Applied Microeconomics: Wine Economics

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Lecture on microeconomics under supervision of Prof. Karl Storchmann of the Whitman College, NY, USA

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Applied Microeconomics: Wine Economics

  1. 1. presentation
  2. 2. Back in the day,an apple was an apple. Source: Scitovszky (1944-45)
  3. 3. Today, it‘s a bit more complicated... Source: Scitovszky (1944-45)
  4. 4. As a consumer you have a great information disadvantage. Source: Akerlof (1970)
  5. 5. How can you find out the true quality of a product? Source: Akerlof (1970)
  6. 6. Source: Cooper (1984)
  7. 7. Source: Cooper (1984)
  8. 8. Source: Cooper (1984)
  9. 9. SIGNALING QUALITY WITH PRICESALEXANDER KRAEMER | BOCHUM | AUGUST 2010Student of Management and Economics (Diplom), ID.no. 108 004 216 923alexander.kraemer@rub.de
  10. 10. Agenda Theoretical Literature  Firms I Consumers Empirical Literature  Overview I Aspects Resumé References
  11. 11. TheoreticalLiterature
  12. 12. Why signal? the informed the uninformedSource: Koku (1995)
  13. 13. Why signal? information gap the informed the uninformedSource: Koku (1995)
  14. 14. Why signal? Building a bridge over the information gapSource: Koku (1995)
  15. 15. An example: Job applicationSource: Spence (1973)
  16. 16.  Indices  Gender, age or race  Ex ante observable information Signals  Work experience, education or motivation  Ex post obeserable information  Can be manipulated by applicant  Manipulation of signals might incur costs Source: Spence (1973)
  17. 17. Pricing strategies Price Penetration Strategy Skimming Strategy Costs TimeSource: Robinson (1975), Koku (1995)
  18. 18. Mixed qualities  Non-constant costs can play important role  Average costs can rise when sales fall  Reduction of false signaling firms  Increase of information on quality  Leaving some false firms, but also goodSource: Cooper (1984)
  19. 19. High and declining prices High quality firm  Low costs  Fakes quality  High costs  Will lose great sales volume  Willing to restrict sales volume  Over time high costs to signal  Will lose less sales volume false quality  Over time less costly to signal quality Low quality firmSource: Bagwell & Riordan (1991)
  20. 20. Freeriding low-quality firms  High information asymmetry  Nothing prevents signaling with high prices  Price does not reveal the true quality of a productSource: Alpert et al. (1993)
  21. 21. The use of price as asignal depends on...  Consumers‘ ability to detect quality variation  Level of price awareness of consumers  Availability of other cues of quality  Actual quality variation  Price variation Source: Zeithaml (1988)
  22. 22. When is price relevant? Consumers rely on more than one signal There is an optimum number of signals The more expensive the product the more signals the consumer uses Source: Jones & Hudson (1996)
  23. 23. Relationship between price, quality and value Source: Zeithaml (1988)
  24. 24. Prices signal true qualityin every equilibrium  Consumers have certain quality expectancies  Consumers penalize firms who signal the wrong quality  Existence of expectancy equilibria  Prices may serve as signals which differentiate quality levels  Consumers have qualities they will spend money on Source: Wolinsky (1983); Gabor & Granger (1966)
  25. 25. EmpiricalLiterature
  26. 26. Price-Quality Correlations  Most products price and objective quality are positively correlated  Most correlations are weak and vary over time  Strength of correlation depends on two factors  Type of product (durable vs. nondurable)  Degree of price despersion in a product category  Price is a poor market signal of quality for most productsSource: Steenkamp (1988)
  27. 27. Price-Quality Relations Source: Faulds & Lonial (2001)
  28. 28. Price-Quality Relations Source: Faulds & Lonial (2001)
  29. 29. Cultural differences  Prices have an allocative effect in china  No quality is transported  Low prices have same effect as high pricesSource: Erevelles et al. (2001)
  30. 30. What Price Quality?  What cues do consumers use to select wine?  Quality ratings by James Halliday as dependant variable  Analysis of Australian and New Zealand wines  Influence of cues is different for each of the wines  e.g. Regional influence on wine quality and the winery style  Some producers might be better than others  Positive relationship between price and quality  Relationship is not linear  Increase in price does not explain equal incraese in quality Source: Horowitz & Lockshin (2002)
  31. 31. What Price Quality?  Consumers go into a store with a style and a price range and then look for wines within those parametersAll prices in Australian Dollars Source: Horowitz & Lockshin (2002)(1 AUSD = 0.72 EUR as of 19.08.2010)
  32. 32. How do consumers use signals toassess quality?  Analysis 6,000 European wine consumers  Speciality of paper: connoisseurs & nonconnoisseurs  Do all consumers use signals in the same way? Source: Gergaud & Livat (2007)
  33. 33. How do consumers use signals toassess quality? Source: Gergaud & Livat (2007)
  34. 34. Prices as Quality Signals  Following Bagwell & Riordan (1991)  price signals respond positively to wine quality  price signals respond negatively to increasing information  Usage of two Datasets  Main Wine Trade Fair & Gault Millau wine guide for Germany  Small fraction of uninformed buyers Source: Schnabel & Storchmann (2010)
  35. 35. Prices as Quality Signals Source: Schnabel & Storchmann (2010)
  36. 36. esu mé R
  37. 37. Resumé  Quality is signaled by prices  Theoretically:  the long run will increase the level of quality  (decrease of low quality firms due to costs)  Empirically:  Price-quality correlations are weak and vary over time  Different cultures, different price-quality perceptions  Consumers know what they want to buy  State of information matters
  38. 38. Thank you for your attention.Questions?
