Assess the main criticisms which may be made of the orthodox theory of consumer behavior. Briefly Comment on any modifications to the theory that you would suggest.

Figure 1.1 Positive Network Externality: Bandwagon Effect

The quantity of the good demanded grows in response to the growth of purchases by individuals. The demand for a good shifts to the right from Da to Dd due to the Bandwagon effect as the price of the product falls from $Yn to $Yo.

Figure 1.2 Negative Network Externality: Snob Effect

The quantity of a good that an individual demands falls in response to the growth of purchases by other individuals. The demand for the good shifts to the left from Da to Dd as the price falls from from $Yn to $Yo and more people by the good.

Although standard neoclassical economists would argue that advertising just additionally informs consumers about products and improves efficiency of markets by ensuring that markets operate on full information, opposition to the theory of consumer behavior would claim that advertising has a dominant influence on consumer choice by changing consumer preferences rather than providing objective facts. The theory of consumer behavior would argue that an extra pound spent in one direction provides the same amount of satisfaction spent in any other way on the utility curve. The more sensitive the consumer is to price change (i.e. the greater the elasticity of the demand curve), the smaller the margin of cost for the firm hoping to maximize profits. Thus, a firms’ desire to raise the price of its product will be offset by its recognition that it will lose substantial sales if it does so. Firms are, however, able to effectively reduce the price elasticity of demand for their products by creating psychological dependence through advertisement.  Achieved through the Bandwagon effect or by increasing market power by offering competitive services and reducing competition as a result of consumer loyalty in the long run, advertising influences purchases by reducing the set of goods consumers regard. Purchases are thus determined by the role of advertisement rather than consumers maximizing a fixed utility function subject to known constraints.

        In its assumptions, the orthodox theory of consumer behavior assumes that individuals optimize their choices, have the necessary information to make a decision of what to consume based on preferences, and that nothing else limits their actions other than their budget constraint. “Man, however, is a developing, learning, and social animal and it would be absurd to assume that the preferences of a consumer are fully known and that they remain unaffected by time and the environment.”  Critics of the orthodox theory, however, point out that the set of available goods and services is continually changing, that knowledge is partial, expensive, and unreliable and that consumers’ own tastes evolve as their age or marital status changes. A large proportion of consumers are members of multi-person households who are limited in their decisions by the attempt to satisfy more than one person in their spending. Optimization in the sense that all possible alternatives are considered and the best possible is chosen to maximize utility. In the words of Nobel laureate Herbert Simon, however, consumers are “satisfiers not maximizers.” This would imply that consumers work partly on the basis of “satisficing” or repeating satisfactory purchases until something goes wrong or on the basis of trial and error by exploring their reactions to products they have not previously tried.  This commonplace and frequent everyday behavior of a shopper goes against the underlying principles of the orthodox theory of consumer theory and is thus legitimate grounds for its criticism.

        Consumer behavior is also known as the standard rational choice model. As its name implies, this model assumes that individuals behave in a rational manner evaluating events in terms of their overall effect on total wealth and maximum utility. Numerous examples of human behavior, however, contradict the predictions of the standard rational choice model because as many psychologists would argue, that behavior is the result of limitations in human cognitive capacity. These behaviors are also known as the rational (Orthodox theory) model and behavioral (how people actually think) models. People often use mental accounting systems that reduce the complexity of their decisions at the expense of consistency with the axioms of rational choice. Unlike the orthodox model, people tend to give losses much heavier decision weight than gains. Decisions under uncertainty also often violate the prescriptions of the expected utility model. People tend to be risk averse in the domain of gains but risk seeking in the domain of losses. In addition, the orthodox theory fails to account for purchases that are neither planned nor calculated but are due to sudden urges and serve no rational purpose. Due to unpredictable human behavior and peoples’ “incapability to act like rational human beings”, the orthodox theory again fails to account for all behaviors of consumer traits.

        The orthodox theory of consumer behavior is a microeconomic model that represents a simplified description of the reality in order to concentrate on the underlying principles of an individual’s utility, budget constraint, and consumer demand. Although the theory fails to account for network externalities, role of advertising, and irrational human behavior, it is successful in providing a general picture of how individuals consume. It would probably be beneficial if the orthodox theory attempted to incorporate some aspect of impact of network externalities and role of advertising into its assumptions, but due to the many variations of these influences, it would probably be extremely difficult to establish a generalization for the impacts since they would vary depending on the type of goods and time. Due to varying individual circumstances and irrational behavior of each consumer, it would be even harder to establish a common basis to include in the theory because it would vary with time, environment, and goods. Behavioral models of choice may be more successful in predicting actual decisions compared to the rational choice model, but have no normative significance. The rational choice model that dictates how a consumer should behave, however, at least implies what would be beneficial to the individual, even though the latter would not be able to react accordingly as a result of limited cognitive capacity and social circumstances.  Due to complex social behavior and varying time, environment and social structure, a changed orthodox theory would again remain inexact and thus again criticized. As a result, it would probably prove best if the theory was not modified but remained continually criticized since it is from these criticisms that an economist discovers how consumer behavior truly functions.

Bibliography:

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Cowling, Keith. „Advertising and the Economic System“. The Economic Review. May 1985: p. 2 – 6.

Frank, Robert H. Microeconomics and Behavior. 4th ed. Boston: Irwin/McGraw-Hill, 2000.

Green, John H.A. Consumer Theory. Middlesex, England: Penguin Books Ltd, 1971.

Katz, Michael L and Rosen, Harvey S. Microeconomics. 3rd ed. Boston: Irwin/ McGraw-Hill, 1998.

Leibenstein, H. „Bandwagon, Snob, and Veblen Effects in the Theory of Consumers‘ Demand“ in  Breit, W and Hochman, H. Eds. Readings in Microeconomics. New York: Holt, Rinehart, and Winston, Inc., 1971.

Pindyck, Robert S and Rubinfeld, Daniel L. Microeconomics. 4th ed. New Jersey: Prentice-Hall, Inc., 1998.