1.26 Alternative views of consumer behaviour

Assumptions of Consumer Behaviour

As we have previously mentioned, the view that the free market allocates resources efficiently based on allocating resources where Demand=Supply or the marginal benefit = marginal cost is based on the following assumptions.

Consumers act rationally -
Consumers have perfect Information -
Consumers aim to maximise their utility - Earlier we learn't that a rational decision maker aims to maximise their own utility for goods that they consume. For example, imagine if a consumer was presented with a choice between buying a sub sandwich, which gives the consumer 6 utils of satisfaction, or a burger for that gives 8 utils of satisfaction. If both cost $5, the the rational consumer will chose to consume a burger as this would give them the most utils for their $5.

Limitations to the assumptions of rational behaviour

Traditional economic theory assumes that individuals are rational decision-makers who act in their own self-interest, using all available information to maximise their utility (satisfaction). This model of behaviour underpins much of neoclassical economics, where consumers and firms are assumed to make consistent, logical choices.

However, real-world evidence suggests that people often behave in ways that deviate from pure rationality. They may make inconsistent, short-sighted, or emotional decisions. Behavioural economics seeks to explain these deviations by combining insights from psychology, sociology, and neuroscience with economic thinking. It explores how biases, heuristics (mental shortcuts), emotions, and social influences affect decision-making.

Common Biases in Decision-Making

Anchoring

Anchoring occurs when individuals rely too heavily on an initial piece of information (the “anchor”) when making decisions.
For example, when a retailer first lists a product at £100 and then discounts it to £60, consumers may perceive it as good value, even if £60 exceeds the product’s true worth.
Anchors influence decisions even when they are irrelevant or arbitrary, leading to distorted judgments in pricing, negotiation, and risk assessment.

Framing

Framing refers to how the presentation of information influences choices. The same information can lead to different decisions depending on how it is framed.
For instance, a doctor telling a patient that a treatment has a 90% survival rate sounds more reassuring than saying it has a 10% mortality rate, even though both statements describe the same probability.
Framing effects show that people’s decisions are sensitive to context and wording, not just factual content.

Rule of Thumb (Heuristics)

Because real-world decisions are complex and information is limited, people often use rules of thumb—simple mental shortcuts that save time and effort.
For example, consumers may assume that “well-known brands are better quality” or “bigger packs are better value.” While these heuristics can be useful, they can also lead to systematic errors or irrational spending.

Herding Behaviour

Herding occurs when individuals follow the behaviour of others rather than making independent decisions. This can be seen in financial markets, where investors buy or sell because “everyone else is,” leading to bubbles or crashes.
Herding may also explain why people choose popular restaurants, fashions, or social media trends. It arises from social pressure, fear of missing out (FOMO), or the belief that others know better.

Habitual Behaviour

Many economic decisions are habitual rather than the result of active reasoning. Once consumers form routines—such as buying the same coffee every morning or using the same energy supplier—they tend to repeat them automatically.
Habit formation reduces cognitive effort but may lock individuals into suboptimal choices. For example, consumers might fail to switch to cheaper utility providers simply out of habit.

Availability of Information

As mentioned above, rational decision-makers will have access to and will give importance to all information the same. However, we tend to give more importance to the information we have received more recently. This may be because we tend to remember more recent events or information rather than those from longer time periods. So if the consumer has recently been exposed to a lot of advertisements for a specific good, they may be more likely to choose that good over another due to this over exposure as opposed to the good being the best.

Alternative Concepts of Consumer Behaviour - Bounded Realities

Bounded Rationality is the idea that rationality is limited by the cognitive limitations of the mind and time available to make the decision. As a result decision makers act as satisfices, seeking a satisfactory solution rather than an optimal one.

Bounded Self Control assumes consumers are able to exercise self-control, but unable to do so with some decisions. For example some consumers continue to purchase goods and services even though they are aware of the law of diminishing marginal utility

Bounded Selfishness is most easily expressed as a concern for the well-being of others, e.g. giving to charities or helping a stranger, despite this expenditure offering no direct benefit to the consumer.

