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Consumer Rationality

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Economics

Imagine you go shopping for new shoes. How do you decide what to buy? Would you make the decision solely based on the price? Or perhaps based on the style or quality of the shoes? The decision wouldn’t be the same if you were looking for shoes for a special occasion or for everyday trainers, right?

COnsumer Rationality Shoe shop StudySmarterA shoe shop, Pixabay.

Do you believe that as a consumer you are always making rational choices? The answer is simple: it may be impossible for us to always act rationally. This is because as consumers we are affected by our emotions and our own judgments which prevent us from always selecting the best available alternative. Let’s learn more about consumer rationality.

What is a rational consumer?

A rational consumer is an economic concept that presupposes that when making a choice, consumers will always focus primarily on the maximisation of their private benefits. In decision making, rational consumers select the option that will bring the most utility and satisfaction to them.

The concept of rational consumer describes the individual acting out of self-interest with the main aim of maximising their private benefits through consumption.

The concept of rational consumer assumes that consumers behave in a way that maximises their utility, welfare, or satisfaction through the consumption of goods or services. The rational consumers' choices also involve consideration of a product's prices and other demand factors.

Imagine that a person has to choose between buying a more expensive car A and a cheaper car B. In case the cars are identical, the rational consumers would pick car B since it will give the most value for its price.

Nevertheless, if the cars have different energy consumption levels, this will factor into the consumer’s decision. In that case, rational consumers will work out which car will be more affordable in the long run.

Additionally, rational consumers will evaluate all important factors and assess other demand factors before making a choice.

Finally, the rational consumers will make a choice that leads to the maximisation of their private benefits.

However, consumers in the real world may not always act rationally. Their choices are usually made based on their own judgements and emotions in regards to what seems the best option at a particular time.

A rational consumer’s behaviour

As we already mentioned the behaviour of a rational consumer would be to act in terms of maximising their private benefits that include satisfaction, welfare, and utility. We can measure these using utility theory, in regards to how much utility the good provides to consumers at that time.

To learn more about consumer utility and its measurement check our explanation on Utility Theory.

A rational consumer behaviour follows the individual’s demand curve like Figure 1 shows. This means that the changes in prices of goods should impact the changes in the quantity demanded. For instance, once the price for certain goods decreases, the demand should increase, and vice versa.

To learn more about the law of demand check our explanation on Demand for goods and services.

Other factors that may affect rational consumers’ behaviour are the conditions of demand. These include factors such as income, individual consumers’ preferences, and taste. With an increase in income, for example, consumers’ purchasing power increases. This results in an increase in demand for normal goods, but decreased demand for inferior goods.

Consumer Rationality individual's demand curve StudySmarter Figure 1Individual’s demand curve - StudySmarter.

Inferior goods are goods that are of poorer quality and are more affordable substitutes for normal goods. Therefore, once income rises, the consumption of these goods decreases, and vice versa. Inferior goods include products such as canned foods, instant coffee, and supermarkets’ own branded value products.

To learn more about how the quantity demanded of normal and inferior goods responds to income changes check our explanation on Income elasticity of demand.

Assumptions of consumer rationality

The main assumption of rational behaviour is that when the price of a good falls, the demand for that particular good is likely to increase, whereas if the price of a good increases, the demand for the good decreases. Additionally, we assume that consumers will always attempt to maximise their utility by choosing the best alternative using a limited budget.

Let’s review some additional assumptions of consumer rationality:

Consumers choices are independent. Consumers base their buying decisions on their preferences and taste, and not on the opinions of others or on commercial advertisements.

Consumers have fixed preferences. The consumers’ preferences will remain constant over time. Consumers will not choose alternatives over their most preferred choices.

Consumers can gather all the information and review all available alternatives. Consumers have unlimited time and resources to review all the alternatives available.

Consumers always make optimal choices regarding their preferences. Once consumers have reviewed all their options, they can pick the best choice based on their preferences.

It’s important that you remember that these are all theoretical assumptions. This means that consumer behaviour might be different in real life.

