Analysis of the Lancaster Approach to Consumer Theory: Application of The Theory of Intrinsic Value
The intrinsic value approach to consumer theory extended the traditional theory of consumer behaviour. The assumption of this theory that goods give rise to multiple characteristics and these characteristics help the consumers in making choices makes its application in production theory possible. This new approach to consumer behaviour is more heuristic explanatory and has more predictive power than the fundamental traditional theories of consumer behaviour. Therefore this new approach deals with many common-sense characteristics of the actual consumer behaviour that was not possible with traditional theories.
The Lancaster Approach to Consumer Theory
The basis of developing a new approach is the deficiency of the traditional approach that is considered the goods as a direct source of utility rather than its properties and characteristics. According to the new approach, the goods are the inputs that are transformed into characteristics as output and consumption is the activity that performs this transformation. Thus, the utility or preference ordering is just the rank collection of the different characteristics of the goods consumed. The consumption of different single and combined goods possess different types of characteristics that makes them different from each other. One single good can also possess more than one character and many single goods can possess a common characteristic as output. So although those goods are different in terms of input they may be related to each other in terms of output.
The new approach also assumes that the consumer’s preference is an objective kind. In other words, whatever the characteristics the goods will possess will be the same for all consumers and the unit of measurement of goods also will be the same. So the inter-personal difference in consumer choice will be based on the choice between the collection of characteristics only not the allocation of the characteristics to the goods by itself.
The new approach is based on the following assumptions where each assumption describes the break up of the new approach from the traditional approach.
- The goods themselves do not possess any utility but it is the characteristics of the goods that derive the utility. So, goods possess characteristics not utility as the traditional approach claims.
- A single good can possess more than one character or many goods can possess a single characteristic.
- The characteristics of the goods in combination can be different from the characteristics of those goods separately.
The simplified model of the consumer choice by supposing one-to-one corresponding between goods and activities can be written as:
Subject to px ≤ k
With z = Bx
z, x ≥ 0.
Where U(z) is the utility function that can be maximized subject to budget constraint px ≤ k, k is total income, x is goods purchased, z is characteristics and B is the technology vector that transform the good x into characteristics z.
Applications of the new approach
In this section, we will check the practical implication of the new approach of consumer theory in various circumstances and research work.
- Commodity Groups, Substitutes, Complement
The new approach is applicable in the complex economy where there are many commodities as well as characteristics with two matrix consumption technology. With the help of this approach, one can establish the relationship between the goods with revealed characteristics in the structure of the technology.
It is to be noted that some set of characteristics can be derived only from some set of activities and no other characteristics can further be derived from that set of activities. In other words, other characteristics can be derived from another set of activities from the remaining of the technology. If a specific set of activities requires a specific set of goods and that set of goods can not be used in another set of activities, then we can say that those goods are forming an intrinsic commodity group. Therefore, there will be a substitution between the commodity when the relative price of the goods within that group changes. If the price of the goods from another group will change then there will not be any effect on the goods in the first group.
Goods can be regarded as intrinsically related or unrelated if goods belong to the same intrinsic commodity group or a different intrinsic commodity group. If in two activities different goods are showing one to one relationship and the characteristics derived from those goods differ only in scalar we can consider two goods as an intrinsic perfect substitute. On the other hand, if the bundle of characteristics derived from those goods is similar then we say it as a close substitute.
Similarly, if an activity requires more than one goods and those goods can not be used in other activities then we can say it as an intrinsic total complement. Here those goods will be consumed in a fixed proportion.
There is one more case where two goods can be a substitute for each other as well as a complement to each other. In such a case two goods will be used together in more than one activity. So within an activity, those goods will be a complement and in between different activities, those goods will be a substitute.
- Labour Leisure and Occupational Choice
The new theory of intrinsic value in consumer behaviour has important implications in deciding labour, leisure, and occupation. We can consider labour as a reverse activity, characteristics as input, and a commodity or producing commodity as output.
Let take a model where there are two characteristics with labour and consumption goods as two commodities. Both commodities in separate activities produce two characteristics. Here characteristics are produced in different proportions. Now take consumption good as wage rate for the labour and consider work-consumption as a single activity. The characteristics produced by the work and consumption separately will be linear combination and wage rate will be the weight of that linear combination.
Now consider leisure as another activity that also produces two characteristics and the weighted sum of leisure and labour activity will be a constant.
Take the model as given in the diagram above where W represents work-consumption activity and l represents leisure activity and both produce positive characteristics. The AB line shows the time constraint where every individual sets its preference that whether they want more work or more leisure. The line AB is the negative line where the utility function of the different individuals will tangent. This type of choice can be considered a private choice.
