Monday, 25 July 2011

Are Consumers Rational?

Are Consumers Rational?

When we start studying Microeconomics the first thing we study is that we have limited resources and we have unlimited wants. Second thing which we studies is that “Consumer is Rational” and our teachers used to explain us that the consumer will not buy a rotten tomatoes and rotten vegetables; which is true when we talk only about buying tomatoes or mangoes etc. However, if we think in a broader sense, beyond grocery items then consumer may or may not remain rational, e.g., taking stocks in stock market, doing investment, buying foreign exchange, movements of interest rate, buying a lottery ticket etc.
We’ll take this one by one:
  1. People, especially the retired ones” always thing that decreasing interest rate is a bad thing and what they are getting in hand is meaningful. These people do not have an idea about real interest rate but I don’t blame them because if prices go up 3fold and interest rate initially goes up to 13 percent and they are getting good amount of money. But after inflation has declined and interest rate declines too they are getting profit or interest money on the same fixed amount and money they are getting at, say 6.5 percent, is half of what they are getting previously. In this case they do not want interest rate to decline. J According to their own view they are rational ones but if the rationality is to lower inflation and lower interest rate then they are not rational.
  2. Continuing with the interest rate, if there is a recession, with high inflation and high unemployment --- increase in interest rate leads to more unemployment and inflation otherwise. Policymakers would want to reduce more at the same time but due to trade-off they cannot. Simply stating, unemployed wants to re-employ again and already employed people want inflation to be at the lowest. Who is rational then, unemployed or already employed or both are rational.
  3. In the long run we are all dead, said by a biggie and people use it out of context J  most of the public (I am using here for general consumers)  has a myopic view and cannot or do not want to see what’ll happen after ten years. They want their rewards the next day. Some people do not believe my statement and they say that no we do not want our rewards the next day, “yes” they can wait for a year. But they always argue that what has happened in the last 20 years or so is not favorable for us and these are those people who do not have confidence in the government. Thus who are rational, those who do not believe in the government or those who believe in the government. Because when u don’t believe in the government then government cannot make the policies correctly because they had in mind that consumers are rational (irrational) and they believe don’t believe) us J.
  4. Continuing point three from where I started, i.e., Long Run. Does general public know what is long run or this word is used just to fool general public? Or if you do not know about long run then you are not rationalJ. Medium plans are made, long term 2010, 2020, and 2030 plans were made. But is it again the question whether people have confidence in government or not. Some people want quick money and some people think that 30 year is a long period and no idea whether they’ll live till then or not. Are these people Rational?
  5. There will be different points where we can ask whether consumer is rational? Trading in FOREX market when exchange rate is increasing. Buying stocks when it’s increasing. Most of the big investors do not think that it’s a good idea to buy when stocks are increasing. Thus are these people rational?

Continued…. With your comments


Omer said...

Ali, first of all you need to be clear what rationality means as used in neoclassical microeconomic theory. Most of the examples you've given relate to the policies by the government, which has little to do with consumer rationality. Besides, how can you say that a person buying rotten tomatoes is irrational? If someone buys rotten tomatoes from a poor vendor, from whom no one else is buying tomatoes, then the buyer may not be as irrational as the standard microeconomic theory might make him to be.

Farid said...
This comment has been removed by the author.
M Ali Kemal's Blog said...

Omer, I take rationality as the behavior of the people which includes the knowledge and information. I could be wrong totally.
Why would anyone buys rotten tomatoes from a poor vendor. Are you thinking of a philanthropist.