Edexcel A-Level Economics · Revision notes

1.2.10 Alternative views of consumer behaviour

Traditional economic theory assumes consumers are rational: they weigh up costs and benefits and choose whatever maximises their utility. Behavioural economics questions that assumption. It draws on psychology to explain why real people often make choices the rational model would not predict. This topic covers three reasons.

The rational model, and why it is challenged

The rational consumer described in 1.2.1 Rational decision making has clear preferences, full information and the ability to compare every option accurately. Behavioural economists argue that real consumers fall short on all three. They are influenced by other people, they repeat past choices without reconsidering them, and they find complex calculations hard.

Watch out: None of this means people are foolish. Often these shortcuts are sensible ways of coping with limited time and information. But they mean consumers do not always maximise their own utility, and markets may not allocate resources as efficiently as the rational model suggests.

The influence of other people's behaviour

Consumers' choices are shaped by what others around them do.

• Herd behaviour. People copy the choices of the majority, assuming that if many others are buying something, it must be good. Queues outside a restaurant attract more customers; a product with thousands of reviews looks safer than one with few.
• Social norms. People follow unwritten rules about what is normal or acceptable in their group. Whether someone recycles, smokes or drinks heavily is heavily influenced by what their friends and family do.
• Status and fashion. Some goods are bought partly to signal status or to fit in, so demand depends on who else owns them, not just on the good itself.

This matters because it can push consumption well above or below the level an individual would choose on their own. Herding helps explain sudden surges in demand for particular products, and speculative bubbles in assets such as housing, where buyers pile in because prices are rising.

The importance of habitual behaviour

Many purchases are made out of habit rather than as a fresh decision each time.

• Consumers buy the same brands week after week, even when a better or cheaper option appears.
• Defaults are powerful. People tend to stick with whatever option is set for them, such as an existing energy tariff, a phone contract that rolls over, or a pension scheme they are automatically enrolled in.
• Habits can be addictive. With goods such as cigarettes, alcohol and gambling, past consumption raises the desire for future consumption, so demand becomes very price inelastic.

Habit helps explain why many consumers stay on poor-value tariffs rather than switching, and why demand for some goods responds slowly to price changes. A rational consumer would review each purchase; a habitual one does not.

Consumer weakness at computation

Rational choice assumes consumers can work out the costs and benefits of every option. In practice, many decisions are too complex.

• Bounded rationality. People are rational within limits. With limited time, information and mental capacity, they make choices that are good enough rather than the best possible.
• Rules of thumb. Instead of calculating, consumers rely on simple shortcuts, such as buying the mid-priced option or assuming a more expensive product is better quality.
• Difficulty with numbers. Consumers struggle to compare interest rates, mobile tariffs or insurance policies with many different terms. They may underestimate the long-run cost of borrowing or overvalue an offer framed as "buy one, get one free".
• Short-termism. People tend to give too much weight to costs and benefits now and too little to those in the future, so they under-save for retirement and over-consume goods with long-term harms.

Firms can take advantage of these weaknesses, for example through complicated pricing that makes comparison hard, or introductory offers that rely on consumers not switching later.

How far does this undermine the rational model?

There are good reasons to keep using the rational model:

• It still predicts behaviour well in many markets, especially for routine purchases where consumers have experience and the stakes are clear.
• It provides a simple, testable benchmark against which irrational behaviour can be identified.
• Some apparently irrational behaviour is rational once the cost of gathering information and thinking is taken into account.

But behavioural economics has real policy implications. If consumers systematically make choices against their own interests, there is a case for government to change the way choices are presented, for example by changing defaults, requiring clearer information, or using social norms in public messages. These ideas link to information failure and government intervention later in the course.

Key terms

Common mistakes

• Calling irrational behaviour stupid. The point is that consumers depart from utility maximisation in predictable ways, often for understandable reasons.
• Listing examples without the mechanism. Each example needs to show why the choice differs from what a rational consumer would make.
• Treating the three reasons as the same thing. Influence of others, habit and computation are different causes and should be explained separately.
• Concluding that the rational model is useless. It remains a useful starting point; behavioural economics refines it rather than replacing it.

How this has been examined

In the Edexcel papers indexed on this site, this topic has appeared as:

• 10-mark "Assess" data response — asked twice across 2 series (2019 to 2023)

Where this goes next

The model being challenged is set out in 1.2.1 Rational decision making, and the demand theory built on it in 1.2.2 Demand. Poor information as a cause of market failure is covered in 1.3.4 Information gaps, and government responses, including the provision of information, in 1.4.1 Government intervention in markets.