Rational Choice and Consumer Behaviour

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UniversitateaTransilvania

Din Braşov Facultatea de Stiinte Economice si Administrarea

Afacerilor

Specializarea: Business Administration

Rational Choice and Consumer Behaviour


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Table of contents

I.Utility and the rational consumer ..................................................................1I.1. O !ectives" alternatives and constraints.......................................................1

I.#. $%e principle of diminis%in& mar&inal utilit'.................................................#

I.( .Diminis%in& mar&inal utilit' and t%e consumer c%oice..................................#

II. Substitution and income efects ..................................................................(

III. Consumer surplus ......................................................................................... (

III.1.)easurin& t%e surplus..................................................................................*III.#.Importance of consumer+s surplus............................................................... ,

IV. Excess burden o taxation ...........................................................................,

V.Concluding emar!s .......................................................................................-

VI. Bibliography ....................................................................................................


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Rational Choice and Consumer Behaviour

/ational c%oice t%eor' : is a frame0or for understandin& andoften formall' modelin& social and economic e%avior. It is t%e main

t%eoretical paradi&m in t%e currentl'2dominant sc%ool of microeconomics .

/ationalit' 3%ere e4uated 0it% 50antin& more rat%er t%an less of a &ood56

is 0idel' used as an assumption of t%e e%avior of individuals in

microeconomic models and anal'sis and appears in almost all economics

te7t oo treatments of %uman decision2ma in&.

Because rational choice theory lacks understanding of consumer motivation, some

economists restrict its use to understanding business behavior where goals are usually very

clear. Competition in the market encourages businesses to maximize profits (in order to

survive). Because that goal is significantly less vacuous than maximizing utility and the

like, rational choice theory is apt.

I. Utility and the rational consumer!hy people consume goods and services" Because consumption of goods and services is

a source of pleasure and satisfaction. #conomists have their own term for this$ %he use or

consumption of goods and services gives people utility.

• &tility $%he pleasure, satisfaction, or need fulfilment that people get from theconsumption of goods and services.

I.1. Objectives, alternatives and constraints• 'ational choice$ urposeful choice directed systematically toward the achievement of

ob ectives given the alternatives and constraints of the situation.

1.

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I.2. The principle of diminishing marginal utilit • *arginal utility $%he amount of added utility gained from a one+unit increase in

consumption of a good, other things being e ual.• rinciple of diminishing marginal utility$ %he principle that the greater the

consumption of some good, the smaller the increase in utility from a one+unit increase

in consumption of that good.

Figure 1.Diminishing Marginal Utility

-s the rate at which a person consumes good increases, the utility gained from one additional

unit decreases. %his graph shows hypothetical utility data for the consumption of Coca Cola

by a certain consumer. %he numbers are only illustrative. n practice, utility is a sub ectiveconcept and cannot be measured.

I.! . "iminishing marginal utilit and the consumerchoice

• Consumer e uilibrium : - state of affairs in which a consumer cannot

increase the total utility gained from a given budget by spending less on one good and

more on another .


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• /rom consumer e uilibrium to the law of demand

II. Substitution and income efects• 0ubstitution effect $ %he part of the increase in uantity demanded of a good whose

price has fallen that is caused by a substitution of the good that is now relatively

cheaper for others that are now relatively more costly.• ncome effect $ %he part of the increase in uantity demanded of a good whose price

has fallen that is caused by the increase in real income resulting from the price change.

III. Consumer surplus1ow much will consumers be willing to pay for an additional unit of a good

given the uantity they already have" n this note we look at the importance of willingness to

pay for different goods and services.!hen there is a difference between the price that you

actually pay in the market and the price or value that you place on the product ,then the

concept of consumer surplus becoms a useful one to look at.

Consumer surplus is a measure of the welfare that people gain from the consumption of goods

and services,or a measure of the benefits they derive from the exchange of goods.


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DEMAND CURVE AS WILLIN NESS !" #A$

%he height of a demand curve shows the maximum that this consumer would be willing to

pay for an additional unit of a good. /or example, he2she would be willing to pay up to '34

56,777 for first yoghurt each month, but only '34 58,777 for a seventh. %he maximum

he2she would willingly pay for each unit is shown by a vertical bar. n this case, the market

price is '34 57,777. %hus he2she buys 57 cans of yoghurt a month, paying a total of '34

577,777. %he difference between what he2she actually pays at the market price and the

maximum she would have been willing to pay, shown by the shaded area, is called consumer

surplus.


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8.

III.1. #easuring the surplusConsumer surplus$ t is the difference between the maximum that a consumer will be willing

to pay for a unit of a good and the amount that he or she actually pays.

roducer surplus $ %he difference between what producers receive for a unit of a good and the

minimum they would be willing to accept.

