CONSUMPTION CHOICES
Consumption: the process by which goods and services are put to final use by people. People refers to two groups of individuals – the customer who pays for the good or services; and the consumer who is the ultimate user of the good or services that have been purchased by the customer. Sometimes, the customer is at the same time the consumer. The importance of consumption is that it is the indicators for what quantities the market wants – or will require in the future.
From Adam Smith onwards, much of economic discourse has assumed that everything about the successful functioning of the economy is anchored in the final demand for goods and services. Adam Smith, in 1770s, said that “Consumption is the sole end and purpose of all production and the welfare of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer”.
The consumer as sovereign: traditional economics approach therefore views the consumer as sovereign. Consumer sovereignty is the belief that consumer satisfaction – consumers’ needs and wants – determine the nature of all economic activities in an economy.
- Each consumer behaves in a rational manner to maximize his/her self-interest in order to maximize satisfaction. Consumer’s needs and wants determine the shape of all economic activities in an economy.
- Economic activities are there to satisfy consumer choices. S/he dictates what the market has to
deliver – so that s/he consumes it. The consumer is a king.
Traditional approach to Utility Theory
Theory of utility first presented by Jeremy Bentham (1748-1832) when he stated that people will
choose those options that give them more pleasure and less pain. That we can view utility in hedonistic terms (using an imaginary instrument, hedonimeter) as a measure of pleasure and pain. It is based on the principle that a customer chooses what will offer him/her the highest satisfaction. This theory is about a rational human being making choices driven by self-interest and constrained by their income. Such a human being does not buy goods on impulse or emotion but based on reason – on the need.
Such a person is referred to in economic text books as homo economicus (‘an economic man’). The theory is based on the following assumptions:
- The consumer prefers more of his/her desired goods and services to less; The consumer tastes and preferences are known and complete; The consumer has perfect information (and that this information enables a consumer to make choices between present and future consumption).
- The homo economicus has to maximize their satisfaction both today and in future, and these assumptions enable them to compare and add together all their consumption choices. It is not the wishes (‘wanting’) but the actual purchases (‘enjoyment’) that matter to individuals.
Experienced Utility and Decision Utility
Utility has been divided into two: experienced utility (utility as hedonic experience) and decision utility (utility as a representation of preferences). This distinction has been strongly proposed by behavioral economists (Kahneman et al. 1997, 2000, 2005, 2006). Decision utility (‘wanting’) is the weight of an outcome in a decision while experienced utility is hedonic quality, as in Bentham’s usage.
Experienced utility (‘enjoying’) can be reported in real time (instant utility), or in retrospective evaluations of past episodes (remembered utility).
Decision utility is a representation of preferences, and the concept of preference is understood in terms of choice: a person’s preferences are the mental entities that explain his choices, and are revealed in those choices. Accordingly, pleasure and pain are attributes of a moment of experience.
There is also remembered utility as part of experienced utility. Past experiences influence future enjoyment of a good or service. People tend to visit again the restaurant where they had a nice meal. Those dimensions of experience related to pleasure, enjoyment, and fun; collectively referred to as Hedonic Experience (HE). According to the Greek definition, ‘hedone’ means pleasure – akin to sweet. (Stelmaszewska, H., Fields, B. & Blandford, A. (2004) Conceptualising user hedonic experience. Decision utility has also been called ‘wantability’; it is inferred from choices and used to explain choices. (Kahneman and Thaler 2006, p.221).
Experienced utility refers to the hedonic experience associated with an outcome. (Kahneman and Thaler 2006, p.221).
Remembered utilities also have an adaptive function: they determine whether a situation experienced in the past should now be approached or avoided. Unlike pain and pleasure, which control behavior in the current situation, learned attractions and aversions adjust current behavior to the remembered evaluations of events in the past. (Kahneman et al., 1997 p.380)
The “hungry shopper”
Nothing in life matters quite as much as you think it does while you are thinking about it People’s decision utilities are revealed by their choices.
When people purchase what they had predicted in decision utility, then experienced utility and decision utility will not be different. This does not always happen because of the state of the individual at the time of decision utility or predicting. A hungry shopper may order more than he/she will actually consume when time to consume actually comes.
See the “hungry shopper” who missed lunch on Monday by Kahneman and Thaler (2006). The “hungry shopper” example illustrates a proposition that has been systematically explored in numerous studies: forecasts of future hedonic and emotional states are anchored in the current emotional and motivational state. The outcome has been labeled a “projection bias” (Kahneman and Thaler 2006, p.222-3)
Limitations of the Neoclassical Consumer Theory
- The traditional utility approach provides a simple model about how consumers make choice, but with fairly restrictive assumptions which are different from what happens in the real world.
- Consumers always face the challenge of imperfect information. For example people marry without perfect information. They may have ample information but later find out that some key information had been kept by one of the parties.
- Sometimes consumers buy based on impulse (or emotion) than reason (at times with the influence of advertising and other marketing communication tools). They just have the money to buy that other item that was not on their shopping list. So they buy it. Consumers’ tastes and preferences are not always known and complete.
Behavioural economics approach and consumer behaviour
It may not apply in the age of affluence in developed countries. Mainly in developed countries, there has developed a situation of consumerism. Behavioural economics approach and main behavioural ideas about consumer behaviour that violate utility maximization.
These include framing effects, anchoring, forecast bias, context of choice, and pea/end rule. Peak-end rule: a simple average of the quality of the experience at its most extreme moment and at its end predicted retrospective evaluations with substantial accuracy.
People do not always know what they like; they often make systematic errors in predicating their experience of outcomes and, as a result, fail to maximize their experienced utility. Because of the ‘‘focusing illusion’’ (exaggerating the importance of the current focus of one’s attention), individuals’ forecasts of experienced utility are subject to systematic error.
Framing effects – concern the context or frame through a person perceives a decision..….For example, the options between which choose are not as clear-cut or objective as economic theory implies (Aldred (2010, p.14)
The peak-end hypothesis: “the remembered utility of pleasant or unpleasant episodes is accurately predicted by averaging the Peak (most intense value) of instant utility (or disutility) recorded during an episode and the instant utility recorded near the end of the experience” (Kahneman et al., 1997, p.381).
