Matthew Sumption

Consumer Theory Assumptions Essay

What standard assumptions do economists make about consumer preferences? Are these reasonable?
In the words of Jonathan Schlefer (admittedly a political scientist), what economists do is make simplified assumptions about our world, build imaginary assumptions based on those economiesand use them to draw practical lessons.1 Thus far, the aim of the discipline at least appears straightforward enough. However, difficulty soon arises if we pose the question of are the assumptions of economics reasonable? In this essay I will be assessing how reasonable the standard assumptions economists make about consumer preferences are. The broad questions I will be posing for reasonability are: how justified are we in thinking the assumption we have made models the real world? To the extent that it does not, what reasons are there for working under such an

assumption? Are the exceptions which fall outside the bounds of the assumption notable, and, if so, why? First of all, a brief outline of the theory and its assumptions. The standard economics we shall be discussing assumes a consumer to be a rational person who has the opportunity to buy various different commodities at fixed market prices.2 This consumer will choose the best bundle of things he/she can afford, according to our standard theory. Even within those short sentences there are assumptions that could be assessed at length for reasonability, assumptions I shall return to at the end of the essay (given space). The bundle of goods is taken to be made up of 2 goods which can be represented by (x1, x2). To consider situations where more than simply 2 goods are being considered, economists take the second good in question to represent all other goods. Standard economics supposes that the consumer can rank different consumption bundles according to desirability, and there is a language used to convey the way economics assumes consumers to rank products. Briefly, a consumer strictly prefers bundle1 over bundle2 if he/she would choose the former over the latter, given the opportunity. A consumer is indifferent between the bundles if they would be just as satisfied consuming bundle1 as bundle2. A consumer weakly prefers bundle1, then they consider bundle1 at least as good as bundle2. The relations outlined in bold above are interrelated, and allow economists to make some conclusions about the consumers preferences, given their choices.

Jonathan Schlefer, The Assumptions Economists Make, (Cambridge: The Belknap Press of Harvard University Press, 2012), xiv. 2 Mark Dean, Brown University. 2009. Consumer Theory. Last accessed October 14. http://www.econ.brown.edu/fac/Mark_Dean/IM_CT.pdf

Matthew Sumption

Consumer Theory Assumptions Essay

The major assumptions about consumer preferences are sometimes known as axioms, as they are so fundamental to the standard economics I am assessing. They are as follows.

1. Complete: it is assumed any 2 bundles can be compared in the way set out above. In other words if the consumer were to be given a questionnaire about their choices between different consumption bundles, they would have to answer in the language outlined above. 2. Reflexive: it is assumed that any bundle is at least as good as itself.

3. Transitive: it is assumed that if bundle1 is weakly preferred to bundle2, and bundle2 is weakly preferred to bundle3, then bundle1 must be weakly preferred to bundle3. The assumption of completeness does not consider some other major answers the consumer might give when confronted with the choice between 2 consumption bundles. These include when the consumer is (at least partially) ignorant about one of the consumption bundles, and so is not rationally assessing the choice situation. The consumer may also feel unable to decide between the bundles. This also comes back to the big assumption of the rational consumer. In reality, there are big imperfections of information with almost every decision people make, so most of these choices will not fully satisfy completeness. These imperfections arise from consumers not having time to fully research/ consider the consumption bundles they are choosing between, crucial information needed to make a rational choice is not disclosed or relegated to small-print, advertising adding to the factors consumers consider when making a decision (to name a few issues). Equally, some consumption bundles will involve highly complex goods which require a level of expertise not common to everyone. An example of this is which combination of medication a person may choose to take. Consumers here are reliant on the knowledge of doctors and pharmacists to guide them, therefore due to the asymmetry of information, and frequently the highly emotional choices people make regarding health, it is not reasonable to think that the consumer can perfectly choose between consumption bundles.

A consumer may justifiably not feel able to choose between 2 consumption bundles, as they might be preferable in different respects, for example shoes that are very stylish but not durable, and very durable shoes that are unfashionable. Furthermore, 2 bundles might be so similar a consumer might find it impossible to make a distinction, and so mark their choice as being indifferent. However, if we were to incrementally alter the bundles, we might arrive at a situation the consumer would not have marked as indifferent. This is shown by the example of adding 1 grain of sugar to your tea make any noticeable impact on the taste, so you would be justified in viewing the 2 goods (tea without sugar, tea with one grain) indifferently. However moving up the scale, tea with 10,000 grains as compared with tea with 10,001 grains is has the same relative difference; however we would consider the situation in a noticeably different light. The assumption that any 2 bundles are always able to be 2

