In order to model economic situations, economists make a number of assumptions in their analysis. One of the most intrinsic of these assumptions is that consumers are fundamentally rational and will seek to maximise their utility; they will not make decisions that leave them worse off. However , consumers don’t always act rationally, as this essay will show, and the rise of new technology in the form of contactless payment has placed further limitations on the validity of this assumption.
After being introduced in 2007, contactless payment has steadily become easier to use and more popular, with more and more stores now accepting it. Ten years after its introduction, the number of transactions using contactless technology exceeded that of cash payments; 13.2 billion contactless payments in 2017 versus 13.1 billion in cash (UK Finance, 2017). Previous economic analysis has suggested that the method of spending affects the consumers utility for a good or service (Huber, Payne and Puto, 1982), leading to the questions this essay will attempt to answer:
1) What impact does contactless payments have upon consumer behaviour?
2) What does this impact mean for the validity of the rational consumer assumption?
III. Rationality
Despite appearances, rationality is not on the side of the consumer; almost all actions undertaken by an individual seem rational from their perspective. In fact rationality comes from economists ability to predict the actions of consumers. If the decision made defies predictions, then we consider it irrational. Bounded rationality is the idea that the consumers rationality is limited by three unavoidable constraints; only limited and often unreliable information is available regarding alternative outcomes, the cognitive limitations of their minds, and the limited time available to make a decision (BusinessDictionary.com, 2018). This concept suggests that consumers act rationally to an extent, however there are limitations on their ability to do this. However even this doesn’t fully describe the processes by which consumers make decisions. Barker Scott (2013) argued that decision makers can be easily influenced, even blinded by a number of factors, such as perspective, need or socio-political forces. In some situations, interpretation follows choice; actions are taken and supportive reasoning follows.
Rationality argues that consumers have a fixed set of tastes and preferences, and they base their decisions on what corresponds to these preferences. However individuals are not isolated and the actions of others influence their decisions; they adopt different tastes or opinions simply because other people have them (Ormerod, 2012). The rise of social media has increased this effect greatly.
IV. Impact on Consumer Behaviour
A number of studies have been done on the effect the method of payment has on consumer behaviour. Loewenstein and Prelec (1992) suggested that the use of a card creates a ’mental decoupling’, where the disutility of payment is reduced. This disutility is a function of the wealth of the consumer; the disutility of a £100 payment is much higher to someone who only has £150 in their bank account than a millionaire. This is in contrast to cash payments, where the tangibility of cash creates an increased awareness to the actual transaction cost {Soman, 2001). More recent studies have placed specific focus on contactless payment (Runnemark, Hedman and Xiao, 2015) and findings indicated that method of payment can have a significant influence on the volume or frequency of purchases made, and that consumers can be led to spend more as a result of a less physical payment format (James, 2017).
By reducing the time it takes to complete a transaction, contactless payment reduces further the disutility of payment and the rationality of the decision made. Contactless cards and mobile payment technology also reduces the information available to the consumer at that moment; when using cash to make purchases, the consumer has an immediate knowledge of the amount of money they have to spend, and therefore whether the utility of the good they are purchasing exceeds that of their disutility of payment. However with less and less consumers using cash, there is a lack of information on behalf of the consumer of this disutility, as they are not immediately aware of their wealth. Mobile banking looks to solve this problem by making it very easy to check bank balances, some banks even send automated texts reminding consumers of their balance. However the majority of consumers only check their bank balance at certain times; specifically, when they are expecting good news and will avoid checking their account if they are expecting negative information (Olafsson and Pagel, 2017). This is not exactly rational; consumers are actively avoiding information that would help them make decisions.
The disconnect between a consumer and their wealth has been there ever since normal debit and credit cards have been introduced but the rise of contactless payment technology has increased it to new levels. Consumers can make purchases with a single tap of their mobile phone, negating even the need to carry a bank card on their person. This takes away the feeling that consumers are actually spending their money, leading to irrational purchases. Decisions are made without thought due to the speed and ease of use of this technology, and if consumers are acting first and using reasoning to support their decisions after the fact then the ability of economists to predict their behaviour is reduced greatly.
V. Validity of the Assumption
All these limitations, both old and new, of rationality call into question the validity of this assumption. There is a clear difference between the way we assume decisions are made and the reality of it. Rationality fails in describing the process by which decisions are made, and as this new technology becomes even more prominent in society, rationality will fail in predicting behaviour. Contactless payment encourages off the cuff, almost whimsical purchases that defy the assumption. In its current form, rationality should play a very limited, next to no role in non-academic economics, such as the shaping of policy, since it is an assumption that does not reflect reality. The theory of rationality has become a quest for generality, it attempts to predict the behaviour of all economic agents irrespective of the different socio-economic systems in which they reside (M. Hodgson, 2012). This is where the assumption truly fails in describing reality, as the process by which decisions are made are as unique to the agent as their own thoughts. Assuming they all follow the same process to reach a decision is clearly false, and attempting to create a general assumption is the wrong approach when dealing with reality.
However, it still has a place in academic economic theory as it is necessary to simplify reality in order to teach economic principles. It is useful as a control over variables in economic models, so long as these models are not being used to draw conclusions that are applicable in reality.
VI. Conclusion
Rationality is a flawed assumption even before taking into account limitations the rise in prominence of new technology, such as contactless payment have place son it. Contactless payment challenges the assumption in a number of new ways. It creates a disconnect between the consumer and their wealth, leading consumers to think less about the purchases they make; it reduces the information available to the consumer, reducing the extent to which they can make rational choices and its speed and ease of use increase the volume of purchases made. All these factors are examples of the method of spending affecting the behaviour of consumers, which completely defies rationality.
Due to both these new factors, as well as its previous failures, the assumption of rationality is one that does not hold in reality, and because of that, should not be used in a practical economic sense. Instead, rationality only really has a place in an academic sense as a useful control over variables and as a tool to simplify other economic principles that are being taught to aspiring economists.