Archive for the 'Consumer behavior' Category

Jul 01 2011

Rational ‘bee’havior

Economists make several assumptions about humans, a fundamental assumption being that we are rational decision makers, able to weight costs and benefits of our actions and pursue the option that maximizes our benefits and minimizes our costs, thus leading to the greatest personal happiness, or utility. Only if this assumption holds true does a free market economic system, made up of individuals pursuing their own interests lead to a socially beneficial outcome. 

But are humans the only animal driven by rational, self-interested, benefit maximizing and cost minimizing behavior? Is our ability to make the right decision based on a complex set of options and variables made possible by our large brain and hundreds of thousands of years of adaptation? To some extent, our biology must drive our decision making and therefore the institutions and organizations that have allowed our species to thrive. But let us not think we are the only species to have thrived due to our rationality.

If you’re like me, you’ve often wondered to what extent animals can think. I have a dog, and after five years I still can’t figure out if he really likes me or if he has just learned that I’m the one who feeds him and scratches his belly, so he demonstrates the behaviors that offer the greatest rewards in terms of food and attention, and those behaviors are ones that I enjoy about him. It is a win win relationship, for sure, but is his behavior evidence of rationality, or just his biological need for food and attention? Is my dog’s behavior the outcome of a series of rational, self-interested calculations, or is it something more simple we usually associate with animal behavior: instinct?

Rationality may be as much a biological instict as an economic one. A recent study out of the UK has found that bumble bees are able to make rational decisions based on complex sets of options to mimimize costs and maximize benefits, much as humans must do countless times every day.

When deciding which flowers to fly to when collecting nectar, a bee must consider two variables: distance and the amount of nectar available in a particular flower. Of course, the distance the bee must fly represents the cost of collecting the nectar, and the amount of nectar in the flower is the benefit of having flown to it. The report explains: 

“Computers solve it (the problem of which flower to fly to) by comparing the length of all possible routes and choosing the shortest. However, bees solve simple versions of it without computer assistance using a brain the size of grass seed.”

The team set up a bee nest-box, marking each bumblebee with numbered tags to follow their behaviour when allowed to visit five artificial flowers which were arranged in a regular pentagon.

“When the flowers all contain the same amount of nectar bees learned to fly the shortest route to visit them all,” said Dr Lihoreau. “However, by making one flower much more rewarding than the rest we forced the bees to decide between following the shortest route or visiting the most rewarding flower first.”

In a feat of spatial judgement the bees decided that if visiting the high reward flower added only a small increase in travel distance, they switched to visiting it first. However, when visiting the high reward added a substantial increase in travel distance they did not visit it first.

The results revealed a trade-off between either prioritising visits to high reward flowers or flying the shortest possible route. Individual bees attempted to optimise both travel distance and nectar intake as they gained experience of the flowers.

“We have demonstrated that bumblebees make a clear trade-off between minimising travel distance and prioritising high rewards when considering routes with multiple locations,” concluded co-author Professor Lars Chittka. “These results provide the first evidence that animals use a combined memory of both the location and profitability of locations when making complex routing decisions, giving us a new insight into the spatial strategies of trap-lining animals.”

In economics, we refer to the behavior descibed above as cost, benefit analysis. It surprised me to read that insects, when faced with a trade off between further distance and more nectar, weigh both the cost and the benefit, and pursue the action that maximizes their profit, which is the bee’s case is a function of both distance of the flower and quantity or nectar collected.

Humans and our institutions make similar cost, benefit calculations. A business produces a quantity of output and sells it for a price that maximizes the difference between the price at which it can sell its product for and the average cost of production, thus maximizing its profits. A consumer will purchase a combination of goods and services at which the amount of utility per dollar is equalized across the various goods consumed, thus maximizing the consumer’s total utility

Bees, with their brains the size of a grass seed, weigh variables nearly as complex as those weighed by businesses and individuals in their economic decisions. Are bees rational? Or is their behavior purely biological instinct?

