Question

An individual consumer in the neoclassical theory is assumed to be ‘rational,’ ‘isolated,’ and ‘representative.’ (i) Explain the meaning of a rational, isolated, and representative consumer; and (ii) explain why such a hypothetical individual consumer is needed in the neoclassical theory of consumption.

Answer 1

1. The assumption with regard to a rational consumer refers to a theoretical proposition where each individual consumer has full information about the market and is in a position to weigh all options available to her and the consumer is aiming to maximize utility from the transaction.

Isolated consumer refers to the assumption that the consumer makes a purchasing decision based on her own preferences rather than being aligned to preferences of the other consumers in the market.

Representative refers to the assumption that a rational consumer represents the market and aggregate of preferences of consumers may define market demand.

2. Such a hypothetical consumer is needed in the neoclassical market situations for the following reasons-

A. The neoclassical consumption theory assumes consumer decision to be based on perception of marginal utility i.e. the consumer is aiming to maximize marginal utility so the assumption of rational consumer.

2. The neoclassical consumption theory assumes prices are based on the perceived value of the product for the consumer and not determined by the costs and market demand alone. The individual consumers may be willing to pay different price for the same quantity of a good based on their perceived utility from the transaction. This is referred to the assumption of isolated consumer.

3.The neoclassical consumption theory derives the market demand for a product through the aggregation of individual demand and also takes in to account individual responses to demand in the event of price variations i.e. elasticity, so it assumes that the individual consumer is representative of the market demand and preferences.