Imperfect Information is a situation where either buyers and/or sellers lack the necessary information to make an informed decision about the price or quality of a product

Choice Arcitecture

We briefly touched on Nudge Theory in the introduction to this course. Watch this short video below to understand a bit more what nudge is:

As we can see Nudging is used in our everyday life. From businesses to government policy makers, Nudge is a growing trend that aims to influence and change our decisions. As we have seen, this method is about influencing consumers to change their decisions and "nudge" them to a desired outcome. We can see from the video, schools placing healthy food in eye view improved healthy eating habits in school children.

Choice Architecture

Choice architecture is all about how we can design a particular environment to nudge people to the desired outcome. Governments can use choice architecture to change choices made by people in order to achieve the desired outcome. The following a methods governments can use to "nudge" through the way choices are presented to them.

Default Choice

Default choice is a choice that is made by default for the individual and does not require the individual to do anything. We often make choices based on habit or the "path of least resistance", that is, the choice that is the easiest and requires the least amount of effort. Therefore governments can use default choice options to induce people by making the desired outcome the default choice for people. An example of this, can be with organ donation. One study in the UK found that making the default choice for people to be organ donars rather than having people "opt in" increased registered organ donars by up to 80%.

Restricted Choice

Another option is for a government to limit individuals choices. For example, one study found that when individuals were limited to two options of waste and recycling (regardless of material), recycling levels increased. By restricting choices from for example 4 recycling bins (Plastic, Glass, Paper and metal) and a waste bin, to simply a waste bin and recycling bin, the choice is easier for the individual and therefore they are more likely to put the recycle than when faced with a higher number of choices.

Mandated Choice

Mandated choice is simply the government telling the individuals the choice they must choose. The individual still has the choice to do it or not, however, it is simply the mandated choice or not.

Case Studies

Case Study 1: Organ Donation and the Default Choice

One of the most notable examples of behavioural economics influencing UK policy is the introduction of the opt-out system for organ donation. For many years, the UK used an opt-in model, where individuals had to actively register as organ donors. Despite high public support for organ donation in surveys, registration rates remained relatively low. Behavioural economists argued that this was due to inertia and the default choice bias—people tend to stick with the pre-set option rather than take action, even when the action aligns with their values.

In response, the government introduced the Organ Donation (Deemed Consent) Act 2020, which established an opt-out system in England. Under this policy, all adults are automatically considered potential organ donors unless they choose to opt out. This small change in choice architecture shifted the default option while preserving individual freedom of choice. Early evidence from NHS Blood and Transplant suggests that the reform has increased public awareness and improved donor registration rates, while also normalising organ donation as a social norm. This policy represents a classic example of “libertarian paternalism”—guiding individuals towards beneficial behaviour without coercion.

Case Study 2: HMRC Tax Payment Letters and Social Norms

Another successful example of the UK government using behavioural insights comes from HM Revenue & Customs (HMRC). Each year, HMRC faces challenges in collecting tax payments from individuals and small businesses who fail to pay on time. Rather than relying solely on penalties or repeated reminders, the government’s Behavioural Insights Team (BIT)—often referred to as the “Nudge Unit”—tested a new approach based on social norms and herding behaviour.

The BIT redesigned the language used in tax reminder letters, including messages such as, “Nine out of ten people in your area pay their tax on time.” This simple addition encouraged compliance by appealing to individuals’ desire to conform to the behaviour of others. By highlighting that paying tax promptly was the socially typical action, HMRC triggered a psychological response that made late payment seem abnormal or irresponsible. The results were impressive: compliance rates increased significantly, with some trials showing up to a 15% improvement in payment rates, generating millions of pounds in extra revenue. Importantly, this nudge was highly cost-effective, requiring only minor wording changes to achieve substantial results.

Case Study 3: Pension Auto-Enrolment and Default Options

A further example of behavioural economics in UK policy is the introduction of automatic enrolment into workplace pensions, a policy that uses the default choice nudge to promote long-term financial wellbeing. Before its introduction, many workers—especially younger or lower-income earners—failed to join pension schemes, even though they acknowledged the importance of saving for retirement. Traditional economics could not easily explain this inconsistency, but behavioural economists identified the causes as inertia, procrastination, and present bias—the tendency to prioritise immediate consumption over future benefits.

