The conclusion excerpted below;
Marketing researchers are very interested in determining the degree of consumers' responses to changes in quality. There is also a great interest in identifying which aspects of quality are more relevant to consumers, in the sense that they value them the most, and also which aspects are considered luxuries. The usual approach is to conduct sample surveys and use psychometric techniques to derive estimates. In this paper we have suggested a basic framework to obtain price and income elasticities of attributes from market data. The advantage of using market data is the preferences are revealed through purchasing decisions, and hence one can avoid some of the biases commonly associated with survey methods. Furthermore, it is much more economical. However, the approach is not a panacea. The power of our method depends critically on the conformity of the observables with the underlying assumptions.
The basic idea of our approach is that consumers view differentiated products as different bundles of homogeneous characteristics for which an implicit market exists. The procedure consists of two stages. In the first stage a hedonic price equation is estimated. In the second stage a demand-supply system of characteristics is estimated where the shadow price vector of characteristics is the one derived from the first stage. The implied functional form for the hedonic price equation is derived from a utility-maximization framework that allows arbitrage among homogeneous attributes in a competitive market. A procedure to select representative characteristics for the estimation of the hedonic price equation is suggested. Conditions for the identification of a demand and supply of characteristics model are discussed. Methods for obtaining parameter estimates of the second-stage model that uses estimated shadow prices of characteristics are proposed, including the approach of using auxiliary data for the prices of other products, in the same broad category, for forming instruments.
We illustrate our approach using the US automobile demand data compiled from publications such as Consumer Reports, Automobile News, Motor Trend, Consumer Bulletin Test Reports and Ward's Automotive Yearbook for a period of 18 years (1969-86). We find that a linear hedonic price function for automobile characteristics is an adequate specification. The instrumental variables estimates of a demand system for the horsepower, luggage capacity and miles per gallon attributes appear reasonable. The demand for horsepower is elastic with respect to income. The luggage capacity has near-unitary income elasticity, but the income elasticity of miles per gallon is less than unity. This indicates that, as income rises, consumers care more for the performance (HP) and comfort (LU) of a car than for fuel efficiency (MPG). The own-price elasticities for all three attributes are all less than one in absolute value, with HP having the largest price elasticity while LU is totally price inelastic. Cross-price effects are mixed. The performance (HP) and fuel efficiency (MPG) are substitutes, but the size (LU) appears to be a complement to the performance (HP). However, the results must be interpreted with caution. They are obtained from a small data set. To obtain more reliable estimates, we need a much larger number of observations.
In summary, although many issues remain unresolved, the limited results obtained in this paper appear to indicate that the combination of economic analysis and econometric technique can complement the psychometric approaches and can provide useful information for marketing research.
Discuss; How has the marginal rate of substitution of horsepower for gas mileage changed over the years in the US?
Related;
The More We Make, the Better We Want ;
Decisions to spend are also driven by perceptions of quality, the desire for which knows no bounds. But quality is an inherently relative concept. The same car that would have been deemed as having brisk acceleration and sure handling by drivers in Keynes’s day, for example, would be much less charitably evaluated by today’s drivers — even those with no desire to outdo their neighbors.
An economist’s formal mathematical model of the demand for automobile quality would incorporate an explicit comparison of a car’s features with the corresponding features of other cars in the same local environment. Cars whose features scored positively in such comparisons would be seen as having high quality, for which consumers would be willing to pay a premium. In purely mathematical terms, such a model would be essentially identical to one based on a desire not to own quality for its own sake, but rather to outdo others...
Until recently, for example, the Porsche 911 Turbo was considered perhaps the best all-around sports car on the market. Priced at over $120,000, it handles impeccably and has blistering acceleration.
But in 2004, Porsche raised the bar by introducing its Carrera GT, which handles slightly better than the Turbo and beats its 0-to-60 time by two-tenths of a second. People who really care about cars find these small improvements genuinely exciting. To get them, however, they must pay almost four times the price of the Turbo.
By placing the desire to outdo others at the heart of his description of insatiable demands, Keynes relegated such demands to the periphery. But the desire for higher quality has no natural limits. Keynes and others were wrong to have imagined that a two-hour work week might someday enable us to buy everything we want. That hasn’t happened and never will.
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