ECONOMICS MARKETS

Economics Markets

Economics Markets

The traditional economics which is the theory of consumer behaviour explains how a rational consumer allocates his income to the purchase of different goods and services in order to maximise his satisfaction subject to a budget constraint (Shefrin 2002 19). The theory assumes that a consumer has the full knowledge of all the available commodities, their prices and his income. The traditional economics state that utility always increases with income.

In reality, consumers do not always make decisions rationally due to various factors such as social norms, emotions, prices of goods and choices of goods available. Therefore, economists have developed a new area of research called behavioural economics to better understand consumer choice and characteristics of consumer demand (Daniel Hirshleifer Subrahmanyam 2008 1839-1885).

Traditional assumption claims that consumer is happy no matter what his colleagues received even though the amount might be greater than what he received because income increment has increased his utility. Behavioural economics claims that consumer will get depressed if he found his colleagues are receiving higher bonuses because consumers evaluate their outcomes with reference to the group norm. Under this example, the reference point is receiving a smaller bonus than others. Another key issue is adaptation. Traditional economics assumes utility increases with income and it is sustainable. Behavioural economics think consumers tend to adapt to new circumstances and their utility will revert to a homeostatic position.

Traditional economics are based on three basics assumptions. Firstly, consumers are assumed to have clear preferences for certain goods over others. Next, they encounter budget constraints. Lastly, with their preferences, restricted incomes and the prices of different goods, consumers opt to purchase combinations of goods that maximize their satisfaction (Rabin 2008 11-46). However, an emerging behavioural economics challenge that consumers cannot be generalized accordingly to these traditional assumptions through ...