The concept of Rationality, as defined for firms, is the objective of maximizing profits. In the realm of householders or consumers, this term is much more difficult to define. The problem lies in the fact that consumers are humans and not abstract ‘economic units’. If the conventional definition ‘maximization of utility with a given income’ is used, a certain idea is evaded - ‘To err is human’. The fact is, we as humans have a certain subjectivity to us which prevents the recognition and discernment of ‘right choices’ on any uniform basis and often we live to regret our choices. As Neo in The Matrix: Reloaded put it, “Choice. The problem is choice”. So, how does economics come to terms with this problem? Simple. It creates this concept called ‘utility’ and supposedly each one of us is a perpetual utility calculating machine which solves single utility functions every moment of our existence. The utility calculus was complicated further with the introduction of another variable – “rational expectations” (the belief that agents know everything there is to know about their choices). A reasonable amount of thought reveals that such a single-dimensional view of human beings conceals many other motivations which do not fall under the ambit of ‘purposeful decisions based on considerations of means and ends’. Even if one momentarily silences the likes of Amartya Sen who termed such agents of economic theory “rational fools” and believe that there is no such thing as altruism or commitment, the problem of rationality refuses to go away. The following critique of rationality is on two fronts – 1) information problems and bounded rationality make it impossible for “rational expectations” to exist and 2) “market failures” because of the failure of rationality and the case for governmental intervention.
In standard optimizing theory, agents act as if they perform all exhaustive searches over all possible decisions and then make the optimal one. Anyone who has ever shopped for that ubiquitous product, a widget, will know that this is hardly possible. As Simon hypothesized, instead of exhaustive searches, agents perform limited searches, accepting the first satisfactory decision. This ‘satisficing’ hypothesis provides an insight to decision making processes undertaken by consumers. The simplest explanation for this phenomenon comes from the most traditional economic tool – a cost-benefit analysis. The marginal cost of a search beyond the first satisficing widget far exceeds the marginal benefit as perceived by the consumer. This explanation is further strengthened by the empirical claim that as the Price or Benefit of a product increases, the tendency towards exhaustive searches increases. Consider the purchase of a digital camera, a laptop, a car and a house, and in the same order. An increasing order of willingness to expend time will be noticed among the products in question. Coming back to the question of rationality, an interesting hypothesis comes to the fore: Rationality of choice is directly proportional to value of goods and services in question. The popular notion of rationality being a constant within individuals and a variable across them is open to question. A more feasible proposition is that rationality is variable within individuals and its existence in all of us is the only constant. Another consequence of this kind of thinking is that there aren’t ‘irrational’ individuals, just that their rationality is based on a different preference set. The rational criminal hypothesis is a good example of this line of thought.
An idea related to satisficing is sub-optimization: a decision maker who finds optimization impossible or unduly costly may solve a simpler or more approximate optimization problem. Because errors due to sub-optimization in one period may call for adjustment in the next, it is natural to embed sub-optimization in a dynamic context which generates feedback. This feedback leads to an action yielding greater benefits the being the choice, the next time a similar situation arises. Also known as “recursive programming”, this theory was formalized by the John Cross and (1973,1983) and Susan Himmelweit models of stochastic choice. In these models, an agent chooses at random among a list of possible actions, where the choice probabilities evolve according to the historical evolution of the performances of the choices.[1] Such a theory seems demeaning to the discerning faculties of consumers and it may be one end of the spectrum of decision making processes which the human behavior exhibits. Many more theories from psychology seem to reinforce this apparent incapability of human behavior – whether it be cognitive dissonance, refusal to take risk and susceptibility to external influence (here is where the Salesman of Malcolm Gladwell’s The Tipping Point comes in). Based on these idiosyncrasies of human behavior, other models like the interacting agent model argued for by Paul Ormerod in his book Butterfly Economics have come to the fore. If nothing else, these alternate models present a more complete picture of reality than the distorted version often presented by economists.
The information problem is not one particular to the consumers only – the problem exists, in perhaps even more frightening proportions on the Supply side as well.
It is quite meaningless to talk of a businessman’s expectations without explicit consideration for information. In fact, it is here that the importance of information as a cost factor comes back. We may regard an entrepreneur who knows everything about costs, prices and demands to be completely informed, even though he knows nothing about say, oriental art. The very small chance that an advertising idea based upon oriental art may change the demand conditions in the trade can be regarded as an effect of the second order magnitude.[2]
While on the point about advertising, a number of troublesome examples crop up. A relatively recent controversy involved soft drinks in India – Pollution Monitoring Laboratory of the Centre for Science and Environment, a prominent environmental organization based in New Delhi released shocking results of toxic pesticides in concentrations up to thirty-six times higher than those permitted by the European Economic Commission being found in twelve soft drink brands. To add to the conundrum was the fact that the Pollution Monitoring Laboratory found no pesticide residues in bottles of the two soft drink brands, Pepsi and Coke, sold in the United States[3]. As sales dipped and protests grew, both multinational giants adopted the strategy of ‘reassurance’ ad campaigns to win back their consumers. In fact, the companies took the pains of explaining in full page ads the purification process which they undertook before releasing their products into the market. A similar exercise was carried out by Cadbury India, when reports of worms being found in the chocolate began to affect sales[4]. Using the image of the sixty year old legendary actor Amitabh Bachchan handing these chocolates to his grandchildren, the brand sought to win back the trust of its consumers (children). Needless to say, the sales of Cadbury chocolates, Pepsi and Coke were back to pre- Together, these two examples serve to establish the direct ling between information and demand for a product, already emphasized earlier.
