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Economics is a social science. The goal of social scientists is to understand human behavior. A fundamental question of social scientists is “why do we do what we do?” In an attempt to answer this fundamental question about human behavior, let’s first consider how social science disciplines explain what motivates consumer behavior.
Psychology is the study of individual behavior. Psychologists study how individuals relate to each other and how they relate to their environments. Through the lens of psychology, consumer behavior revolves around satisfying needs and wants in socially accepted ways.
Sociology is the study of social behavior. Sociologists study consumer behavior in the context of society and the influence of different groups within society. Through the lens of sociology, as members of groups, we adopt preferences and patterns of behavior based on our own experiences and through observation of others.
Political science is the study of politics and political institutions. Political scientists have an explanation for consumer behavior that revolves around political identity. Through the lens of political science, consumer behavior has a political context that aligns with political values and perceived characteristics of an individual’s political identity.
The explanations about consumer behavior from the perspectives of psychology, sociology, and political science provide insight about possible influences on behavior. However, they do not extend to the act of purchasing the product and how much of the product to purchase. As you have learned, economics is the study of choices, and of how the choices of individuals and groups impact society. In the context of economics, consumer behavior is explained by demand, which identifies a set of factors that affect both consumers’ willingness and ability to make actual purchases and specifies how much of the good or service the consumer will purchase.
Traditional economic thought is grounded in the humanities and developed out of the thinking of philosophers. In the late 19th century, economic theory began to diverge from classical theory.
Traditional economics models behavior assuming that people act rationally, which means that people take all available information and make consistent and informed decisions that are in their best interest. The explanations of consumer and producer behavior, which you are learning about in this course, employ the assumptions of rational choice theory. Rational choice theory states that individuals make decisions based on optimizing their own level of benefit or according to their own rational self-interests.
In the early 2000s, psychologist Daniel Kahneman and economist Vernon L. Smith were awarded the Nobel Memorial Prize in Economic Sciences for their work in integrating the insights of psychology into traditional economics. This newer field of economics has become established as behavioral economics. Behavioral economics relies on observation and integrates insights from the field of psychology, including the role of social influence on our decision-making process. Behavioral economics gathers evidence by actually observing people's behavior rather than using more general information to arrive at a specific conclusion. Traditional economics, on the other hand, relies on reasoning from certain laws or principles, which are assumed to be true, over the analysis of observable facts in the real world. Traditional economics involves inferring conclusions from more general information. This is known as deduction.
As you have learned, rational choice theory states that individuals make decisions based on optimizing their own level of benefit or according to their own rational self-interest. A rational individual is described as follows:
In traditional economic theory, a rational individual has preferences that are given and are logically consistent. Recall that being logically consistent means you, as a consumer, are able to order your preferences when given choices.
Suppose next week you have a day off. Given the three choices below, rank the items in order of most preferred to least preferred. How would you rank these given choices?
To be logically consistent means that if you preferred a trip to the mall to a trip to the museum (C to B), and you preferred a trip to the museum to a trip to the beach (B to A), then you logically preferred a trip to the mall to a trip to the beach (C to A).
We have concluded that consumers have well-defined preferences and those preferences should be logically consistent. What’s the problem with this critical assumption of traditional economics? From the perspective of behavioral economics, it is assumed that consumers don’t make their decisions in a vacuum. Individuals are presumed to be influenced by social context.
Is there a social context to our preferences? In traditional economics, preferences simply exist. In reality, however, we know that preferences are shaped by society: by what we see, learn, or do. What we like and what we don’t like is often dependent on what our friends and family like or don’t like. The world of advertising exerts pressure on consumers, creating “desire” when none may have existed, and making us more favorably inclined toward some brands of goods and services. Sociologists and political scientists recognize the role of social influence in shaping an individual.
Traditional theory assumes that a rational individual has perfect information concerning all possible choices and makes these decisions without cost. A costless decision implies that no time, energy, or resources are spent to make a decision. But do consumers have perfect information?
EXAMPLE
Suppose your niece’s birthday is coming up and you want to get her a gift. You’re thinking of buying her a special bicycle in her favorite color with a basket on the handlebars. But do you know what the bike might cost? Maybe you have a general idea. Do you know where you can purchase one? You could do a quick search on your phone or run to a couple of nearby stores. Having to expend extra time and effort to find the right bicycle strongly implies you lack perfect information.EXAMPLE
Stock traders are one group of people who attempt to profit from the purchase and sale of assets such as stock shares. Traders buy stocks they believe to be underpriced in hopes of reselling these same stocks later at a higher price. How is financial gain from buying and selling stocks even possible in a world of perfect information? If all traders had perfect information, then every asset would be correctly priced–neither underpriced or overpriced in the market. This would leave no “gain” to be earned. This confirms that perfect information doesn’t exist in the stock market.In traditional economics, individuals arrive at a choice only after processing all the available alternatives, calculating how satisfied each choice will make us, assigning utils to each choice, then picking the option that equates the margins. This is the process for making decisions, but it's an exhausting process to do constantly.
