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DP IB Economics: HL Your notes
2.4 Critique of the Maximizing Behaviour of

Consumers & Producers
Contents
Rational Consumer Choice
Behavioural Economics in Action
Business Objectives
Page 1 of 23
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Rational Consumer Choice

Your notes
Assumptions of Rational Consumer Choice
Free markets are built on the assumptions of rational decision making
In classical economic theory, the word 'rational' means that economic agents are able to consider the
outcome of their choices and recognise the net benefits of each one
Rational agents will select the choice which presents the highest benefits (utility)
Rational choice theory states individuals use logical and sensible reasons to determine the right
choice connected to an individual’s best self-interest
Many economic theories assume that economic agents (individuals, firms and governments) make
decisions that result in maximising their satisfaction
E.g. The law of demand which states that as the price falls consumers will increase their demand
for goods and services
This traditional economic view is based on the following three assumptions
1. Consumer Rationality
The assumption that individuals use rational calculations to make choices which are within their own
best interest, using all the information available to them
2. Utility Maximisation
Traditional economic theory assumes economic agents select choices that maximise their utility to
the highest level
E.g. If an individual gains greater satisfaction from swimming than going for a run, they will chose to
go swimming
3. Perfect Information
Rational choice theory assumes information is easily accessible about all goods and services on the
market. It assumes individuals have access to all the information available to make the best decision
Limitations of the Assumptions of Rational Consumer

Choice
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Behavioural economics contrasts traditional economics as it challenge the view that economic
agents behave rationally
Your notes
Behavioural economics is a field of study that combines elements of psychology and economics to
understand how people make decisions and behave in economic contexts
Behavioural economics recognises that human decision-making is influenced by cognitive biases,

emotions, social, and other psychological factors that can lead to deviations from rational behaviour
The assumptions of traditional economics regarding decision making do not hold
The following limitations mean individuals are unlikely to always make rational decisions
Limitations of the assumptions of rational consumer choice
1. Biases
Biases influence how we process information when making decisions and these influence the process
of rational decision making
Examples of bias include common sense, intuition, emotions and personal and social norms
Types of Bias
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Type of Bias Explanation

Your notes
Rule of This is when individuals make choices based on their default choice based on
Thumb experience
E.g. Individuals may also order the same pizza anytime they order from Pizza
Hut
However the best choice may be to buy the new tasty option which is
available at 50% discount
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Anchoring Anchoring bias occurs when individuals rely too heavily on an initial piece of
and Framing information (the "anchor") when making subsequent judgments or decisions
Your notes
E.g. When buying a used car the seller may initially suggests a price of
$10,000. Even if you know the market value is lower, the anchor of $10,000
might still influence your perception and as a result, the consumer ends up
paying a higher price than intended
Framing refers to how the presentation or wording of information can significantly

influence people's choices or judgments
The same information can be framed in different ways, leading to different
outcomes
E.g consumers are likely to purchase a product that states ‘80% fat free’ than
‘20% fat’
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Availability Occurs when people rely on immediate examples or information that comes to
Bias mind easily when making judgments or decisions
Your notes
It leads individuals to overestimate the likelihood or importance of events or
situations based on how readily available they are in their memory
Availability bias is influenced by personal experiences, vividness of the

information, media exposure, and emotional impact
E.g. people use alternative modes of transport when there is a plane crash,
even though the probability of a crash happening is very low
2. Bounded Rationality Theory

This theory argues that people make decisions without gathering all the necessary information to
make a rational decision within a given time period
Individuals may not understand the technical jargon linked to selecting insurance or pensions
The theory assumes rational decision making is limited because of

An individual's thinking capacity
Availability of information
Lack of time available to gather all of the infromation and make a judgement
Too much choice can also cause people to make irrational decisions
E.g. when making choices about purchasing particular products in the supermarket, there may be
too much choice making it difficult to make a decision
3. Bounded Self-Control
The theory of bounded self-control suggests that individuals have a limited capacity to regulate their
behaviour and make decisions in the face of conflicting desires or impulses
It recognises that self-control is not an unlimited resource that can be exercised endlessly without
consequences
Humans are social beings influenced by family, friends and social settings. This often results in
decision making which conforms to social norms but does not result in the maximisation of consumer
utility
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Bounded self control leads to decision making based on emotions, which may not yield the best
outcome.
Your notes
E.g people may indulge in impulsive spending, purchasing goods they didn’t originally intend to
buy
Businesses use marketing to capitalise on the lack of bounded self-control of individuals when
appealing to their target audience to maximise sales
E.g. Supermarkets place a range of items at the checkout register to encourage impulse
purchases
4. Bounded Selfishness
Behavioural economics challenges the view that economic agents always act within their own self
interest
Bounded selfishness recognises that individuals do things for others without a direct reward
Altruism is the practice of acting selflessly helping others expecting nothing in return
Examples of bounded selfishness include

