Nova workboard

a blog from young economists at Nova SBE

Models, Schmodels

In the standard microeconomic model on consumer’s preferences we tend to assume certain general characteristics that we believe are in accordance with the real world.

We state that preferences are convex, meaning that consumers prefer a “mixed” bundle of goods rather than more of a single good, that people always want more of a good than less (non-satiation) and preferences are complete, meaning the consumer can always rank goods from the least to the most preferred.

But what if these assumptions are fundamentally flawed? Behavioral economists have been working on these issues and have concluded that people’s choices are not as clear as the models generally assume.

For instance, in several studies researchers found that people have an innate sense of “fairness” and they make decisions that contradict the general assumption of rational self-interest. Other studies found that there are time inconsistencies in preferences, meaning that people discount their future selves welfare much more than what is generally assumed. One clear example of this is tobacco consumption (this idea is brilliantly discussed by Gregory Mawkin in is article “Can a Soda tax save us from ourselves?”). Consumers are also poor at judging their future preferences. One study gave students the opportunity of choosing a set of snacks for consumption for the following three weeks while giving others the choice of choosing them on a daily basis. It found that those students who had to choose all the snacks at once tended to select a higher variety of different snacks than those who could choose daily. Meaning that the first group probably assumed that it would want to diversify its choices while actually consumers  seem to stick to a set of standard choices. In microeconomic terms this would mean that the moment of consumption has a high influence on preferences.

One particularly interesting study (Iyengar & Lepper) analyzed the impact of choice on consumption. It gave consumers the choice to try a set of 6 or 24 jams and a discount voucher. Afterwards they had a voucher to spend on. It found that those who were given the choice of 24 jams were much less likely to make a purchase. When given too many choices consumers were overwhelmed by the information and their consumption actually went down.

How is all of this relevant? In a context where economists all over the world are rethinking their approach to the science, following the 2008 financial crisis these studies could shed a new light on how policy makers can avoid repeating the same mistakes by giving us new, improved models to think about the world!

Jorge Santos nº616

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Author: studentnovasbe

Master student in Nova Sbe

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