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Is it appropriate to assume that all individuals are rational utility-maximisers for the purpose of economic analysis?
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Table of Contents
Table of Contents
Introduction
General Model of Choice Behavior
The rational choice approach to Economic Behavior
Neoliberal Economic Consumption Policy
Utilitarian View of Economic Analysis
Modern Approach to the Economic behaviors
Decision making and Judging
Conclusion
References
Introduction
Many economic decisions are complex and involve choices that are non-marginal, such as choices of occupation, particular consumer durables, house types and residential locations, recreation sites, and commuting modes. Although economists are mainly interested in market demand, the fact that each individual makes individual consumption decision based on individual needs and environmental factors. In addition, these decisions are usually complex, making the relationships between market and individual demand even more complicated.
For instance, the framework of economic rationality and the associated assumption of utility maximization allows the possibility that unobserved attributes of individuals, like tastes, can vary over a population in such way that they obscure the implication of the individual behavior model.
According to Adam Smith, people act in their own self-interest and this would promote the general welfare. The concept of the invisible hand has become quite popular, however, it implies that if people only behave with self-interest, they will do what is best for the entire society. Smith’s emphasis is on the desire of people to have self-respect and the respect of others depend on people acting honorable within their own communities (Amadae, 2016).
General Model of Choice Behavior
A general model of individual choice behavior requires that three key factors be taken into consideration.
First of all, these are objects of choice and sets of alternatives that are available to decision makers known as choose set generation. Depending on the set of choice, the individual has a range of decision-making, which can vary from one individual to another. Having limited choices will narrow down the expectations of the choice behavior, as the choice maker is making a decision on the available set of choices (Nechyba, 2017).
Second, the observed attributes of decision makers and a rule for combining them. Whether or not an individual already has what is presented in the choice set, may influence their choice behavior (Nechyba, 2017).
Third, a model of individual choice and behavior, and the distribution of behavior patterns in the population. Society, including customs and traditions, have a tremendous impact on the choice behavior (Nechyba, 2017).
The general model of individual behavior represents the set of individual behavior riles, which is relevant to all individuals who define the sampled population. For instance, individual behavior rule may be a particular choice function that results from maximizing a specific utility function, while set of individual behavior rules may be a set of choice functions resulting from the maximization of a particular utility function (Nechyba, 2017).
The rational choice approach to Economic Behavior
According to Down, individuals are utility maximizers, meaning that they make use of the most appropriate of the available means to pursue their ends. In addition, individuals exhibit a well-behaved preference structure, which makes them utility maximizers. Rational choice approach to the analysis of social life recognizes that human behavior frequently departs from the canons of rationality, so that rational choice models are not realistic (Amadae, 2016).
One of the main approaches to the lack of realism of rational choice models based on the assumption that rationality provides the means of identifying the place of non-rational elements in human action. There is no suggestion that rational self-interest is the sole motivation of human action. It is rather that the assumption of “narrow rationality” is the essential starting point for analysis and that it might have been supplemented by consideration of other source of action. A signification assumption of rationality is that the choice of appropriate means to pursue one’s ends, and a preference structure exhibiting a certain consistency of choice.
As for collective action, it is a mistake to assume that rational individuals sharing an interest in a collective outcome can normally be expected to act so as to produce that outcome. The problem is that there is no clear connection between the contribution of the individual member on the one hand and the strength of the larger group and the provisions of the shared collective benefits on the other. The rational self-interest member has no reason to incur the costs of contributing the group dues, therefore the less active involvement in the organization (Amadae, 2016).
Neoliberal Economic Consumption Policy
It is fully recognized that individuals are at the same time constrained by, and co-creators of , societal infrastructure, and that social institutions are reproduced through the daily actions of individuals. The conventional microeconomic view of consumption is derived in a rather circular way from assumptions about individual behavior. In neoclassical approach, all individuals are rational utility maximizers, that is to say they calculate and follow the course of economic action which brings them the most utility that they can afford.
Individuals consume goods and services in free markets with perfect competition, and it is assumed that this behavior reveals inherent preferences. In addition, this behavior illustrates utility maximization, and so consumption acts as an analogue for human happiness and well-being. The theory does not question how the preferences are made, or how the decisions are motivated, however, the theory makes inferences of value based on the human economic behavior (Amadae, 2016).
