Universitatea Transilvania

Din Braov
Facultatea de Stiinte Economice si Administrarea
Afacerilor
Specializarea: Business Administration

Rational Choice and

Consumer Behaviour

Table of contents

I.Utility and the rational consumer..................................................................1

I.1. Objectives, alternatives and constraints.......................................................1
I.2. The principle of diminishing marginal utility.................................................2
I.3 .Diminishing marginal utility and the consumer choice..................................2
II. Substitution and income effects..................................................................3
III. Consumer surplus......................................................................................... 3
III.1.Measuring the surplus.................................................................................. 5
III.2.Importance of consumers surplus...............................................................6
IV. Excess burden of taxation........................................................................... 6
V.Concluding Remarks....................................................................................... 7
VI.Bibliography.................................................................................................... 8

Rational Choice and Consumer

Behaviour

Rational choice theory: is a framework for understanding and

often formally modeling social and economic behavior. It is the main
theoretical paradigm in the currently-dominant school of microeconomics.
Rationality (here equated with "wanting more rather than less of a good")
is widely used as an assumption of the behavior of individuals in
microeconomic models and analysis and appears in almost all economics
textbook treatments of human decision-making.
Because rational choice theory lacks understanding of consumer motivation, some
economists restrict its use to understanding business behavior where goals are usually very
clear. Competition in the market encourages businesses to maximize profits (in order to
survive). Because that goal is significantly less vacuous than "maximizing utility" and the
like, rational choice theory is apt.

I. Utility and the rational consumer

Why people consume goods and services? Because consumption of goods and services is
a source of pleasure and satisfaction. Economists have their own term for this: The use or
consumption of goods and services gives people utility.

Utility :The pleasure, satisfaction, or need fulfilment that people get from the
consumption of goods and services.

I.1. Objectives, alternatives and constraints

Rational choice: Purposeful choice directed systematically toward the achievement of

objectives given the alternatives and constraints of the situation.
1.

I.2. The principle of diminishing marginal utility

Marginal utility :The amount of added utility gained from a one-unit increase in

consumption of a good, other things being equal.

Principle of diminishing marginal utility: The principle that the greater the
consumption of some good, the smaller the increase in utility from a one-unit increase
in consumption of that good.

Figure 1.Diminishing Marginal Utility

As the rate at which a person consumes good increases, the utility gained from one additional
unit decreases. This graph shows hypothetical utility data for the consumption of Coca Cola
by a certain consumer. The numbers are only illustrative. In practice, utility is a subjective
concept and cannot be measured.

I.3 . Diminishing marginal utility and the consumer

choice

Consumer equilibrium :A state of affairs in which a consumer cannot

increase the total utility gained from a given budget by spending less on one good and
more on another.

2.

From consumer equilibrium to the law of demand

II. Substitution and income effects

Substitution effect : The part of the increase in quantity demanded of a good whose
price has fallen that is caused by a substitution of the good that is now relatively
cheaper for others that are now relatively more costly.
Income effect : The part of the increase in quantity demanded of a good whose price
has fallen that is caused by the increase in real income resulting from the price change.

III. Consumer surplus

How much will consumers be willing to pay for an additional unit of a good
given the quantity they already have? In this note we look at the importance of willingness to
pay for different goods and services.When there is a difference between the price that you
actually pay in the market and the price or value that you place on the product ,then the
concept of consumer surplus becoms a useful one to look at.
Consumer surplus is a measure of the welfare that people gain from the consumption of goods
and services,or a measure of the benefits they derive from the exchange of goods.

3.
DEMAND CURVE AS WILLINGNESS TO PAY

The height of a demand curve shows the maximum that this consumer would be willing to
pay for an additional unit of a good. For example, he/she would be willing to pay up to ROL
19,000 for first yoghurt each month, but only ROL 13,000 for a seventh. The maximum
he/she would willingly pay for each unit is shown by a vertical bar. In this case, the market
price is ROL 10,000. Thus he/she buys 10 cans of yoghurt a month, paying a total of ROL
100,000. The difference between what he/she actually pays at the market price and the
maximum she would have been willing to pay, shown by the shaded area, is called consumer
surplus.

4.