Constrains preventing consumers’ rationality

Consumers can’t always act rationally because there are individual and marketplace constraints that prevent them from maximising their utility and selecting the best alternative.

Constrains that prevent utility maximisation

These are the constraints that stop consumers from maximising their utility. In this case, even if consumers have rational behaviour, they face constraints to choosing the best possible alternative due to these factors:

Limited income. Although consumers may be wealthy, they can’t afford all the goods available on the market that will maximise their utility. Therefore, they encounter an opportunity cost: if they spend their income on one good, they can’t spend it on another.

A given set of prices. Consumers are powerless to influence market prices. Therefore, they have to follow the prices set by the market. Consumers are price takers, not price makers, which means marketplace prices can influence their choices.

Budget constraints. A limited income and prices imposed by the marketplace, influence consumers’ budgets. Consumers, thus, don’t have the freedom to buy all the goods that can maximise their utility.

Limited time available. A time limit restricts consumers’ ability to consume all the goods on the market that will maximise their utility. This happens regardless of whether these goods were free or consumers had unlimited income.

Rational consumer behavioural constrains

Their behavioural constraints prevent consumers from acting rationally. For instance, behavioural factors such as the inability to fully evaluate all alternatives, social influences, and lacking self-control are some of many behavioural factors that prevent consumers from acting rationally.

The key behavioural constraints are:

Limited calculation capabilities. Consumers are unable to collect and review all the information regarding possible alternatives to choose the best one.

Influences from social networks. Usually, people close to an individual can influence that person’s choices, which is what prevents consumers from sticking to their individual preferences and tastes.

Emotions over rationality. There are times when consumers can make consumption choices based on their emotions rather than logical thinking. For instance, instead of looking at the technical aspects of a product, consumers may select a product because a celebrity they like endorsed it.

Making sacrifices. Some people may not always act out of self-interest and make a decision that benefits them the most. Instead, consumers may want to make sacrifices for other people. For instance, donating money to charity.

Seeking instant rewards. Even though one alternative will give more benefit in the future, sometimes consumers seek instant rewards. For example, consumers may want to indulge in a high-calorie snack instead of waiting for a healthy lunch.

Default choices. Sometimes, consumers sometimes don’t want to invest the time and energy into making rational decisions. Due to this, consumers may make choices that are easily accessible or stick with the same choices requiring the least amount of effort. For instance, consumers may choose McDonald’s or KFC when they travel to a new country because they don’t want to make the effort to try something new.

To learn more about the limitations to rational consumer behaviour take a look at our article on Aspects of Behavioural Economic Theory.

Consumer and Rationality - Key takeaways

  • A rational consumer is an economic concept that presupposes that when making a choice, consumers will always focus primarily on the maximisation of their private benefits.
  • Rational consumer behaviour follows the individual’s demand curve, which means that the changes in prices of goods should impact the changes in the quantity demanded.
  • Other factors that may affect rational consumers’ behaviour are known as conditions of demand. They include factors such as income, preferences, and individual consumers' tastes.
  • The assumption of rational behaviour is that when the price of a good falls, the demand for that particular good is likely to increase, whereas if the price of a good increases the demand for the good decreases simultaneously.
  • Other consumer rationality assumptions include: consumers choices are independent, consumers have fixed preferences, consumers can gather all the information and review all available alternatives, and consumers always make optimal choices regarding their preferences.
  • The key constraints that prevent consumers from maximising their utility are limited income, given sets of prices, budget constraints, and limited time.
  • The key constraints that prevent consumers from behaving rationally are limited calculation capabilities, influences from social networks, emotions over rationality, making sacrifices, seeking instant rewards, and efault choices.

Consumer Rationality

No. As rational consumers aim to maximise their individual private benefits, they all differ from each other.

A choice made by a rational consumer. Rational consumers continuously make choices that maximise their utility and that are closer to their preferred alternative.

There are quite a few assumptions of consumers' rationality: 

  • The price of goods affects the consumers’ demand for particular goods.
  • Consumers have to choose the best alternatives using a limited budget. 
  • Consumers’ choices are independent.
  • Consumers have fixed preferences.
  • Consumers can gather all the information and review all alternative choices.
  • Consumers always make optimal choices regarding their preferences.