To address this, the UK government implemented automatic enrolment under the Pensions Act 2008, which began rolling out in 2012. The policy requires employers to automatically enrol eligible employees into a workplace pension scheme, while still allowing them the freedom to opt out if they choose. By changing the default option from non-participation to participation, the reform leveraged individuals’ natural tendency to stick with the status quo. The results have been striking: pension participation among eligible workers rose from around 47% in 2012 to over 80% by 2023, significantly increasing long-term savings across the workforce.

This policy demonstrates how behavioural insights can be used to achieve major policy goals at low cost, without restricting individual freedom. It shows that by reframing choices and altering defaults, governments can help citizens make decisions that are in their own long-term interests—an idea central to behavioural economics and the philosophy of nudge theory.

Advantages and Disadvantages of Nudge Theory

Advantages of Nudge Theory

One of the main advantages of nudge theory is that it preserves freedom of choice. Unlike taxation or direct regulation, nudges do not force people to behave in a certain way. Individuals retain the ability to choose, but are gently guided towards decisions that are in their own best interests. This aligns closely with the libertarian side of the theory, maintaining autonomy while helping people make better choices. The automatic enrolment of workers into pension schemes is a clear example: employees are free to opt out, yet many remain enrolled because of the default setting.

Another strength of nudging is its cost-effectiveness. Many nudges require only minor adjustments to existing systems, such as rewriting a letter or redesigning a form, yet they can yield large behavioural changes. In the UK, the Behavioural Insights Team has shown that small interventions — for example, adding social norm messages to tax letters — can generate millions of pounds in additional revenue at very low cost to the taxpayer.

Nudges are also valuable because they help individuals overcome behavioural biases that lead to poor long-term outcomes. People are often affected by inertia, short-term thinking, or present bias — preferring immediate gratification to future benefits. By adjusting defaults or presenting choices more clearly, governments can help individuals act more consistently with their long-term interests, such as saving for retirement or improving their health. Moreover, because nudges are gentle and non-intrusive, they are generally more politically and socially acceptable than heavy-handed measures. Finally, the theory recognises that human beings are not perfectly rational decision-makers, as traditional economics assumes, but are influenced by context, emotion, and habit. In this sense, nudge theory offers a more realistic and humane model of policymaking.

Disadvantages of Nudge Theory

Despite these strengths, nudge theory is not without its critics. One major concern is ethical. Some argue that nudges manipulate people’s behaviour without their explicit awareness, raising questions about consent and transparency. If citizens are being subtly guided towards particular decisions, their choices may not be as free as they appear. This is sometimes called the “manipulation argument,” and it challenges whether libertarian paternalism truly respects autonomy. For example, individuals may not realise that defaults in pension schemes or organ donation registers are deliberately set to steer them in a particular direction.

Another limitation is that the effects of nudges are often small or short-lived. While they can produce measurable changes in behaviour, these changes may not persist once the novelty wears off or when individuals face stronger opposing incentives. Nudges are less effective for addressing complex, deep-rooted problems such as poverty or inequality, which require structural economic interventions.

There is also the slippery slope concern, which warns that allowing governments to shape behaviour, even gently, could justify more intrusive measures over time. Philosophers such as Glaeser (2006) and Hausman and Welch (2010) argue that the line between helping and controlling is a thin one. Governments could, in theory, use nudges to advance political goals rather than the genuine welfare of citizens, undermining the libertarian foundation of the approach.

A further issue is the lack of transparency. Nudges often work best when individuals are unaware of them, yet this can erode trust in public institutions. If people discover they are being subtly manipulated, even for their own good, they may become sceptical of government motives. Lastly, critics point out that nudges can only go so far when economic or social barriers exist. Encouraging people to eat healthily is limited in effectiveness if healthier foods remain unaffordable. In such cases, nudges may act as superficial solutions to deeper structural issues that require regulation, subsidies, or redistribution.

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