Rational decision making and behavioural economics

The rational assumption

Standard economic theory assumes:

• Consumers aim to maximise utility (satisfaction) from their limited income: they weigh the benefit of each purchase against its price.
• Firms aim to maximise profit.

These assumptions make models simple and give clear predictions, such as downward-sloping demand curves.

Why consumers may not maximise utility

The specification lists these reasons:

• Consideration of the influence of other people's behaviour (herding): people copy others, for example buying shares because everyone else is, or choosing a busy restaurant.
• The importance of habitual behaviour: people repeat past choices without reconsidering, for example always buying the same brand.
• Inertia: people put off decisions or stick with the default, for example staying on an expensive energy tariff rather than switching.
• Poor computational skills (consumer weakness at computation): people struggle to work out the best choice, such as comparing interest rates, unit prices or the cost of a loan.
• The need to feel valued: purchases are made for status or to fit in, not for their underlying usefulness.
• Framing and bias: the way choices are presented changes decisions. '90% fat free' sounds better than '10% fat'; a crossed-out 'was $100, now $60' price makes $60 look cheap.

Why it matters

If people do not behave rationally, demand may not respond to price as models predict, and markets can produce poor outcomes (bubbles, under-saving for pensions). Governments use these insights, for example by making pension saving the default (using inertia) or requiring clear unit pricing (helping computation). These are sometimes called nudges.

Evaluate: firms may not maximise profit either. They may aim for growth, market share or ethical goals, and owners may lack the information to find the profit-maximising price.

Worked example

A government changes workplace pensions so workers are enrolled automatically unless they opt out. Explain, using behavioural economics, why more people save.

1. Rational theory: workers already weigh saving against spending, so the default should not matter.
2. Behavioural view: inertia means people stick with whatever option is set for them.
3. Before, joining needed action, so many never did; now staying in needs no action.

Answer: Inertia: people stay with the default, so automatic enrolment raises saving.

Check yourself

1. Many people buy a cryptocurrency mainly because their friends are buying it. This is an example of
   • inertia
   • framing
   • herding
   • utility maximisation
   Show answer

   herding. Copying the behaviour of others is herding.

2. A customer stays with an expensive mobile phone contract for years even though cheaper deals exist, because switching seems like effort. This is best explained by
   • inertia
   • the need to feel valued
   • herding
   • diminishing marginal utility
   Show answer

   inertia. Putting off a decision and sticking with the status quo is inertia.

3. A label reading '95% fat free' makes a product more popular than one reading '5% fat', although the products are identical. This shows
   • habitual behaviour
   • weak computation
   • framing
   • rational choice
   Show answer

   framing. The presentation, not the content, changes the decision.

4. Consumers take an expensive loan because they cannot work out the true total cost of repayments. This is
   • herding
   • poor computational skills
   • the need to feel valued
   • rational utility maximisation
   Show answer

   poor computational skills. Difficulty with calculations leads to poor choices.

5. Standard economic theory assumes that firms aim to
   • maximise utility
   • maximise market share at any cost
   • minimise output
   • maximise profit
   Show answer

   maximise profit. Consumers maximise utility; firms maximise profit.

6. Explain how the need to feel valued can lead a consumer not to maximise utility.
   Show answer

   The consumer may buy an expensive designer brand to gain status or fit in with others, paying more than the product's usefulness justifies, so the same income could have given more satisfaction if spent differently.. Status motive, then the effect on the use of limited income.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.