Consumer Behaviour (AQA A Level Economics)

Rational Economics & Incentives

• Individual economic decision-making is influenced by

  • Rationality

  • Incentives

  • Marginal utility 

• When analysing markets, a range of assumptions are made about the rationality of economic agents involved in the transactions
  

• In classical economic theory, the word 'rational' means that economic agents are able to consider the outcome of their choices and recognise the net benefits of each one. Rational agents are incentivised to select the choice which presents the highest benefits

  • Consumers are assumed to act rationally. They do this by maximising their utility

  • Producers are assumed to act rationally. They do this by selling goods and services in a way that maximises their profits

  • Workers are assumed to act rationally. They do this by balancing welfare at work with consideration of both pay and benefits

  • Governments are assumed to act rationally. They do this by placing the interests of the people they serve first in order to maximise their welfare

• In many ways, the assumption of rational decision-making is flawed. For example, consumers are often more influenced by emotional purchasing decisions than a rational computation of net benefits

Utility Theory

• Utility is the satisfaction gained from consumption 

  • Marginal utility is the additional utility (satisfaction) gained from the consumption of an additional product

• The utility gained from consuming the first unit is usually higher than the utility gained from consuming the next unit

  • For example, a hungry consumer gains high utility from eating their first hamburger. They are still hungry and purchase a second hamburger but gain less satisfaction from eating it than they did from the first hamburger

• To calculate total utility, the marginal utility of each unit consumed is added together

  • This means that total utility keeps increasing even while marginal utility is decreasing

• The Law of Diminishing Marginal Utility states that as additional products are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit
  

• The Law of Diminishing Marginal Utility helps to explain why the demand curve is downward sloping

  • When the first unit is purchased, the utility is high and consumers are willing to pay a high price

  • When subsequent units are purchased, each one offers less utility and the willingness of the consumer to pay the initial price decreases

  • Lowering the price makes it a more attractive proposition for the consumer to keep consuming additional units

  • This is one reason why firms offer discounts such as '50% off the second item' 

• A consumer achieves utility maximisation when they spend their limited income in such a way that they will achieve the most satisfaction from their money

The Influence of Marginal Analysis on Choices

• A rational consumer seeks to maximise satisfaction with their limited income

• When deciding at the margin, they weigh whether to consume a little more or a little less of something

  • This involves considering the additional happiness or utility gained from each extra unit (marginal benefit) and the extra money spent (marginal cost)

  • Consumers continue to consume until the extra happiness from each unit equals the extra cost, which is making decisions at the margin 

• Every choice involves a balance between benefits and costs, taking into account each additional unit consumed

• Thinking at the margin is not exclusive to consumers but is also fundamental for firms and governments

• It guides decisions on how to allocate scarce resources by evaluating the marginal benefit and marginal cost of an additional unit

• By comparing the best decisions to their costs, the aim is to achieve optimal choices