By: Aayushi Vats
Economics, as any other science, is governed by certain fundamental
laws which make economic analysis viable. These laws, in order to work
for all scenarios, take certain assumptions, certain factors which are
assumed to be the same for all cases and all situations.
Such is the assumption of rationality of the consumers in the case of classical theory of consumer behaviour analysis. A consumer is always
assumed to be rational in his patterns of consumption. What this means
is that a consumer will always make such choices of goods which maximise his satisfaction obtained from their consumption. But the question is, is the definition of rationality the same for all people and all cases? Is satisfaction maximization the sole motive for all consumption in all cases? Can human behaviour, which is an integral part of economic analysis, be defined, generalized, and restricted to some laws?
Facets of Rationality
Professor Richard Thaler, with his nobel- prize winning contributions to Behavioral Economics, sought to disprove the age-old assumption of classical economics that the consumer is ‘rational’.
Behavioral economics attempts to study the effects of cognitive, emotional, psychological, social and cultural factors on the economic decisions of individuals and institutions and how those decisions vary from those implied by classical theory. Behavioral economics is a newfound branch of economic analysis that deals with the bounds of rationality of consumers and other economic agents. Behavioral models integrate insights from
neuroscience, psychology and microeconomic theory. Behavioral economics also studies how market decisions are made and analysis mechanisms responsible for driving public choice.
Professor Thaler states that the consumers do not always behave rationally, and the economic analysis based on the assumption they do is flawed. Every consumer decision is affected by a variety of social, cultural, economic, and psychological factors and the choices they make are
not always for getting maximum satisfaction by spending the least. For example, when it starts raining, you won’t look for your most preferred and cheapest restaurant but instead, get into the first restaurant in your sight to dodge the rain. Professor Thaler, through his book ‘Nudge’, propagates ‘Nudge Theory’, a theory disproving the classical theory’s assumption of rationality of economic agents. Nudge Theory recognises the behavioral trait of humans, who, not being completely rational, often require some kind of encouragement or external intervention – a nudge, to make the right decisions for their larger good. For example, Spain operates an opt-out system, whereby all citizens are automatically registered for organ donation unless they choose to state otherwise, which, due to inertia of
rest, most citizens would not do. Thus, we see that the consumers are not actively making their choices, but are subconsciously being directed to take the decisions desired of them.
Thus, consumers have varying levels of rationality, or decision-making criteria. What may be an important factor to consider while purchasing a good for one person, may not hold relevance for others. while the law of demand states that as the price of a commodity increases, it’s demand
decreases. However, it has been observed that for some goods, demand increases as their prices increases because consumers attribute higher prices to higher quality, giving rise to a paradox. Thus, humans who are inherently different in their thinking and preferences, and cannot all be put into the same mold of a rigid assumption of ‘rationality’.
Microeconomic analysis is known to use a lot of mathematical tools to
define consumer behaviour. While this seems to be a viable means of
analysis, it certainly isn’t the most elegant solution. Mathematics is a
language, in which economics can be expressed. But this does not and
should not imply that it is the only medium of ‘conversation’. There are
many theoretical and subjective aspects, rather facets of behaviour of
economic agents which must be accounted for to make our analysis
Thus, rationality cannot be treated as a constant. Consumers, in many
practical situations, act irrationally and that has to be accounted for in
economic theory to make analysis universally applicable.