Salman Ahmed Shaikh

Mathematical tractability has restricted economic analysis of consumer behavior within a confined boundary of certain axioms. Often, these axioms are found to be empirically false. Even more importantly, these axioms and the analytical framework based on them is incapable of explaining economic choices in environment goods, public goods and social sphere. Studies in behavioral finance have also documented information processing incapacities and biases that challenge some of the rationality assumptions.

In traditional mainstream neoclassical consumer theory, the consumer is supposed to maximize a utility function subject to some budget constraint. To conduct maximization analysis, certain axioms are imposed on the consumer choice set that enable mathematical tractability and optimization analysis. These axioms can be summarized into the following: completeness, transitivity, invariance of preferences, convexity, continuity of the utility function and monotonicity or local non-satiation.

Apart from Economics, other social sciences are not always thrilled to restrict consumer behavior analysis within such a framework which is only used for mathematical tractability in economics. Lehtinen & Kuorikoski (2007) defend the neoclassical methods for analyzing consumer behavior by arguing that the false assumptions are not potent reasons to abandon the mainstream methods and analysis. It is the empirical validity of predictions with observed behavior which gives the mainstream tools and methodology the credibility and wide acceptability.

However, the relevance and validity of these axioms are not trivial to Gowdy & Mayumi (2001). They opine that if consumer behavior does not conform to the set of axioms adopted in neoclassical theory, then one cannot make the leap from maximizing utility to constructing welfare measures of consumer surplus using Hicksian or Marshallian demand curves.

Thaler (1980) explains that since mainstream consumer behavior theory is based on a rational maximizing model, it describes how consumers should choose given the model and its assumptions; however, not necessarily describing how they do choose. Mainstream consumer behavior theory is normatively based and it only claims that it is also a descriptive theory.

But, in many cases, the mainstream consumer theory fails to predict the economic choices either because of rigid axioms or simplistic preference structure.

Sen (1977) explaining the shortcomings in the structure in neoclassical approach comments as follows:

“A person is given one preference ordering, and as and when the need arises this is supposed to reflect his interests, represent his welfare, summarize his idea of what should be done, and describe his actual choices and behavior. Can one preference ordering do all these things? A person thus described may be “rational” in the limited sense of revealing no inconsistencies in his choice behavior, but if he has no use for these distinctions between quite different concepts, he must be a bit of a fool.”

Gowdy & Mayumi (2001) correctly argue that monotonicity axiom is irrelevant in environment goods where the balance and coherence matters more than abundance. Health goods also require a balance for their effectiveness. Same is true when consumption is analyzed with respect to health effects. Moreover, just like the consumer choice implicitly maintains or should maintain a balance with regards to health effects of consumption, the mainstream consumer theory will be much better off by giving due importance to the balance with regards to ecology, biodiversity and intergenerational equity. This may require incorporating the attribute of ‘commitment’ in consumer theory (Sen, 1977).

Using an example from social choice, Sen (1977) states that even when individual voters have limited probability of affecting actions and when the costs of casting votes could be substantial in particular circumstances, people still take the pain to cast votes to document their true preferences. Sen argues that if this desire reflects a sense of commitment, then the behavior in question would be at variance with the view of man in traditional economic theory.

Furthermore, ‘Ultimatum Game’ reflects the fact that people tend to look at their choice outcomes relatively. Prisoner’s Dilemma highlights the fact that choices by each player in a self-centric way are not necessarily going to be best for them either individually or collectively.

On the other hand, there is another critique on the rational consumer theory that it is overly optimistic about the information processing capability of the consumer. On this, Simon (1957, p. 198) wrote:

“The capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problems whose solution is required for objectively rational behavior in the real world — or even for a reasonable approximation to such objective rationality.”   

Furthermore, recent evidence in behavioral finance and consumer psychology points to the fact that consumer information processing capabilities are limited and prone to error. Alias paradox (1953) and Ellsberg paradox (1961) are good examples of this phenomenon.

References

Gowdy, John M. & Mayumi, Kozo (2001), “Reformulating the foundations of consumer choice theory and environmental valuation”, Ecological Economics, 39, pp. 223–237.

Lehtinen, Aki & Kuorikoski, Jaakko (2007), “Unrealistic Assumptions in Rational Choice Theory”, Philosophy of the Social Sciences, 37, pp. 115 -137.

Sen, Amartya K. (1977), “A Critique of the Behavioral Foundations of Economic Theory”, Philosophy and Public Affairs, 6(4), pp. 317 – 344.

Simon, Herbert (1957), “Models of Man”, Wiley: New York

Thaler, Richard (1980), “Toward a Positive Theory of Consumer Choice”, Journal of Economic Behavior and Organization, l, pp. 39 – 60.

Allais, M. (1953), “Le comportement de l’homme rationnel devant le risque: critique des postulats et axiomes de l’école Américaine”. Econometrica, 21 (4), pp. 503 – 546.

Ellsberg, Daniel (1961), “Risk, Ambiguity, and the Savage Axioms”, Quarterly Journal of Economics, 75 (4), pp. 643–669.