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Consumer X-inefficiency and The Problem of Market Regulation
Abstract
Although most scholars regard Harvey Leibenstein's main contribution to consumer theory to be his 1950 article that reconciled Veblen's institutionalist theory of fashion with the axiomatic neoclassical microeconomics, this paper's argues that his work on X-inefficiency is likely to be more significant to consumer researchers in future. Its basic proposition is very straightforward: whereas X-inefficient firms achieve lower productivity than they might have been able to achieve, X-inefficient consumers pay more to meet their goals, or to obtain particular bundles of consumption characteristics, than they needed to do, or they fail to meet goals they could have achieved had they used their resources differently. In both cases, the extent of X-inefficiency may be affected by competitive pressures and by the regulatory context in which decisions are taken. After arguing that the sources of consumption X-inefficiency are analogous to those that Leibenstein (1976) posited as causes of X-inefficiency in organizations, the paper examines in general terms the kinds of markets in which consumption X-inefficiency is likely to be rife and explores regulatory policies that might reduce it. This is followed by a case study analysis of the market for housing renovation products and services and a discussion of some of the distributional issues that arise from attempts to reduce X-inefficiency.
... If beneficiaries of poverty-abatement programs lack consumption skills then it is possible for their additional purchasing power to be used in satisfying desires that contribute little to their well-being. Rojas (2008b) and Earl (2007) shows that there is considerable X-inefficiency in the use of income at all levels. Thus, ...
High income inequality in Latin America translates into high poverty rates in many countries. Those in income poverty report lower well-being; however, the well-being impact of income poverty is not generalized across domains of life. Satisfaction in some important domains of life, such as the family and the affective ones, are not affected by people’s material condition, and this implies for a not so strong association between income poverty and well-being deprivation. Thus, it is important for policy makers to expand their perspective in order to go beyond the limited income-poverty conception and incorporate other well-being considerations in poverty-abatement programs.
... These themes were brought together in Earl's (2007) contribution to a memorial volume for Leibenstein in which he argued the case for recognizing the X-inefficiency of consumers as well as of firms. However, unlike the new wave of behavioural economists who focus on distorted perceptions and preferences as causes of departures from rationality, Earl also recognized a key implication of the use of simple decision rules for coping with situations of bounded rationality: ...
This paper draws lessons about the allocation of resources to research aimed at studying the efficiency of consumer decision making in complex, fast-moving markets. These lessons emerged during research involving a large-sample survey of choices of mobile phone service plans by Australian consumers. In this kind of market, researchers will run into difficulties in collecting and evaluating data, and market conditions will not stand still while they address these problems. It is even possible that what seems suboptimal to researchers will sometimes actually be highly appropriate choice for consumers. The paper concludes by advocating the use of simpler methods to approximate the prevalence of decision-making inefficiency—such as collaborative work with owners of websites that try to assist consumers—as knowledge of optimal choices is not essential for understanding the sources of inefficiency or devising methods by which better choices might be made.
... Thus, well-being enhancing programmes should focus not only on raising income but also on providing the knowledge and skills, as well as the institutional arrangements to enable people to spend it wisely. This area has been completely neglected by traditional economic theory which assumes that people are rational; however, a vast literature in economics and behavioural-economics theory stresses the possibility of people underperforming in their use of income (Scitovsky, 1976;Earl, 2007). ...
This paper questions the assumption used in designing social policies that raising people’s income automatically translates
into greater well-being. Based on a subjective well-being approach and a representative survey from Costa Rica the paper shows
that there is substantial dissonance in the classification of persons as poor and as being in well-being deprivation. The
existence of dissonances leads to the conceptualization of different trajectories out-of-poverty and into well-being. Public
policies oriented towards the abatement of income poverty can have a greater impact on people’s well-being if they recognize
the complexity of human beings and acknowledge that their programs affect satisfaction in all domains of life. The paper states
that public policy should not only be concerned with getting people out of income poverty, but also with placing them in a
life-satisfying situation. The paper also discusses strategies that could improve poverty-abatement programs.
... The lesson is that major environmental costs might be avoidable if policies begin with the assumption that consumers suffer from bounded rationality that to some extent can be reduced via regulations that promote self-education (cf. Earl 2007). Furthermore, rather than having immutable preferences, consumers choose via aspiration levels that are moveable: if they can get used to running central heating and hot water systems at lower temperatures, then they are likely also to be able to get used to smaller cars. ...
