A behavioural approach to kinked demand curves (original) (raw)

REVISITING HUMAN BEHAVIOUR THROUGH DEMAND ANALYSIS: WHY A DEMAND CURVE MAY NOT BE DOWNWARD SLOPING?

Assumption of a downward sloping demand curve establishes a negative relationship between price and quantity demanded. Unfortunately, in real life, we do not come across such downward sloping demand curves. On the other hand, what we observe in real life is, within a specific price range, a consumer consumes fixed amount of a commodity irrespective of the price and abandons the commodity beyond the price range. The paper argues that a consumer classifies different commodities as necessary and unnecessary and develops a sort of inertia of demand loyalty for the specific commodities she consumes. During price fluctuations, she may have to spend more or less of money on the commodity, but her consumption remains the same. Therefore, the demand curve should be a vertical straight line irrespective of the levels of prices. A typical consumer would switch over to another new commodity and will not reduce the quantity consumed of the existing commodity if she finds the present commodity more pricey or the other more affordable. The paper draws on some of the available literature on the critical analysis of demand as a concept and makes an effort to present the understanding through arguments and some real life examples.

Psychological Thresholds, Demand and Price Rigidity

The Manchester School, 1992

The starting point of this paper is the idea of threshold behavior, which has considerable support in psychology but has been neglected by economists. The implications of having a consumer theory that puts emphasis on threshold behavior towards prices and quantities are examined. It is shown that a threshold-based demand curve can be derived from a hierarchical approach to consumer behavior and also from a customs- or habits-oriented response to price by the consumer. These threshold-based demand curves can provide an additional explanation for price rigidity in the product market.