According to orthodox views, individuals are assumed to be rational utility maximizers who for most purposes are capable of overcoming problems of limited information through private ordering of different kinds. Social and legal norms are seem as functionally important to deal with particular forms of market failures, which are triggered by the idea of transaction cost. Legal activity plays a significant role in the rational economic activity, and some economists tried to explain its interdependence (Amadae, 2016).
Individuals, while still acting according to self-interest, are faced with a complex external environment about which they necessarily have limited information. Under these circumstances, individual action, including economic behaviors, presupposes the existence of a body of social and legal norms, which serve to coordinate the expectations of individual agents (McKenzie, 2010).
The market order rests on rules of a certain kind, which is associated with the private law. Private law and the market order are mutually supportive elements of a “spontaneous order”, which is both the foundation of a society’s well being and also the necessary condition for the freedom of its individual members.
Utilitarian View of Economic Analysis
For the purposes of economic theory, each individual is supplied with a single scale of preferences covering all objects of desire. The economic problem confronting each individual in how to manage the limited resources in choice between alternatives according to their scale of preferences. Choice is not always deliberate and not always rational, however, the principle of price is always active.
Wicksteed is critical of the idea of economic individual acting from a specific economic motive, Economics is not based on the assumption of a specific motive at all, but on a specific, impersonal, economic relation called “non-tuism”. For the purposes of economic behavior analysis, there is no need to presume that individuals are self-interested. It depends and they may act from altruism or benevolence, which is unpredictable (McKenzie, 2010).
The only presumption that Wicksteed is making is that individuals are not altruistic or benevolent towards parties to exchange, even though they try to strike the best bargain they can within their economic transaction. Economic relations are usually fixed in social relations of various sorts, however, the assumption of isolated economic relations for the purposes o economic science has a place to exist (McKenzie, 2010).
Alfred Marshall in his turn, believed that much of ordinary life is governed by habit and custom. In addition, he also suggested that most customs have been adopted and survived because they are rational or functional. Therefore, the theory of rational choice is of wider scope in modern than traditional society (Marshall, 2013).
One of his main assumptions is that economic agents, which are individuals, will try “to obtain better results with a given expenditure, or equal results with a lesser expenditure” (Marshall, 2013). In other words, he suggests that individuals are maximizers, even though everything might be considered as relative.
The utilitarian model of consumption assumes that decision making is a linear cognitive process, that is an internal calculation of all available information to decide the course of action which will deliver the greatest utility. This makes the efforts to promote sustainable consumption based on this models tends to depend on the initiatives to correct market failures and ensure that individuals have greater information to ratify their consumer independence (Marshall, 2013).
As an example, some consumer initiatives designed to promote pro-environmental behavior, hoping that this information will influence the particular behavior, like wasting energy or consuming patterns, like buying less plastics. Such campaigns tend to make the logical changes in behavior, particularly where there are clear financial incentives for making certain changes. This information strongly impacts individuals’ economic behavior, but not making them less rational or utility maximizers. It’s just that the logical understanding of maximizing utility changes based on the new information that has been taken into consideration (Edwards, Holland, & Franklin, 2012).
Modern Approach to the Economic behaviors
There is a number of modern economists and sociologists who try to oppose the classical economical approaches to the economic behavior. They propose that the behavior or real modern people differs from the economic behavior the classical economic theory expects them to have (Critique #2).
The first reason why modern individuals cannot be considered as rational utility maximizers is the bounded rationality. They refer to this term, which has been initially introduced by Herbert Simon, as to the essential fact that the human cognitive abilities are not unlimited. The studies refer to the limited computational skills and imperfect memory. Like people would make a list in order to not forget what to buy, making the decision making choice not cognitive. By limiting costs and setting up the spending budgets, people respond rationally to their own cognitive limitations. However, using these modern methods that organize human lives, it is possible to assume that human economic behavior differs from the one, predicted by the standard economic models (Hoyer, 2017).
A second respect that initiates the idea that individuals are not rational utility maximizers is the bounded willpower. This term refers to the truth that human beings often take actions and make decisions that they know will be in conflict with their long-term interests. Like in regards the cigarette consumption, most smokers would prefer not to smoke and still they spend too much money on cigarettes. Some smokers would pay money for the programs that would help them quit.