At the given level of wage and technological coefficient, the constraint can have a positive slope. The line A’B and AB’ represent the positive slope constraint where all individuals will choose B on constraint OA’B and A on OB’A respectively. This type of choice can be considered a universal choice.
The above-given choices have a good implication in the decision-making process for entering into the labour market where we can consider “working in own field” as leisure and “entering into the market economy” as work-consumption activity. Here in this case the characteristics of work-consumption activity will be in the same proportion if work characteristics are in the same proportion. In this case, one can achieve the efficient characteristics bundle by choosing one or occupation.
- Consumer Durables, Assets, and Money
The present approach to consumer theory gives a good basis for dealing with durable goods and assets. We can consider the durable goods as leads to the activity where the outputs are dated characteristics. It is to be noted that characteristics produced on different dates are different characteristics.
Let take cross-section and time as two dimensions of the characteristics space and the consider characteristics as joint output, at one point in time the assets and durable goods will produce a combination of many characteristics. The combination of characteristics also changes over time. For example, if one wants to purchase a mobile phone then the characteristics related to RAM and ROM might change over time but the characteristics related to the battery backup will remain unchanged.
Similarly, money has many characteristics like safety and liquidity, etc that can easily be incorporated with the new approach to consumer theory. By using the multiple characteristics in the situation involving risk we can better analyze the behaviour of the individual. For example by considering the three characteristics of gambling i.e., a mathematical expectation, a maximum loss, and a maximum gain we can easily separate the individual choice of gambling by specifying their utility function. Some people may give more weight to maximum gain rather than maximum loss and expected value while others may give more weight to maximum loss. So we can develop many kinds of models using this approach by considering multiple characteristics.
- Marketing and Consumption of Traditional Food Products
The product quality of food products is now one of the important aspects for consideration for the manufacturers of traditional food products. This is the aspect that is giving impetus to the growth of the international market. The particular brand strategy, geographical marking of the product, and product differentiation are the outcome of the development of the new approach to consumer behaviour. The protected designation of origin (PDO) shows the region of origin where the tradition and climate of that particular region are suitable for that product and it creates a base for the product differentiation. It helps in gaining the consumer’s trust about the special quality or characteristics of that product. the European countries have nowadays more than 700 protected products ( Espejel et. al., 2007).
Nowadays consumers decide on the purchasing of a product based on multi-attribute. This multi-attribute can be classified into intrinsic and extrinsic attributes. By intrinsic attribute we mean the physical quality or characteristics of the product i.e., colour, flavour, smell ingredients, etc. while, extrinsic attributes refer to the brand, image, and place of origin, etc. The intrinsic, as well as extrinsic quality or attribute, are playing a very important role in buying decision of a consumer. The consumer evaluates the products based on these two attributes. For the PDO of a product, both of the attributes are very important as more quality leads to more trust in the product while more extrinsic attributes reflect more trust in the particular brand.
Thus, these attributes have a clear impact on the satisfaction, loyalty, and purchasing intention of the consumers. PDO reflects the set of these two attributes and attracts the consumers’ attention efficiently. It affects the marketing and consuming decision both as it has a significant influence on the production and consumption decision by both market stakeholders.
- Internet Marketing and Internet Consumer
The marketing trend has been changing over time. Now marketers are using the internet as the medium to reach the mass consumer. This not only gives rise to their revenue but also adds new dimensions in consumption decisions by the consumers. Internet marketing generally includes activities like communication strategy for online advertising, sales promotions and spreading information and awareness, distribution strategy for easy doorstep delivering of goods and services, web designing for providing a user-friendly interface to the consumers, and payment options and security for easy and smooth transactions and payment.
Consumer behaviour in internet marketing is derived from both intrinsic and extrinsic factors but it has been pointed out that the intrinsic factor has a high influence on consumer behaviour than the extrinsic factor. However, within the intrinsic factor, convenience is the most dominant factor that affects consumer behaviour in online purchasing online (Bagga and Bhatt, 2013). The other factors that affect consumer behaviour in online shopping are hedonic needs and security concerns. A consumer may like going outside and purchasing from an offline store or the consumer is feeling not secure while purchasing online especially in the case of online payment.
Convenience is the factor that influences the younger consumer behaviour most. The other factors like social networking and information searching also influence consumer behaviour in online shopping. Advertising and promotions also affect the consumer decision-making process and influence consumer choice.
Author: Alok Aditya Junior Research Fellow Institute for Social and Economic Change