Market Models and Uncertain Subjective Value Estimates

Abstract: In microeconomic market models it is a standard assumption that actors have perfect information and act rationally. These are strong assumptions for products where the value to the consumer is subjective. We theoretically investigate the market effects of uncertainty in purchase decisions by incorporating Fechner stochastic decision models in a market model of monopolistic competition. These models provide a mechanism for errors in decision-making by subjecting the consumer's before-purchase evaluation of the product to inconsistency. The market is modeled with and without bias in the evaluation, and the effects on quantity and price, as well as consumer and producer surplus are investigated. We find that unbiased inconsistency does not affect quantity and price but decreases consumer surplus. Positive bias increases quantity, price and producer surplus, while negative bias has the opposite effect. Any bias has a negative effect on consumer surplus. Drawing from these implications we discuss how marketing is used to create positive bias in potential customers' perception of a product. The results show that there is an incentive for producers to create and reinforce positive bias, exploiting consumers' behavioral heuristics and lack of information. In so doing, the economy will suffer through some combination of reduced consumer surplus and distorted resource allocation.