From the perspective of behavioral economics, if pay was sufficient to drive your employment decision, then you used a shortcut. In behavioral economics, shortcuts are recognized ways that individuals use to cope with the constant need to make decisions. These shortcuts, known as heuristics, are mental rules of thumb that allow us to skip the hard work that might be required for a decision. People use heuristics because obtaining information takes time, energy, and, sometimes, a monetary expenditure. Using a rule of thumb involves deciding on a strategy for selection, then choosing the first option that meets your selection criteria, even if better options may exist. Having too many choices can be just as bad as having too few–it can immobilize us.
In behavioral economics, choice overload is real. It recognizes that people can get overwhelmed when presented with too many choices. Choice overload can cause consumers to delay making a decision, or make a decision, and then regret it. Choice overload decreases satisfaction and lowers our confidence in our ability to make decisions. This is clearly the opposite of maximizing satisfaction!
The rational consumers of traditional economic theory with their perfect information and costless decisions certainly seem out of step with the real world. Yet from an economic point of view, someone who shops for groceries week after week has a great deal of practice with how to purchase the combination of goods that will provide that person with maximum utility, even if the shopper doesn’t think about decisions in terms of marginal utility per the price. When thinking about the economic actions of groups of people, firms, and society, traditional theory is reasonable, as a first approximation, for explaining the economic behavior of individuals. The added benefit of behavioral economics is the enrichment of our understanding of decision-making by integrating the insights of psychology into economics.
Traditional economic theory assumes that a rational individual makes decisions based on optimizing their own level of benefit or according to their own rational self-interest. In short, our concerns are about ourselves without regard for other people.
Behavioral economic theory assumes that the decisions of individuals may be influenced by factors that are not rational as defined by traditional economics. Have you ever purchased tickets to attend the latest movie with friends and found yourself losing interest 30 minutes into the movie? If so, what did you do? If you’re like most people, you didn’t want to disappoint your friends so you sat through the entire movie and rationalized, “Well, I’ve already spent the money.” A rational individual, on the other hand, would have simply got up and left the theater, knowing their time was better spent elsewhere.
Gifting, giving to support a cause, or dedicating personal time to a community project would seem to lie outside the framework of optimizing one’s own self-interest. Behavioral economists, though, see these actions in terms of how they maximize social well-being by strengthening social connections. Investing in the well-being of others creates value for the giver. Strong social connections make people happier and healthier.
Traditional economists don’t rule out altruism but stress self-interest as people’s primary motive. The assumption that individuals are purely self-interested is a simplification about human nature. Behavioral economists’ explanations combine economics with psychology to provide a richer description of how and why people behave as they do in the real world. The traditional assumptions about behavior are often relaxed in behavioral economics, for example, preferences are not fixed but shaped by society
The traditional economic models developed through deductive reasoning provide a starting point for logical and objective discussions about the economic behavior of individuals. This approach provides a singular description of the individual as a consumer. Consumers are rational with well-defined preferences and make well-informed, costless, self-interested decisions based on those preferences. They seek to equate their preferences with their budget constraints and maximize their satisfaction or happiness, given the limitations of their income.
To enrich our understanding of consumer behavior, we can turn to the behavioral economists who integrate the insights of psychology into economics by employing experiments and observing people's responses, while acknowledging that the state of people's minds or feelings can influence their decision-making behavior. The insights of behavioral economists enrich our understanding of economic behavior and sometimes those behaviors appear outwardly inconsistent, or irrational, relative to traditional explanations. Both traditional and behavioral explanations have value and a role in understanding consumer behavior.
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REFERENCES
Altschuler , G. C. (2020, January 27). The Surprising Benefits of Social Connections. Psychology Today. Retrieved May 31, 2022, from www.psychologytoday.com/us/blog/is-america/202001/the-surprising-benefits-social-connections
Deloitte. (2019, May 29). The consumer is changing, but perhaps not how you think. Deloitte Insights. Retrieved May 31, 2022, from www2.deloitte.com/us/en/insights/industry/retail-distribution/the-consumer-is-changing.html
