1.1.2 - Economic Assumptions

Underlying economic assumptions - Syllabus 1.1.2(a)

  • Economic Assumptions = Assumptions to predict rational consumers’/producers’ behavior.

  • Rational consumers aim to maximize their benefits

    • Same good/services of same quality → Choose cheapest good/service

    • Same price set goods/services of varying quality → Choose highest quality good/service

  • Rational producers (especially businesses/firms from private sectors) aim to maximize their profits

    • Same raw materials of same quality → Choose cheapest → Reduced production cost → More profit

    • Range of prices accepted by market/consumers → Set highest price → More revenue → More profit

Why consumers don’t always maximize benefit - Syllabus 1.1.2(b)

  • Use IHC acronym

  1. Inaccurate calculations/comparisons between the benefits gained from consuming different products.

    1. Satisfaction cannot be quantified so over- or under-estimations are easily made.

  2. Habits that are difficult to give up.

    1. Example: Brand loyalty can prevent consumers from being economically rational.

  3. Copying other people’s behavior due to peer pressure.

    1. Example: People may purchase expensive bags from famous brands, when there are cheaper bags of similar quality, to adhere to trends and prove their social status as well as financial stability.

Why producers don’t always maximize profit - Syllabus 1.1.2(c)

  • Use CASI acronym:

  1. Charities or non-profit organizations.

    1. Their aim is not to get profit but to raise awareness/money for a particular issue.

    2. Subsidies for their good work is from fundraising and donations.

  2. Alternative business objectives

    1. They may prioritize customer satisfaction/care over profit.

  3. Social enterprises

    1. Their aim is to create social value by ameliorating human/environmental well-being.

    2. Profit is made by selling goods/services, NOT by fundraising + donations like charities.

    3. Social enterprises are NOT charities, because profit IS used to pay employees.

  4. Influences by behavior of other people in organization.

    1. Sales department managers want to maximize revenue and/or sales because more sales → more revenue → more commission and salary for them → ↑ production costs for wages; large-scale selling requires lowered prices, which can lower the profit gained from each extra unit sold → loss.

Why consumers AND producers don’t always maximize profit

  • Lack of information

    • Customers may not know where to choose cheaper or higher-quality products

    • Producers may not know about acceptable price ranges or where to choose cheaper raw materials.

    • Less of an issue now; the internet has plenty of information accessible to consumers and producers.