The rural South Pare highlands in Tanzania experience a deteriorating environmental situation. Of particular importance is the disappearance of forests and woodlands. The consequences are declining amounts and reliability of rainfall, declining amounts of water levels and loss of biodiversity. Deterioration of environmental resources increases the costs of collecting environmental products, which in many respects have no feasible close substitutes. One of the major components of the increased costs is labour time allocated by household members to collecting environmental products and/or grazing activities.
This study presents an empirical investigation of the impact of this reallocation of intra-household labour resources on livelihood for different members of a household. We used cross-sectional data. To analyse how variations in environmental degradation affect intra-household labour allocation, three types of areas were distinguished: severely-degraded, medium-degraded, and non-degraded environments.
Our findings show that (1) the environmental products collection and/or grazing activities were gender-biased with husbands specializing in grazing while wives and children fetching water and fuelwood, and labour time allocation was significantly influenced by environmental condition; (2) environmental degradation was limiting the production and consumption potentials in the area and limited adoption of agricultural modernization further aggravated this problem; (3) factors like school crowdedness, illness, bad weather, poor school quality, and school absenteeism due to street vending contributed negatively to the probability of primary school attainment for children apart from the environmental degradation situation; and (4) subjective welfare and well-being of household members were affected by the quality of the environment.
This study contributes to the understanding of the situation and setting proper measures towards solving the problems of sustainable development, poverty alleviation, environmental policy, and human capital formation in South Pare.
Competition is often thought of a fairly obvious thing, a rivalry. In a market context the meaning of competition is usually taken to be a rivalry among the sellers. The article seeks to broaden this view by considering other competitive relationships in the marketplace. Using the simplifying assumption that there are only two types of market actors, sellers and consumers, there are three possible types of relationships or interdependencies among these actors in a market. In competitive terms this includes the familiar competition among sellers but there is also the possibility of competition between sellers and consumers, as well as competition among consumers. The article outlines essential characteristics of the three modes. Implications of multi‐mode competition for market performance and welfare are discussed.
This investigation uses a subjective well-being approach to provide a novel empirical answer to an old normative debate in economic literature: whether consumers use efficiently their income. Based on a large database from Mexico, the paper shows that there exists substantial X-inefficiency in the use of income; even when a relaxed criterion to define the thick frontier is followed. X-inefficiency in the use of income can emerge from personal errors and from social-organization deficiencies. Sustainable development concerns make it critical to focus on reducing X-inefficiency as an alternative way to increase economic well-being.
Simple Heuristics That Make Us Smart invites readers to embark on a new journey into a land of rationality that differs from the familiar territory of cognitive science and economics. Traditional views of rationality tend to see decision makers as possessing superhuman powers of reason, limitless knowledge, and all of eternity in which to ponder choices. To understand decisions in the real world, we need a different, more psychologically plausible notion of rationality, and this book provides it. It is about fast and frugal heuristics--simple rules for making decisions when time is pressing and deep thought an unaffordable luxury. These heuristics can enable both living organisms and artificial systems to make smart choices, classifications, and predictions by employing bounded rationality. But when and how can such fast and frugal heuristics work? Can judgments based simply on one good reason be as accurate as those based on many reasons? Could less knowledge even lead to systematically better predictions than more knowledge? Simple Heuristics explores these questions, developing computational models of heuristics and testing them through experiments and analyses. It shows how fast and frugal heuristics can produce adaptive decisions in situations as varied as choosing a mate, dividing resources among offspring, predicting high school drop out rates, and playing the stock market. As an interdisciplinary work that is both useful and engaging, this book will appeal to a wide audience. It is ideal for researchers in cognitive psychology, evolutionary psychology, and cognitive science, as well as in economics and artificial intelligence. It will also inspire anyone interested in simply making good decisions.
Economic analysis of law usually proceeds under the assumptions of neoclassical economics. But empirical evidence gives much reason to doubt these assumptions; people exhibit bounded rationality, bounded self-interest, and bounded willpower. This article offers a broad vision of how law and economics analysis may be improved by increased attention to insights about actual human behavior. It considers specific topics in the economic analysis of law and proposes new models and approaches for addressing these topics. The analysis of the article is organized into three categories: positive, prescriptive, and normative. Positive analysis of law concerns how agents behave in response to legal rules and how legal rules are shaped. Prescriptive analysis concerns what rules should be adopted to advance specified ends. Normative analysis attempts to assess more broadly the ends of the legal system: Should the system always respect people's choices? By drawing attention to cognitive and motivational problems of both citizens and government, behavioral law and economics offers answers distinct from those offered by the standard analysis.
