Post on 01-Jan-2016
178.307 Markets, Firms and Consumers
Lecture 9- The Consumer
Quote
Tough guys don’t do math. Tough guys fry chicken for a living.– Jaime Escalante– From the movie Stand and Deliver (1988).
Reading
Earl, P. Economics and Psychology: A Survey
In the 1990s
Nintendo’s N64 gaming console lost massive marketshare to the Sony Playstation
The N64 was the (technically) better console What motivated consumer’s to switch?
Introduction
Overview– Revision of the
Neoclassical Model– The Lancaster Model– The Behavioural
Approach
This lecture considers the important interaction between the firm and their consumers.
Emphasis is on understanding how consumer’s make choices.
The Neoclassical Model
If preferences are– Complete (any 2 goods can be compared)– Reflexive (any commodity is at least as good as
itself)– Transitive (if A preferred to B and B preferred to
C, A must be preferred to C).– Continuity, strict convexity, monotonic, free
disposal.
..then
It is easy to model the consumer’s utility function
We can logically show that demand is a function of prices and income
Problems– Smooth substitutions
don’t occur– Consumption may be not
be continuous (e.g. lexicographic).
– Why would new goods enter the market?
Lancaster’s Model
Lancaster treated goods as combinations of attributes.
The household functions like a firm.
If transformation technology fixed
If attributes have to be combined in a linear fashion then…
The model can be easily represented in Cartesian space.
Analysis
New goods can be represented as extra rays.
Price changes will change the length of the ray.
Quality improvements will also change length of ray
We can show “jumps” in consumer behaviour.
Proliferation of attributes in a good understandable.
We can answer why Nintendo lost market share…
Behavioural Perspective
Consumers use heuristics (simplifying procedures) to purchase a good.
Rules are retained so long as they lead to satisfactory results.
Simplification necessary because of limited processing ability.
Miller’s rule Cognitive skills Theorists distinguish
deliberative choices from routine behaviour.
Such decision processes may have little to do with impact of choice!
How do consumers actually make choices?
Consumers can be conceived as having certain aspirations.
Characteristics of goods are tested against these aspirations.
Compensatory heuristics permit good achievement in one characteristic to compensate for a poor achievement in another.
Compensatory Heuristics I
Additive Differences– Take a rival pair of
prodcuts– Value their diffferences– Use victor as a new
reference point– Continue until one good
selected
Unweighted Averaging– Score goods for each
test characteristic– Determine which has the
highest total or average– Note that unweighting is
a poor method.
Compensatory Heuristics II
Polymorphous Procedure– Define series of aspirational tests– Rank each good in terms of the number of tests
passed– Does not take into account the margin of
success/failure.
Non-Compensatory Heuristics
Non-compensatory procedures are unforgiving if a good fails a particular aspirational test
This suggests that substitution effects are actually weak.
Non-Compensatory Heuristics I
Disjunctive Rule– Choose the product that
scores the best in respect of one characteristic.
– Either very ‘low involvement’ or that preferred by a fanatic…
Conjunctive Rule– Set aspirational targets
for each characteristic– Reject any that fail to
meet any targets, regardless of margin.
Non-compensatory Heuristics II
Elimination by aspects– Compare goods against
a single aspirational level.
– Eliminate any that fail– Tests goods against
another aspirational target until choice is made
Lexicographic Rule– Characteristics are
ranked in order of priority– Use lower priorities only
if multiple goods meet first priority.
Non-compensatory Heuristics III
Characteristic Filtering– Set aspirational targets
for each characteristic– All products that pass
the first test, can take the second etc.
Target 1 1st Priority
Tar
get
2
2n
d P
riorit
yA
B
C D
E
Summary
Characteristic Filtering: D & E are 1st equal, B next, then A, then C.
Conjunctive Rule: D & E are 1st equal, A,B & C are equal
Naïve Lexicographic: E 1st , B 2nd , D 3rd , A 4th , C 5th.
Hybrid rules can also be used.