AINS FR"M !RADE

%his graph shows that both consumer and producers gain from trade in free markets. 1ere the

e uilibrium market price is '34 97,777 per unit. %he demand curve shows the maximum that

consumers would willingly pay for each unit. Consumers: gain from trade takes the form of

consumer surplus, shown by the area between the demand curve and the market price. %he

supply curve shows the minimum that the producers would willingly accept rather than put

their resources to work elsewhere. roducers earn a surplus e ual to the difference between

what they actually receive at market price and the minimum they would have been willing to

accept. %he area between the supply curve and the market price shows this producer surplus.


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%otal gains from trade are thus the entire area between the supply curve and the demand curve

up to the e uilibrium point.

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III.2. Importance of consumer$s surplus

n public finance is very useful to the /inance *inister in imposing taxes and fixing the

rates.1e will impose more taxes on commodities in which consumer:s surplus is more.

• %o the businessman and monopolistic as they can increase the price of the

commodities in which there is large consumer:s surplus.

• Comparing advantages of different places.

• *easuring benefits from international trade.

I9. E7cess urden of ta7ation

n economics , the excess burden of taxation , is one of the economic losses that society

suffers as the result of a tax. #conomic theory posits that distortions changes the amount and

type of economic behavior from that which would occur in a free market without the tax.

#xcess burdens can be measured using the average cost of funds or the marginal cost of funds

(*C/). %he cost of a distortion is usually measured as the amount that would have to be paid

to the people affected by its supply, the greater the excess burden. %he second is the tax rate$

as a general rule, the excess burden of a tax increases with the s uare of the tax rate.

%he average cost of funds is the total cost of distortions divided by the total revenue

collected by a government. n contrast, the marginal cost of funds (*C/) is the size of the

distortion that accompanied the last unit of revenue raised. n most cases, the *C/ increasesas the amount of tax collected increases.

%he total economic burden of a tax includes both payments that taxpayers make to the

government and any lost economic value from inefficient activities undertaken in reaction to

taxes. %he excess burden of taxation is commonly measured by the area of the associated

;1arberger triangle< (1ines, 5666). %he base of the 1arberger triangle is the amount by

which economic behavior changes as a result of price distortions introduced by the tax, and

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the height of the 1arberger triangle is the magnitude of the tax burden per unit of economic

activity.

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V. Concluding emar!s

n this paper have tried to give the reader a sense of how rational choice theory

works.

'ational Choice %heory is an approach used by social scientists to understand human

behavior. %he approach has long been the dominant paradigm in economics, but in recent

decades it has become more widely used in other disciplines such as 0ociology, olitical

0cience, and -nthropology.

%his theory generally begins with consideration of the choice behavior of one or more

individual decision+making units = which in basic economics are most often consumers and2or

firms. %he rational choice theorist often presumes that the individual decision+making unit in

uestion is ;typical< or ;representative< of some larger group such as buyers or sellers in a

particular market. 3nce individual behavior is established, the analysis generally moves on to

examine how individual choices interact to produce outcomes.

%he analysis of firm behavior has many similarities with the analysis of consumer

behavior. /irms are generally assumed to make choices with the idea of maximizing profitsor the market value of the firm (as reflected in the firm:s stock price if it is a corporation).

'ational choice theory is sub ect to a number of criticisms, but that is to be expected.

!e are not likely to attain complete knowledge about anything, especially social phenomena

any time soon.


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-.

VI. Bibliography

%&&'s:

5. >'#>3'? @. *-@A !

%he rinciples of #conomics, second edition, 1arcourt College ublishers, @ew ?ork, 9775

9. '3B#'% 1. /'-@A and B#@ 0. B#'@-@A#

rinciples of #conomics, *c>raw 1ill, @ew ?ork, 97758. # ! @ >. 34-@ and - 4 @ 0#?

#conomics, fifth edition, %he ryden ress, @ew ?ork, 56DD,

E. epartment of #conomics and #conomic olicy, -#0 #conomics, fifth edition, #ditura

#conomica, Bucharest, 9778

Internet:

http$22www.bus.umich.edu2otpr2! 977F+5.pdf

http$22en.wikipedia.org2wiki2#xcessGburdenGofGtaxation

http$22en.wikipedia.org2wiki2'ationalGchoiceGtheory

http://www.bus.umich.edu/otpr/WP2007-1.pdfhttp://en.wikipedia.org/wiki/Excess_burden_of_taxationhttp://en.wikipedia.org/wiki/Rational_choice_theoryhttp://www.bus.umich.edu/otpr/WP2007-1.pdfhttp://en.wikipedia.org/wiki/Excess_burden_of_taxationhttp://en.wikipedia.org/wiki/Rational_choice_theory


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Rational Choice and Consumer Behaviour

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