Tag Archives: Kevin U

Rational Economics: Think We Make Rational Decisions? Think Again

Why are some people willing to purchase designer purses, watches and shoes for thousands of dollars from names such as Louis Vuitton, Gucci and Rolex, when similar products that have the same functionality for fractions of the price are neglected? While many of us may think we make rational decisions as a consumer, it turns out, humans tend to make irrational decisions on a rather consistent basis.

Image result for fashion brand name vs regular

http://www.thebrandchecker.com/news

Before I explain why humans are not rational decision makers, we must first examine the definition of ‘rational decision making’. For a decision to be deemed as rational, all emotional contents from the decision making process must be removed and must solely be based on the facts presented.

“A rational behavior decision-making process is based on making choices that result in the most optimal level of benefit or utility for the individual. Most conventional economic theories are created and used under the assumption all individuals taking part in an action/activity are behaving rationally. Rational behavior does not necessarily always involve receiving the most monetary or material benefit because the satisfaction received could be purely emotional. “

-According to Investopedia

On the contrary, an irrational decision is one that lacks logical thinking. Irrational decisions are often based on emotions and personal bias. To be specific, as person’s memory can take presence over analysis or consideration.

https://www.ucl.ac.uk/media/library/decisionbrain

Image result for irrational decision making

In traditional economics, supply and demand models demonstrate how supply and demand relate to quantity and price. On the model, the vertical axis is the price and the horizontal axis is the quantity.  The supply and demand curves both intersect at a point which represents the equilibrium price and quantity.

Image result for supply and demand graph

Since we are talking about the rational decision making that consumers exhibit, it is necessary to note the factors which effect consumer demand – it is not necessary to discuss the factors which effect supply. The five determinants which effect demand are: buyer’s income, buyer’s preferences/consumer’s taste, buyer’s expectations, other prices and number of buyers.

We refer to a lack of goods, due to a low price as a shortage. In this case, consumer demand more than what suppliers will produce. The supplier will counter this by increasing the price, until the equilibrium price is attained. However, if there is an excess in goods, due to a price that is just too high, we refer to this as a surplus. In this scenario, the suppliers will produce more than customers demand. The supplier will then decrease prices until the equilibrium price is reached. Supply and demand directly impact the market, which is then reflected on the price of a particular good. However, as it turns out, due to the irrational behavior we exhibit, the price actually determines the market. This is studied in behavioral economics.

https://www.youtube.com/watch?v=ptluv3didYI

A common example which demonstrates our irrational behavioral decisions as consumers is the purchasing of iPhones. A rational person might reckon that consumers are willing to pay anywhere around $500 for a smartphone. However, Apple has found a genius way to overprice there iPhones to nearly double the willing consumer price and still get remarkable sales. You might be wondering how this is possible. Well, it is simple. There are people out there willing to overpay for these smartphones!

Image result for why do people pay for overpriced iphones

Therefore, as this applies to the food and drink, automotive and particularly fashion industry, we can conclude that people are willing to make decisions, beyond reason, to purchase goods and services that are simply not worth it. Everyday, we constantly go against our reasoning and logic for decisions based on emotion and memory. In doing so, as a consumer, we can be deemed as irrational.

http://www.investopedia.com/terms/r/rational-behavior.asp#ixzz4dKpQg0dZ https://pdfs.semanticscholar.org/ace5/115e38d84696f745cbaa9647dc17a77a9734.pdf

https://www.emptywheel.net/2015/07/20/mankiws-principles-of-economics-part-3-rational-people-think-at-the-margin/

http://www.ase.tufts.edu/gdae/Pubs/te/MIC/3e/MIC_3e_Ch7.pdf

http://economictimes.indiatimes.com/definition/rational-behaviour

https://www.behavioraleconomics.com/rationality-and-affective-biases-do-you-know-what-they-are/