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5: Consumer Theory and Models
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- You may have encountered the idea of popular sovereignty in a civics or political science course. This means that the people rule, as opposed to a monarch, dictator, clique of oligarchs, religious authorities, etc. When it comes to the economy, it is often said that consumers are sovereign. Consumer sovereignty is the idea that consumer choices rule the economy. A firm that provides a product or service that better meets consumer wants and needs is likely to succeed and be profitable. A firm that fails to do so will not remain in business very long, or so the theory goes. Evidence that businesses recognize the importance of consumer sovereignty is provided by placards common in many workplaces reminding employees that “the customer is always right.” This notion is also encapsulated in the Latin phrase, De gustibus non disputatum est, which translates into English as “tastes are not disputable”.
- Explain the main logic of consumer choice theory in terms of preferences and budget sets.
- Graph budget sets and budget frontiers, given price and income data, and explain what happens to the budget set as prices and/or income change.
- Outline the basic assumptions required for well-behaved preferences. Given a specific example, be able to determine whether these assumptions are satisfied.
- Describe the difference between ordinal utility and cardinal utility.
- Graphically derive individual demand functions.
- Diagram efficient consumption frontiers (Lancaster-type budget constraints) and identify products that are and are not competitive.
- Analyze how changes in price, income, and product characteristics affect consumer choice in Lancaster’s framework.
- Describe hedonic pricing models and identify characteristics to be included in a hedonic pricing model for a given product.
- Derive the full-time income constraint of Becker’s model.
- Use the logic of Becker’s model to explain consumer valuation of time-saving (convenience) built into food products.
- Use the logic of Lancaster’s and Becker’s models to analyze trends in food consumption.
- 5.1: Objectives
- 5.2: Neoclassical Consumer Theory
- 5.3: Lancaster’s (1966) Characteristics Model
- 5.4: Becker’s (1965) Household Production Model
- 5.5: Concluding Comments
- 5.6: References
- 5.7: Problem Sets