Consumers are rational when they make consumption choices that maximise their utility and private benefits. Additionally, rational consumers will always choose their most preferred alternative.

Consumers don’t always act rationally because consumers choices are often based on their own judgment and emotions which may not be the best choices bringing them the most utility.

Final Consumer Rationality Quiz

Question

What is utility?

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Answer

Utility is the level of satisfaction a person derives from the consumption of goods or services.

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Question

What are the units of measuring utility called? 

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Answer

Utils

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Question

Total utility decreases as the units of consumption increases.

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Answer

False

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Question

Marginal utility and total utility have the same curve.

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Answer

False

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Question

Marginal utility decreases as the units of consumption increase.

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Answer

True

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Question

What is marginal utility?

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Answer

Marginal utility is the satisfaction that a person receives from consuming an additional unit of the same good or service. 

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What is total utility?

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Answer

Total utility is the aggregate satisfaction a person receives from the consumption of all the units of the same good or service. 


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Question

When TU reaches its maximum level, MU is zero.

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Answer

True

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Question

As the number of units increases, MU increases and TU reduces.

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Answer

False

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Question

As the number of units increases, MU reduces, and TU Increases. 

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Answer

True

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Question

What is perfect information?

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Answer

Perfect information occurs when the economic agents are perfectly informed when making their decisions. 

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What is imperfect information?

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Answer

Imperfect information occurs when the economic agents lack information about a good or any other information relevant to the transaction. 

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Question

In which kind of market structure does perfect information exist?

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Answer

Perfectly competitive

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Question

In which form of market structure does imperfect information exist?

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Answer

Imperfect information may exist in a monopoly, oligopoly, or even monopolistic competition.

We assume it exists in all other market structures apart from perfect competition.

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Question

What is the level of transaction risk involved in perfectly informed markets?

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Answer

As the consumers make an informed decision, the chances of transaction risk are low.

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Question

What is the level of transaction risk in imperfectly informed markets?


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Answer

The consumer may not be able to make an efficient decision due to incomplete information. Hence, the transaction risk is high.

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Question

What is asymmetric information?

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Answer

Asymmetric information is a type of imperfect information where one party has significantly more information than the other and the other part cannot access it.  

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Question

What are two examples of asymmetric information?

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Answer

- Adverse selection

-Moral hazard


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Information for decision-making is relevant only for consumer market structures. 

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False

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Question

Which type of market failure is called under-consumption of the merit good?

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Answer

A consumer may not have the perfect information about the merit goods and may not consume an optimum quantity. This type of market failure is called under-consumption of the merit good. 

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Question

Which type of market failure is called over-consumption of the demerit good?


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Answer

The consumer may be unaware of the ill effects of demerit goods, which may result in over-consumption. This type of market failure is called over-consumption of the demerit good. 

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Question

What can lead to a market failure?

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Answer

If the economic agents don’t have enough information, they make a decision based on incomplete information and arrive at an inefficient outcome. This leads to market failure.


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Question

Perfectly informed markets are more prevalent than imperfectly informed markets.

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Answer

False

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Question

What is expected utillity?

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Answer

Expected utility in simple terms is the utility that an economic agent is expected to reach in the future given several probable outcomes. 

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What is Subjective utility?

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Answer

The subjective utility is utility based on an individual's perceived personal level of satisfaction that they obtain from consuming a good or service. 

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How is expected utility calculated?

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Answer

 It is calculated by multiplying each possible utility outcome by the probability of its occurrence and then adding them up. 

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Question

What does the law of diminishing marginal utility explain?

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Answer

The Law of diminishing marginal utility states that the level of satisfaction for an individual diminishes as the use of the same product increases and eventually the consumer either looks for an alternative or stops consuming the product. 


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Question

The consumer starts getting negative utility after a particular unit of consumption, which is the same for all individuals.


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Answer

False

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Question

What does rational consumer mean?

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Answer

The rational consumer means that consumer's choices will always have a primary focus of maximising private benefits.

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Question

How does the rational consumer behave?