Donating money to charity
Organ donations
Voluntary work
5. Imperfect Information
Rational Choice Theory assumes information is perfectly accessible, however this is incorrect due to
factors such as
Intellectual property rights e.g. patents, copyrights and trademarks
Cost of accessing information
The sheer amount of information and options available
This means people make decisions based on limited information meaning they may not make the best
choice
Asymmetric information may also lead to decisions based on limited information

E.g. When purchasing second hand cars, the seller always has more information than the buyer
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Behavioural Economics in Action

Your notes
Choice Architecture
Choice architecture refers to the intentional design of how choices are presented so as to to
influence decision making
E.g. Salad bar placement at the beginning of buffets to encourage people to put fruit and veg on
their plate
Supermarkets placing more profitable products at eye level on the shelves
Choice architecture aims to simplify the decision making process

E.g. Restaurants present information about food options in a particular format to encourage
individuals to make a particular choice - often bundling items together
E.g. Tesco replaced confectionary usually found at the checkout till with healthier options so as to
encourage people to make better food choices
Types of Choice Architecture
Type of How does it work?

Choice
Default Occurs when an individual is automatically signed up to a particular choice

Choice
This reduces choice as it means a decision is already made even if no action has
been taken
Research has shown that individuals rarely change from the default choice
E.g. Driver licence agencies select 'organ donation' as the default choice when
offering driver's new licences
When signing up for an online service, the default choice for receiving
promotional emails may be set to "opt-in,"
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Restricted Occurs when the choices available to individuals are limited which helps individuals
Choice make more rational decisions
Your notes
E.g. In a cafeteria, if unhealthy food options like sugary drinks are removed and
replaced with healthier choices like water, consumers will be more likely to
purchase them
Mandated Mandated choices require individuals to make a specific decision or take a

Choices particular action by imposing a requirement or obligation
Mandated choices can be used to ensure compliance with regulations or societal
norms, making it necessary for individuals to make certain decisions
E.g. Some countries mandate car insurance which requires all vehicle owners
to make an active decision to choose and purchase car insurance rather than
leaving it as an optional choice
An Evaluation of Choice Architecture

When evaluating Choice Architecture, it is useful to consider the advantages and disadvantages
The Advantages and Disadvantages of Choice Architecture
Advantages Disadvantages
Influences Behaviour Manipulation
Choice architecture can be used to nudge

individuals towards making choices that are It can be seen as a form of manipulation as it
in their best interest or align with desired attempts to influence people's decisions
outcomes without their explicit consent which may
infringe on the principle of free choice
Simplifies Decision-Making Ethical Concerns
Well-designed choice architecture can Individuals may not be aware that their choices
simplify complex decisions by providing are being influenced, or they may not fully
clear and understandable options understand the consequences of their
decisions due to the way choices are presented
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Improved Outcomes Potential for Bias

Your notes
Effective choice architecture can lead to Choice architecture is susceptible to biases
improved outcomes such as encourage inherent in the design process and may be used
healthier eating habits and combatting issues by companies to increase profits
like obesity
Enhance Decision Quality Unintended Consequences
By structuring choices carefully, it can Changes in the presentation of choices can

provide guidance, reduce biases, and have unforeseen effects and the outcomes
increase the likelihood of individuals making may not align with the original goals
choices they would consider to be better
Nudge Theory
Nudge theory is the practice of influencing choices that economic agents make, using small prompts
to influence their behaviour
Richard Thaler coined the phrase ‘nudge theory’ and argued that firms should use nudges in a
responsible way to guide and influence decision making
Examples of Nudges
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Your notes
Save My Exams Choice Architecture nudges users to select the £5 a month option
The choice architecture above ‘nudges’ individuals towards selecting the monthly plan above the
other plans available
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Source: Transport for London
Your notes
The baby on board badge is supplied by Transport for London to expectant mothers to wear when
using public transport
Other commuters should see the badge and accommodate for the expectant mother by giving
their seat to her
Dr David Halpern, from the UK Behavioural Insights team suggested the following EAST framework to
nudge decision making
Easy – Simplify or make it straight forward
Attractive – Gain people's attention e.g personalised messages, encourage people not to miss
out on opportunities
Social – Individuals are influenced by what other people do rather than rules and regulations
Timely – identify when people are most responsive
An Evaluation of Nudge Theory