Another examples of the bounded will power may be the sales. Most consumers know that buying Christmas presents before Thanksgiving Day would not give them any discount, so they willingly wait until the sales to buy all Christmas presents. This works with shopping too, as most consumers realize that most stores initiate after Christmas sales, so shopping before that sales time is irrational. This makes the demand for and supply of law may reflect people's understanding of their will power, which they bound in order to save more money. The traditional economic theory does not reflect the aspect of seasoning, that when the prices are regular the consumer behavior may be less active than during the sales time(Critique #2).
The third truth about individuals not being rational utility maximizers is the bounded self-interest. Self-interest is bounded in a broader way than simply the economics presumptions. In many circumstances, people regard the way they are being treated. Every consumer wants to be treated fairly and treat others fairly if those are themselves behaving fairly. Therefore, self-interest is even more bound than the customs and traditions presented by neoclassical theory (Critique #2).
Of course all these listed above truths may be regarded as already rational cognitive choice made by individuals to find the best maximum utility for their own interests. However, self-interest, personal values and a variety of a choice makes the assumption that the “preference” oversimplifies the ground of utility, by failing to differ understandings of desire, emotion, action and intention.
Decision making and Judging
Individuals are assumed to be the best judge for their own welfare, often referred to as consumer independence. Consumer independence is a normative standard against which the performance of markets can be judged. It is a standard that implies that, in order to improve the performance of markets, production has to focus on and respond to the consumer demands and preferences. The market rules should guarantee that consumer preferences are the ultimate control of the process of the production.
Consumers, however, do not always act rationally. Human rationality is bound as a result of human individuals’ limited capacity to acquire and process information. Decision-makers may fail all the time to deal with information even in situations where the market does not have difficulty in producing the adequate amount of information.
Conclusion
There are different approaches that discuss whether or not individuals can be regarded as rational utility consumers. Different economic theories approaches this question by defying self-interest, will power and rationality to be the driven aspect in consumer decision making process. Even though many have agreed whether all these aspects are unbound or bound, whether or not an individual has to take a list to be more rations, which contradicts the cognitive approach to the questions, human beings are not rational utility maximizers.
There is a number of outside triggers that would make an individual to buy more than he needs or things that are not rationally best to be purchased. Things like market trends or fashion standards make a person to buy things that are considered more popular. Sales periods will make people safe money before hand to increase their consumer ability later, when the prices are cheaper. This makes the willpower to be bounded, as they money should be saved before hand and with a certain purpose to spend them later, unlike the traditional economic theory that claims that willpower is unbound. The same case is with cigarettes, a person who smokes will spend money on treating his dependency, rather than buying cigarettes for the rest of his life.
Consumer behavior is seriously influenced by social aspects, including budget, trends, social status, gender, sex and even occupation. A consumer, who experiences difficulties in terms of career advancement or status level, may compensate by purchasing status symbols, such as a nice and expensive car or nice clothes, to help to restore lost self-esteem (Hoyer, 2017).
Moreover, utility discussed by neoclassical theory is considered to be a single item varying only in quantity. With the variety of options today, free market and healthy competition, utility simply cannot be described as a single item, as every market competitor will try to provide advantages and modifications of the utility that will attract more and more customer. By modifying utilities under the consumers’ needs and preferences makes the market to be competitive and decision making tightly bound to the self-interest.
References
Amadae, S. M. (2016). Prisoners of reason: game theory and neoliberal political economy. New York, NY: Cambridge University Press.
Critique #2: People are not the rational maximizers of individual preferences that economic analysts assume them to be. Retrieved from of Law and Economics
Edwards, R., Holland, J., & Franklin, J. (2012). Assessing Social Capital: Concept, Policy and Practice. Cambridge Scholars Publishing.
Hoyer, D. (2017). Consumer Behavior. Cengage Learning.
Marshall, A. (2013). Principles of Economics. Springer.
McKenzie, R. B. (2010). Predictably rational?: in search of defenses for rational behavior in economics. Heidelberg: Springer.
Nechyba, T. J. (2017). Microeconomics: an intuitive approach with calculus. Boston, MA: CENGAGE Learning.