The rational consumer theory is a frameworkfor understanding and modelling economic and social behaviour. The theorystates that consumers will always make prudent and logical purchases, resultingconsumer satisfaction within the specific nature of good selected. Thereby stating that consumers assess the optimal way to leverage theirpurchasing power, to maximize their utility and minimize opportunity coststhrough employing trade-offs. Interestingly, there are real world implications that may disprove the rational consumertheory, this is due aspects such as stress, anxiety, and time, which lead theconsumer to make illogical and irrational choices. “Ourirrational behaviours are neither random nor senseless; we all make the sametypes of mistakes over and over, because of the basic wiring of our brains” (Dan Ariely, Predictably Irrational – 2008).
Toexemplify the Budget Constraint, Figure 1 displays the rational decision makingof a consumer named Ashley, who is observing two different types ofrefreshments from a store. The consumer’s income is £50 a week, and the cost ofa Case of Coca-Cola is £5 whilst the Case of Pepsi is £2.50. Therefore, Figure1 illustrates the maximum bundle amount the consumer can purchase underAshley’s budget. For example, if Ashley spends his total income on Cases of Coca-Cola,then this would result in Ashley obtaining 10 Cases of Coca-Cola, furthermore,if Ashley decided to instead spend all of his income on Cases of Pepsi, then thiswould result in having 20 Cases of Pepsi. These two items can then be combinedas long as it is in the budget constraint.
If Ashley willingly sacrificed asingle Case of Coca-Cola, then he would be able to purchase two Cases of Pepsi,this is due to the slope of the budget constraint (A1) being -0.5= (-(10/20). As you can see in Figure 1, the budget constraint curve has now shiftedto the right (A2), this is due to there being a speical offer of 20% off theprice of Cases of Pepsi. This shallthereby increase Ashley’s budget constraint for Cases of Pepsi by 20%, thediscount leads to further benefits such as increasing the variety of bundlesthat can be combined with Cases of Coca-Cola, and this is due to him having 20%more to spend on Cases of Pepsi.
If his income was allocated equally at £25for both shops, the offer would result in him having £5 more to spend on Casesof Pepsi. However, this does not increase the amount of units purchasable of Casesof Coca-Cola (y-axis) in the budget constraint, as the offer is exclusive to Casesof Pepsi. There is also an indifference curve displayed in figure1, this curve shall exhibit all of the combinations of two products, which will yield the same level ofsatisfaction or utility to the consumer. Firstly, the curve is quite steep meaningthat the marginal rate ofsubstitution is high, so Ashley person would be willing to give up a very largeamount of y to obtain very little of x.
Ashley’s main objective whenchoosing what bundle to consume, is to reach the highest level of utility ,thereby achieving the highest indifference curve possible. Therefore, ifAshley gains a pay rise, then his net utility will rise, resulting in an upward shift on the indifference curve from (I1) to (I2), therebyincreasing consumption of goodsX and Y. When considering both the budget constraint andindifference curve, the ‘Optimal bundle point’ from Figure 1 is where thecircle situated, meaning that the optimal point will be when Ashley purchases20 ‘Cases of Pepsi’ and 2 ‘Cases of Coca-Cola’. Figure 1 further shows thateven though Ashley’s has not fully utilised the 20% discount applied to ‘Casesof Pepsi’, he has managed to allocate the optimal bundle of goods within this circumstance, in which shall providehim with the highest utility.Overtime,Ashley’s preference towards Pepsi and Coca Cola have become equal. Therefore, fromFigure 2, Ashley’s change in preference makes both of these products perfectsubstitutes, hence making the indifference curve linear. Ashley shall thereforetry to gain the highest possible utility at the best possible price for him; andthis is the point whereby he is able to purchase the highest amount of goodsgiven his weekly budget.
This is because the two products are perfectsubstitutes and therefore he will not have a preference regarding either good.For example, in Figure 2, we can see Ashley will gain the highest utility atthe point where line B2 intercepts the x-axis, as he will be able to get 25 Casesof Pepsi and zero Cases of Coca Cola, thereby exploiting the 20% discount applied. Thisis a demonstration of the continuity and convexity axiomatic assumptions beingbroken.