The Psychology of Decision Making

For decades, economics has functioned according to the theory of rational consumers; this means that they use all information provided to make a decision that not only maximizes their utility, but is carried out with the lowest opportunity cost, what one gives up to gain something else.

This theory leads to multiple assumptions, including: consumers face a known set of alternatives; these alternatives are complete, meaning one good is preferred over another, or they are indifferent to the consumer; and the consumer will select the most preferred alternative (Green 3). According to this definition, I have behaved irrationally. There are many instances where I have chosen an option because it is on sale, even if I do not actually value the product. This type of thinking completely disproves the assumptions that outline the economic definition of rational. Holistically, these assumptions are flawed and do not accurately reflect the actions of consumers.

There are countless factors that alter the choice of a consumer, the primary being an abundance of choice. When consumers are presented an assemblage of choices, they typically do not use all the information provided. This can result in an irrational outcome for many different reasons. When there is too much choice, people are more likely to use their past experiences to choose a product rather than looking at each option. Additionally, consumers are heavily influenced by other people. As Derek Thompson states, “We’re social animals. We let our friends and family and tribes do our thinking for us” (Thompson). Rather than consider the costs and benefits of a decision with regards to their own situation, consumers will choose the option that is preferred by their peers. Finally, decision making is physically exhausting, leading consumers to become lazy and uninformed. These factors are perpetuated by efforts of stores. After shopping I have decided to buy candy that was right next to the register even though I did not need it. My actions deviated from the assumptions of classical economics, and could be viewed as irrational.

It is important to remember that the definition of irrational discussed is strictly economic. Many choices may not seem irrational or illogical to a typical person, but when consumers are analyzed and modeled under strict stipulations, many actions are deemed as such.

The following example is often cited to prove the irrational tendencies of a consumer: “To prove his point, Gittins gave us the example of a radio that sells for $25 dollars in one shop but $20 in another several blocks away. Predictably we are told that most people will choose to save the $5 by walking to the other shop. However, when the same situation emerges regarding two televisions priced at $500 and $495 most people will choose to pay the $500” (Jackson).

Those who view this behavior as irrational claim that consumers value the five dollars relative to the price of the good rather than to the value of saving five dollars. To them, the opportunity cost of walking the extra blocks is the same in both examples.

Maybe this action is irrational. However, to claim that a consumer’s action is irrational simply because it does not conform to outdated definitions is unsubstantiated. First, economists claim that the five dollars should be valued the same in both situations. When analyzed, this can be readily disproven. In the radio example, there is a 25 percent different between both radios, but there is a 1 percent difference between the televisions (Jackson). If viewed in this way, the choice to forego the extra distance seems entirely logical.

Ultimately, the debate is a matter of values. For an economist to claim that a behavior is irrational is to impose their own values on a consumer’s choice. Every person is different and each takes into account different factors when making a decision. As Johannes Nider states, “The proper value of a thing (and it is values we are really talking about) depends on the way buyers or sellers may think about prices” (Jackson). A consumer is the deciding factor as to if a decision is made based on their own opportunity costs. I am the only person who is capable of making a decision based on my own situation. This choice cannot be made or analyzed by other people. The consumption of a good is a subjective process, one that cannot be forced to conform to classical economic theory. To attempt to generalize the actions of consumers based on disingenuous models is to fail to realize the essence of rational decision making altogether.

This does not mean that consumers never act irrationally. These values control how people act, and as consumers we must be aware of our habits. One example of these values in action is advertising. Companies advertise to spread awareness of their product. This industry demonstrates one way in which consumers can act irrationally. Advertisers can analyze patterns in consumer behavior and exploit them. Smoking has been proven to be detrimental to the human body. “The World Health Organization (WHO) estimates that, globally, smoking causes over US$500 billion in economic damage each year” (Ekpu). This does not include the health effects, such as heart disease, lung cancer, and bronchitis. This overarching evidence towards the negatives of cigarette smoking is contradicted by the fact that smoking is one of the most heavily advertised industries. This advertising has manipulated the tastes of citizens around the world. Cigarettes have a negative externality attached to them, meaning they affect a bystander in a negative way. Although the negative effects of smoking “far outweigh any benefits that might be accruable” (Ekpu), the decision to smoke is still made by millions worldwide. As consumers, we need to be aware of these types of choices because they impact everyone. This is a clear example of an irrational decision, and one where classical economics is not needed.

Although the classical economic definition of rational cannot be applied to all situations, consumers still behave irrationally. This behavior is the driving force behind the state of our economy and society. As consumers we must confront irrational decisions because of the unforeseen impact many of them have. By reducing the number of decisions that have a negative externality that are made, we can work towards a more healthy and socially beneficial world.