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Flaws in Rational Decision Making

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14 views3 pages

Flaws in Rational Decision Making

eco

Uploaded by

tazlinazamilakhantzk
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Rational Decision Making

 When analysing markets, a range of assumptions are made about the rationality of economic agents involved in the
transactions
 In classical economic theory, the word 'rational' means that economic agents are able to consider the outcome of
their choices and recognise the net benefits of each one. Rational agents will select the choice which presents
the highest benefits
o Consumers are assumed to act rationally. They do this by maximising their utility
o Producers are assumed to act rationally. They do this by selling goods and services in a way that maximises their
profits
o Workers are assumed to act rationally. They do this by balancing welfare at work with consideration of both pay and
benefits
o Governments are assumed to act rationally. They do this by placing the interests of the people they serve first in
order to maximise their welfare
 In many ways, the assumption of rational decision making is flawed
o For example, consumers are often more influenced by emotional purchasing decisions than a rational computation
of net benefits

Consumers may not Maximise Their Utility


 In classical economic theory, the word 'rational' means that economic agents are able to consider the outcome of
their choices and recognise the net benefits of each one. Rational agents are incentivised to select the choice which
presents the highest benefits
o Consumers are assumed to act rationally. They do this by maximising their utility
o Producers are assumed to act rationally. They do this by selling goods and services in a way that maximises their
profits
 However, consumers and producers do not always act rationally and may make decisions that do not always aim to
maximise benefits or profits

Reasons Consumers may not Always Maximise Their Utility


Reason Explanation
 The wider the range of choice, the harder it is for a consumer to gather information
and compute which one offers the highest net benefits
Measuring
 Consumers often lack the time or ability to consider the relative prices of different products
satisfaction
and sellers will frequently make it difficult for them to do so

 Consumers make so many purchasing decisions that they often rely on habits to speed up the
process
 Consumer inertia often develops as convenience is prioritised
 Consumers make purchasing decisions that directly harm them and are usually addictive, for
Habits
e.g. alcohol
 Sellers recognise habitual patterns and exploit them. For example, products placed at the
checkout till to benefit from impulse purchasing (chewing gum)

 Peer pressure often prompts consumers to make purchasing decisions that may go against
a computation of net benefits
 Producers influence consumers choices through various forms of advertising, including
Social norms lifestyle, celebrity endorsement and influencer culture
 Producers use advanced behavioural psychology techniques to influence consumer choices
e.g. Neuro branding

Producers may not Maximise Their Profit


 The objectives of a firm are a reason for their existence or the desired focus of their owners
o The main objective is profit maximisation
o However, firms can pursue other objectives that include managerial objectives (growth of firm), customer care or
charitable activities

Reasons why Producers may not seek to Profit Maximise


Explanation
Reason
 Managers may have a goal of growth which is focused on increasing sales revenue or market
share
Influence of  Firms will also maximise revenue in order to increase output and benefit from economies of
managers scale
 A growing firm is less likely to fail

 Some producers prioritise caring for their customers over maximising profit
 They may invest in customer service to improve brand loyalty, even if it involves additional
Customer care
costs that could impact profitability

 More firms than ever have a charitable objective


 These typically include a focus on climate action and addressing poverty or inequality

Charitable  They still require profit to survive, but will accept less than if they were profit maximising as
activities long as they are meeting their social objective
 E.g Google has partnered with World Wildlife Fund and the Jane Goodall Institute to
protect endangered species and habitats

Common questions

Powered by AI

Managers may prioritize growth in market share or sales revenue and aim to achieve economies of scale, which are benefits gained from increased levels of production. Such goals can lead firms to focus on expanding output or resources rather than immediate profit maximization, anticipating long-term benefits such as cost efficiencies, reduced competition risk, and stability, even if these come at the cost of short-term profit reductions .

Social norms impact consumer choices by compelling individuals to conform to group behaviors or expectations that might not align with rational, utility-maximizing decisions. These influences include peer pressure, lifestyle advertising, and endorsements that prompt purchases based more on societal acceptance than on an individual’s calculated benefits .

A firm might prioritize customer care to foster strong brand loyalty and improve long-term customer relationships. While this may include higher immediate costs, the strategy can result in sustained customer retention, positive brand reputation, and ultimately greater stability and market presence, which could lead to increased profits in the future despite short-term profit trade-offs .

Emotional factors lead consumers to make purchasing decisions based on immediate feelings rather than rational calculations of net benefits. Consumers might purchase items due to impulse or habitual buying, influenced by emotional elements such as peer pressure or advertisement tactics that appeal to emotions, like celebrity endorsements .

Sellers exploit habitual purchasing behavior by placing products strategically to capitalize on impulse buying, such as placing certain consumables near checkouts. They also leverage the predictable nature of habits to market products in a way that aligns with consumers’ existing preferences, which often involves creating environments that reduce transaction costs and decisions .

Producers employ advanced marketing techniques such as lifestyle branding, celebrity and influencer endorsements, and behavioral psychology tactics like neuro branding to influence consumer purchases, shifting consumer choice from rational utility maximization to emotionally driven decisions .

Consumers fail to maximize their utility for several reasons: the difficulty in measuring satisfaction due to choices' complexity, reliance on habits for decision-making efficiency, inertia for convenience, and the impact of social norms on decisions which may not align with rational calculations of benefits .

Producers may focus on objectives such as managerial goals aimed at growth, customer care by investing in service to improve loyalty, and engaging in charitable activities. These alternate focuses might involve foregoing some profits to achieve increased market share, better customer relations, or social good, which include supporting causes like climate action and reducing inequality .

In classical economic theory, it is assumed that consumers act rationally by maximising their utility, producers maximise their profits, workers balance welfare at work with pay and benefits, and governments focus on the interests of the people to maximise their welfare. However, these assumptions are often flawed as various factors lead to decisions that deviate from purely rational behavior .

Charitable activities within a firm align with objectives that prioritize social responsibility over immediate profit maximization. These activities may involve accepting lower profits for social gains, such as environmental protection partnerships or social equality initiatives. This approach can conflict with profit maximization but often enhances corporate image, attracts socially conscious customers, and contributes to long-term sustainability goals .

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