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.