Critique of Maximizing

Behaviour of Consumers &

Producers
Unit 2 - Lesson 6
Learning Outcomes:
● Define all the terms in orange bold for section 2.6
● Evaluate the assumptions of consumer rationality, utility maximization and perfect
information.
● Referring to the following points, discuss the limitations of standard behavior
made by behavioral economist:
○ Bases including rule of thumb, anchoring, framing and availability
○ Bounded rationality
○ Bounded self-control
○ Bounded selfishness
○ Imperfect information
● Discuss policies of behavioral economics:
○ Nudge theory, choice architecture with respect to default, restricted and
mandated choices.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

‘Rational Self-Interest’ or Rational Decision Making

Assumptions:

● Individuals are expected to act in their best self-interest

● Try to maximize the satisfaction/utility they receive from economic decisions.
○ Consumers spend their money on purchases to maximize the utility they get
from buying goods and services.
○ Firms try to maximize the profits they make from their businesses
○ Workers try to get the highest wage for their job.
○ Investors try to get the highest returns for their investment

Standard economic models and theories are based off the assumption of
‘rational self-interest’ or rational decision making.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Rational Consumer Choice: consumers make purchasing decisions that align with
their taste and preferences.

Assumptions:

1. Consumers are able to rank goods in order of preference

a. Given two goods A & B, the consumer is able to say with certainty that they prefer one
good over the other.
2. Preferences among alternative choices are consistent.
a. Transitivity Assumption: if a consumer prefers good A to B and Good B to C then
they must prefer Good A to C.
3. The consumer always prefers more of a good to less.
a. Non-satiation Assumption: two groups of goods where one group contains more of a
good than the other group, the consumer will always choose the group that has more.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Perfect Information:

Assumption:

● Consumers have perfect information about all their choices allowing them to
make a decision with certainty.
○ Given Good A and Good B, the consumer possesses all possible
information about both goods.
○ Having all information about both products eliminates all doubts,
questions and uncertainties about the their choice.
○ Consumer has knowledge of all possible product qualities and pricing.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Utility Maximization

Utility is the benefit a consumer receives from consuming something.

Assumption:

● Consumers maximize their utility

○ Look to buy a combination of goods and services that will result in the
highest utility/benefit given the amount of money spent.
○ Base off of the rational decision making and perfect information.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Command term - Evaluate - make a appraisal by weighing the strengths and

limitations of a theory or action.

Behavioral Economics: an area of economics that is strongly influenced by

Psychology, Sociology and Neuroscience.

Behavioral Economics examines the limitations of rationality including perfect

information and utility maximization based on biases.

Bias (Cognitive Bias): systematic errors in thinking and evaluating. Biases affect
consumer behavior in the following ways.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Rules of Thumb (Biases)

● Simple guidelines that an individual consumer follows based on experience,

common sense and simplifying complicated choices.
● If “Rule of Thumb” if not used choices would be made on complex consideration
of every possible choice available.
● A “Rule of Thumb” is a general principle that gives practical instructions for
accomplishing or approaching a certain task.

Example:

● A home purchase should cost less than an amount equal to two and half years of
your annual income.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Anchoring

● Use of irrelevant information to make decisions

● Often occurs due to the fact that it is the first piece of information that a consumer
comes across

Example:

● When purchasing a car the price of the car is attached to the window listing all features
and price (Anchor Price).
● You negotiate with the salesman a price lower than the price listed on the window.
● You feel like you are getting a good deal because you are paying a price lower than the
“anchor price”.
● In reality it may not be a good deal at all!
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Framing
● Deals with how consumers are presented information (framed).

For example:

● What would you be more likely to buy?

○ Hamburger meat that is 80% lean or hamburger meat that is 20% fat?
○ In reality they both say provide the same information, but they are “framed” differently.
● A rational consumer would be indifferent to the two phrases as they are the same.

Would you be indifferent or more likely to make your choice based on how the
product is “framed”?
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Availability

● Information that is most recently available

● Consumers tend to rely on that information more heavily.
● No reason to expect the information is any more reliable than information that was
available at an earlier time.
● Could rely on the fact that consumer/individuals remember recent events rather than
older events.

For example:

● If a consumer recently received multiple ads stating one product is more superior than
another, they would be more likely make a purchase based off the most recent
information they received.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Bounded Rationality

● Idea developed by Nobel Prize Economist, Herbert Simon in 1971

● Argued people do not have unlimited capacity to process information
● Searching for information that maximises utility is a costly process

Described consumer behaviour in terms of “Bounded Rationality”.

● Consumers are only rational within certain limits

● Consumers rationality is limited by insufficient information, cost of obtaining
the information, and limitation of human mind to process large amounts of
information
● Consumers seek satisfactory outcomes rather than optimal outcomes
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Bounded Self-Control

● Similar to “Bounded Rationality”, consumers only exercise self-control within limits.

● Often consumers do not have the self-control that would require them to make a
rational decision

Have you ever eaten too much in one sitting?

Have you ever spent too much money on a purchase?

Have you ever studied to little for an assessment?

