Consumer Behaviour

Rational choice theory. Assumes consumers:

• Have clear preferences.
• Have complete information about prices, qualities, alternatives.
• Choose the combination of goods that maximises utility (satisfaction) within their budget constraint.

Utility is a measure of satisfaction. Total utility is the overall satisfaction from a quantity consumed; marginal utility is the additional satisfaction from one more unit.

Law of diminishing marginal utility. The more you consume of a good in a given time, the LESS additional satisfaction each successive unit brings.

Worked example. First slice of pizza gives utility of 10. Second slice 7. Third 4. Fourth 0. Fifth -3 (you feel sick).

Diminishing MU explains the downward demand curve at the individual level: you'll only pay a lower price for each additional unit because each adds less utility.

Optimal consumption rule. Spend additional dollars where they give the highest marginal utility per dollar. In equilibrium:

$\frac{MU_A}{P_A} = \frac{MU_B}{P_B} = ... = \frac{MU_n}{P_n}$

That is, the LAST DOLLAR spent on each good gives the same marginal utility. (Not formally tested at SL, but underpins the theory.)

Behavioural economics identifies systematic deviations from rational choice.

Bounded rationality. Real consumers have limited time, information, and cognitive capacity. They use heuristics (mental shortcuts) — often good enough, but vulnerable to bias.

Common biases:

Bias	What it does
Loss aversion	Losses feel ~2× as bad as equivalent gains (Kahneman & Tversky)
Anchoring	First number seen biases later judgments (e.g. high "original price" makes sale price seem cheap)
Availability	Risks that come easily to mind feel more probable (plane crash vs car crash)
Framing	Same options described differently produce different choices ("90% survival" vs "10% mortality")
Status quo bias	Stick with defaults; reluctance to change
Herd behaviour	Copy what others do (housing booms, stock bubbles)
Present bias	Overweight immediate rewards (overeating, undersaving)

Choice architecture and nudges. Design of the way choices are presented affects decisions. A "nudge" changes choice context without restricting options:

• Default opt-in to pension saving raises participation dramatically.
• Calorie labels on menus reduce calorie intake.
• Organ donation defaults — countries with opt-out have far higher donation rates than opt-in.

Nudges PRESERVE freedom of choice but shape behaviour — sometimes called "libertarian paternalism".

Policy implications.

• Information disclosure helps but is often insufficient (people don't read).
• Defaults are powerful — choose them deliberately.
• Framing of taxes (e.g. "carbon dividend" vs "carbon tax") affects acceptance.

Critique of behavioural economics. Nudges can be manipulative; defaults might exploit consumers rather than help them. Who decides what's "optimal"?