Demand, Demand Curves and Consumer Surplus

Introduction What follows are lecture notes on demand theory with commodity money. While I have used the contents of chapters 2 and 3 of the textbook entitled “Microeconomic Theory” by Andreu Mas-Colell, Michael D. Whinston and Jerry R. Green, published by Oxford University Press in June 1995, as a template for a substantial portion of these lecture notes, I am not aware of the existence of any other full length and exclusive treatment of demand theory with money as a commodity. At times it was extremely tempting for me to work on the MS Word lecture notes prepared by Paul Glewwe for his course on “Applied Microeconomics of Consumer Choice and Consumer Demand” (Apec 8001) in the Applied Economics department of University of Minnesota, which he had very kindly and generously shared with me. I did not, since preparing these notes gave me an opportunity to revisit the subject- an opportunity I would have missed otherwise. The motive for these lecture notes is the paper by me entitled “Consumer Surplus and Budget Constrained Preference Maximization”, (forthcoming in Managerial Economics). These notes are a rigorous exposition of the framework of the paper with additional results that may be of interest. An immediate consequence of introducing money as a commodity is that that the homogeneity assumption of the demand function for goods (i.e. non-monetary commodity) has to be sacrificed. We do provide an alternative definition of homogeneity which is appropriate in our framework and whose implications are discussed in the fifth chapter. Our demand functions are meaningful in two contexts: the partial equilibrium model, where money is saved to be spent on commodities other than those that we consider in our model and in the general equilibrium context, where money is saved for consumption during future periods. However, this general equilibrium model is not the Arrow-Debrue- McKenzie model with dated commodities, but the temporary general equilibrium model introduced by Sir John Hicks in his treatise entitled “Value and Capital”. If the temporary general equilibrium model is akin to a model with every day in a man’s life being a different day with its own morning and its own evening, then in the Arrow-Debreu model the entire life of a man being is considered to be a day, with as many different mornings and different evenings, as the number of days he actually lives (assuming all men die at night!). If a man lives for just one day, then obviously no savings are required. However, if “tomorrow is another day” then a person may or may not choose to save for tomorrow. With money as a commodity, the Marshallian demand “curve” acquires a non-trivial existence of its own and meaningfully represents the concept of a marginal willingness to pay function for surplus maximizing consumers. Its implications for social welfare are enormous- social welfare is “best” if and only if consumers are surplus maximizers. Another implication of a surplus maximizing consumer is that our chapter 1 on consumer demand theory (based largely on Chapter 2 of MWG (June 1995)) acquires a relevance of its own, beyond being an abstract generalization of some results in classical demand theory. The fourth chapter of these lecture notes deals with classical demand theory. Most treatments of classical demand theory begin with an elaborate discussion about numerical representation of preferences or more generally binary relations. Undoubtedly this is an important topic in Order Theory, which is a branch of applied mathematics and in the study of representation of social preferences by social utility functions- an important topic in welfare economics. In consumer demand theory, I have hardly ever come across any application of consumer preferences which are not representable by utility functions. Even the demand function generated by the “much hyped” lexicographic preferences can be generated by a budget-constrained utility maximizing consumer whose utility from a consumption bundle is measured by the quantity consumed of the commodity that enjoys “top priority”. Hence we adopt the approach towards demand theory that has been adopted by Duncan Foley in his classic text “Economic Reasoning”, and assume that consumers in classical demand theory have preferences representable by utility functions. Our major contribution in this chapter is that budget constrained utility maximimizing consumers with Walrasian demand “curves” satisfying a “Boundedness Condition” are surplus maximizers, because the area under the demand curves measure their willingness to pay for the quantity of the good (whose demand curve we are concerned with) that is consumed. The rest is mostly as in the chapter on classical demand theory in MWG (June 1995). The fifth chapter of these lecture notes discusses a concept of homogeneity that is appropriate for our framework. Its implication for classical demand theory is quite interesting- the shadow price/ marginal value/marginal indirect utility of income is in fact the marginal utility of savings for a budget constrained utility maximizing consumer. In the sixth and last chapter of these notes we discuss functional forms in demand theory- a topic that- for reasons unknown to me- are not discussed in most graduate microeconomics or any mathematical economics course, but dealt with in applied econometrics or demand analysis courses. Hence this topic- in spite of being probably the most practically applicable one in demand theory- remains unnoticed by several mathematically inclined graduate students during their course work at graduate school and thereafter. I have introduced this topic in these notes for three reasons: (i) for its potential as a serious research topic for theoretically inclined graduate students in economics who are interested in demand theory; (ii) for its wide applicability; and (ii) to show that introducing savings in consumer demand theory has significant implications for the associated functional forms for possible utility and demand functions. For instance, assuming that savings are a constant fraction of expenditure goes a long way in accommodating the existing results within our framework. Even homogeneity properties often require adjustment for the results we seek. To understand these notes, it would be a good idea to be familiar with the mathematics in “Fundamental Concepts of Analysis”, by Alton H. Smith and Walter A. Albrecht, Jr. and the economics in “Essentials of Microeconomics” by Bonnie Nguyen and Andrew Wait. Two people taught me consumer demand theory: Professor Shanti Chakraboty at ISI (Kolkata) in 1979 and Professor Leonid Hurwicz at University of Minnesota in 1981. However, these notes are an attempt as a teacher of microeconomics at MBA and undergraduate level, to provide a rigorous foundation of some things we teach. Although I have been teaching microeconomics to MBA and undergraduate students as a full-time faculty since 1987, it was only after joining PDPU in September 2007, that I got the opportunity to teach the whole and hence the pre-midterm portion of the course, and that is where demand theory is located. Before that it was almost always that I got to teach the post-midterm portion only. There is always a big difference between a hypothetical problem and a problem that one faces in reality. Convincing myself that there is a rigorous and logically consistent basis for what I teach the students- whether I share the details with them or not- is a problem in the latter category for me. Hence, there is some truth in the assertion that these notes owe a lot to the courses I teach at PDPU. After I move on, these notes will remain for enquiring minds- both student and faculty. This is work in progress and hence a separate Acknowledgment section makes sense, only after it has been class tested by friends and colleagues and I have been informed about the innumerable errors these notes contain. For those generous individuals who will spare a few pennies’ worth of thought for these notes and revert back to me (constructively?), I have the following extract from the parody of Thomas Moore’s poem (“Oft in the stilly night...”) that was penned by Ogden Nash: Oft in the stilly night, When the mind is fumbling fuzzily, I brood about how little I know, And know that little so muzzily. Ere slumber's chains have bound me, I think it would suit me nicely, If I knew one tenth of the little I know, But knew that tenth precisely. ~ ~ ~ Gently my eyelids close; I'd rather be good than clever; And I'd rather have my facts all wrong Then have no facts whatever. It is for such generous and “critical” readers of these notes that the real “Thank you” is yet waiting to be said. Somdeb Lahiri. Ahmedabad. September 14, 2020.