Do consumer s tastes differ final 1.7. - HEC

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D O C ONSUMER’ S T ASTES D IFFER? Utility Theory and Preferences 2 What are the ultimate reasons for consumption? Clearly, the most important reason is a physiological need. But once this is satisfied, human beings strive for psychological and physiological well-being, which might include any satisfaction of non-basic needs or even consumption for prestige reasons. The development of research on preferences started by analysing consumption behaviour using utility theory and was further developed to the revealed preference theory, this process is described below. Analysis of marginal utility The idea of analysing marginal utility in order to understand consumption behaviour dates back to the 1870s. It is a cardinal measurement of utility, which implies an order of goods and indicates differences in utility and their relation; for example, one good can be regarded twice as useful as another one. As this is only the case for very specific goods, this theory might not be appropriate. Analysis of indifference curves Pareto (1906) found that it is not necessary to use an ordinal measure, so that it became possible to replace the cardinal measure by an ordinal one, which implies a subjective evaluation of goods or their combinations. This change introduces the possibility of establishing an order of preferences. Its intensity, however, is not determined. The further development has led to the concept of indifference curves, a geometrical design of ordinal utility. Although this approach has been developed by including more subjective measures, it is not yet perfect. Weak points for example are the non-observability of utility, the assumption of perfect information of individuals, the fact that isolated individuals are analysed and are considered to only be influenced by price and income. Additionally, the hypothesis of utility maximisation has not been confirmed in empirical results and it is assumed that indifference curves are commonly known in order to derive individual demand curves. Analysis of revealed preferences Samuelson (1938) has introduced a new approach to preferences: he derives a consumer’s demand not from utility aspects, but from decisions taken on the marketplace, therefore being called behaviouristic or revealed preference theory. Up to now it is the only theory trying to respect an empirical verification of results. Even though indicating an ordinal scale, the revealed preference theory is aiming at avoiding both cardinal and ordinal measures, focusing on observable indicators like income, prices and bought amounts of goods. The subject being analysed is the household, considered as a decision- making unit. The household will consume a certain amount of material or non-material goods (services, rights,…), the amount being constant over the timeframe of the observation. The household has a specific income, which does not vary during the observation, but may change from situation to situation. The subject wants to reach a maximum level of satisfaction with a given level of income. The revealed preference theory reckons that a consumer’s demand behaviour gives information on his structure of preferences; the reasons for favouring one good or a combination of goods are not of interest. Given the purchasing decisions, the household’s preferences are deducted. A preference is interpreted as observed behaviour; an assumption of a correspondence of consumer behaviour and its system of values is considered superfluous. 2 This section summarises A. Ihnen, Die Revealed Preference–Analyse – Darstellung und kritische Würdigung, 1983, giving further explanations from Varian, H.R., Intermediate Microeconomics: A Modern Approach, 2nd ed., 1990, Norton International Student Edition B EKE T INNEBERG 3 19 MARCH 2003
D O C ONSUMER’ S T ASTES D IFFER? To illustrate this approach, one can refer to a product, which is revealed preferred to another one as the observation of it being chosen over the other one, although it was affordable. Figure 1 In figure 1, X was observed to have been chosen over other product bundles in the dark shaded area, which are therefore considered as worse bundles. Y and Z were observed to have been chosen over X, and are therefore considered revealed preferred to it. All the weighted averages of Y and Z can also be seen as revealed preferred to X. Therefore, the indifference curve must lie somewhere in the region between the two shaded areas. Consequently, this approach provides a possibility to trap the indifference curve quite tightly simply by using observations rather than any specific measure. Even though the revealed preference theory is the most modern one, there are still some weak points to be identified. As only a single household is analysed, the revealed preference analysis does not give any implications on a general market demand function. And in fact, it does not lead to conclusions additionally to the ones already found by the first two theories. B EKE T INNEBERG 4 19 MARCH 2003
Page 1 and 2: Beke Tinneberg Macroeconomic Modell
Page 3: Tastes are the same. Are tastes rea
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