Economics Why Do Consumers Make Irrational, Decisions?

Economics

Why Do Consumers Make Irrational, Decisions?

In economics there is usually the underlying assumption that people who make choices will act in a rational manner, weighing up the costs and the benefits and determining a course of action dependent which choice provides them with the greatest benefit. The assumption may appeal to logic, and is seen in rational choice theory, but the reality is many consumers will not act in a rational manner, making choices that result disadvantages or costs rather than benefits. There are a number of influences which may explain how and why consumers do not always make the rational or optimal choices in economic terms.

One of the key aspects of rational choice theory, which dictates individuals will make rational choices are the underlying assumption that individuals making the choices will be in possession of perfect information regarding the choices and the potential outcomes, and that the decision maker will have the cognitive ability to make the rational choice. It is these underlying assumptions which are at the heart of apparent irrational decision making.

The first potential cause of irrational decision making may be the lack of full pr perfect information, leading to a position where there is an asymmetry of information. This is often over looked, but it is fairly common in the consumer markets, as it is very difficult to get full or perfect information about any decision and all the outcomes. One of the reasons firm will spend a great deal of money on branding it so increase the perception of brand knowledge and reduce the potential for consumers to look at competing products; this action reduces the search for accurate information and a choice is made based on asymmetric data. For example, if food manufacturer markets a product under a brand name, and also packages the same product under a private label, it is likely they will restrict the knowledge, and consumers will buy the more expensive branded packaging believing it to be better.

Bounded rationality can also be considered in the context of irrational decision making. The idea is that in any given scenario it is unlikely that all of the information required for full or perfect information will be available, so it is hypothesized that there will be a desire by individuals to make an optimal decision based only on limited information that is held. For example, when searching for an insurance policy there are many potential providers, consumers may maximize the information they collect before making a purchase by using a broker or an aggregating internet site, where numerous quotes can be obtained tumultuously, but it is not feasible that they will collect all the data, so the decision is likely to be less than perfect due to the limitations on the information collection and processing.

In addition to the practical aspects there are also the psychological aspects of decision making, and the limitations of personal cogitative abilities, which are impacted by mental constraints (which may also be seen as a form of bounded rationality). In a well-known experiment Kahneman and Tversky undertook an experiment in which they offered subjects two options, one option was a sure thing, the second was a gamble for a larger amount, but with very high odds of paying off. Most subjects preferred the 'sure thing' and avoided the risk, even though the risk was very minimal; demonstrating the way mental constraints will impact on decision making.