Consumer nudges are designed to guide people towards certain decisions or actions while still
allowing them to have freedom of choice
These interventions are typically based on behavioural economics principles and aim to nudge
individuals towards decisions that are considered beneficial for themselves and society as a whole
Consumer nudges should be designed with transparency, respect for individual autonomy, and clear
societal benefits in mind
Ethical considerations should be taken into account to ensure that interventions are not
manipulative or coercive
An Evaluation of Using Nudge to Influence Behaviour
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Your notes
The advantages and disadvantages of using nudge to influence behaviour
The Advantages
Cost effective
Relatively low-cost compared to other marketing measures
Preserves freedom of choice

Steers individuals towards certain choices while still allowing them to retain their freedom of
choice
Improved public health

Nudges can be used effectively to encourage healthier behaviours such as exercising, eating
nutritious food, or quitting smoking
Better decision making

Helps individuals make better decisions by simplifying complex information, providing reminders,
or structuring choices
Environmental sustainability
By influencing individual choices in a subtle way, firms/governments can contribute to broader
environmental goals without imposing strict regulations
The Disadvantages
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Ethical concerns
Some critics argue that nudges can be manipulative, as they rely on influencing behaviour without Your notes
individuals being fully aware of the intervention
This raises ethical concerns about autonomy, consent, and the potential for abuse by
governments
Lack of transparency
Nudges often operate behind the scenes, making it difficult for individuals to understand or
question the influences shaping their choices
Unintended consequences
As citizens become used to firms/government's using nudge, they may well begin looking for it
and actively work against the nudges e.g. In the UK more people now look for automatic inclusion
in organ donor databases and quickly select the non-default option
Variable success rates

Nudges may not be equally effective for all individuals due to differences in cognitive biases,
cultural backgrounds, or personal circumstances
Page 14 of 23
Business Objectives
Your notes
Profit Maximisation
Most firms have the rational business objective of profit maximisation
Profits benefit shareholders as they receive dividends & also increase the underlying share price
An increase in the underlying share price increases the wealth of the shareholder
To achieve profit maximisation firms, follow the profit maximisation rule
When marginal cost (MC) = marginal revenue (MR) then no additional profit can be extracted by
producing another unit of output
When MC < MR additional profit can still be extracted by producing an additional unit of output
When MC > MR the firm has gone beyond the profit maximisation level of output
It is making a marginal loss on each unit produced beyond the point where MC = MR
In reality, firms may find it difficult to produce at the profit maximisation level of output
They may not know where this level is
In the short term they may not adjust their prices if the marginal cost changes
Marginal costs can change regularly and regular price changes would be disruptive to
customers
In the long-term firms will seek to adjust prices to the profit maximisation level of output
Firms may be forced to change prices by the competition regulators in their country (especially
natural monopolies)
The profit maximisation level of output often results in high prices for consumers
Changing prices changes the marginal revenue
Page 15 of 23
Your notes
The profit maximisation level of output occurs at Q1 where MC = MR resulting in a market price of P1
Diagram Analysis
This firm has market power as the MR and average revenue (AR) curve are downward sloping
At the profit maximisation level of output (MC = MR)
The selling price is P1
The average cost is C1
The supernormal profit = (P 1 − C 1 ) × Q 1
Examiner Tips and Tricks

Profit maximisation is all about the quantity of output.
To determine the level of profit:
Page 16 of 23
1. identify where MC = MR and then extend the dotted line upwards to the point where it hits the
AR curve - this is your selling price
2. Where this line crosses the average cost curve (AC) represents the cost per unit at this level of Your notes
output
3. The profit is the difference between the selling price and the average cost
Evaluating Profit Maximisation as a Business Objective

Apart from the very significant advantages that are offered by pursuing profit maximisation, there are
some distinct disadvantages too
The Advantages & Disadvantages of Pursuing Profit Maximisation
Financial Stability and Growth Ethical and Social Concerns

Maximising profits allows businesses to Focussing on profit maximisation can result in
accumulate capital, reinvest in growth actions that disregard the well-being of
opportunities, and withstand economic employees, communities, and the environment
uncertainties (negative externalities)
Shareholder Value Creation Risk of Neglecting Non-Financial Metrics