  39. 39. REFERENCES
  40. 40. Akerlof, G.A. The Market for „Lemons“: Quality Uncertainty and Market Mechanism The Quarterly Journal of Economics Vol. 84, No. 3 1970 pp. 488-500Almenberg, J. and Dreber, A. When does the Price affect the Taste? Results from a Wine Experiment American Association of Wine Economics 2009 Working Paper No. 351-12 pp.Alpert, F.; Wilson, B. and Price Signaling: does it ever work? Journal of Consumer Marketing1993 Vol. 10, No. 4 pp. 4-14Elliott, M.T.Ashenfelter, O. Predicting the Quality and Prices of Bordeaux Wines American Association of Wine Economics 2007 Working Paper No. 4 1-20 pp.Ashenfelter, O. Predicting the Quality and Prices of fine wine The Economic Journal 2010 Vol. 5, No. 1 pp. 174-184Bagwell, K. and Riordan, High and Declining Prices Signal Product Quality The American Economic Review991 Vol. 81, No. 1 1 pp. 224-239M.H.Benfratello, L.; Piacenza, M. Taste or reputation: What drives market prices in the wine industry? Estimation Applied Economics 1009 Vol. 49 pp. 2197-2209and Sacchetto, S. of a hedonic model for Italian premium winesBergemann, D. and Välimaki, Dynamic pricing of new experience goods Journal of Political Economy 2006 Vol. 114 pp. 713-743J.Caves, R.E. and Greene, D.P. Brands quality levels, prices, and advertising outlays: empirical evidence on International Journal of Industrial Organization 1996 Vol. 14 pp. 29-52 signals and information costsChin, M.-C.; Weaver, R.D. Contracting, Signalling of Uncertain Quality, and Price Volatility? Prepared for presentation at the Xth EAAE Congress 2002 pp. 1-15Cooper, R.; Ross, T.W. Prices, Product Qualities and Asymmetric Information: The Competitive Case Review of Economic Studies 1984 Vol. 51, No. 2 pp. 197-207Daughety, A.F.; Reinganum, Communicating Quality: a unified model of disclosure and signalling RAND Journal of Economics 2008 Vol. 39, No. 4 pp. 973-989J.F.Daughety, A.F.; Reinganum, Imperfect competition and quality signalling RAND Journal of Economics 2007 Vol. 39 pp. 163-183J.F.Daughety, A.F.; Reinganum, Competition and Confidentiality: Signaling Quality in a Duopoly When There is Games and Economic Behavior 007 Vol. 58 2 pp. 94-120J.F. Universal Private InformationDener, E. Signalling Quality Through Prices in a durable Market www.ecares.org/ecaresdocuments/ws/summerschool2009/papers/dener.pdfEdwards, F.; Spawton, T. Pricing in the Australian Wine Industry Emeral Backfiles 2007Ervelles, S.; Roy, A. and Yip, The universality of the signal theory for products and services Journal of Business Research 2001 Vol. 52 pp. 175-187L.S.C.Faulds, D.J. and Lonial, S.C. Price-Quality Relationships of Nundurable Consumer Products: A European Journal of Economic and Social Research No. 1 2001 Vol. 3, pp. 59-76 and United States PerspectiveFolwell, R.; Bales, T. and Cost economies and economic impacts of pricing and product mix decisions in Journal of Wine Research 2001 Vol. 12, No. 2 pp. 111-124Edwards, C. premium table wine wineriesGabor, A. and Granger, Prices as an indicator of Quality: Report on an Enquiry Economica 1966 pp. 43-70C.W.J.Gergaud, O.; Livat, F. How do consumers use signals do assess quality? American Association of Wine Economics 2007 Working Paper No. 3 1-22 pp.Gerstner, E. Do Higher Prices Signal Higher Quality? Journal of Marketing Research1985 Vol. 22, No. 2 pp. 209-215Goldstein, R; Almenberg, J.; Do More Expensive Wines Taste Better? Evidence from a Large Sample of American Association of Wine Economics 2008 Working Paper No. 161-14 pp.Dreber, A.; Emerson, J.W.; Blind TastingsHerschkowitsch, A. and Katz,J.