Matthew Sumption

Consumer Theory Assumptions Essay

compared does not seem to correlate with our experience of the world. It might happen some of the time, however there are frequent occasions where this assumption seems over-ambitious. The real world conditions add complexity and asymmetry which the model does not provide for. The reflexive assumption may seem simple; however I feel I cannot underline stringently enough the idea that this is true for a rational consumer in certain circumstances. The circumstances I humbly suggest as a guide to maintain consistency in a consumers choices are that he/she be fully informed about both bundles of goods and the consequences of consuming them (full amount they have to pay, upkeep, specifications goods of both bundles etc.) and be in exactly the same context. Bundles containing ice-cream and umbrellas would be considered very differently in summer as compared to winter, due to a fundamental change in the circumstances which affect the choice being made. That example may seem too simple, but the point is that consumers in the real world are wont to make inconsistent preferences if one does not factor in changed circumstances. In terms of reflexivity, consumers regularly may not be consistent in viewing a bundle as at least as good as itself due to factors that may highly influence their perception of the very same bundle, such as advertising and convincing salesmanship. The assumption of transitivity may seem to follow logically, however once again there are exceptions. Before a lecture, students at the University of Tel Aviv were asked to fill in a questionnaire about 9 alternatives specifying four characteristics of a travel package. In the 2004 group of 18 students, only 2 had no instransitivities in their answers. Many intransitivites resulted from procedural mistakes the MA student made, such as expressing preferences based on the order the characteristics were written in the questionnaire(this is known as the framing effect), the expressed indifference to alternatives that are too close to be distinguishable and the aggregation of considerations.3 The above result of systematic violations of transitivity, as has been seen, is common even among the highly educated Master students! If we exclude the procedural mistakes, then the picture we get is much more in line with the rational homo economicus, which is taken to be the ideal. So far the three major axioms seem to be unreasonable if we compare how consumers act in reality. However, a defence can be mounted. Even though consumers regularly show signs of irrational decision making, rationality of a certain degree does develop early, as children of 7 and adults of 21, display roughly the same average of intransitive decisions in a study, with all age groups considered scoring better than random.4 It has also been noted that people tend to make more rational decisions over time, with exposure to
3

Ariel Rubenstein, Princeton University, 2006. Lecture Notes in Economic Theory. Last accessed 15 October. http://arielrubinstein.tau.ac.il/Rubinstein2005.pdf 4 Brown. 2009.

Matthew Sumption

Consumer Theory Assumptions Essay

market like conditions, this is crucial, as it shows that the world may tend to become more like the model we have developed over time. An imperfect situation, granted, as one would hope the model would be used to fit the world, yet the model does allow us to draw lessons, as mentioned in the introduction. Some studies also show humans making notably rational decisions.5 The conclusion we may draw from this brief and reasonably superficial assessment of some of the assumptions that standard economics makes about consumer preferences is that the assumptions, and therefore the model, can only be viewed as holding absolutely true for a rational consumer who possesses the features, and the situation the sameness as outlined on page 3. Whenever extrapolating to the real world, the decision making process is bound to get inconsistent by virtue of the fact that it is human beings under study, perfectly capable of irrational decision making or flawed reasoning in numerous situations. That does not prevent the models from being useful however. As Ariel Rubinstein notes, It is meaningful to talk about the concept of being good even in a society where everyone is evil. Similarly it is meaningful to talk about the concept of a rational man and about the interactions between rational economic agents even if all people systematically behave in a non-rational manner.6 As long as we remain conscious of the bounds of the assumptions we work under and their limits as regards human interaction, then we should not stray into making normative claims about the world based on a model of the world, instead of positive ones and practical lessons we can draw. Those lessons and that rational ideal form the real value economics can bring. 1689 words

References
Books Samuelson, Paul.A and Nordhaus, William D. Economics: Nineteenth Edition. New York: McGraw-Hill International. 2010. Schlefer, Jonathan. The Assumptions Economists Make. Cambridge: The Belknap Press of Harvard University Press. 2012 Varian. Hal R. Intermediate Macroeconomics: A modern approach, Seventh Edition. New York. W.W Norton & Company. 2006

5 6

Ibid. Princeton, 2006.

Matthew Sumption

Consumer Theory Assumptions Essay

Online Lecture Notes Brown University, Mark Dean, 2009. Consumer Theory. Last accessed October 14. http://www.econ.brown.edu/fac/Mark_Dean/IM_CT.pdf Princeton University, Ariel Rubenstein, 2006. Lecture Notes in Economic Theory. Last accessed 15 October. http://arielrubinstein.tau.ac.il/Rubinstein2005.pdf