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Answer

Rational consumers behave in a way that maximises their utility, welfare, or satisfaction through the consumption of goods or services.

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Question

How can we measure the utility/satisfaction that a good or service provides to consumers?


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Answer

Consumers’ utility/satisfaction in regards to consumption of a good or service can be measured using utility theory, which measures how much utility/satisfaction a good provides to consumers at the time.

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Question

What is the individual's demand curve?


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Answer

Individual’s demand curve explains rational consumer behaviour in terms of product’s price and quantity demanded. For instance, once the price for a product decreases the demanded quantity increases and vice versa.

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Question

What is the name of the term that describes other factors that may influence rational consumers behaviour?


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Answer

Conditions of demand.

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What are the main factors that the ‘conditions of demand’ include?

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Answer

Income, individual consumer's preferences, and taste.

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Question

With an increase in income the consumption of what type of goods will decrease?

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Answer

Inferior goods.

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Question

What are inferior goods?

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Answer

Inferior goods are goods that are of poorer quality and are more affordable substitutes for normal goods.

Show question

Question

What are the main assumptions of consumer rationality?

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Answer

The main assumptions of consumers rationality are:

  • When the price of certain goods decreases the demand for those goods should increase.
  • Consumers are assumed to always attempt to maximise their utility by choosing the best alternative using a limited budget.
  • Consumers' choices are independent.
  • Consumers have fixed preferences.
  • Consumers are able to gather all information and review all available alternatives.
  • Consumers always make optimal choices regarding their preferences.

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Question

What does it mean that consumers always have fixed preferences?

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Answer

This is the assumption that the consumers’ preferences will remain constant over time. Consumers will not choose alternatives over their most preferred choices.

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Question

If there are two identical products, A and B, and their only difference is that A is more expensive than B, which product would the rational consumers pick?

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Answer

The answer is B, as a rational consumer will choose the product that will give the most value for the lowest price.

Show question

Question

What are the key constraints that prevent consumers to maximise their utility through consumption?

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Answer

The key constraints preventing consumers from maximising their utility are:

  • Limited income
  • A given set of prices
  • Budget constraints 
  • Limited time 

Show question

Question

How does the time limit prevent consumers from maximising their utility?

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Answer

A time limit restricts consumers' ability to consume all the goods on the market that will maximise their utility, regardless of whether these goods were free or consumers have unlimited income.

Show question

Question

What are the key constraints that prevent consumers from behaving rationally?

Show answer

Answer

The key constraints that prevent consumers from behaving rationally are:

  • Limited calculation capabilities
  • Influences from social networks
  • Emotions over rationality
  • Making sacrifices
  • Seeking instant rewards
  • Default choices


Show question

Question

Can you explain and give an example of what ‘default choices’ means?

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Answer

Default choices are choices that consumers will make when they don’t want to make a lot of effort. Therefore, they stick to choices that are easily accessible or require the least amount of effort. For example, consumers may choose McDonald's or KFC when they travel to a new country because they do not want to make an effort to try something new.

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Question

What is behavioural economics?

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Answer

It’s the study of human behaviour using psychological and economic theories.

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What disciplines does behavioural economics combine?

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Answer

Psychology and Economics

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Question

What's the aim of behavioural economics?

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Answer

It aims to provide an alternative to conventional economic theory, which assumes that all human beings are rational and that their decisions are always optimal.

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Question

What does the rational choice theory suggest?

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Answer

Rational choice theory suggests that when individuals are faced with many choices and constraints, each individual is reasonable enough to make the choice that best maximizes their gains.

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Question

Give some examples that behavioural economics takes into account when studying human behaviour.

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Answer

Behavioural economics takes into account other aspects of an individual, such as their social norms, habits, personality, etc.

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Question

What are some of the factors that influence rational decision making according to behavioural economic theory?

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Answer

Behavioural economics suggests that bounded rationality, bounded self control, and the time it takes to come up with a decision influence rational decision making.

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Question

Name three biases in decision making.

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Answer

Biases in decision making include: availability bias, anchoring, biases based on social norms, habitual behaviour, and rule of thumb.

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