By Dennis John, April 2020
Rationality, as a concept, has been linked with the idea that people make choices based on sensible reasons and logic. A rational agent is an agent that will always choose to perform the action with the optimal expected outcome for themselves from among all feasible actions. Consumers are assumed to be utility-maximising, while firms are assumed to be profit-maximising. However, it is very clear that we are not rational beings. There are a few reasons for this.
Firstly, the human brain is incapable of computing all the information it receives. We can only process a limited level of information at a given time and examine only a few options. For example, an experiment was conducted in California, where two marketing researchers set up sampling booths for jam in a supermarket. One booth offered 6 flavours, while another offered 24 flavours. Conventional economic theory would argue that more choice is better for consumers. However, this is not necessarily the case. Despite more people stopping at the larger booth, considerably more jam was sold at the smaller booth. While more choice was indeed attractive, our brain’s inability to compute which one of the 24 choices was better was understandably a lot greater as well, discouraging many people at the larger booth from purchasing jam at all.
Secondly, choice bracketing often considerably influences a consumer or firm’s decisions. Choice bracketing is the concept that preferences are susceptible to how broad or narrow the decision context is. It also believes that people act differently when they consider the total consequence of a number of decisions, rather than consider the benefits and limitations of a single decision one at a time. For example, when buying a pizza, a medium pizza, roughly around £10, is often enough to satisfy a consumer’s total utility. But since the large pizza may only be a few pounds extra, and they might think the medium pizza is not worth it, the consumer may still buy the large pizza, as they believe they will gain lots more pizza for a small extra payment. However, after a consumer buys something, they will use it to avoid “wasting it”, even if they have already reached their total utility. As a result, consumers often end up eating the extra pizza, even though they may be gaining negative marginal utility per additional slice that they consume. This is again irrational behaviour, as after the consumer has finished the meal, they may regret the fact that they have over-eaten, and regret that they have not obtained the optimal expected outcome from eating the pizza.
Thirdly, the choices of consumers are dominated by their tendency to behave habitually. Habitual behaviour is linked with the status quo bias, which is when an economic agent sticks with a particular decision, even if it is no longer the decision with the optimal expected outcome. For example, despite multiple attempts by the Competition and Markets Authority in the UK, promoting people to switch bank account providers is not working. According to statistics from 2018, there are around 70 million deposit accounts across the UK, with the average citizen having 2.4 accounts, yet we are only seeing a million account switches per year. That’s about 1.4% who switch, compared to 98.6% who don’t do anything. This is another example of irrational behaviour, since switching can often lead to better options for the consumer, but they are unwilling to do so as they have been with the same firm for so long.
In conclusion, firms and consumers attempt to be rational and act in their best interests. However, the truth is they often struggle to do so, and as a result, there are no truly rational economic agents.
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