If you answered yes to one or all questions you experienced “Bounded Self-Control”.
If your choices were all rational you would not have done any of the above!
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Bounded Selfishness

● The “Rational Decision Making” assumes that individuals will make

decisions based on maximising their own self-interest
● “Bounded Selflessness” states individuals are only selfish within limits
therefore all decisions will not be made to maximise their own self-interest
● Maximisation Principle does not explain individuals selfless behaviour and
willingness to contribute to the overall public well-being.
● These selfless acts come at the expense of the individuals own self-interest
and personal utility/welfare.
Evaluate the assumptions of consumer rationality, utility maximization and
perfect information.

Imperfect Information

● Theory of consumer behaviour is that individuals have complete or perfect

information needed to make informed decisions.
○ Prices
○ Product quality
○ Products available
● If perfect information is not available then they would not be able to make
the optimal/best choice
● Not realistic to think that individuals have access to perfect information.
● With imperfect information it is not possible to maximise utility as the
choices made are based on incomplete and faulty information
Discuss policies of behavioral economics.

Nudge Theory

● A method designed to influence

individuals choices in a predictable way
● This influence does not involve offering
financial incentives, restricting or
limiting choice of an individual.
● Goal is to try and have individuals act in a
socially desirable way without imposing
any restrictions.
● Popular in both the public (government)
and private (businesses) sectors

Examples: Reducing cigarette waste on the streets of London MORE EXAMPLES

Discuss policies of behavioral economics.

Choice Architecture

● Theory suggests that consumer spending habits are strongly influenced by

the way goods are presented to them.
● Changing the way goods are presented can influence what is bought.
● Method to retain a consumer's right to choose, but nudging them to make
certain choices.
● Choice Architecture offers different kind of choices
○ Default Choice
○ Restricted Choice
○ Mandated Choice
Discuss policies of behavioral economics.

Default Choice

● Choice that is made by default

● Meaning choosing the option by not doing anything
● Choices are often made by default due to habit or lack of interest even if not
doing is the best option

Examples:

● Imagine as a business making an additional $40 million by implementing the

default choice option. An European railway company did by making one small
change to their website.
● Read about in the Harvard Business Review along with some other examples.
Discuss policies of behavioral economics.

Restricted Choice

● Because of Bounded Rationality, individuals can find it difficult to make effective

decisions
● Choice that is limited by government or another authority
● Examples of choice being limited are restrictions or boundaries imposed.
● Argued restrictions or boundaries are necessary because people have too
many choices
● In the absence of better or more complete information individuals make poor
choices
● Choice Architecture using restricted choice can help individuals make choices
that result in a more socially desirable outcomes

Examples: speed limits, voting age, recycling guidelines to name a few

Discuss policies of behavioral economics.

Mandated Choice

● A scenario where individuals must

make a decision/choice (usually
required by law) whether they wish
to participate or not.
● Individuals are mandated to make
a choice.

Examples:

● Public policy utilises mandated

choice
● Organ donor
Response of mainstream economists to the critique of utility theory

Many economist argue that the theory of consumer behaviour based on the
assumption of rationality does a good job of predicting behaviour.

Mostly consumers will respond rationally to financial incentives.

For example, if the price of gas increases, the most likely result in a decrease in
quantity demanded.

Thus supporting the downward sloping demand curve.

Even though consumers do not act rationally all the time, on the average their
behaviour is consistent with utility theory.
Response of mainstream economists to the critique of utility theory

Mainstream economist would further argue the following points:

● Use of Choice Architecture is manipulative.

● Purpose is to try and influence consumer choices.
● Free choice becomes an illusion.
● Affects consumers sub-consciously making them do things they might not choose
to do if they were fully aware of the implication of their choices.

Choice Architecture takes advantage of the imperfect information that is available to

consumers, and selectively provides information to the consumer encouraging them
to act in a particular way.

Therefore it is argued that there should be open discussions and transparency

of nudges used for economic policy.
Evaluating behavioural economics and economic policy

Evaluate: Make an appraisal by weighing up the strengths and limitations.

Possible Strengths:
● May be a relatively low cost and efficient way to influence people to behave in a
socially desirable way.
● Choice Architecture and nudging have shown to be successful in many different
areas. The possibility of impacting economic policy are numerous.
● Does not restrict choice of consumers. Offers individuals general freedoms of
choice without forcing them to do anything or prevent them from doing anything.
● May help to overcome the limitations of consumer behaviour being rational.
Rational consumer behaviour is not able to explain the irrationality of consumer
behaviour.
● Policies are based on Principles of Psychology, for example framing, which
have been tested over many years, therefore more likely to succeed.
Evaluating behavioural economics and economic policy
Possible Limitations

● Behavioural economics is not based on understanding human behaviour. Will not

lead to a unifying theory on how consumers behave.
● The unsystematic approach to economic policy over time may not hold true over time
or within different social, income and cultural groups.
● Risks of using psychological approaches to manipulate individual choices much the
same way marketers have used these psychological principle to influence consumer
behaviour.
● Concern that behavioural policies will be used in place of some other costly political
policies such as increasing taxes which can be politically damaging.
● These other more politically unfavourable policies may be more effective - taxes,
subsidies.
● May be another form of Government regulation guised as freedom of choice.
● Choice architecture and nudging may be successful in impacting people’s choices, but