Hierarchy of Needs and Dynamics of Consumer Behavior

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Hierarchy of Needs and Dynamics of Consumer
Behavior
Presentation for the EAEPE 2004 Conference
Rethymno, October 28-31, 2004

• Pavel O. Luksha
• Higher School of Economics
• http//www.geocities.com/pluksha bowin_at_mail.ru

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Controversies of mainstream consumption theory

• Unrealistic assumptions of consumer properties
• need for enormous computational capabilities of
  individuals and full information about markets,
• knowledge of ones own utility function (implying
  a complete and conscious understanding of ones
  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).

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Attempts 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)

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Consumption 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)

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Need 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 Maslows social philosophy
  has received, his view of the need structure is
  now generally accepted. Hierarchical structure
  therefore to be maintained in consumption patterns

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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, OHara, 2001),
  (Hagerty, 1999)

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Model 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.

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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

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Model design (3)
Model variables yield non-linear dynamics based
on the matrix of needs (A)
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Model design (4)
Due to non-linearity, dynamics has been simulated
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Model testing

• For the purpose of modeling, model has been
  tested with a relatively low number of consumers
  (k15) and a low number of goods (l15)
• Model has been examined under the following
  conditions
• (1) prices, volumes of production and income are
  given exogenously (producers 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).

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

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Disturbances 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.

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Analysis 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).

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Analysis of disturbances (2)
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Validity 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

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Conclusion

• 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.