ECO 3104

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ECO 3104

• Lecture 9

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Product Attributes and Product Quality

• Lancasters approach to consumer choice
• general
• goods are not entities in and of themselves, but
  are collections of attributes
• characteristics are bundled up into goods and
  sold to consumers who unwrap them

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Product Attributes and Product Quality

• consumption technology
• combinable versus non-combinable goods
• combinable goods can be mixed together
• example coffee and cocoa
• non-combinable goods can not be mixed together
• example skateboard and jelly

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Product Attributes and Product Quality

• consumption technology
• divisible versus indivisible goods
• divisible goods can be divided into smaller units
  that have proportional value
• examples fruit juice, french fries
• if indivisible goods are divided up they are no
  longer the same good and do not retain value
• examples car, socks, raincoat

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Product Attributes and Product Quality

• Applications of characteristics approach
• complements and substitutes
• complements can be viewed as goods that are
  combined to produce desired mix of attributes
• substitutes are goods that have common
  characteristics

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Product Attributes and Product Quality

• Applications of characteristics approach
• measuring quality
• can define quality as the amount of some valued
  characteristic per unit of traded good
• tax effects
• if goods, not attributes, are traded, then tax on
  goods can lead to change in quality
• example taxes and quality

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Product Attributes and Product Quality

• Applications of characteristics approach
• measuring the value of unpriced (non-market)
  attributes
• if have attributes that are only sold in bundles,
  can infer attribute prices by comparing values of
  bundles with different combinations of attributes
• hedonic pricing

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Estimation of Hedonic Equations

• Estimate reduced-form price equation of bundle
• estimating an expenditure equation
• need to include both supply and demand variables

• example price of a house

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Estimation of Hedonic Equations

• Coefficients on attributes represent implicit
  prices
• ?expenditure/?attribute
• Applications
• value of non-market goods
• economic tradeoffs involved in product
  enhancement
• value of brand name or company reputation

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Estimation of Hedonic Equations

• Issues/Problems
• if employ linear specification, implicitly assume
  that attribute price/value does not vary with
  quantity consumed by an individual
• if not true, need non-linear specification
• for example, quadratic function (including
  (quantity of attribute) and (quantity of
  attribute)2) would allow for diminishing marginal
  value of attribute

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Estimation of Hedonic Equations

• Example Using Excel to estimate the value of
  commuting distance.

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Information, Search and Advertising

• Costly information
• in general, consumers will not be perfectly
  informed about prices and qualities of goods
  available in the market
• there will exist some dispersion in
  prices/qualities available in the market

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Information, Search and Advertising

• Consumer search
• given dispersion of prices, consumers will engage
  in some search for the lowest price
• will continue search as long as expected marginal
  benefit is greater than expected marginal cost

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Information, Search and Advertising

• Consumer search
• marginal benefit of search will decline with
  number of searches
• example equal number of 2 and 3 stores

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Information, Search and Advertising
Number Prob. of Prob. of Expected Canvassed 2.00
Min. 3.00 Min. Min. Price
1 0.5000 0.5000 2.5000 2 0.7500 0.2500 2.2500 3
0.8750 0.1250 2.1250 4 0.9375 0.0625 2.0625
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Information, Search and Advertising

• search cost and full price
• full price consumer pays equals sum of search
  costs and transaction price
• similarly, if consumption takes time, money price
  understates full price
• measured (cash) price elasticity is less than
  effective price elasticity
• percentage change in cash price overstates
  percentage change in full price, so price
  elasticity (?Q/?P) is understated
• if advertising economizes on search costs it will
  raise money price consumer is willing to pay

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Information, Search and Advertising

• advertising
• advertising as information
• advertising provides useful information to
  consumers
• leads consumers to goods with most preferred
  characteristics
• reduces search costs
• consumer willing to pay higher money price (Pfull
  PMoney PSearch)
• if marginal cost of search decreases, engage in
  more search which may reduce PMoney
• most valuable for goods where cost of purchasing
  and trying good is high

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Information, Search and Advertising

• advertising as persuasion
• changes consumers preferences
• creates (false) brand loyalty
• persuades consumers to buy goods they did not
  previously desire
• misleads, brainwashes

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Information, Search and Advertising

• advertising as image creation
• advertising may benefit consumers by providing
  desired images to others
• macho image and Marlboros
• liberated woman and Virginia Slims
• athletic prowess and Nikes

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Information, Search and Advertising

• advertising as a signal of quality
• dollars spent on advertising establish a brand
  name which acts as a bond
• if lower quality, value of advertising investment
  is diminished
• the more spent on advertising, the more that is
  lost by cheating on quality
• example

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Information, Search and Advertising

• Questions
• Which would likely have the greatest effect on
  your consumption, a 50 decrease in movie ticket
  prices or a 50 decrease in take-out pizza
  prices?
• Would you expect the variance in prices of MP3
  players to be greater on the internet or among
  local retailers? Why?

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End of Lecture 9