By focusing on profit maximisation, Important factors like employee satisfaction,
companies can enhance shareholder customer loyalty, product quality, and
value, attract new investors and maintain environmental sustainability may be neglected if
their competitiveness in the market they are not directly tied to immediate profit
generation
Resource Allocation Efficiency
Businesses are incentivised to allocate Short term profits versus long term value
resources efficiently which can lead to creation
improved productivity and cost control Extracting the highest level of short term profits
will often detract from future value creation
through research or innovation
Growth
Some firms have the business objective of growth
Firms with a growth objective often focus on increasing their sales revenue or market share
Page 17 of 23
Firms will also maximise revenue in order to increase output & benefit from economies of scale
A growing firm is less likely to fail Your notes
1. Revenue Maximisation as a Sign of Growth

Firms aim to maximise revenue in order to increase output & benefit from economies of scale
In the short-term firms may use this strategy to eliminate the competition as the price is lower than
when focussing on profit maximisation
To achieve revenue maximisation firms produce up to the level of output where MR = 0

When MR > 0, producing another unit of output will increase total revenue
The revenue maximisation level of output occurs at Q1 where MR = 0 resulting in a market price of P1
Diagram Analysis
At the revenue maximisation level of output (MR = 0)
Page 18 of 23

The average cost is C1 Your notes
The supernormal profit = (P 1 − C 1 ) × Q 1
The supernormal profit is less than when the firm follows the profit maximisation rule
2. Market Share as a sign of Growth
Some firms have the business objective of sales maximisation which further lowers prices and has the
potential to increases market share
Sales maximisation occurs at the level of output where AC = AR (normal profit/breakeven)
In the short-term firms may use this strategy to clear stock during a sale or increase market share
Firms sell remaining stock without making a loss per unit
The sales maximisation level of output occurs at Q1 where AC = AR resulting in a market price of P1
Diagram Analysis
At the sales maximisation level of output (AC = AR)
Page 19 of 23

The average cost is also at P1 Your notes
The firm is breaking even (normal profit)
Examiner Tips and Tricks

Although sales and revenue maximisation are not in the syllabus per se, due to the fat they can form
part of the growth objective, it would be useful to understand them. Revenue maximisation was also
examined in the May 2023 session.
Evaluating Growth as a Corporate Objective

Companies need to carefully assess the trade-offs and consider a balanced approach to growth,
taking into account risk management, organisational capabilities, and long-term sustainability of any
growth actions
The Advantages & Disadvantages of Pursuing Growth
Increased market share and Growth comes with inherent risks and complexities.
competitive advantage Expanding into new markets, integrating
acquisitions, or scaling operations can strain
resources, disrupt existing processes, and expose
Growth is often associated with the company to new challenges
improved financial performance and
increased shareholder value Rapid growth can strain organisational resources,
systems, and structures e.g the ability to offer
effective customer service
Pursuing growth stimulates innovation
and attracts top talent Pursuing growth opportunities can lead to a loss of
focus if companies diversify into unrelated markets
Growth also creates opportunities for or industries, diluting their expertise and stretching
employees to take on new roles and their resources
responsibilities, fostering a dynamic
and engaging work environment
Satisficing
Page 20 of 23
Satisficing refers to the pursuit of satisfactory or acceptable outcomes rather than profit
maximisation
Your notes
It is a decision-making approach where businesses aim to meet a minimum threshold or standard
of performance rather than striving for the absolute best outcome
Small firms may satisfice around the desires of the business owner (sole trader) to have more well-
being in their life
Many large firms often end up satisficing as a result of the principal agent problem
Rationally, managers know shareholders want to profit maximise
However, managers want to maximise sales or revenue so as to increase their wages
Managers (who control the business) settle for a level of output somewhere between profit and
sales maximisation
This increases their wages and reduces potential conflict with shareholders
Evaluating Satisficing as a Corporate Objective

Balancing the advantages and disadvantages of satisficing is essential, and companies may adopt a
combination of satisficing and profit or growth strategies to achieve the best possible outcomes
The Advantages & Disadvantages of Pursuing Satisficing
Page 21 of 23
Offers internal stakeholders (owners, There is the potential for mediocrity or

management and employees) the opportunity suboptimal results. Companies may miss out
Your notes
to develop a healthy work-life balance - or to on opportunities to achieve better results and
focus on other goals they consider to be improve their competitiveness
important
Satisficing may discourage the pursuit of
innovative and creative solutions
It reduces decision-making costs and
speeds up the decision making process as By focusing on satisfactory outcomes,
less extensive and time-consuming research is companies risk falling short of higher
required as compared to seeking optimal expectations, which can lead to customer
solutions that maximise profit dissatisfaction, employee disengagement, or
investor skepticism
Corporate Social Responsibility (CSR)

