Explain how rules of thumb and irrationality can affect consumers' demand for goods and services
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Course
Rule of thumb and irrationality
Institution
AQA
An essay written by myself in the first year of the Economics course. The exam board is AQA. I achieved a grade C which is great as I started the year achieving D's and E's. I personally think this is a great essay covering a very important module within Economics. Hope it helps!
Explain how rules of thumb and irrationality can affect consumers' demand for goods
and services
In this essay, I will be discussing how cognitive biases (including rules of thumb) and irrationality
can affect consumers' demand for goods and services. Utility means satisfaction. Utility can be
broken down into “Marginal utility” and “Total utility.” Marginal utility is the additional utility from
consuming an extra unit. Total utility is the total utility from consuming all units in total.
Most economic models assume that consumers will maximise utility (i.e. satisfaction). They also
assume that consumers behave in a way that is perfectly rational. However, in real life this is not
the case. Consumers often behave irrationally and firstly, one reason is “Bounded Rationality.”
Bounded Rationality is when our brain power is limited, or “Bounded.” As a result, we often make
irrational choices which do not maximise our utility. For example, if we are presented with two
mobile phone deals and there is a time limit, we may choose a deal only to later realise the deal
we have chosen does not maximise our utility. Since they will be in timed conditions, consumers
will not have the ability to know which deal is better for them and may hastily choose a deal
which they perceive to be better; ie. Which deal is cheaper or will be beneficial for them. This
shows how consumers will not have the mental capacity to choose a good which will maximise
their utility as they may be faced in conditions which will make this decision difficult for them; for
example, if both phone deals look equally as good and there is a time limit.
Another reason as to why irrationality can affect consumers’ demand for goods and services can
be explained through, “Bounded self-control.” Bounded self-control refers to our limited ability to
control ourselves which can explain why we make irrational decisions (decisions which don’t
maximise our utility.) For example, a smoking addict may not be able to control themselves and
due to their habit, they may regularly smoke; despite many attempts to stop. We could say from
the example above, the smokers “Bounded self-control” drove them to act irrationally and
therefore not maximise our utility. Therefore, we can say a consumer - such as a smoking addict
- will still have a very high demand for goods - such as cigarettes - even though they are
receiving a temporary short-term marginal utility. We can say that they still buy cigarettes,
knowing the effects of smoking and this means they are acting; “irrationally.”
Irrational behaviour can also come under, “Cognitive biases.” These are predictable mental
errors when decision-making. One cognitive bias is called, “Rule of thumb.” A rule of thumb
occurs when consumers use mental shortcuts to make decisions quickly. It does mean that a
consumer will not use all available information when making the decision and so it may well be
an irrational decision. For example, if we are purchasing a good online, a rule of thumb would be
to buy the good with the highest reviews, instead of researching and finding the good that best
meets your requirements. Although this is good as this rule of thumb allows us to make decisions
quickly, it can also present a problem as there could be problems with the goods we have just
purchased. In this case, we won't be able to maximise our utility. Rule of thumb comes under,
“cognitive bias.” These can effectively lead to irrational decisions which do not maximise our
utility. Another cognitive bias is called, “Social norm.” Consumers are always influenced by what
other people think. This can lead to us making bad irrational decisions. For example, someone
can easily adopt a bad habit such as drinking as it may be a normalised thing to do by their
peers. They can pick up the bad habit of drinking as they were initially following the, “Social
norm.” We call this Herd behaviour, which is a type of cognitive bias which occurs when people
follow social norms too much. People follow the herd and do what everyone else does. If
someone is an alcoholic, this would increase their demand for goods - such as alcohol - as
drinking may be something normalised by the people around them. This may lead to them
drinking even more and in general purchasing more alcohol.
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