3 responses so far

Oct 05 2010

From heart transplants to watermelons: Understanding price elasticity of demand

Consumers are interesting creatures to study. Economics offers us a unique set of tools for understanding the behavior of consumers in various markets. Elasticity is one of those tools, one which helps us understand how consumers will respond to the change in price of some goods more or less than others. Some of the questions about consumer behavior elasticity helps answer are:

  • Why do governments place such huge taxes on cigarettes?
  • Why did Apple cut the price of the new iPhone in half from the original one, despite the fact that it had so many new features?
  • Why do movie theaters seem to raise their prices so steadily over the years, rather than doubling the price of tickets each year?

These and other questions can be answered by knowing something about the relative price elasticities of demand for the goods in question. Price elasticity of demand refers to the sensitivity of consumers to a change in price. For some goods, even the slightest increase in price will scare consumers away, while for others, price can go up and up and up and the quantity demanded won’t budge!

Here’s just one illustration of a good for which consumers are extremely sensitive to changes in price: Every autumn, around the city of Shanghai thousands of small farms harvest the Chinese watermelon, a small, green, juicy melon that looks and tastes the same regardless of which farm it came from. The farmers sell their melons to one of the hundreds of melon vendors who drive their big blue trucks into the city of Shanghai during about two weeks in October to sell the watermelons to the city folk who love their refreshing taste.

During the two weeks of the melon harvest, there are hundreds of blue trucks parked two or three per block all over the city. The hundreds of melon vendors sell an identical product, acquired at identical costs from thousands of farms using identical techniques for farming. In other words, the melon market in Shanghai during these two weeks is close to being perfectly competitive.

The price of melons is established through competition at something very close to the exact cost to the vendor of getting the melons into the city. Consumers know this, and therefore if one vendor tries to sell his melons for more than the equilibrium price, consumers will respond by buying NONE of that vendors melons. Conversely, if a vendor were to lower his price at all, rationally EVERY consumer would want to buy from that vendor, but since the price is already at the cost to the vendor, no vendor is able to lower the price without losing money. The outcome in the market for melons in Shanghai is that demand for melons is close to being perfectly elastic, meaning that consumers are completely sensitive to changes in price of watermelons.

Not all goods are like watermelons. In fact, for some goods demand is close to perfectly inelastic. Study the graph below, showing the relative elasticities of five different products, then answer the questions below in your comment!

Discussion Questions:

  1. For which product is demand pefectly inelastic? Perfectly elastic? Unit elastic?
  2. What relationship exists between relative slopes of demand curves and elasticity?
  3. What are two characteristics of cigarettes that make demand for them inelastic?
  4. What are two characteristics of heart transplants that make demand perfectly inelastic?
  5. What are the characteristics of a good for which demand is perfectly elastic?

73 responses so far

Sep 23 2010

The magical recession proof bunny

Chocolate Sales: A Sweet Spot in the Recession – TIME

Living in Switzerland, I find an article featuring a local business from the town my school is in irresistible, particularly when it appear in TIME magazine. Lindt chocolate, the company featured in this article, manufactures its delicate treats right down the hill from the ZIS campus, which means that when the wind is just right, you can just catch the scent of fresh, creamy chocolate wafting up the hillside while walking to campus.

Lindt, as well as its global competitors in the chocolate business, is enjoying surge in demand even while countless other industries are forced to cut back production, lay off workers, and close their factory doors. From TIME:

While the credit crisis has slowed down sales of everything from cars to organic groceries, people seem happy to keep shelling out for chocolate. Last year, as the global recession was gaining ground, Swiss chocolate makers bucked the trend with record sales — nearly 185,000 tons, an increase of 2% over 2007, sold domestically and in 140 export markets…

“Switzerland’s image sells well abroad, and nothing says ‘Switzerland’ more than chocolate,” says Stephane Garelli, director of the World Competitiveness Center at the Institute of Management Development (IMD) in Lausanne, predicting that this comfort food will continue to sweeten the sour economy for months to come…

“Now that people don’t have a new television or a new car,” he noted, “they eat a bit more chocolate.”