Corporate social responsibility involved conducting business activity in an ethical way and balancing
the interests of shareholders with those of the wider community
Examples of Corporate Socially Responsible Activities
Socially Responsible Example

Activity
Sustainable sourcing of High street retailer H&M has a goal of using only recycled or sustainably
raw materials and sourced materials by 2030
components
It also publishes a list of the majority of their supplier’s information
which is updated regularly, allowing stakeholders to verify and hold the
company responsible for their suppliers’ conduct
Responsible marketing Marks and Spencer ensures that it never actively directs any marketing
communications to children under the age of 12 and does not directly
advertise any products high in fat, sugar or salt to children under the age
of eighteen
Protecting the Cafe chain Prêt à Manger offers discounts to customers who bring their
environment own coffee cup, reducing the number of single-use plastic containers it
dispenses
Page 22 of 23
Responsible customer John Lewis's famous 'Never Knowingly Undersold' slogan refers to the
service company's commitment to checking competitor prices regularly to
Your notes
ensure that the price its customers pay is the lowest available in the local
area at that time
It is now common practice for large companies to publish annual Corporate Responsibility Reports
which provide an audit of the steps being taken to meet their commitments to a range of stakeholders
alongside annual financial reports
Extra costs are involved in operating in a socially responsible way and these costs must be passed on
to consumers
The Advantages of CSR Objectives

CSR can enhance the business image and reputation
CSR is attractive to many stakeholders
CSR can be very profitable as it adds value for many stakeholders
CSR may improve employee motivation and productivity
CSR can help to recruit strong candidates for jobs advertised
CSR may help to solve social problems e.g. resource depletion
The Disadvantages of CSR Objectives

CSR goals can involve significant financial and resource commitments which can divert funds and
attention away from other business priorities
CSR goals means facing increased expectations from stakeholders, including customers,
employees, investors, and the general public
Defining and measuring the impact of CSR initiatives can be challenging as it may be difficult to
establish clear metrics and demonstrate tangible results
Adopting CSR goals without genuine commitment and meaningful action can lead to accusations of
greenwashing or socialwashing
Page 23 of 23

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DP IB Economics: HL Your notes

2.4 Critique of the Maximizing Behaviour of

Rational Consumer Choice

This traditional economic view is based on the following three assumptions

Limitations of the Assumptions of Rational Consumer

Behavioural economics recognises that human decision-making is influenced by cognitive biases,

The assumptions of traditional economics regarding decision making do not hold

Limitations of the assumptions of rational consumer choice

Type of Bias Explanation

Framing refers to how the presentation or wording of information can significantly

Availability bias is influenced by personal experiences, vividness of the

2. Bounded Rationality Theory

The theory assumes rational decision making is limited because of

Examples of bounded selfishness include

Asymmetric information may also lead to decisions based on limited information

Behavioural Economics in Action

Choice architecture aims to simplify the decision making process

Type of How does it work?

Default Occurs when an individual is automatically signed up to a particular choice

Mandated Mandated choices require individuals to make a specific decision or take a

An Evaluation of Choice Architecture

The Advantages and Disadvantages of Choice Architecture

Influences Behaviour Manipulation

Choice architecture can be used to nudge

Simplifies Decision-Making Ethical Concerns

Improved Outcomes Potential for Bias

Enhance Decision Quality Unintended Consequences

By structuring choices carefully, it can Changes in the presentation of choices can

Source: Transport for London

An Evaluation of Nudge Theory

An Evaluation of Using Nudge to Influence Behaviour

The advantages and disadvantages of using nudge to influence behaviour

Preserves freedom of choice

Improved public health

Better decision making

Variable success rates

The supernormal profit = (P 1 − C 1 ) × Q 1

Examiner Tips and Tricks

Evaluating Profit Maximisation as a Business Objective

The Advantages & Disadvantages of Pursuing Profit Maximisation

Financial Stability and Growth Ethical and Social Concerns

Shareholder Value Creation Risk of Neglecting Non-Financial Metrics

1. Revenue Maximisation as a Sign of Growth

To achieve revenue maximisation firms produce up to the level of output where MR = 0

The selling price is P1

The selling price is P1

Examiner Tips and Tricks

Evaluating Growth as a Corporate Objective

The Advantages & Disadvantages of Pursuing Growth

Evaluating Satisficing as a Corporate Objective

The Advantages & Disadvantages of Pursuing Satisficing

Offers internal stakeholders (owners, There is the potential for mediocrity or

Corporate Social Responsibility (CSR)

Socially Responsible Example

The Advantages of CSR Objectives

The Disadvantages of CSR Objectives

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