  41. 41. Horowitz, I.; Lockshin, L. What Price Quality? An Investigation into the Prediction of Wine-quality Ratings Journal of Wine Research 2002 Vol. 13, No. 1 pp. 7-22Hubert, S.; Storchmann, K. Prices as Quality Signals: Evidence from the Wine Market Journal of Agricultural & Food Industrial Organization 2010 Vol. 8 pp. 1-21Janssen, M.C.W.; Roy, S. Signalling Quality Through Prices in an Oligopoly http://faculty.smu.edu/sroy/quality.pdfJones, G.; Storchmann, K. Wine market prices and investment under uncertainty Agricultural Economics 2001 Vol. 26 pp. 115-133Jones, P. and Hudson, J. Signalling Product Quality: When is Price Relevant? Journal of Economic Behavior &1996 Vol. 30 Organisation pp. 257-266Koku, P.S. Price signaling: does it ever work? Journal of Consumer Marketing 1995 Vol. 12, No. 1 pp. 45-49Landon, S.; Smith, C.E. Quality Expectations, Reputation, and Price Southern Economic Journal 1998 Vol. 64, No. 3 pp. 628-647Lecocq, S. and Visser, M. What Determines Wine Prices: Objective vs. Sensory Characteristics Journal of Wine Economics 2006 Vol. 1, No. 1 pp. 42-56Lee, L; Frederick, S. and Try It, You‘ll Like It - The Influence of Expectation, Consumption, and Revelation Psychological Science 2006 Vol. 17, No. 12 pp. 1054-1058Ariely, D. on Preferences for BeerLima, T. Price and Quality in the California Wine Industry: An Emipiral Investigation California State University, Hayward 1999 pp. 1-50Lockshin, L.S. and Rhodus, The Effect of Price and Oak Falvor on Percieved Wine Quality Emeral Backfiles 2007 pp. 13-25W.T.Milgrom, P.; Roberts, J. Price and Advertising Signals of Product Quality Journal of Political Economy 1986 Vol. 94, No. 4 pp. 796-821Obermiller, C. When do Consumers infer in Quality from Price? Advances in Consumer Research 1988 Vol. 15 pp. 304-310Rao, A.R. The Quality of Price as a Quality Cue Journal of Marketing Research 2005 Vol. XLII pp. 401-405Render, B. and O‘Connor, T.S. The Influence of Price, Store Name, and Brand Name on Perception of Product Journal of the Academy of Marketing Science 1976 Vol. 4, No. 4 pp. 722-730 QualityRoberts, P.W. and Reagans, Critical Exposure and Price-Quality Relationships for New World WInes in the Journal of Wine Economics 2007 Vol. 2, No. 1 pp. 56-69R. U.S. MarketRosenman, R.E. and Wilson, Quality Differentials and Prices: Are Cherries Lemons? The Journal of Industrial Economics Vol. 39, No. 6 1991 pp. 649-658W.W.Rosenthal, R.W. A Model in which an Increas in the Numer of Sellers LEads to a Higher Price Econometrica 1980 Vol. 48, No. 6 pp. 1575-1579Rothshild, M. Searching for the Lowest Price When the Distribution of Prices is Unknown The Journal of Political Economy 974 Vol. 82, No. 4 1 pp. 689-711Schmalensee, R. A Model of Advertising and Product Quality The Journal of Political Economy 978 Vol. 86, No. 3 1 pp. 485-503Scitovszky, T. Some Consequences of the Habit of Judging Quality by Price The Review of Economic Studies 945 Vol. 12, No. 2 1 pp. 100-105Shapiro, C. Premiums for High Quality Products as Returns to Reputations The Quarterly Journal of Economics Vol. 98, No. 4 1983 pp. 659-680Spence, M. Signaling in Retrospect and the Informational Structure of Markets The American Economic Review2002 Vol. 92, No. 3 pp. 434-459Spence, M. Job Market Signaling The Quarterly Journal of Economics Vol. 87, No. 3 1973 pp. 355-374Steenkamp, J.-B. E.M. The Relationship between Price and Quality in the Marketplace De Economist 1988 Vol. 136 pp. 491-507Stigler, G.J. The Economics of Information The Journal of Political Economy 961 Vol. 69, No. 3 1 pp. 213-225Stiglitz, J.E. The Contributions of the Economics of Information to the Twentieth Century The Quarterly Journal of Economics 2000 pp. 1441-1478 EconomicsWeil, R.L. Analysis of Reserve and Regular Bottlings: Why Pay for a Difference Only the Chance 2005 Vol. 18, No. 3 pp. 9-15 Critics Claim to Notice?Wolinsky, A. Prices as signals of product quality Review of Economic Studies 1983 Vol. 50 pp. 647-658Yehezkel, Y. Signaling Quality in an Oligopoly when some consumers are informed Journal of Economics & Management Vol. 17, No. 4 2008 Strategy pp. 937-972Zeithaml, V.A. Consumer Perceptions of Price, Quality, and Value: A Means-End Model and Journal of Marketing 1988 Vol. 52 pp. 2-22 Synthesis of EvidenceZhao, H. Raising Awareness and Signaling Quality to Uninformed Consumers: A Price- Marketing Science 2000 Vol. 19, No. 4 pp. 390-396 Advertising Model

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