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T H O U G H T Q U E S T I O N S
1.Many economists consider behavioral economics to be an affront to the field of economics for its focus on irrational behavior. Others consider anomalies to be so rare as to make the study of behavioral anomalies irrelevant. Do rational and behavioral economics work against each other? What role might each play in describing economic decisions? What does Occam’s razor have to say about the relationship between rational and behavioral economics?
2.Describe a behavior either you or a friend has engaged in that you would describe as irrational. Why would
you consider this behavior irrational? What was the motivation for engaging in this behavior?
3.Why has behavioral economics come to be so heavily associated with experimental economics? Why might econometric approaches to behavioral economics be so challenging?
4.Describe the difference among rational, procedural rational, and behavioral models of economic decisions.
R E F E R E N C E S
Conlisk, J. “Why Bounded Rationality?” Journal of Economic |
Simon, H.A. “Rationality as Process and as Product of Thought.” |
Literature 34(1996): 669–700. |
American Economic Review 68(1978): 1–16. |
Nicholson, W., and C.F. Snyder. Microeconomic Theory: Basic |
Simon, C.P., and L.E. Blume. Mathematics for Economists. |
Principles and Extensions. Eagan, Minn.: South Western College |
New York: W.W. Norton, 1994. |
Publishers, 2008. |
Varian, H.R. Microeconomic Analysis. New York: W.W. Norton, |
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Simon, H.A. “Theories of Decision-Making in Economics and Behav- |
1992. |
ioral Science.” American Economic Review 49(1959): 253–283. |
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Advanced Concept
Deriving Demand Curves
At times in this book it is useful to solve for consumer demand relationships explicitly. This is done by setting up the LaGrangian for the constrained optimization problem. A LaGrangian can be considered a simple trick to remember the first-order conditions for a constrained optimization problem. In this case, we can write the LaGrangian as
L = U
x1, x2
+ λ
y − p1x1 − p2x2
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where λ is the LaGrangian multiplier, representing the marginal utility gained from relaxing the constraint (in this case increasing y). For a full discussion of optimization theory and the conditions required for an internal solution the reader is referred to Simon and Blume. The LaGrangian is solved by the point at which the derivative of the LaGrangian with respect to each decision variable and the LaGrangian multiplier is equal to 0, or 
x1*, x2*, λ*
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The demand curve can be found by solving this system for x1*
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Here, the left side represents the slope of the indifference curve at the optimal consumption point, and the right side represents the slope of the budget constraint. By solving (1.C) for the proper consumption quantity and substituting into (1.D), we may derive the demand function for either good.
CONSUMER PURCHASING DECISIONS
PART1
People make hundreds of consumption decisions each day. With so many decisions, it can be very difficult for them to muster the level of attention, focus, and thought necessary to deliberate each one. Thus, consumer purchasing behavior is a field ripe for investigating behavioral economics. Given the importance of consumer behavior and consumer psychology in the field of marketing, this should not be surprising. This section outlines many of the consistent behavioral patterns that have been identified in the literature. These patterns are important to the economics of markets because they can influence consumer demand and potentially affect quantities and prices through aggregation of individual behavior. Patterns of consumer behavior may be important to a policymaker if they represent judgment errors that lead consumers to purchase goods they don’t want or to pay more than they should be willing to for a good. In this case, a policymaker may be interested in creating greater transparency in the market to facilitate a more convenient and accurate decision process on the part of consumers. Finally, marketers are interested in behavioral patterns in consumer purchasing for the ability it can give them to inflate the sale or the perceived value of their product in the eyes of consumers.
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Transaction Utility and |
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Consumer Pricing |
Suppose you were in an upscale, yet unfamiliar, restaurant and while perusing the menu you come across your favorite dish. It sounds delicious, but it is very expensive. You convince yourself that it will be worth the price given the reputation of the restaurant: This will be something special. When the food arrives, it looks different from what you had expected. You taste it and are disappointed. The sauce that is integral to your preference for the food is all wrong. In fact, it is so bitter that it makes eating the food somewhat unpleasant. Nevertheless, you convince yourself to eat because you paid so much for the meal. Why should you let all that money go to waste?
The consumer is constantly faced with deciding what to buy and how much to buy. To make these decisions, they must take into account the potential gain or loss from the purchase. Cost–benefit analysis is a staple of economic policy analysis and business planning. This analysis requires one to tally all potential income or benefit from a project and potential cost to engage in the project. The idea is that if the planned benefit of a venture exceeds the cost, it may be a worthwhile venture to engage in. More to the point, if a set of choices are mutually exclusive (i.e., one cannot choose more than one option), then an individual or firm should choose the option with the highest net benefit, defined as total benefit minus total cost. Inasmuch as the price of a good, as well as the atmosphere, can signal quality, price can perhaps influence the expectations of the consumer. This could in turn influence the consumer’s willingness to pay for the good.
Questions of how much to consume should follow the simple economic rule of equating marginal cost and marginal benefit. So long as initial consumption produces more benefits than costs, one should consume until the cost of the marginal good increases and/or the benefit of the marginal good decreases to the point that there is zero net benefit for consumption of the next unit. If one reaches a constraint on consuming (such as finishing the entire dish one has been served) before net benefits are reduced to zero, then the consumer should consume all that is possible.
In many of our experiences we take price or atmosphere as a signal of the quality of a good. As well, we might order items in a restaurant that leave us wanting more when we have
finished eating. This does not imply that price always signals quality differences, nor does it mean we should always complete a meal at a restaurant whether we like what we are eating or not. Nonetheless, in many cases people seem to react in curious ways to the pricing of goods. Often we hear of the need to “get your money’s worth” for a transaction. Such a notion can
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