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The Underlying Economic Assumptions

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6 views3 pages

The Underlying Economic Assumptions

Uploaded by

Johanna Urwin
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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The Underlying Economic Assumptions (Edexcel IGCSE

Economics)
Rational Decision Making
When analysing markets, a range of assumptions are made about
the rationality of economic agents involved in the transactions.
In classical economic theory, the word 'rational' means that economic
agents are able to consider the outcome of their choices and recognise
the net benefits of each one. Rational agents will select the choice which
presents the highest benefits.
 Consumers are assumed to act rationally. They do this
by maximising their utility
 Producers are assumed to act rationally. They do this by selling
goods and services in a way that maximises their profits
 Workers are assumed to act rationally. They do this by balancing
welfare at work with consideration of both pay and benefits
 Governments are assumed to act rationally. They do this by
placing the interests of the people they serve first in order to
maximise their welfare
In many ways, the assumption of rational decision making is flawed
For example, consumers are often more influenced by emotional
purchasing decisions than a rational computation of net benefits
Reasons why ASSUMPTION might be flawed
Consumers may not Maximise Their Utility
In classical economic theory, the word 'rational' means that economic
agents are able to consider the outcome of their choices and recognise
the net benefits of each one. Rational agents are incentivised to select
the choice which presents the highest benefits.
Consumers are assumed to act rationally. They do this by maximising
their utility
Producers are assumed to act rationally. They do this by selling goods
and services in a way that maximises their profits
However, consumers and producers do not always act rationally and may
make decisions that do not always aim to maximise benefits or profits
Reasons Consumers may not Always Maximise Their Utility

Reason Explanation
Measuring  The wider the range of choice, the harder it is for a
consumer to gather information
and compute which one offers the highest net
benefits
satisfaction  Consumers often lack the time or ability to consider
the relative prices of different products and sellers
will frequently make it difficult for them to do so

 Consumers make so many purchasing decisions


that they often rely on habits to speed up the
process
 Consumer inertia often develops as convenience is
prioritised
 Consumers make purchasing decisions that directly
Habits harm them and are usually addictive, for e.g.
alcohol
 Sellers recognise habitual patterns and exploit
them. For example, products placed at the
checkout till to benefit from impulse
purchasing (chewing gum)

 Peer pressure often prompts consumers to make


purchasing decisions that may go against
a computation of net benefits
 Producers influence consumers choices through
various forms of advertising, including lifestyle,
Social norms
celebrity endorsement and influencer culture
 Producers use advanced behavioural
psychology techniques to influence consumer
choices e.g. Neuro branding

Producers may not Maximise Their Profit

 The objectives of a firm are a reason for their existence or the


desired focus of their owners
o The main objective is profit maximisation
o However, firms can pursue other objectives that include
managerial objectives (growth of firm), customer care or
charitable activities

Reasons why Producers may not seek to Profit Maximise

Reason Explanation
 Managers may have a goal of growth which is
focused on increasing sales revenue or market
share
Influence of  Firms will also maximise revenue in order to
managers increase output and benefit from economies of
scale
 A growing firm is less likely to fail

 Some producers prioritise caring for their


customers over maximising profit
Customer  They may invest in customer service to
care improve brand loyalty, even if it involves additional
costs that could impact profitability

 More firms than ever have a charitable objective


 These typically include a focus on climate action
and addressing poverty or inequality

 They still require profit to survive, but will accept


Charitable
less than if they were profit maximising as long as
activities
they are meeting their social objective
 E.g Google has partnered with World Wildlife Fund
and the Jane Goodall Institute to
protect endangered species and habitats

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