178 307 Markets Firms and Consumers Lecture 9

178. 307 Markets, Firms and Consumers Lecture 9 - The Consumer

Quote l Tough guys don’t do math. Tough guys fry chicken for a living. – – Jaime Escalante From the movie Stand Deliver (1988).

Reading l Earl, P. Economics and Psychology: A Survey

In the 1990 s l l l Nintendo’s N 64 gaming console lost massive marketshare to the Sony Playstation The N 64 was the (technically) better console What motivated consumer’s to switch?

Introduction l Overview – – – Revision of the Neoclassical Model The Lancaster Model The Behavioural Approach l l This lecture considers the important interaction between the firm and their consumers. Emphasis is on understanding how consumer’s make choices.

The Neoclassical Model l 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 l l It is easy to model the consumer’s utility function We can logically show that demand is a function of prices and income l 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 l l Lancaster treated goods as combinations of attributes. The household functions like a firm. l l l 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 l l l 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 l l l We can show “jumps” in consumer behaviour. Proliferation of attributes in a good understandable. We can answer why Nintendo lost market share…

Behavioural Perspective l l l 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. l l 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? l l Consumers can be conceived as having certain aspirations. Characteristics of goods are tested against these aspirations. l Compensatory heuristics permit good achievement in one characteristic to compensate for a poor achievement in another.

Compensatory Heuristics I l Additive Differences – – Take a rival pair of prodcuts Value their diffferences Use victor as a new reference point Continue until one good selected l 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 l 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 l l 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 l Disjunctive Rule – – Choose the product that scores the best in respect of one characteristic. Either very ‘low involvement’ or that preferred by a fanatic… l Conjunctive Rule – – Set aspirational targets for each characteristic Reject any that fail to meet any targets, regardless of margin.

Non-compensatory Heuristics II l Elimination by aspects – – – Compare goods against a single aspirational level. Eliminate any that fail Tests goods against another aspirational target until choice is made l Lexicographic Rule – – Characteristics are ranked in order of priority Use lower priorities only if multiple goods meet first priority.

Characteristic Filtering – – Set aspirational targets for each characteristic All products that pass the first test, can take the second etc. C D E Target 2 l 2 nd Priority Non-compensatory Heuristics III A B Target 1 1 st Priority

Summary l l Characteristic Filtering: D & E are 1 st equal, B next, then A, then C. Conjunctive Rule: D & E are 1 st equal, A, B & C are equal Naïve Lexicographic: E 1 st , B 2 nd , D 3 rd , A 4 th , C 5 th. Hybrid rules can also be used.