“Chocolate is one of the more recession-resilient food sectors,” says Dean Best, executive director of Just-Food, a U.K.-based news and information website for the global food industry. “With consumers eating out less and eating at home more, there is evidence that they are still allowing themselves the occasional indulgence — and chocolate is a relatively inexpensive indulgence.”

But the question of why there is no meltdown in the chocolate business may be more a matter of psychology than economics. “There is well-documented evidence going back to Freud, showing that in times of anxiety and uncertainty, when people need a boost, they turn to chocolate,” says Garelli of the IMD. “That’s why when the economy is bad, chocolate is still selling well.”

Which goes to show that chocolate is more than a candy treat — it’s real food for the soul.

So does this mean chocolate is an inferior good, or one for which demand increases as incomes fall? I doubt many Swiss chocolate producers would consider their product inferior, but perhaps it does fit the definition.

On the other hand, perhaps the reason demand for chocolate increases during a recession has more to do with the substitution effect than the income effect. As people eat out less, they consume fewer expensive deserts at restaurants and instead fill their shopping baskets with more affordable dessert options for the home. I can say from experience that this is the case for myself.

Living in Switzerland, I find myself rarely going out to eat at restaurants, an activity reserved for special occasions in this country where a steak can set you back 75 dollars. Instead, I eat at home almost every night, and nothing is more appealing to me, especially during hard economic times, than a bar of delicious chocolate after a home cooked meal. Demand for chocolate may rise during recessions simply because the demand for one of its substitutes (restaurant desserts) falls.

Discussion questions:

  1. Do you think chocolate is an inferior good or a normal good? What’s the difference? What types of goods do YOU consome more of when you find yourself faced with a tighter budget?
  2. Does economics have a good explanation for the above situation? The article mentions Freud, a pioneer in  the field of psychology; do humans’ economic behavior always appear rational?
  3. If chocolate were an inferior good, what would happen to chocolate sales when the global economy finally turns around and incomes start increasing? What do you think will happen to chocolate sales when the economy starts imrpoving? Explain.

28 responses so far

Oct 22 2008

The “bright side” of the economic meltdown… have Americans really learned to live within their means?

Colbertnation | The Colbert Report Official Site | Comedy Central

Newsweek international edition editor Fareed Zakaria explains in clear terms the root causes of the United State’s economic hardships. Simply put, Americans have lived beyond their means for far too long.

When a household, a firm, or a national government spend more than it earns (in income or tax revenues), it must borrow to do so. The only problem with this type of deficit financed spending is that at some point “the only way people will keep lending you money is that you have to pay higher and higher interest rates…” This, according to Zakaria, is why the US economy has begun to slow down. Higher interest rates make borrowing and spending less and less attractive, while making savings more attractive.

Savings rates have started to rise in America as our debts have come due. Higher savings means less spending, less spending means weak Aggregate Demand, which means slower growth and rising unemployment. There you have it, the root cause of our economic meltdown. Americans have spent beyond their means for far too long; the question is, have we learned our lesson? Will our current hardships teach us to spend more responsibly in the future?

4 responses so far

Oct 17 2008

Advice from an economic oracle – buy American stocks now!

Op-Ed Contributor – Buy American. I Am. – NYTimes.com

So Wall Street has recently experienced its worst shocks since the great depression. Every day the Dow Jones is like a roller coaster, DOWN 800 points, then  UP 500 points, then DOWN 200 followed by another rally of 600! In just three weeks the Dow has gone from 11,500 to below 900 points. Surely, the wise thing to do is get OUT of the stock market, right? WRONG! At least, so says the richest man in the world, Warren Buffet, someone who should know a thing or two about smart investing.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Discussion Questions:

  1. Why does holding cash seem like the smart thing to do during periods of volatile stock prices like the last month or so? Why does Mr. Buffet think that holding cash is NOT so smart?
  2. Mr. Buffet’s advice is counter-intuitive to some. Buying more of something that is falling in value (American stocks) may appear unwise… but what is Buffet’s rationale for why buying now may in fact be the smartest thing for an investor to do?
  3. Does the behavior of investors on the stock market reflect the behavior of consumers in a typical product market? In other words, do the laws of supply and demand apply to the stock market? Discuss…

12 responses so far

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