2.
ECONOMIC ASSUMPTIONS
UNDERLYING ASSUMPTIONS IN ECONOMICS
In economics, individuals and businesses face limited resources.
Because of scarcity, they must make choices.
Economists assume that people behave rationally.
What does Rational Mean?
A rational person:
● Thinks carefully before making decisions
● Chooses the option that gives the most benefit or satisfaction
● Avoids wasting money or resources
Economists make two main assumptions about rational behaviour:
CONSUMERS AIM TO MAXIMISE BENEFIT
Meaning:
Consumers try to choose the option that gives them the greatest satisfaction (utility).
Example:
If Anita has Rs. 5000 and four options, she will choose the one that gives her the most
satisfaction.
Two Examples of Consumer Rationality:
1. Buying the Cheapest Price
○ If the same product is sold at different prices,
○ A rational consumer will buy from the cheapest supplier.
○ Paying more for the same product is irrational.
2. Buying the Best Quality
○ If prices are the same,
○ A rational consumer will buy the best quality product.
Therefore, economists assume consumers always try to maximise benefit.
BUSINESSES AIM TO MAXIMISE PROFIT
Meaning:
Businesses aim to earn the highest possible profit.
Profit = Revenue – Costs
Two Examples of Producer Rationality:
1. Buying Cheapest Raw Materials
○ If quality is the same,
○ A business will buy from the cheapest supplier.
2. Charging the Highest Possible Price
○ A business will charge the highest price the market can accept.
○ Charging lower than possible reduces profit.
Economists assume businesses are rational and aim to maximise profit.
REASONS WHY CONSUMERS MAY NOT ALWAYS MAXIMISE BENEFIT
In real life, consumers do not always behave rationally.
Difficulty Measuring Satisfaction
● Satisfaction cannot be measured exactly.
● Consumers may overestimate or underestimate benefits.
● Therefore, they may not choose the best option.
Brand Loyalty (Habit Behaviour)
● Consumers often continue buying the same brand.
● Even if cheaper or better options exist.
● This is habitual behaviour, not rational comparison.
Businesses use marketing to create strong brand loyalty.
Influence of Others (Peer Pressure)
Consumers may be influenced by:
● Parents
● Friends
● Social groups
Example:
● Young people may open bank accounts at the same bank as their parents.
● They choose familiarity, not necessarily the best option.
REASONS WHY PRODUCERS MAY NOT ALWAYS MAXIMISE PROFIT
Some businesses do not focus only on profit.
Managers Have Different Objectives
In large businesses:
● Owners delegate decisions to managers.
● Managers may try to maximise sales (for commission).
● Maximising sales does not always maximise profit.
Alternative Objectives
Some businesses focus on:
● Customer satisfaction
● Product quality
● Employee welfare
Example:
Spending more on staff training improves service but increases costs → reduces profit.
Not-for-Profit Organisations
Some organisations aim to help society, not earn profit.
Example:
UNICEF
● An international charity.
● Raises money for humanitarian work.
● Profit maximisation is not its goal.
Social Enterprises
These businesses:
● Operate commercially
● Aim to improve social or environmental well-being
Example:
MitiMeth
● Uses water hyacinth plants to create handmade products.
● Aims to solve ecological problems.
● Profit is not the main objective.
LACK OF INFORMATION
Consumers and producers may fail to maximise benefit or profit because:
● They do not have complete information.
● They may not know cheaper alternatives exist.
However:
● The internet
● Social media
have improved access to information, helping people make better decisions.