Reasons why the Assumptions may be Flawed (Edexcel IGCSE Economics)

Revision Note

Written by: Lorraine

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
However, consumers and producers do not always act rationally and may make decisions that do not always aim to maximise benefits or profits

Reasons Consumers may not Always Maximise Their Utility

Reason	Explanation
Measuring satisfaction	The wider the range of choice, the harder it is for a consumer to gather information and compute which one offers the highest net benefits Consumers often lack the time or ability to consider the relative prices of different products and sellers will frequently make it difficult for them to do so
Habits	Consumers make so many purchasing decisions that they often rely on habits to speed up the process Consumer inertia often develops as convenience is prioritised Consumers make purchasing decisions that directly harm them and are usually addictive, for e.g. alcohol Sellers recognise habitual patterns and exploit them. For example, products placed at the checkout till to benefit from impulse purchasing (chewing gum)
Social norms	Peer pressure often prompts consumers to make purchasing decisions that may go against a computation of net benefits Producers influence consumers choices through various forms of advertising, including lifestyle, celebrity endorsement and influencer culture Producers use advanced behavioural psychology techniques to influence consumer choices e.g. Neuro branding

The objectives of a firm are a reason for their existence or the desired focus of their owners
- The main objective is profit maximisation
- However, firms can pursue other objectives that include managerial objectives (growth of firm), customer care or charitable activities

Reasons why Producers may not seek to Profit Maximise

Reason	Explanation
Influence of managers	Managers may have a goal of growth which is focused on increasing sales revenue or market share Firms will also maximise revenue in order to increase output and benefit from economies of scale A growing firm is less likely to fail
Customer care	Some producers prioritise caring for their customers over maximising profit They may invest in customer service to improve brand loyalty, even if it involves additional costs that could impact profitability
Charitable activities	More firms than ever have a charitable objective These typically include a focus on climate action and addressing poverty or inequality They still require profit to survive, but will accept less than if they were profit maximising as long as they are meeting their social objective E.g Google has partnered with World Wildlife Fund and the Jane Goodall Institute to protect endangered species and habitats

Reason

Explanation

Influence of managers

Managers may have a goal of growth which is focused on increasing sales revenue or market share
Firms will also maximise revenue in order to increase output and benefit from economies of scale
A growing firm is less likely to fail

Customer care

Some producers prioritise caring for their customers over maximising profit
They may invest in customer service to improve brand loyalty, even if it involves additional costs that could impact profitability

Charitable activities

More firms than ever have a charitable objective
These typically include a focus on climate action and addressing poverty or inequality

They still require profit to survive, but will accept less than if they were profit maximising as long as they are meeting their social objective
E.g Google has partnered with World Wildlife Fund and the Jane Goodall Institute to protect endangered species and habitats

Last updated: 9 April 2024

the (exam) results speak for themselves:

Did this page help you?