The irrationality of the ‘rationality’ assumption

Historically, the term ‘rationality’ has been ascribed various meanings within the sphere of economics.  Typically, rationality has been expressed in terms of the idea that consumers attempt to maximise utility by arriving at an optimal decision in light of a complete set of information relating to the market in which they operate.

That is, the rational person of neoclassical economics opts for the decision that is subjectively best for that person in terms of a given utility function.^[1] Consequently, neoclassical reasoning relies heavily on artificial factual assumptions such as perfect information, rather than accepting the reality of limited information and cognitive capacity in making any given decision.^[2]

Artificially imposing these neoclassical assumptions on consumer decision making is far from reflective of the impulsive nature of consumer behaviour (indeed, if consumers were rational they would not respond to advertising targeting their emotions – more on this later,) and the dynamic environment in which they reside. The reality is, the economy exists in a perpetual state of flux and motion. The environment is constantly changing and evolving. Tastes and preferences rapidly shift. Information is limited. Cognitive capacity varies for each individual. Human choice is fluid, protean, and unpredictable. It cannot be conceptualised in terms of simplistic patterns.

Consumer decisions are limited in terms of both the availability of information and the multiplicity of environmental variables. Collectively, these limitations operate so as to restrict the the ability of consumers to make the optimal or utility maximising decision that neoclassical economies would suggest is possible.

The line of distinction between an optimal decision and more realistic decision can be conceived in terms of a game of chess. In theory, each player is conferred a large number of strategies and potential moves that they can make at each given turn. In reality, players do not consider every potential move available but rather explore a limited number of moves at each stage in the game. Players act on the basis of incomplete information, as they have neither the time, available information, nor the mechanical capacity to consider all the possible alternatives.^[3] The aim of each  choice is not to make an optimal decision in a vaccuum, but rather, obtain an advantage in the taking into account their previous position and their opponent’s last move. ^[4]

The chess analogy can easily be extrapolated so as to reflect consumer behaviour in an economic environment. Economics assumes consumers have complete preferences, that is, that they are able to rank and compare all possible market baskets that affect their decisions. This unbounded approach to rationality implies there are no limits to consumers and their choices in terms of the available information.

‘Rational’ consumers are able to mechanically process and decipher the abundant information available, and compartmentalise this knowledge into a objective relative ranking of their preferences of the market baskets from most preferred to least preferred. Yet, in reality, the consumer’s mind is highly impressionable, cognitively limited, easily manipulated by extraneous variables, and typically lacks all the information to make a utility maximising decision. The consumer is unlikely to make an optimal decision in light of the information available, but rather, makes a decision on the basis of incomplete information, therein obtaining a temporarily satisfactory as opposed to a permanently optimal result.

To illustrate these principles in practice, imagine a consumer in the market for smartphones. Say a consumer is debating which phone to purchase and is presented with a range of alternatives comprising the iPhone 5, and Samsung Galaxy S4 and the Motorola Droid Razr Maxx HD. In theory, if the consumer is conferred complete knowledge pertaining to the respective features of the three aforementioned phones, an impartial, objective analysis of these features may result in consumer A opting for either the iPhone, Samsung or the Motorola. Choosing a phone based on objective features such as battery life, screen size and camera quality (to name a few), and ordering the phones into an objective relative ranking on this basis, seems to be a logical extension of the utility maximising principle.

In reality however, consumers are regularly exposed to marketing campaigns attempting to differentiate the phones, as well as certain trends displayed by friends and family members who have opted for a certain brand of phone. Take the most common example, namely, the extensive marketing employed by the Apple brand. Through pervasive marketing, ‘Apple’ has been rendered synonymous with simplicity, elegance and modernity in the fabric of the consumer’s mind.

Carefully targeted advertising programs are utilised to convince consumers into artificially augmenting the perceived value of the Apple iPhone relative to its competitors. Even if consumers are aware of the objective differences between the three phones, the subjective value of the iPhone can be enhanced by advertising to the extent that many consumers would forgo the better camera of the Samsung or the longer battery life of the Motorola, so as to acquire the higher perceived value of the Apple brand instead. Consequently, irrespective of the fact that the iPhone may be relatively less effective in terms certain features compared to the Samsung or Motorola, if the consumer perceives the iPhone as superior, they will opt for higher priced Apple product.

Does a consumer really analyse all available and comparable phones on the market when they make a decision? Often, consumers purchase iPhones with minimal consideration of any viable alternatives – possibly because they had no inclination to consider these alternatives or possibly because they were convinced by marketing or popular trends into believing the iPhone was the best phone on the market. By failing to consider alternatives, consumers cannot rank the available phones on the market in order of most preferred to least preferred. By acting on imperfect and incomplete information, consumers do not possess the knowledge that enables them to make the optimal decision in light of all the potential alternatives. Accordingly, the consumer does not always make the optimal or utility maximising decision that the study of economics would lead one to believe is possible.