In recent years, legal scholars dissatisfied with the behavioral assumptions of the rational actor model have increasingly turned to the findings of cognitive psychologists and decision theorists to enhance the accuracy of efficiency analysis. Jon Hanson and Douglas Kysar review those findings in this Article, concluding that scholars have been well justified in incorporating the behavioralist account of human behavior into law and economics. Nevertheless, Hanson and Kysar argue that those scholars simultaneously have failed to take the findings of behavioral research to their logical conclusion. Using the scholarly application of behavioralist insights to products liability theory as an example, the authors demonstrate that legal scholars thus far have treated cognitive anomalies as relatively fixed and independent influences on individual decisionmaking. Rather than such an exogenous analysis, Hanson and Kysar advocate an endogenous examination of behavioralist findings that allows for internal, dynamic effects of cognitive biases within the decisionmaking model. By recognizing that cognitive anomalies influence not only the behavior of biased decisionmakers bur also the incentives of other economic actors, Hanson and Kysar reveal the possibility of market manipulation-that is, the possibility that market outcomes can be influenced, if not determined, by the ability of one actor to control the format of information, the framing and presentation of choices, and, more generally, the setting within which market transactions occur. Again using the field of products liability theory as an example, the authors argue that such market manipulation will come to characterize consumer product markets; powerful economic incentives will drive manufacturers to engage in practices that, whether consciously or not, utilize non-rational consumer tendencies to influence consumer preferences and perceptions for gain. The authors conclude by previewing the evidence from their companion article that demonstrates the seriousness of the problem of market manipulation and the need for corrective legal devices such as enterprise liability.
This paper considers the hypothesis that commodities purchased on the market by consumers are inputs into the production of goods within the household. Its implications for the family of consumer demand functions whose arguments are real income and relative prices are drawn and compared with those of the hypothesis of additive separability. The paper closes with some examples of differences in commodity demand elasticities which are qualitatively consistent with the household production hypothesis and some comments upon how the latter might be utilized in empirical work.
I. The nature of the problem, 183. — II. Functional and nonfunctional demand, 188. — III. The bandwagon effect, 190. — IV. The snob effect, 199. — V. The Veblen effect, 202. — VI. Mixed effects, 205. — VII. Conclusion, 206.
The purpose of this book is to help people make better decisions.
Written in a clear and non-technical way it deals with the basis of intuitive judgement, demonstrates the limitations on the human ability to make judgements, and suggests the means of overcoming potential shortcomings. At the same time it stresses the importance of learning the limits to one's judgemental ability. (PsycINFO Database Record (c) 2012 APA, all rights reserved)
Abstract Criticism of the book by Choi is expressed by Professor Pressman and responded to by the author. Three problems are noted. These deal with ambiguities in the concept of paradigms and conventions, the relationship between them, and how individual feelings of envy and the notion of social conventions fail to provide a good justification for fully supporting entrepreneurship.
Three years ago, I read Michael Polanyi's contribution—as a philosopher—to a symposium entitled Scientific Outlook: Its Sickness and Cure. In a brilliant, penetrating, and delightfully humorous criticism of R. W. Gerard's1 biological contribution, he unerringly diagnosed the sickness of medicine:
The fact that a so learned, ingenious and imaginative survey of living beings should deal so perfunctorily with some of the most important questions concerning them shows a fundamental deficiency of human thinking.... If a rat laps up a solution of saccharine, the rational explanation of this lies in the act that the solution tastes sweet and that the rat likes that. The tasting and liking are facts that physics and chemistry as known today cannot explain. Nothing is relevant to biology, even at the lowest level of life, unless it bears on the achievements of living beings... and distinctions unknown to physics and chemistry... The current idea of
The economic theory of the consumer is a combination of positive and normative theories. Since it is based on a rational maximizing model it describes how consumers should choose, but it is alleged to also describe how they do choose. This paper argues that in certain well-defined situations many consumers act in a manner that is inconsistent with economic theory. In these situations economic theory will make systematic errors in predicting behavior. Kanneman and Tversey's prospect theory is proposed as the basis for an alternative descriptive theory. Topics discussed are: undeweighting of opportunity costs, failure to ignore sunk costs, scarch behavior choosing not to choose and regret, and precommitment and self-control.
