The Non-Rational Consumer in Economics

Economics is at the fundamental level a human science, premised on how people allot finite resources to produce and consume goods and services. This conception of human nature is, however, at odds with behavioural and social insights that suggest that humans are far more fallible and irrational when making decisions than traditional ideas of economics allowed for.

Classical economic thinkers, most famously Adam Smith, conceived of humans as a species fundamentally oriented towards self-interest and economic gain. In fact, Smith believed humans were Homo economicus, ‘economic man,’ and that it was human nature to make choices in a rational way that maximised economic gain. However, this was an extremely reductionist view of humans. Research into human psychology and neuroscience, and practical studies of people’s economic choices, have suggested that is impossible for humans to be rational, infallible or predictable all of the time, as we are subject to a number of conflicting impulses and imperatives, not all of which can be predicted or even understood rationally. 

As the philosopher Immanuel Kant put it, “From such crooked timber as humankind is made of nothing entirely straight can ever be built.” Thus, assuming that humans’ economic behaviour is based on rational patterns of profit maximisation and cost minimisation, with no scope for error or aberration, is an inherent fallacy.

A few theories, even in traditional economics, have been based on a more realistic idea of human agency; for example, the backward bending supply curve of labour is a model that depicts people choosing to work less at higher wage rates. While this makes sense from a practical point of view, it would be against the assumption that humans always choose to maximise profit, as working more at higher wage rates would logically be the way to do so. This indicates that other factors apart from pure profit motivate humans’ economic activity.

Essential values that govern humans, such as altruism, charity, and a desire for something more than just work, are ignored in traditional economic models. Similarly, as consumers we may make decisions that needn’t minimise our cost or economic gains, but rather, be governed by other factors such as tastes and preferences, the impact of others’ purchase decisions, and the belief that products that command a higher price must be better in quality. Our rationality, which in reality is bounded by all these factors, is incorrectly assumed by Adam Smith and others to be infinite.

Behavioural economics is a newer field of economics that takes as its basic assumption the fact that human rationality is necessarily bounded and that their actions are not always predictable. There have been several studies and incidents that corroborate the basic model of behavioural economics, including the recent GameStop short squeeze incident.

GameStop is a video game retail company that several hedge funds had bet against on the stock market in early January 2021, as it was seen as too volatile and not sufficiently cutting-edge to become profitable. However, they underestimated the power of individual investors who, prompted by social media like Reddit, invested in GameStop stock while it was selling at a discount, and expected to drop even further. However, this increase in demand caused a rise in the stock price, as the company’s value increased twelve-fold. This was celebrated as a victory of small investors and businesses over hedge fund behemoths.

This incident was an illuminating example of behavioural economics in action. The individuals who invested in GameStop while it was trading at a discount, fully aware that it could drop further, were acting contrary to their own economic self interest. However, they were driven by equally compelling motivations - the demonstration effect of thousands of others on Reddit who were buying GameStop stock, the nostalgia for declining small businesses and retailers like GameStop, and a desire to disrupt the existing and unfair power dynamics of Wall Street. 

Allowing for non-rationality in economic behaviour may make it harder to predict exactly what entities like consumers, producers and investors are likely to do. However, this does not necessarily lead to chaos in the economic system. It opens up scope to move beyond profit maximisation, allowing for more humane values and general acknowledgement of human fallibility, which could in turn be a powerful impetus to bring about change in the economic system. 

Image credits: By Mike Mozart from Funny YouTube, USA - GameStop, CC BY 2.0, https://commons.wikimedia.org/w/index.php?curid=89854717