Some different results were achieved by food advertisers in US during the ‘80s. The strategy of targeting kids as consumers spawned a whole slew of advertisements during the Saturday morning time slots meant for children’s programming. Moreover, 95% of the 10,000 food commercials children saw each year were for foods high in sugar and/or fat, as total advertising expenditures tend to be highest for convenience food, confectioneries, snacks, and soft drinks. Health experts believe that constant promotion of high-calorie food have and are still contributing to the epidemic of childhood obesity in the United States by encouraging preferences for junk food and contributing to poor eating habits. The effect of this creation of preferences for high-calorie food can be gauged from the fact that kids influence an estimated 72% of family food and beverage purchases. So the resulting obesity is not just limited to the kids but their parents as well. National figures indicate that 25% of children and adolescents are overweight and that 50% have a chance of becoming overweight during their lifetimes. Greg Critser explains this phenomenon in his book Fat Land and pegs this as one of the many reasons because of which ‘Americans becoming the fattest people in the world’.
Today’s advertising agencies have taken their cue from their predecessors and have used the fact that parents’ preferences could be changed through advertising for children to devastating effect. The best example is the seemingly mindless advertisement for cars during children’s programming. So profound is the influence of these ads on nine year olds that parents been found to bend not just to their choice of the car color, but the brand of the car itself – so much for endogenous preferences and single utility functions.
Several other studies also link children’s beliefs about drinking to alcohol advertising. One study found that alcohol advertising can actually shape the drinking expectations of children by the time they are ten years old. Children who are more aware of television beer commercials have more favorable attitudes toward drinking, greater knowledge of beer brands, and an increased intention to drink as adults. Alcohol advertising seeks to associate drinking with desirable qualities or pleasurable experiences, frequently portraying alcohol consumption as a common—if not necessary—part of recreational activities and sporting events. These messages may encourage underage drinking by appealing to young people.
Aside from teenagers and young adults, alcohol advertising can appeal to very young children. For instance, the Budweiser frog campaign introduced in 1995 during the Super Bowl was highly recognizable among children. In just over a year, children’s familiarity with the frogs’ “Bud-weis-er” slogan nearly equaled their recognition of Bugs Bunny’s signature greeting (“What’s up, Doc?”). The children could also recall the Budweiser slogan more frequently than slogans from commercials shown during children’s programming, which feature characters such as Tony the Tiger and the Mighty Morphin’ Power Rangers. In 1996, children named Budweiser beer commercials as among their favorite advertisements. Although recognition disparity between the Budweiser frogs and Saturday morning characters may come as a surprise, most children watch television during the hours of 7 and 8pm, illustrating how easily alcohol advertising reaches underage television audiences. This does not include the involuntary exposure they get from billboards, magazine ads, and promotional materials, such as clothing and novelty items. [5]
Tobacco advertising, even though banned on television seems to be quite successful in reaching children, considering that 90% of all young smokers choose the three most heavily advertised brands.24 A 1993 survey revealed that Marlboro decreased in adolescent popularity by almost 9%, while Camel gained more than 5%, fluctuations directly coinciding with the respective companies’ brand-specific advertising expenditures. This shift in preference also coincided with the introduction of Old Joe Camel’s cartoon image, which has become widely familiar among young children. Studies have found more than 90% of six-year-olds can match Joe Camel with pictures of a cigarette, making him as well known as Disney’s mascot, Mickey Mouse.
When statistics such as the one stated above start to blip on the social radar, it can be safely concluded that there has been a market failure and the equilibrium produced is sub-socially optimum. In the haste to take corrective measures, the link between lack of information, irresponsible advertising and market failure cannot be forgotten. It is the vacuum created due to the inability of human cognition to process the plethora of information, and the resulting tendency to satisfice which is filled in, by advertising. In fact, it is probably unfair to lay the blame at the human mind’s doorstep. The sheer impracticality of being able to sift through the sea of choices in the market is heightened by the premium modern man places on time. And to queer the pitch further, profit maximizing businesses seek to create new markets, namely children, in spite of the cognizance of the spillover costs.
In light of all these factors and conditions, it is but obvious that the State needs to step in, and bring about changes to the allocation of goods so that a social optimum is achieved. Often that translates economically to taxes being imposed and the market itself being forced to pay for the externalities. For all the hue and cry that proponents of a free market make, it is ultimately the State which bears the costs of an unhealthy society. For a country where 25% of the population is overweight, and 3000 kids below the age of 18 start smoking every day, it would be suicidal to suggest that the State should stay out of the picture. After all, it is the smokers, drinkers and obese who are indirectly raising taxes, costs of healthcare and insurance. Taxation of these markets serves a dual purpose – that of being a disincentive to teenagers who are not financially capable of sustaining the high costs as well as the retrieval of costs necessary for the purposes of healthcare during old age. The goal which taxation does not solve is one of bridging the lack of information or disinformation. For this goal, the government needs to adopt a different role. For advertising agencies and the like, it has to be a watchdog, instituting checks and balances to ensure that the target audience does not include children. For the consumers, it needs to act as an education dispenser, allowing access to critical information which could affect the decision making process of the agent. The conclusion of all these suggestions is that reliance on human rationality and the “invisible hand” can at best, provide outcomes which are sub-optimal and at worst, ones which are devastating. Either way, the onus is on us, members of a society, to come up with better solutions – Our lives are on the line.
[1] Conlisk, John. Why Bounded Rationality Journal of Economic Literature, Vol.34 No. 2 (June, 1996) 669-700
[2] Gerard, Bill, Beyond Rational Expectations: A constructive Interpretation of Keynes’ analysis of behavior under certainty The Economic Journal Vol 104 No. 423 (Mar 1994) 327-337
[3] http://www.newfarm.org/international/news/080103/081103/in_pest_drinks.shtml
[4]http://www.domain-b.com/companies/companies_c/cadbury_india/20031128_worm.html
[5]http://www.mediascope.org/pubs/ibriefs/cha.htm
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