This article described three heuristics that are employed in making judgements under uncertainty: (i) representativeness, which is usually employed when people are asked to judge the probability that an object or event A belongs to class or process B; (ii) availability of instances or scenarios, which is often employed when people are asked to assess the frequency of a class or the plausibility of a particular development; and (iii) adjustment from an anchor, which is usually employed in numerical prediction when a relevant value is available. These heuristics are highly economical and usually effective, but they lead to systematic and predictable errors. A better understanding of these heuristics and of the biases to which they lead could improve judgements and decisions in situations of uncertainty.
The article attempts to develop a general theory of the allocation of time in non-work activities. It sets out a basic theoretical analysis of choice that includes the cost of time on the same footing as the cost of market goods and treats various empirical implications of the theory. These include a new approach to changes in hours of work and leisure, the full integration of so-called productive consumption into economic analysis, a new analysis of the effect of income on the quantity and quality of commodities consumed, some suggestions on the measurement of productivity, an economic analysis of queues and a few others as well. The integration of production and consumption is at odds with the tendency for economists to separate them sharply, production occurring in firms and consumption in households. It should be pointed out, however, that in recent years economists increasingly recognize that a household is truly a small factory. It combines capital goods, raw materials and labor to clean, feed, procreate and otherwise produce useful commodities.
This study develops an evolutionary theory of the capabilities and behavior of business firms operating in a market environment. It includes both general discussion and the manipulation of specific simulation models consistent with that theory. The analysis outlines the differences between an evolutionary theory of organizational and industrial change and a neoclassical microeconomic theory. The antecedents to the former are studies by economists like Schumpeter (1934) and Alchian (1950). It is contrasted with the orthodox theory in the following aspects: while the evolutionary theory views firms as motivated by profit, their actions are not assumed to be profit maximizing, as in orthodox theory; the evolutionary theory stresses the tendency of most profitable firms to drive other firms out of business, but, in contrast to orthodox theory, does not concentrate on the state of industry equilibrium; and evolutionary theory is related to behavioral theory: it views firms, at any given time, as having certain capabilities and decision rules, as well as engaging in various ‘search' operations, which determines their behavior; while orthodox theory views firm behavior as relying on the use of the usual calculus maximization techniques. The theory is then made operational by the use of simulation methods. These models use Markov processes and analyze selection equilibrium, responses to changing factor prices, economic growth with endogenous technical change, Schumpeterian competition, and Schumpeterian tradeoff between static Pareto-efficiency and innovation. The study's discussion of search behavior complicates the evolutionary theory. With search, the decision making process in a firm relies as much on past experience as on innovative alternatives to past behavior. This view combines Darwinian and Lamarkian views on evolution; firms are seen as both passive with regard to their environment, and actively seeking alternatives that affect their environment. The simulation techniques used to model Schumpeterian competition reveal that there are usually winners and losers in industries, and that the high productivity and profitability of winners confer advantages that make further success more likely, while decline breeds further decline. This process creates a tendency for concentration to develop even in an industry initially composed of many equal-sized firms. However, the experiments conducted reveal that the growth of concentration is not inevitable; for example, it tends to be smaller when firms focus their searches on imitating rather than innovating. At the same time, industries with rapid technological change tend to grow more concentrated than those with slower progress. The abstract model of Schumpeterian competition presented in the study also allows to see more clearly the public policy issues concerning the relationship between technical progress and market structure. The analysis addresses the pervasive question of whether industry concentration, with its associated monopoly profits and reduced social welfare, is a necessary cost if societies are to obtain the benefits of technological innovation. (AT)
We combine Post-Keynesian financial fragility analysis, behavioural analysis of decision rules and the evolutionary economics of rule trajectories to provide an empirically grounded and computationally tractable theory of the complex dynamics of speculative financial upswings. The dynamics of asset bubbles can be conceptualized as the joint consequence of the adoption and diffusion process of new investment decision rules coupled with the degradation of those rules as they pass from a few expert investors to larger population of amateurs. A study of the recent Brisbane property market bubble (1999-2003) is consistent with the existence of such cascading decision rules.
The conditions under which transactors can use the market (repeat-purchase) mechanism of contract enforcement are examined. Increased price is shown to be a means of assuring contractual performance. A necessary and sufficient condition for performance is the existence of price sufficiently above salvageable production costs so that the nonperforming firm loses a discounted steam of rents on future sales which is greater than the wealth increase from nonperformance. This will generally imply a market price greater than the perfectly competitive price and rationalize investments in firm-specific assets. Advertising investments thereby become a positive indicator of likely performance.
