximising sales or revenue will not necessarily maximise profits as prices may be lowered to maximise sales and also if a manager is aiming to sell a large amount, they do not care about the costs. 

Some producers have alternative business objectives. Although profit may be important to them, other issues may also be important. Consequently, by focusing on other objectives, it may not be possible for the producer to maximise profits. For example, some businesses focus on customer care; they may try to exceed customer expectations by providing high-quality customer service. This may mean that they spend more money on training their staff in giving good customer service. As a result, the extra costs incurred in training will reduce profitability

Some businesses operate as charities. Their main aim may be to raise money or awareness for a certain cause. Therefore, they may not be aiming to maximise profits.