Rationality of an Irrational Consumer

 

Rationality of an Irrational Consumer

With rapid globalization and technological advancement in recent years, consumers have become lazy and more occupied. 

Does this affect consumer rationality?

The mainstream field of economics emanated and evolved rapidly when man realized there is scarcity of resources. And that’s why the archetypal economic theory of consumer says that ‘people should relish choices and make a rational decision out of their constrained budget and preferences they hold’. But sometimes making a rational choice could be exhausting such that anyone forced to make a number of decisions in a row is likely to appear as lazy and having too many choices can leave a consumer ending without a rational conclusion. That’s why ‘rationality’ of a consumer is often questioned in contemporary economics.

Having choices or alternatives is good. It makes the market more competitive and paves the way for gains from trade. That's the view of neoclassical consumer theory. But it turns out that people don't really like making decisions. Consumers have habits and like thinking automatically. This automatic decision-making instinct is often ascribed to two irrational behavioral traits of a consumer – laziness and occupancy.

A consumer is an indolent as well as a busy being. The two might sound contradictory, isn’t it? However, being indolent here is referring to an ‘effort-saving’ consumer where he/she tries to avoid putting in effort for less productive activities and being busy means a ‘time-saving’ consumer. Because both ‘effort’ and ‘time’ have some opportunity costs involved in the real world.

Neo-Keynesian economists when deriving the formula for calculating demand for money have already highlighted the ‘cost of individual’s time’, which plays a major role in determining the demand for money (specifically M1). The ‘cost of time’, according to them, is the income lost by the consumer in the time he spent to make a visit to a bank to withdraw his own funds. Similarly, ‘effort’ has some cost involved too, especially when the effort is made in less productive activities and results in reduced efficiency for other productive jobs.

Consumers, instead of reacting in a rational manner often tend to get aligned with these two costs while making a decision.

Are decisions based on these costs rational?

Absolutely yes, if the time or effort saved are utilized in a rational manner.

The rapid expansion and huge success of Swiggy and Zomato in India are largely dependent on this concept. 

Above is the graph, explaining the rationality behind such irrational behavior of a rational consumer. Point ‘A’ is the equilibrium point where the consumer’s preference is maximized using the classic approach of determining consumer equilibrium at the point where the budget line is tangent to the indifference curve, assuming prices of commodities X and Y and budget to be constant. Let’s say ‘AB’ is the cost incurred by the consumer for saving time or effort. This could be the extra cost paid by the consumer out of his/her constrained budget to reduce effort or time to acquire the equilibrium bundle. For simplicity, we are assuming this cost to be constant here. Due to this extra cost, the budget of a consumer reduces and the budget line now shifts to the left and as a result consumer gets lesser quantity of both the goods.

The rationality behind this behavior is that the consumers get higher returns by utilizing the time or effort they save by not making a typical rational choice.

The time saved could be utilized in a more efficient and productive manner for activities which will fetch them higher returns (Figure-2). Effort they save could be used for maintaining their resting metabolism, which in turn can increase their efficiency for other productive activities which may fetch them higher income (Figure-3). “Consumers opt for a lower bundle when they intuitively calculate that this extra income earned will be more than the cost incurred (AB) to save time or effort.”

Below are the graphs depicting how time and effort saved by the consumer might result in higher returns than AB. 

The straight horizontal line in figure-2 is showing average work done in an hour and the straight vertical line in figure-3 is showing average working hours per day. Dotted lines show extra time or extra effort put in doing the job. The shaded regions above are the extra returns earned by saving time or effort and utilizing the same in the activity which fetches an individual a higher return. 

Though the consumer ranks lower satisfaction with the bundle at point ‘B’ (in Figure-1) but the additional income earned in the future compensate for that loss and ultimately the consumer ends up on a relatively higher indifference curve. By doing this, consumers tend to make intertemporal choices by sacrificing present consumption for future gains. “The time or effort saved may not necessarily be utilized for activities resulting in monetary gains but can also be put in recreational activities which fetches an individual higher satisfaction (than the satisfaction sacrificed).”

It is to note that these graphs are constructed for decisions of similar category and if the consumer predicts the cost incurred (or satisfaction loss) to be too high to recover it in future then he will opt for spending that extra time or effort to make a typical rational choice (point A).

Humans are social animals and not typical economic machines. Costs and benefits behind every decision made are assessed by them with the possible returns in the future.  And that is why being ‘indolent and busy’ has become the usual tendency of a rational consumer.

Author: Gautam Sodani