The research agendas of psychologists and economists now have several overlaps, with behavioural economics providing theoretical and experimental study of the relationship between behaviour and choice, and hedonic psychology discussing appropriate measures of outcomes of choice in terms of overall utility or life satisfaction. Here we model the relationship between values (understood as principles guiding behaviour), choices and their final outcomes in terms of life satisfaction, and use data from the BHPS to assess whether our ideas on what is important in life (individual values) are broadly connected to what we experience as important in our lives (life satisfaction).
Over the last ten to fifteen years, economists and legal scholars have become increasingly interested in and sensitive to behavioralist insights. In a companion article, Jon Hanson and Douglas Kysar argued that those scholars have nevertheless given short shrift to what is, at least for policymaking purposes, perhaps the most important lesson of the behavioralist research: individuals' perceptions and preferences are highly manipulable. According to Hanson and Kysar, one theoretical implication of that insight for products liability law is that manufacturers and marketers will manipulate the risk perceptions of consumers. Indeed, to survive in a competitive market, manufacturers and marketers must do so. In this Article, Hanson and Kysar present empirical evidence of market manipulation--a previously unrecognized source of market failure. The Article begins by surveying the extensive qualitative and quantitative marketing research and consumer behavioral studies that discern and influence consumer perceptions. It then provides evidence of market manipulation by reviewing common practices in everyday market settings, such as gas stations and supermarkets, and by examining familiar marketing approaches, such as environmentally oriented and fear-based advertising. Although consumers may be well-aware of those practices and approaches, they appear to be generally unaware of the extent to which those tactics are manipulative. The Article then focuses on the industry that has most depended upon market manipulation: the cigarette industry. Through decades of sophisticated marketing and public relations efforts, cigarette manufacturers have heightened consumer demand and lowered consumer risk perceptions. Because consumers are aware that smoking may pose significant health risks, the tobacco industry's success in manipulating risk perceptions constitutes especially strong evidence of the power of market manipulation. The Article concludes by arguing that the evidence of market manipulation may justify moving to a regime of enterprise liability. Indeed, according to Hanson and Kysar, the evidence of market manipulation confirms the intuitions of the first generation of product liability scholars, who worried about manufacturers' power to manipulate and called for just such a regime.
Learning processes are widely held to be the mechanism by which boundedly rational agents adapt to environmental changes.
We argue that this same outcome might also be achieved by a different mechanism, namely specialisation and the division of
knowledge, which we here extend to the consumer side of the economy. We distinguish between high-level preferences and low-level
preferences as nested systems of rules used to solve particular choice problems. We argue that agents, while sovereign in
high-level preferences, may often find it expedient to acquire, in a pseudo-market, the low-level preferences in order to
make good choices when purchasing complex commodities about which they have little or no experience. A market for preferences
arises when environmental complexity overwhelms learning possibilities and leads agents to make use of other people's specialised
knowledge and decision rules.
Firms need to incur substantial sunk costs to break in foreign markets, yet many give up exportingshortly after their first experience, which typically involves very small sales. Conversely, other newexporters shoot up their foreign sales and expand to new destinations. We investigate a simpletheoretical mechanism that can rationalize these patterns. A firm discovers its profitability as anexporter only after actually engaging in exporting. The profitability is positively correlated over timeand across foreign destinations. Accordingly, once the firm learns how good it is as an exporter, itadjusts quantities and decides whether to exit and whether to serve new destinations. Thus, it is thepossibility of profitable expansion at both the intensive and extensive margins what makes incurringthe sunk costs to enter a single foreign market worthwhile despite the high failure rates. Using acensus of Argentinean firm-level manufacturing exports from 2002 to 2007, we find empirical supportfor several implications of our proposed mechanism, indicating that the practice of "sequentialexporting" is pervasive. Sequential exporting has broad but subtle implications for trade policy. Forexample, a reduction in trade barriers in a country has delayed entry effects in its own market, whilealso promoting entry in other markets. This trade externality poses challenges for the quantification ofthe effects of trade liberalization programs, while suggesting neglected but critical implications ofinternational trade agreements.
This paper develops the idea that consumers' behaviour matters significantly from the viewpoint of industry performance. This is examined through some theoretical propositions, but then at greater length by means of some case study examples. These examples demonstrate how, even in potentially competitive industries, reluctance on the part of consumers to search or to switch suppliers can lead to a sub-competitive outcome. The significance of non-traditional competition policy remedies in changing the outcome is drawn out.
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