Economics, 3rd Edition

Th E

l C

FIGURE 5.21

Quantity

of food

Quantity of

luxuries

C

B

A

BC

1

BC

2

BC

3

I

1

I

2

I

3

Income–consumption curve

Income (

€)

Demand for

luxuries

Engel curve

Q

1

Y

3

Y

2

Y

1

A

B

C

Q

2

Q

3

---

126  PART 2  SUPPLY AND DEMAND: HOW MARKETS WORK

SUMMARY: DO PEOPLE REALLY THINK THIS WAY?

The standard economic model describes how people make decisions based on certain assumptions. It has 

broad applicability and can explain how a person chooses between cola and pizza, food and leisure, and so on.

At this point, however, you might be tempted to treat the theory of consumer choice with some scepti-

cism. After all, you are a consumer. You decide what to buy every time you walk into a shop. And you know 

that you do not decide by writing down budget constraints and indifference curves.

It is important to remember that the standard economic model does not try to present a literal account 

of how people make decisions. It is a model, and, as we first discussed in Chapter 2, models are not 

intended to be completely realistic. The model does have some merits; consumers are aware that their 

choices are constrained by their financial resources. Many, given those constraints, will do the best they 

can to achieve the highest level of satisfaction.

There is, however, considerable evidence that the SEM has limitations in explaining how consumers 

actually behave. We might like to think we behave rationally but research has shown that our ability to 

make judgements and decisions can be subject to systematic and consistent flaws – biases – that mean 

consumer behaviour as represented by the SEM is, at the very best, a limited model of consumer beha-

viour. Much of the research on this area has been inspired by the work of two psychologists, Daniel 

 Kahneman and Amos Tversky. Indeed, such has been their impact that Kahneman was awarded the Nobel 

Prize for Economics in 2002 (Tversky sadly died at the relatively young age of 59 in 1996). We now present 

a brief overview of behavioural approaches to consumer behaviour.