Rational Consumer Choice (DP IB Economics)
Revision Note
Assumptions of Rational Consumer Choice
Free markets are built on the assumptions of rational decision making
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 will select the choice which presents the highest benefits (utility)
Rational choice theory states individuals use logical and sensible reasons to determine the right choice connected to an individual’s best self-interest
Many economic theories assume that economic agents (individuals, firms and governments) make decisions that result in maximising their satisfaction
E.g. The law of demand which states that as the price falls consumers will increase their demand for goods and services
This traditional economic view is based on the following three assumptions
1. Consumer Rationality
The assumption that individuals use rational calculations to make choices which are within their own best interest, using all the information available to them
2. Utility Maximisation
Traditional economic theory assumes economic agents select choices that maximise their utility to the highest level
E.g. If an individual gains greater satisfaction from swimming than going for a run, they will chose to go swimming
3. Perfect Information
Rational choice theory assumes information is easily accessible about all goods and services on the market. It assumes individuals have access to all the information available to make the best decision
Limitations of the Assumptions of Rational Consumer Choice
Behavioural economics contrasts traditional economics as it challenge the view that economic agents behave rationally
Behavioural economics is a field of study that combines elements of psychology and economics to understand how people make decisions and behave in economic contexts
Behavioural economics recognises that human decision-making is influenced by cognitive biases, emotions, social, and other psychological factors that can lead to deviations from rational behaviour
The assumptions of traditional economics regarding decision making do not hold
The following limitations mean individuals are unlikely to always make rational decisions
Limitations of the assumptions of rational consumer choice
1. Biases
Biases influence how we process information when making decisions and these influence the process of rational decision making
Examples of bias include common sense, intuition, emotions and personal and social norms
Types of Bias
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Rule of Thumb |
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Anchoring and Framing |
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Availability Bias |
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2. Bounded Rationality Theory
This theory argues that people make decisions without gathering all the necessary information to make a rational decision within a given time period
Individuals may not understand the technical jargon linked to selecting insurance or pensions
The theory assumes rational decision making is limited because of
An individual's thinking capacity
Availability of information
Lack of time available to gather all of the infromation and make a judgement
Too much choice can also cause people to make irrational decisions
E.g. when making choices about purchasing particular products in the supermarket, there may be too much choice making it difficult to make a decision
3. Bounded Self-Control
The theory of bounded self-control suggests that individuals have a limited capacity to regulate their behaviour and make decisions in the face of conflicting desires or impulses
It recognises that self-control is not an unlimited resource that can be exercised endlessly without consequences
Humans are social beings influenced by family, friends and social settings. This often results in decision making which conforms to social norms but does not result in the maximisation of consumer utility
Bounded self control leads to decision making based on emotions, which may not yield the best outcome.
E.g people may indulge in impulsive spending, purchasing goods they didn’t originally intend to buy
Businesses use marketing to capitalise on the lack of bounded self-control of individuals when appealing to their target audience to maximise sales
E.g. Supermarkets place a range of items at the checkout register to encourage impulse purchases
4. Bounded Selfishness
Behavioural economics challenges the view that economic agents always act within their own self interest
Bounded selfishness recognises that individuals do things for others without a direct reward
Altruism is the practice of acting selflessly helping others expecting nothing in return
Examples of bounded selfishness include
Donating money to charity
Organ donations
Voluntary work
5. Imperfect Information
Rational Choice Theory assumes information is perfectly accessible, however this is incorrect due to factors such as
Intellectual property rights e.g. patents, copyrights and trademarks
Cost of accessing information
The sheer amount of information and options available
This means people make decisions based on limited information meaning they may not make the best choice
Asymmetric information may also lead to decisions based on limited information
E.g. When purchasing second hand cars, the seller always has more information than the buyer
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