Table of Contents QUESTIONS...................................................................................................................................1 1. Briefly discuss the following terms.........................................................................................1 2. Behavioural Economics and reasons behind irrational behaviour of consumers....................1
QUESTIONS 1. Briefly discuss the following terms a) Consumer's Indifference Curve: In economic, consumer indifference curve refers to the graph that depicts combination of two different commodities which provides equivalent level of satisfaction as well as utility to the consumers. Here, each and every point of this indifference curve shows that users are indifferent among the two as all of the stated points are providing them equivalent utility at every time of its consumption. Graphical representation of this graph isdownward sloping convex towards the origin. It is mainly used to show collaboration of two different commodities that is being consumed by individuals. In order to identify valuable outcome, one variable is remaining constant at a time so that satisfaction of consumer can be easily measure at another level (Harrison, 2016). It shows satisfaction of level of consumers at every level of point represented on the indifference curve. b) Marginal Rate of Substitution Marginal rate of substitution refers to the amount or proportion of commodity which actual user or consumer is wishing to left for the purpose of attaining another product. This is because,theconsumerthinksthathewillgetequivalentsatisfactionwithnewproduct comparatively with old product. The concept is basically used in indifference theory in order to determine behaviour consumer effectively. Graphical representation of this curve is downward sloping which is also called as indifference curve. MRS is basically calculated by placing two different goods over same indifference curve. This shows that both the commodities are given equivalent utility for every combination of two stated commodities that is “Commodity A” and “Commodity B” c) Consumer's Budget Constraints Budget constraints depicts all combination of different product or services that could be purchased by consumer at the specific given prices which relies between their own income. The concept of budget constraint is commonly used in consumer theory in order to understand or analyse choices of consumers (Howley, Buckley and Donoghue, 2015). In simple words it can be said that consumer always wishes to maximise their satisfaction level. But, the main problem relies in between is the limited level of income of consumers its self that is also known as 1
budget. In this regard, an effective budget line is formulated which represents purchasable combination of two commodities with the specification of the current price and income of consumers. Along with this, budget constraint is also defined as the variant amount of two goods which can be afforded by consumer or relies within the income of consumer. d) Diminishing Marginal Utility Diminishing marginal utility is also termed as Law of Diminishing marginal utility. In this, it can be said that utilityin economics is seen as happinesses or satisfaction level of consumers gained by individual at the time of consuming same product or good again and again. This law states that at the starting time of consumption of good, satisfaction level of individual is high but with increase in number of consumption level or utility declines. In other words, marginal utility refers to changes in utility or satisfaction level with the consumption of every additional units (Infante and Lecouteux, 2016). It can be further said that marginal utility could decrease drastically in negative manner with every additional consumption because in many cases consumers are not in a condition of even in taking single unit of whole commodity. e) Income and Substitution Effects It can be said that if prices of any product increases or decrease then it will directly place two different types of effects. These effects are commonly known as income and substitution effects. Effects of both due to change in prices are described as below: Income effect:It can be said that if price of product increases then there are high chances that customers might switch to another company or substitutes. This is because, if substitute products are cheaper then customers ultimately move to them. Substitution effect:On the other hand, increase in price of current product means that it directly minimises disposable income of consumers. This is because there income is low which decreases their purchasing power as a result it reduces demand. 2
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2. Behavioural Economics and reasons behind irrational behaviour of consumers Behaviour economics can be defined as a study of psychology which shows how decisions making process in economy impact on behaviour of organisations and their consumers. Therefore, this study is related with normative economics which state that people willing to purchase products that serves with greatest benefits and satisfaction. In this regard, as per rational choice theory, people get various options at marketplace to maximise their satisfaction, where decisions of purchasing any product depends on costs and benefits of each. But as theory of behavioural economics that draws on psychology, it has been evaluated that people due to incapability of choosing option that satisfy their needs, sometime make irrational decisions. For this assistance, this theory helps in understanding the reasons behind why people do not follow any predictions of economic models, why making decisions for purchasing a commodity. As people are emotional and generally get distract easily towards external factors therefore, they make decisions to consume a service which doesn't maximise the utility (Kanev, 2017). Thus, such type of irrational behaviour can become dominant choice of others also that live in same area. This may lead to loss of economic welfare,cause market failure and more. Therefore,to make any policy, economist need to take under consideration the potential of same for irrationality, before making changes in economical factors.Irrational behaviour of customers can be classified into various ways as shown below - Cognitive bias –Take decisions as per irrational assumptions Discrimination –Dislike people due to irrational reasons Lack of control –Consume any product more than requirement Irrational exuberance –being carried away due to over-optimism Herding effect –Follow others Biased –Opt for short-term pleasure instead of long-term benefits or cause like drugs As per economical behaviour, it has been analysed that irrational exuberance defines as a condition where agents of economy like share market develop confidence to increase economy. This would consider as a factor that causes financial crises because consumers, bankers and surrounding organisations become more confident to keep rising of growth and asset prices. This would encourage people to buy more commodity, that leads to irrational exuberance. Similarly, herding is another factor that cause irrational behaviour, where to consume any product, people make choices as per concerned of majority. While biased to get short term benefits via
consuming alcohol, drugs, smoking and more, people again make irrational decisions and refuse to evaluate long-term causes of same. 2
Cognitive bias type of behaviour occurs when people make decisions on the basis of emotional or impulsive responses. For example – If people get any bad experience from a particular product or service then in future, they will avoid to purchase the same. Present bias that people like to purchase those products that currently consumes more by majority of people, this would also lead to cause irrational behaviour. A lack of control on habits like drug addictions, alcoholic consumptions and more, creates difficulty for people to make rational decisions. Thus, according to behaviour economist, all people generally behave as irrational where distraction towards any factor lead to make poor decisions, which makes no sense (Sen, 2017). People before purchasing any product, used to look out on sources from where they can explore out the feedback of other users who have consumed the same. So, people get highly influence towards their perception and make mind accordingly to purchase a product or not. In this regard, instead of testing, measuring or get own experience, they make decisions according to assumptions. This kind of irrationality effect the marketing and consumer behaviour either on direct or indirect manner, that force companies to offer their products by considering how it impacts on such type of irrational behaviour of people. In decision making process of people, the biggest role isplayed by judgements that explores out from sufficient as well as relevant information, where people seek to consumes products that maximize value at smallest costs. All these things, state that due to irrationality, instead of social benefit people concerns on social cost and get catch up easily in financial bubbles, which proves devastating when such bubble bursts. 3
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REFERENCES Books and Journals Harrison, N. 2016. Student choices under uncertainty: bounded rationality and behavioural economics. InAccess to Higher Education(pp. 99-114). Routledge. Howley, P., Buckley, C., and Donoghue, C. O. 2015. Explaining the economic ‘irrationality’of farmers' land use behaviour: The role of productivist attitudes and non-pecuniary benefits.Ecological Economics. 109. pp.186-193. Infante, G., and Lecouteux, G. 2016. Preference purification and the inner rational agent: a critique of the conventional wisdom of behavioural welfare economics.Journal of Economic Methodology.23(1). pp.1-25. Kanev, D. 2017. Behavioural economics: development, condition and perspectives. Sen, A. 2017. Rational behaviour.The new Palgrave dictionary of economics. pp.1-14. Whitehead, M. and et. al 2017.Neuroliberalism: behavioural government in the twenty-first century. Routledge. 4