III.1. Measuring the surplus

Consumer surplus: It is the difference between the maximum that a consumer will be willing
to pay for a unit of a good and the amount that he or she actually pays.
Producer surplus : The difference between what producers receive for a unit of a good and the
minimum they would be willing to accept.
GAINS FROM TRADE

This graph shows that both consumer and producers gain from trade in free markets. Here the
equilibrium market price is ROL 20,000 per unit. The demand curve shows the maximum that
consumers would willingly pay for each unit. Consumers gain from trade takes the form of
consumer surplus, shown by the area between the demand curve and the market price. The
supply curve shows the minimum that the producers would willingly accept rather than put
their resources to work elsewhere. Producers earn a surplus equal to the difference between
what they actually receive at market price and the minimum they would have been willing to
accept. The area between the supply curve and the market price shows this producer surplus.

Total gains from trade are thus the entire area between the supply curve and the demand curve
up to the equilibrium point.
5.

III.2. Importance of consumers surplus

In public finance is very useful to the Finance Minister in imposing taxes and fixing the
rates.He will impose more taxes on commodities in which consumers surplus is more.

To the businessman and monopolistic as they can increase the price of the
commodities in which there is large consumers surplus.

Comparing advantages of different places.

Measuring benefits from international trade.

IV. Excess burden of taxation

In economics, the excess burden of taxation, is one of the economic losses that society
suffers as the result of a tax. Economic theory posits that distortions changes the amount and
type of economic behavior from that which would occur in a free market without the tax.
Excess burdens can be measured using the average cost of funds or the marginal cost of funds
(MCF). The cost of a distortion is usually measured as the amount that would have to be paid
to the people affected by its supply, the greater the excess burden. The second is the tax rate:
as a general rule, the excess burden of a tax increases with the square of the tax rate.
The average cost of funds is the total cost of distortions divided by the total revenue
collected by a government. In contrast, the marginal cost of funds (MCF) is the size of the
distortion that accompanied the last unit of revenue raised. In most cases, the MCF increases
as the amount of tax collected increases.
The total economic burden of a tax includes both payments that taxpayers make to the
government and any lost economic value from inefficient activities undertaken in reaction to
taxes. The excess burden of taxation is commonly measured by the area of the associated
Harberger triangle (Hines, 1999). The base of the Harberger triangle is the amount by
which economic behavior changes as a result of price distortions introduced by the tax, and

the height of the Harberger triangle is the magnitude of the tax burden per unit of economic
activity.

6.

V. Concluding Remarks

In this paper I have tried to give the reader a sense of how rational choice theory
works.
Rational Choice Theory is an approach used by social scientists to understand human
behavior. The approach has long been the dominant paradigm in economics, but in recent
decades it has become more widely used in other disciplines such as Sociology, Political
Science, and Anthropology.
This theory generally begins with consideration of the choice behavior of one or more
individual decision-making units which in basic economics are most often consumers and/or
firms. The rational choice theorist often presumes that the individual decision-making unit in
question is typical or representative of some larger group such as buyers or sellers in a
particular market. Once individual behavior is established, the analysis generally moves on to
examine how individual choices interact to produce outcomes.
The analysis of firm behavior has many similarities with the analysis of consumer
behavior. Firms are generally assumed to make choices with the idea of maximizing profits
or the market value of the firm (as reflected in the firms stock price if it is a corporation).
Rational choice theory is subject to a number of criticisms, but that is to be expected.
We are not likely to attain complete knowledge about anything, especially social phenomena
any time soon.

7.

VI. Bibliography

Books:
1. GREGORY N. MANKIW
The Principles of Economics, second edition, Harcourt College Publishers, New York, 2001
2. ROBERT H. FRANK and BEN S. BERNANKE
Principles of Economics, McGraw Hill, New York, 2001
3. EDWIN G. DOLAN and DAVID LINDSEY
Economics, fifth edition, The Dryden Press, New York, 1988,
4. Department of Economics and Economic Policy, AES Economics, fifth edition, Editura
Economica, Bucharest, 2003

Internet:
http://www.bus.umich.edu/otpr/WP2007-1.pdf
http://en.wikipedia.org/wiki/Excess_burden_of_taxation
http://en.wikipedia.org/wiki/Rational_choice_theory

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