Discussion of potential violations of the standard, rational, utility-maximing consumer from introductory microeconomics

1. Violations of rational utility-maximization: Where standard economics breaks down

2. Assumptions of the Standard Economic Model of Consumer Behavior People have known preferences. People act with full information. People choose rationally so as to maximize utility. Full Internal Knowledge Full External Knowledge Maximizing Choices

3. It is relatively easy to adjust models for violations of assumption 2 People have known preferences. People act with full information. People choose rationally so as to maximize utility. Full Internal Knowledge Full External Knowledge Maximizing Choices The first two are simple informational deficiencies. Correct information (experimentation, education) cures the deficiency.

4. Violating rational choice to maximize utility is the problem People have known preferences. People act with full information. People choose rationally so as to maximize utility. Full Internal Knowledge Full External Knowledge Maximizing Choices There is no easy “cure” when this assumption is wrong. The model just doesn’t work in those cases.

5. Let’s look at some examples We will look at some examples of different people. Think about whether or not the person is acting rationally to maximize his or her utility (well-being; happiness; satisfaction). I’ll ask your opinion at the end of each.

6. Example 1 http://www.youtube.com/watch?v=AkvdEoM4Uqs from 5:05 to end

7. Rationally maximizing utility? Do you think the previous person was acting rationally to maximize her utility? Yes Probably I have no idea Probably not Definitely not

8. Example 2 http://www.youtube.com/watch?v=_7ltjqBn8K4

9. Rationally maximizing utility? Do you think the previous person was acting rationally to maximize her utility? Yes Probably I have no idea Probably not Definitely not

10. Example 3 http://www.youtube.com/watch?v=OswtLmGX9bw

11. Rationally maximizing utility? Do you think the previous person was acting rationally to maximize his or her utility? Yes Probably I have no idea Probably not Definitely not

12. Example 4 First 1:50 of http://www.youtube.com/watch?v=kOPOK24g9Cc

13. Rationally maximizing utility? Do you think the previous people were acting rationally to maximize their utility? Yes Probably I have no idea Probably not Definitely not

14. The impact of these examples While these examples may seem extreme, consider the associated societal problems … Obesity Addiction HIV/STDs Violence Do you see how these “exceptions” to the rule are not minor issues?

17. Costly choice removal Will people willingly paying more money to remove an option? $1,000 $500

18. Costly choice removal Do people checking into a drug rehab program know that the drug will not be available?

19. Costly choice removal Do people attending a weight loss camp know that their favorite foods will not be available?

20. Costly choice removal Will people fighting alcoholism pay money to take Antabuse (disulfiram), a drug that causes alcohol to be nauseating?

21. Costly choice removal Do people ever choose to drive the longer way home in order to avoid being tempted?

22. Costly choice removal Or the person would not make utility maximizing choices in the presence of this option. Either this choice is not utility maximizing $1,000 $500 ≤

23. Costly choice removal contradicts simple rational utility maximization If I would make rational choices in the presence of the option Then paying for choice removal is an irrational act It is because I would NOT make rational choices in the presence of the option If paying for choice removal is NOT an irrational act

24. Homo Economicus v. Homer Economicus “The falseassumption is that people always make choices that are in their best interest. This claim is either tautological, and therefore uninteresting, or testable. We claim that it is testable and false—indeed, obviously false.” Thaler, R. (U. Chicago), & Sunstein, C. (U. Chicago), 2003, Behavioral economics, public policy, and paternalism: libertarian paternalism. The American Economic Review, 93(2), 175–179.

25. Conclusion Most people understand that we do not always make rational choices that are utility maximizing. The widespread presence of costly choice removal is a specific example indicating that people often do not make rational utility-maximizing choices.

26. Slides by: Russell James III, J.D., Ph.D., CFP® Associate Professor Division of Personal Financial Planning Texas Tech University russell.james@ttu.edu Please use these slides! If you think you might use anything here in a classroom, please CLICK HEREto let me know. Thanks! The outline for this behavioral economics series is at http://www.slideshare.net/rnja8c/outline-for-behavioral-economics-course-component