Hierarchy of Needs and Dynamics of Consumer Behavior

Hierarchy of Needs and Dynamics of Consumer Behavior

Pavel O. Luksha

Higher School of Economics

http://www.geocities.com/pluksha bowin@mail.ru

Presentation for the EAEPE 2004 Conference

Rethymno, October 28-31, 2004

2

Controversies of mainstream consumption theory

Controversies of mainstream consumption theory

• Unrealistic assumptions of consumer properties:– need for enormous computational capabilities of individuals and full

information about markets,

– knowledge of one’s own utility function (implying a complete and conscious understanding of one’s own values, tastes and needs),

– absence of controversy of preferences and values (non-transitivity assumption)

– absence of dynamics in both behavioral pattern and inside consumer herself (impossibility of changing taste) etc.

• Low relevancy of initial assumptions leads to a noticeable gap between the models of consumption theory and the marketing practice (Lillien et al., 2002).

3

Attempts to revise consumption theoryAttempts to revise consumption theory

• Attempts to revise consumption theory have occurred manifold:– the effect of bandwagon, the snob, and Veblen effects [which undermine the

hypothesis of independent individual utility maximization] (Leibenstein 1950) – consumer inertia (Brown, 1952) – demand for variety (Dasgupta and Stiglitz, 1980)– introduction of new products (Lancaster, 1971) – preference formation (e.g. firms manipulating preferences through product

differentiation, product innovation and advertising) (Galbraith, 1967)

• Calls for a theory that could incorporate dynamics and complexity of individual behavior. It has been realized that consumer behavior is far more complex than a neoclassical theory suggests (Glowa, 2001)

4

Consumption theory in EEConsumption theory in EE

• Development of the dynamic consumption theory has been set on the agenda of evolutionary economics (EE) (Metcalfe, 2001). Metcalfe also suggests that micro-economic foundations have to be resolved before macro-theory to be tackled

• Consumption theory also important for traditional issues of EE, such as the industrial dynamics and innovations (Andersen, 1996)

• Recent discussions focused on interdependences among consumers: (Cowan et al., 1998), (Kiel, 1999)

5

Need hierarchy approachNeed hierarchy approach

• Theory of needs elaborated in the works of Maslow (1954, 1971). He noted that needs are hierarchically structured: – basic needs (innate): metabolic needs (food and water),

reproductive needs (need for sex), and safety (need for shelter). These needs have to be satisfied first.

– socially-related (and socially acquired) needs: need for status and need for self-actualization.

• Despite criticism that Maslow’s social philosophy has received, his view of the need structure is now generally accepted. Hierarchical structure therefore to be maintained in consumption patterns

6

Need hierarchy approach (2)Need hierarchy approach (2)

Present state of analysis:• Lynne (2002): ‘multiple utility’ framework• hierarchical theories of needs as more relevant for

description of consumer behavior than mere utility maximization (Islam, Clarke, 2001)

• hierarchical structuring of needs gains popularity, esp. in welfare theory and sustainability economics (Stagl, O’Hara, 2001), (Hagerty, 1999)

7

Model designModel design

• The model suggested considers consumer behavior based on a hierarchically structured system of needs.

• Consumer behavior principles:(a) Goods have different consumer priority, their position in hierarchy

corresponds to their priority. The hierarchy (relative status of goods) is same to all consumers (although specific volume of needs is not).

(b) Needs cyclically arise in every period as a demand for specific types of good

(c) Consumer satisfies her needs starting with prime one and moving down the hierarchy.

(d) If a consumer cannot satisfy her need due to slack of good in the market, she will accumulate this need for the next period.

[In case of good insufficiency, it is assumed that a good is distributed between consumers proportionally to their needs.]

8

Model design (2)Model design (2)• There are k groups of consumers and l goods.• Production and consumption are accomplished in periods. • Variables of the model

– A is a matrix of needs– Pn is a vector of prices in n-th period– Mn is a vector of production in n-th period – Rn is a vector of inventories in n-th period– Qn is a vector of residual demand in n-th period– Dn is a vector of demand in n-th period– Sn is a vector of supply in n-th period– Fn is a vector of consumer incomes in n-th period– An is a matrix of needs that considers residual demand – Bn is a matrix of ‘consumer affordances’ – Bn is a matrix of consumption– Kn is a vector of consumer savings

9

Model design (3)Model design (3)

Kn

Pn

An

Dn

Mn

Rn

Bn

A

Sn1

2

Kn+1

Pn+1

An+1

Mn+1

Rn+1

3

4

Fn

5

Model variables yield non-linear dynamics based on the matrix of needs (A)

10

Model design (4)Model design (4)Due to non-linearity, dynamics has been simulated

11

Model testingModel testing

• For the purpose of modeling, model has been tested with a relatively low number of consumers (k=1…5) and a low number of goods (l=1…5)

• Model has been examined under the following conditions: (1) prices, volumes of production and income are given

exogenously (producer’s behavior not considered),

(2) (a) prices and (b) volumes of production are determined endogenously (interaction between consumers and suppliers),

(3) producers’ income is distributed among consumers to form their budgets (closed economic system).

12

Model runs (sample, case 3)Model runs (sample, case 3)

0

1

2

3

4

5

6

1 9 17 25 33 41 49 57 65 73 81 89 97 105 113

Supply1

Demand1

0

1

2

3

4

5

6

7

8

9

1 9 17 25 33 41 49 57 65 73 81 89 97 105 113

Supply2

Demand2

13

Model runs (sample, case 3)Model runs (sample, case 3)

0

0,5

1

1,5

2

2,5

1 10 19 28 37 46 55 64 73 82 91 100 109 118

Consum_1_1

Consum_2_1

Consum_3_1

0

0,5

1

1,5

2

2,5

3

3,5

1 10 19 28 37 46 55 64 73 82 91 100 109 118

Consum_1_2

Consum_2_2

Consum_3_2

14

Results of testingResults of testing

• For this model, equilibrium point is only a possible, but not an inevitable, final (or, long-term) state; an evolution towards equilibrium is thus seen only as one of the opportunities that may be realized within the economy. It is possible that economy moves towards a ‘limit cycle’ equilibrium, and not an equilibrium point.

• In cases 2 and 3, prices of goods result from a pattern of consumers’ hierarchically organized needs, and are determined by a historical path (a set of previous states) of the economic system

• Case 3 establishes maximal non-linear effects

15

Disturbances in equilibriumDisturbances in equilibrium

• Similarly to a conventional consumption theory, we have conducted analysis disturbances in equilibrium state, when prices, production and consumption are balanced.

• Following types of disturbing factors have been considered: – (1) change in price of one of goods, – (2) change of production volume of one of goods,– (3) introduction of a new good (without increase of income), – (4) introduction of a new consumer, – (5) disappearance of one of goods, – (6) disappearance of one of consumers.

16

Analysis of disturbancesAnalysis of disturbances

Interesting effects have been revealed, in particular:• Change of price (item 1): in case when price increase,

consumption drops; however, decrease in price may not lead to growth in consumption (only to increasing savings), because it is not based on additional needs

• Introduction of a new good (item 3) in equilibrium state does not change the system – nobody needs this new good. Accordingly, one may assume that response to product innovations is possible, to all appearances, only for market systems in disequilibrium state (which assumes inter alia the existence of some need not being satisfied, or not being fully satisfied).

17

Analysis of disturbances (2)Analysis of disturbances (2)Volume of production is not adjusted (cases 1 & 2a)

Prices and volume of production are adjusted (cases 2b & 3)

Increase in price decline in consumption fluctuations, redistribution of savings

Decline in price growth of savings

Increase in production unlimited growth of supply fluctuations; possible new equilibrium

Decrease in production decline in consumption

Introduction of new good new good is not needed

Introduction of new consumer

decline in consumption fluctuations; possible new equilibrium

Disappearance of a good growth of savings growth and resdistribution of savings

Disappearance of a consumer

unlimited growth of supply fluctuations, growth of savings; possible new equilibrium

18

Validity of the modelValidity of the model

Model accommodates a number of observable facts, for instance:

• markets of durable and luxury goods have higher volatility than primary good markets

• frequency of purchases in leisure services (club visiting, tourist travels etc.) is higher for higher income groups

• ‘pioneers’ in consumption (people most inclined to test new goods and services) are typically young and rich

19

ConclusionConclusion

• Suggested framework allows to diverge discussion from properties of utility functions towards description of need hierarchy, based upon biological and social foundations. Also, a possibility to combine these approaches exists.

• Hierarchy can change throughout the lifetime of individuals, due to both biological and social reasons; effects easily embedded into the model

• The model can thus be considered as a contribution to development of a dynamic theory of consumption and pricing.